Sell or Rent
The June issue of the online Journal of Accountancy also has an interesting look by Philip Witmer and Claudia Kelley at the decision process of whether it makes more financial sense to rent out a former residence or just sell it. The authors have even included a fairly detailed Excel spreadsheet to help quantify the projections.
I doubt if I will be using it much because it relies too heavily for my comfort on assumptions of such unknowable factors as future interest and appreciation rates. Anyone who claims to have a crystal ball that can accurately predict such things should be avoided like the plague.
What’s much more important in this kind of decision is whether you can stomach being a landlord and avoid getting a tenant who uses the movie Pacific Heights as his game-plan to steal property, as we had back in the Bay Area.
This article is still quite useful because they do address that point, as well as the very critical aspect of losing the ability to use the Section 121 tax free sale rule after having been out of the home for three years. They do mention that a Section 1031 like kind tax deferred exchange would most likely be a good move in those cases.
Corporate Tax Rates
Subject: your siteHey great site- very informative. Thanks!I had a quick question though if you don't mind. I was looking at the c-corp tax rates and was curious if I was reading it right. Do the rates go up AND down? Why?Thanks again!
While the last bracket appears to be a reduction, a flat tax of 35% effectively eliminates all of the tax savings from the lower rate brackets.
I have updated the schedule on my web site to make this more clear.
I hope this helps you understand the tax rates. Thanks for writing.
Deductions For Rental Properties
Subject: Your ServiceI have a couple of questions about Section 179 and therefore I would like to engage your services; how do I do that.My questions are:In a rental property I own, I put in a new washer and dryer. Is that a 179 item and if so specifically where do I make the entries on the tax return?I manage my own rental and obviously actively participate and I am interested in understanding the "up to $25,000 in losses" Part of what I am trying to determine is can any of the rental loss offset regular income?I would appreciate hearing from you as soon as possible.
I wish I could help you; but I already have too many clients to take care of; so we are not accepting any new ones at this time. In fact, we are actually still cutting back on clients, trying to find the right balance of workload, so that I'm not so backlogged with projects. I have no idea how long that will take.
Unfortunately, we don't have anyone else to whom we could refer you. If you haven't already done so, you should check out my tips on how to select the right tax preparer for you.
Both of your questions are very simple and any experienced tax pro should be able to help you with them.
As is included under the heading of "Nonqualifying Property" for Section 179 on my website is "Property used in connection with furnishing lodging." Thus the washer and dryer may not be expensed, but must be depreciated over their appropriate class lives.
The issue of active participation in a rental property has been around since 1986; so any qualified tax pro should be able to discuss whether or not your personal involvement is enough to qualify for the $25,000 net deductible rental loss.
Selecting the Right Type of Corp
Subject: C vs. S CorporationHi Kerry,
I'm a new (solo) owner of an internet software business (c-corporation in Delaware), and was wondering if you could tell me if it's more advantageous to be a s-corporation? I've read your online article about c vs. s corps and decided to go with the c-corp, but recently a CPA/APC told me that i'd be better off as a s-corporation?
Thanks for your advice,
There are far too many variables involved for me to be able to advise the best entity and jurisdiction to use for your particular situation via this medium.
To work out the best solution for your particular circumstances, you really need to work with a tax pro who can help you set up a strategy that will work for you.
As I mentioned in my article on C vs S corps, too many advisors do rush into S corps without thinking things through as completely as they should. If your CPA is this way, you should check with another one who can take more of a long range perspective.
Posting Credit Card Receipts
Your website is very helpful. Thank you!!I am using quicken home and bu. 05. Recently, our business (a small co. offering professional services) started taking credit cards. The credit card company automatically credits our bank account with the amount of the credit card purchase less the charge for doing the transaction.Before we started taking credit cards, I just recorded the client income as deposits in the quicken checkbook. Should I now just record the net amount as a deposit? This would not give me a record of what the person actually paid.Any help you can give me in this matter would be appreciated.
It's very easy. You need to enter the deposits as split entries on more than one line for each.
You post the full amount to your income account and then on the next line have a negative entry that goes to the "Credit Card Charge" expense account.
This is the exact same way paychecks are supposed to be entered; starting with the gross pay and showing each of the withholding amounts on a separate line, to arrive at the net amount deposited.
Good luck. I hope this helps. Your personal tax and accounting advisor can show you in more detail if you need more explanation.
Tax & Accounting Blogs
Thanks to Joe Kristan of Roth & Co for the heads-up on the AICPA’s new article about existing tax and accounting blogs, as well as some excellent tips for people who may want to start their own. They have links to several new blogs that I wasn’t aware of. It’s good to see that more accountants are jumping into the blogosphere and utilizing this very effective marketing and communication technology.
Senators propose repeal of tax trap for middle class – Are we actually going to see the end of the insane AMT? I wouldn’t hold my breath; but it’s good that our rulers are at least discussing how unfair it has become.
Selling Gifted Stock
Wow, we never realized my daughter would inherit the cost basis of my dad on the stock. Since it started out at $200 and is now around $10,000 that makes a difference. Since we keep her income below the amount that she needs to file a return (I believe it is $4,800?) would we have to file a return if she cashes in only amounts that keep her under that $4,800? If we cashed out part now and then part in January 2006 would that work? She has currently earned $1,800 from working for our company and was going to have a job this summer. Perhaps her tax basis will be low enough that the amount she would be taxed would be minimal anyway.
We always enjoy reading your newsletter each morning and saw our question in there. Reading other peoples questions and your answers is always a great education tool for us.
That is the big difference between receiving appreciated assets via gift versus via inheritance. With an inheritance, the heir's cost basis is stepped up to the asset's fair market value as of the date of death. This effectively wipes out the decedent's capital gain; although it could result in estate tax if there is a large enough taxable estate.
The standard deduction for 2005 is an even $5,000, so if she has less total gross income than that for this year, she won't be required to file a 1040. Filing a tax return is a bit of a hassle and expense; but it still may make sense if she needs to sell off more than $3,200 worth of the stock. Odds are that her effective tax rate will be much lower than it is for your parents, such as 5% instead of the 15% they would probably owe for Federal income tax.
As you should have noticed in many of my other postings, I have always believed it to be a big mistake to hold onto stocks just based on the tax effects. Hold or sell decisions should be purely based on whether that stock is a good investment. If is looks like it has peaked and is about to dive, it would be nuts to hold onto it just to avoid going over the $5,000 income threshold. The 5% taxes saved will be small compared to the actual dollar loss in the stocks.
As you noticed, I do use these emails as an educational tool for my readers. One point that may not apply in your daughter's case, but I have seen in others. The $5,000 income level for a tax return filing requirement is based on the gross income, not the net profit. This is a big mistake I have seen many people make. They may sell stock for $50,000 that has a cost basis of $49,000, or more often, more than the $50,000. Assuming that the tiny net gain or net loss isn't enough to warrant filing a 1040, they don't.
What eventually happens is that IRS receives the 1099-B from the stockbroker showing $50,000 of stock sales. When they don't see a tax return reporting this, IRS computers spit out a letter claiming that there was unreported income, along with a bill for taxes, interest and penalties on $50,000 of ordinary income. Unless a taxpayer tells them otherwise by filing a tax return with Schedule D, IRS literally assumes that the stock had a zero cost basis and that it was owned for less than 12 months, subjecting it to ordinary tax rates rather than the lower long term capital gain rates. As I constantly emphasize, filing tax returns, even when there may be no tax effect, is a self defense measure that can head off problems such as this.
I hope this helps your family work out the best game plan. Let me know if you have any other questions.
The Vulture Tax – Stephen Moore has another very appropriate name for the communistic estate tax. If our rulers in DC can’t kill it now, with full GOP control, it may never go away. The chances of ending this evil confiscation will drop to zero after 2008, when the Clintons are coronated for their third term in the White House. Those two are the most avid supporters of Karl Marx’s principles as any president in our history.
Incorporating To Avoid Liability
Subject: IncorporationOur PTA is being asked by the local BSA to charter them. We are trying to get all information possible and someone suggested incorporation.Our main concern is "willful acts" and the liability taken on by the officers. Would incorporation be possible? How hard is it? How would this protect us?Who would this protect? Would a local PTA be able to incorporate?
I hope you can help!
Thank you for your time!
It sounds as if you need to be more concerned with the legal liability issues than any tax issues. Thus, this is out of my area of expertise.
While Nolo Press has some excellent resources for working with nonprofit organizations, it would a prudent move to consult with an attorney who is familiar with the liability rules for nonprofits in your state. They do vary in different jurisdictions.
Corporate Fiscal Year
Subject: Choosing A Fiscal YearHi,I read your article on choosing a fiscal year, and, as a recently new (solo) owner of a Corporation (in the state of Delaware), I just was wondering what's the best month to choose as the start of a fiscal year?I literally just incorporated a week ago (May 12th, 2005).Thanks for any helpful info,
I just added some more info to my page on choosing a tax year that discusses the ideal month to use.
If you do use the June 30 date, this will mean that your first tax return will be a very short year, from May 12, 2005 through June 30, 2005. If that concerns you, you may want to opt for the next best choice, March 31.
Gifting For College
Subject: Question on College GiftsKerry;Our daughter is graduating from high school this June. Her grandparents want to gift her stock and cash to help pay for college. I am not sure of the amounts but was wondering if I need to consider tax ramifications. Is there a certain amount we should try to stay with in each year?Thank-you;
The issue of gifting has several facets to it, many of which your parents should discuss with their personal tax advisor. The following should help them in their game plan.
First, from the perspective of you and your daughter, the receipt of gifts is one of the few things that is entirely exempt from income tax. There is a potential gift tax that would be levied on the givers, which I will discuss below.
Next is the issue of cost basis of the gifts for your daughter. With cash gifts, the issue of basis is moot. It is just what is received. However, for non-monetary assets, such as stocks, it gets trickier. For gift tax purposes, their fair market values at the time of the gift are used. For publicly traded stocks, that is just the current market price.
For the cost basis to the recipient, she must use the lower of the giver's cost basis or its fair market value. This is normally a serious issue with highly appreciated assets because it means that the givers (aka donors) are also transferring the potential capital gains tax obligations to the recipient. As an example, suppose your parents paid $10 per share for a stock that is now worth $100 per share. For gift tax reporting, the $100 per share value is used. However, for your daughter, her cost basis in the stock remains at just $10 per share. This won't trigger any taxes until she sells the stock, at which time her gain will be the excess over $10. So, if she were to sell the stock shortly after receiving it, she would have a long term capital gain of $90 per share to report on her income tax return. Her holding period does include that of the previous owner. This isn't necessarily a bad thing overall and is often done intentionally if the recipients are in a lower tax bracket than the givers were or have other capital losses that can offset the gains.
If the asset has gone down in value from the giver's cost basis, a gift is generally not a smart move, tax-wise. Suppose the numbers in the above example were reversed. Your parents paid $100 per share for stock that is now only worth $10 per share. While the gift tax would be based on the $10 per share value, so would the cost basis for your daughter. This effectively eliminates the opportunity for anyone to deduct the $90 per share capital loss. In cases like this, it would be better for your parents to sell the stock and claim the $90 per share capital loss on their tax return and just give the cash to your daughter.
Now from the perspective of your parents, the givers, and their gift tax requirements.
There is an annual tax free allowance that many people use in order to time their gifting and avoid the need to file any gift tax returns. It is currently at $11,000 per donor per donee per year. That means your mother could give your daughter $11,000 and your father could also give her $11,000, for a combined total of $22,000. As I mentioned above, the values are the fair market values of the assets.
If they give more than the annual tax free allowance, they will have to file a gift tax return (Form 709) to report the gifts to IRS. Because these would be gifts from grandparents to a grandchild, they would be possibly subject to the 47% Generation Skipping Transfer (GST) Tax, rather than the normal Gift Tax. They have the option of either paying the tax or using part of their lifetime exclusion, which is now $1.5 million per person. That's $3 million combined for your mother and father. On their 709s over the years, they are required to keep a running tally of how much of that lifetime exclusion they have used. This actually carries over to their estate tax returns (Form 706) to see how much of their lifetime exclusion is still available to be used against that tax.
Now for a little fact that might help you all to decide how to structure things. The above discussion dealt with transfers from your parents to your daughter. There are a few types of transfers that are not required to be even counted when considering gift or GST taxes. Those are direct payments for medical costs and for tuition. So, if your parents were to pay your daughter's tuition directly to the college, no reporting to IRS is needed. If, however, they give money directly to your daughter and she uses it to pay for her tuition and other school costs, there could be gift tax reporting requirements if the total paid during a calendar year exceeds the $11,000 per donor/giver threshold.
What would probably work out best is for your parents to pay the college directly for the tuition and then gift your daughter other money to cover her books, supplies and dormitory fees, which are not covered by the special exemption. Of course, they should work out their strategy with their own tax advisor.
This is probably a longer and possibly more confusing answer than you expected. However, who can make the claim that tax matters are simple in this country? Let me know if you need to discuss any of these points in more detail.
QuickBooks Financial Statements
I am a CPA using QuickBooks. I am looking for a way to have better looking financial statements than I can get in QuickBooks. Do you have a recommendation for a product?
I'm sorry but I don't have any add-on products to recommend.
If you are using a version of QuickBooks from before 2005, you may want to check out the latest one. They have incorporated the financial statement designer program into it rather than have it as a separate stand-alone program. With it, as well as the ability to export reports to Excel, I have yet to be unable to produce the kinds of reports I need.
Thanks for your response. I am trying to do the links with Excel. It is working ok but if new accounts are added it will have to be worked on. The reports do look nice.
Someone recently told us that if you have a "historic building" or a building built before (I can't remember what) date, then there were some tax credits available. I don't know where to get the info on this subject, but the building you'll see on our balance sheet … was built in like 1912. It's vacant right now as it needs repairs, but I just wanted you to know so when you get to our 2004 return, we might get some extra deductions.
The tax credit you are referring to is the historic rehab credit, which I think I covered in the seminars I was presenting with Wayne Camp. It's been around since the Tax Reform Act of 1986.
To summarize, an investment tax credit of 20% is allowed against the rehab costs on business use buildings that are listed in the Federal National Register.
The credit is 10% of the rehab costs for buildings that were originally placed into service prior to 1936, which was intended to include any over 50 years old when the law was passed.
There are some restrictions on what percentage of the interior and exterior walls have to be retained in order to prevent people from completely tearing buildings down and erecting new ones.
The credit is non-refundable, which means it can only be used to offset Federal income tax, and not SE tax. The unused portion can be carried forward. I have one client … who rehabbed a certified historic building … about ten years ago, and we are still carrying forward about $10,000 for the credit.
I will make sure to enter the rehab costs accordingly for your 1912 building. The purchase of the building itself doesn't qualify for the credit. Just the rehab costs do.
There are actually "consultants" who will charge you a fee for simplistic ideas such as this.
My 2 corporations which are subchapter S, have been idle, have no assets and have no current bank accounts. We are in NY state. They were formed about 3 years ago, and have been defunct for about 2. I have been getting conflicting advise as to what I need to do. There is no longer any business conducted and the corps. will never be active again. What should I do? Can I just let it go without any further action or filings? I have been keeping up with the tax returns, etc. only because I didn't know what to do. I just want to let them go without any liability--ie:state franchise tax. These are NY state S corporations. Thank you,
Many people make the big mistake of thinking they can just walk away and abandon their corporations without undertaking the appropriate formal paperwork. This can end up becoming a very expensive lesson because you are legally required to continue filing income tax and annual franchise tax reports for every year in which the corp is in existence, whether or not any actual activity was undertaken.
For states with minimum taxes, such as California's $800 per year, this can end up costing a ton of money, especially if the returns aren't filed in a timely manner and all kinds of late penalties and interest charges are added on.
The same office that charters corporations, usually under the state's Secretary of State, also has forms and procedures in place for formally dissolving corporations.
It would be prudent for you to either get with a New York business attorney to prepare the appropriate forms or obtain them yourself from the web.
Once the dissolution papers have been filed and accepted, you will then need to file Federal and New York S corp tax returns that are marked as FINAL so they will know not to look for any more from your corporations.
I hope this helps. Good luck.
Use As Primary Residence
Subject: defining a primary residence
Greetings, Thanks for your very useful information on residences. I have a situation for which I haven’t been able to get credible information and am hoping you might have an idea. I'm a US tax payer living in a house in Belgium which I have owed for the past 3 years. My company is now sending me on a work-related assignment outside of Belgium The length of that assignment is not yet certain, but it may be for 3 -5 years. I want to keep the house here as it is my only property and I consider it my primary residence to which I would return eventually. Would the IRS see it that way, or do I lose the right to claim this house as my primary (read permanent) residence because I’m away on assignment. I understand that claiming a house as one’s primary residence is the sole criterion according to which the IRS either does or does not levy capital gains taxes when property is sold.
Thanks for your help in clarifying this question.
I'm sensing a couple of different issues here.
First, if you are wondering whether your time away on assignment can count as part of the time you owned and occupied the home as your primary residence in order to qualify for the two years out of five years rule, the answer is no. Temporary absences away are fine; but yours is more of a permanent or long-term relocation.
Before the residence sales rules were overhauled in 1997, there was an allowance for older people who were forced to move into a special care facility. They were allowed to count that time as if they were living in their own homes in order to qualify for the occupancy rule that was in effect at that time for the once in a lifetime senior citizen tax free exclusion. There is no such provision in the current law.
If your plan is to hold onto the Belgium house so that you can live there after finishing this current assignment, you would only have to live there for two more years in order to be eligible for the tax free sale of up to $250,000 of profit. Of course, if you rent it out in the meantime, you will have to pay tax on the depreciation.
You also have the option of waiting up to three years after moving out to sell the home and utilize the tax free sale; with the same provision for depreciation recapture.
The other issue you should be concerned with is how to treat the expenses on the home while you are away on assignment, mainly interest and property taxes. That will depend on how the home is actually being used. If it's rented out, everything will go on Schedule E. If you leave it empty or have family or friends stay there, it would be considered a personal (but not primary) residence, with interest and taxes deducted on Schedule A.
As always, my comments are general in nature. You really need to work with a tax pro who can better analyze everything in relation to your unique circumstances.
Dear Kerry,Thank you very much for taking the time to clarify these things. We will consult with someone here now to explore the specifics of our situation - but at least I have a starting frame of reference.Thanks again.
Oregon mulls a new tax that environmentalists and privacy advocates will hate. – Not surprising for the infamous Left Coast. A 1.25 cent per mile tax, to be monitored by Big Brother GPS units in everyone’s vehicles.
Subject: Exchange Question
Dear Sir or Madam:I want to do a partial 1031 exchange. I am selling a relinquished rental property at $550K with a present mortgage of $285K in
Virginia, and buying a replacement rental property at $275K with $0 mortgage in . I am expecting an equity of approx. $240K from the relinquished property which I will fully invest into the replacement property and add $35K from my other sources. My net adjusted basis is $0 since the property has been fully depreciated. I am trying to determine what percentage of my total tax (Federal and State Capital Gains, and Recapture of Depreciation will I be able to defer)? My Recaptured depreciation tax is approximated at $22K; my Federal Capital Gains at $67K, and my Virginia Capital Gains at $30K if I do no exchange at all. I have the following questions: Florida
-Will I defer any Capital Gains in such a partial 1031 Exchange?
-If I do the above partial 1031 Exchange --- what approximate amount will I pay Federal and State capital gains on and what amount will I have to pay recaptured depreciation on?
In summary, I am trying to determine if such a partial 1031 Exchange will defer any taxes for me.
Thank you much,
As you describe the situation, you would save some capital gains taxes by doing a partial 1031 exchange.
However, the taxes you will be saving will be the lowest taxes and not just half of the total possible.
Whenever you do a partial exchange by missing the reinvestment target price, the first taxes that will be payable will be the most expensive ones, which are generally on the depreciation recapture. After all of those have been picked up, will you get into the lower long term capital gains rates, which are the ones you would reduce under your proposed scenario.
If you need to know exactly how much tax you will save by doing a partial exchange, your personal tax advisor should be able to plug the applicable numbers in for you.
Detroit Ponders Fast-Food Tax – Just another sin tax to feed the rulers’ insatiable thirst for tax dollars.
Lowering Expectations for Stock Returns – Good explanation by Gail Buckner of how stock market investments are supposed to work.
Exchanging Real Estate For Stock
Subject: Exchange QuestionAn individual sells a rental producing property (Schedule E) and has identified a rental income property but it is taxable as an S Corp of which he is currently a 22.5% shareholder. The majority shareholder of 55% will sell his interest within the 180 day limit.Will this qualify as a 1031 exchange?Thank you
From the way you described the situation, there would not be a valid 1031 exchange. It sounds as if you will be disposing of a rental property that you own in your own name. The replacement that you are proposing sounds like a purchase of stock in the S corp that owns a rental property.
A valid 1031 exchange requires like kind properties, which is real estate for real estate. Corporate stock is considered to be personal property, regardless of what assets it owns.
If I misunderstood the details here, please give me a better explanation of the actual ownership of the properties involved.
My interpretation of this transaction must have been right, because I received the following reply.
Thanks for getting back to me.
What would an ad look like if we were recruited to endorse the same product as athletes and a certain former United States Senator have pitched?
N.Y. telecommuter tax under fire. Lawmakers’ bill would block double taxation of workers – Thanks to Ben Cunningham for this story of the screw-job the Empire State is doing on people who live in other states, but work for companies that are located in New York. This is the kind of crap the rulers in the PRC like to pull, levying unfair taxes on people who can’t vote in that state or do anything else to punish the elected aristocracy. Unfortunately, the only recourse does seem to be a Federal law banning this because the state government has a vested interest in maintaining this source of unfair revenue.
Some people may feel it’s no big deal to have New York levy income tax on nonresidents because of the credit that is available on most state tax returns for taxes paid to other states. As someone who prepares a high percentage of multi-state income tax returns, I can attest to the fact that such credits do not balance things out properly. For people who do live in taxable states, the net effect is that they pay the higher state tax on their income, which would normally be New York’s for the people discussed in this article. For people who live and work in states without income taxes, they are completely screwed because there is no way to recover the tax paid to New York.
Best Retirement Investment
One of the many misconceptions surrounding the debate over changing the way Social Security taxes are invested is the intentionally misleading one that the only alternative to the current structure is privately owned and controlled accounts that must invest in the stock market. Opponents of private accounts are literally giddy with glee each time the stock market drops because they believe that supports their case that such investment would be too risky for people to stomach. Their ridiculous contention that the only 100 percent safe and secure retirement account is the Social Security Ponzi scheme has already been covered by me, as well as many other learned individuals.
I thought this would be a good time to take another look at something I wrote about a little over a year ago, using your retirement account money to invest in your own business. I referred to a company in San Diego, BeneTrends, Inc, that has the prototype for setting up such an investment. I have no financial connection of any kind with BeneTrends; but I still think their concept is excellent. I have yet to hear of another company providing a similar service, and would be interested in learning of any.
The managers of BeneTrends liked my explanation of their program so well that they requested my permission to include it on their own website. This has lead to various emails from people who have been checking it out, such as the following.
From an attorney:
Do you have any clients who have used BeneTrends? I see that BeneTrends is using your name and was wondering your experience with them? http://benetrends.com/News/TaxGuru.html. Someone has asked me about them.
I don't have any clients of my own who are using BeneTrends. I learned about their service about a year ago from a reader and checked them out and wrote that article for my blog, which I gave them permission to post on their site.
Since then, I have received a couple of emails from people who said they were using BeneTrends and were happy with their service. There were only about two or three such emails.
What is good to note is that I have yet to receive any negative feedback of any kind regarding BeneTrends, which I assume would be forthcoming if anyone were to have a bad experience with them.
I hope this helps.
From a person considering using BeneTrends:
Subject: Benetrends Rainmaker planMr. Kerstetter,
I am very close to retaining the services of the folks at Benetrends to assist me in transferring a portion of my 401K savings to a new C corp. I plan to open.
I read your review of the Rainmaker plan at the Benetrends web site. To your knowledge are there any negative tax consequences using the Rainmaker plan? I would hate to have a surprise at a latter date. It appears the plan is within the IRS guidelines?
Of course I'm asking you because you are the expert. The 401k money will be worth more in ten years in my new business than invested in the stock market for the same duration. The franchise I am buying has a great track record and I feel I can successfully grow a profitable business. I hope in 5-10 years I can sell the business and roll the proceeds (at some higher multiple) into another retirement plan.
I appreciate any words of wisdom to help me through this "scary" process.
As long as you follow the procedures, and properly understand the nature of the transaction that BeneTrends is setting up, everything should be fine.
You have to be very prudent, as manager of your corporation, that the money coming in from the 401k plan is to be considered as an investment in capital stock. You must therefore exercise due fiduciary diligence in conserving, maximizing and protecting that investment, just as you would if the money were being invested by unrelated parties.
I have seen cases where the corp managers got into serious trouble with IRS because they abused this fiduciary responsibility and used the invested funds as their own personal piggy-bank and blew the money on non-business kinds of things. I have never heard of these problems with BeneTrends clients, but I have seen them in similar types of transactions.
You are not supposed to have any personal access to the retirement funds without that being considered a taxable withdrawal. As long as the money is being utilized for legitimate business purposes, there will be no problems.
There will actually be some big tax consequences down the road if your business does well and the value of your retirement account grows considerably in value. There will be more income tax to pay when you draw out of your retirement plan in your later years.
Similarly, assuming our rulers in DC are not successful in killing the estate tax before you pass away, there will be a much larger asset to be included in your estate and possibly confiscated by IRS. Also, if you don't have the plan in a living trust, the increased value could trigger higher probate costs, which are usually based on overall gross estate values. A good estate plan is essential to ensuring that the net worth you build up during your lifetime can be preserved and passed on to your choice of heirs.
Good luck. I hope this helps. As always, you should be working with a tax pro who can help you fine tune everything to fit your particular circumstances.
Thank you very much for the feedback. I really appreciate it and I will take my fiduciary responsibilities very seriously.
Setting Up Corporations
Subject: C and S corporations
Hello,Thank you very much for the informative C vs. S Corporations comparison. Two friends of mine and I are thinking of becoming a corporation (IT Consulting) and are in the process of deciding which type would be best for us. Based on your article, it is apparent that you are more in favor of the C type because of its' flexibilities to be at a lower tax bracket. I have an question which I hope you can shed some light on. To be honest, mine and my friends' main interest of becoming a corporation is to write off the "expenses" from our "corporation" in our current W2s. Because we are planning to continue our day-time employment, we want to minimize the taxable incomes on our W2s by write-off our "corporate expenses". This is why we originally are leaning toward the LLC since we were told that it would allow us to deduct "corporate's expenses" on the W2. We later found out that this would also be the case for S corporation status. I would appreciate your feedback on our thinking process.Kind Regards,
As I have to warn everybody, you should be working with a tax pro who can help you fine tune everything to fit your particular circumstances.
However, a couple of points in your email warrant further scrutiny. It sounds as if your corp won't be generating any actual income, just expenses; and that you are going to continue to be a W-2 employee. That has the inherent problem of whether your corp has an actual profit motive, which would be crucial in determining whether you would be entitled to deduct the pass-through losses from an S corp or LLC. IRS frowns on the use of business entities just to generate paper losses.
What you may want to consider is to terminate your status as a W-2 employee and have our employer pay your new corp instead. I have seen that technique save thousands of people huge amounts in taxes, including payroll taxes. What is also possible is to do it both ways. Some of your compensation is on W-2 and some through your corp. There are various reasons to maintain some employee relationship, such as eligibility for the employer's benefit plans.
If your corp generates income, my earlier conclusion that a C corp has less tax than an S will apply for all of the reasons that I spelled out in my article. As I mentioned in there, in terms of what kinds of expenses can be deducted, the C corp allows much more, especially in the area of fringe benefits and the Section 179 expensing election.
Kerry,Thank you very much for your insightful feedback. We will definitely look more into Section 179 expensing election. Again, thank you for your time and have a great weekend.
Retirees: Should You Pay Off Your Mortgage? – I’ve never been a big fan of owning expensive property free and clear for a couple of reasons. It puts a big chunk of your net worth in one asset, which is not as good as diversifying. Second, being real estate rich and cash poor is not a good spot to be in. This is especially important with the recent appreciation in real estate values. Owning a $500,000 home with no mortgage isn’t a wise move if that means that you don’t have the money you need to take trips, buy a nice car and enjoy your last years.
Thanks to the folks at FairTax.org for this.
Converting Rental Home To Personal Use
Outstanding website! I have a slight variation on the 1031 Holding Period question.
We moved from the East Coast to the Midwest in 2000. At that time, we decided to rent out our East Coast condo. We rented it out until we sold it in 2004 and did a 1031 Exchange due to the huge appreciation. In August 2005, we will have rented out the replacement property for 1 year (actually 10.5 months with 1.5 months needed to get it rented).
Is there substantial risk in moving into this property at this point? (I've come across the 1-year vs. 2-year arguments). Since we have another house in this same town that we are currently living in, we thought of simply moving into the replacement property and turning our existing home into a rental. It's slightly smaller and in an area easier to rent out. Does having consistent rental property income on a tax form look better?
Thank you very much,
There is no hard and fast rule or law regarding how long you have to use the replacement property as rental before you can convert it into your own residence without voiding out the 1031 exchange. What is critical is that, at the time of the acquisition, the intended use of the property was for rental and there was no preconceived plan to convert it into personal use.
The problems with these kinds of situations arise when the taxpayers are blabbermouths and go around telling everyone of their plan to acquire replacement 1031 property with the goal of converting it to personal use. As I've said many times, if that is your ultimate plan, keep it to yourself. Telling others about it will come back to bite you in the butt if IRS were to ever look into it.
As I've mentioned on several occasions, the only current hard and fast time requirement has to do with how long you must own the property in order to qualify for the Section 121 tax free exclusion of up to $250,000 per person. That is five years, starting from when you acquired the home in the 1031 process.
If there is no documentation showing that you had a plan back in 2004 to ultimately move into the new rental home, and everything shows that such a decision came well after that time, you should be okay to do that.
I hope this helps you understand the rules. Good luck.
Taxes Should Be Irrelevant In Investment Decisions
Kerry:Did not help my "new" stock broker's news that we now have $38,000.+/- in losses in Tech Stocks. From a Tax strategy, do we now _need_ to dump this and take the losses over the next three years? Or, offset this with $38,0000.+/- sales of our Bank stock (mostly old Bank of America (BAC)). Bank of America pays 4% dividend on a $44. per share. Our BAC cost basis is $24. per share. I calculate a bit more return than 4% dividend. To keep or not to keep BAC?
Our new broker recommends we move to more cash thru this offset. Go into Mutual funds.Kerry, what say you?
Just as with whether or not it's a good time to sell off real estate, the tax consequences of selling off stocks are completely irrelevant in deciding whether to dump them or not. That decision should only be based on whether you believe that their value has peaked and is likely to go down, and whether you could put the proceeds into a more lucrative investment.
Assuming that you do come to the conclusion that those tech stocks have no upside potential and are heading downward, selling would be the best move from an investment perspective. From the tax angle, that will give you $38,000 of capital losses that can be used to offset up to that much of capital gains.
Again, you shouldn't sell off appreciated assets just to recognize the gains, unless those assets meet the same criteria of heading downward.
If you don't have enough capital gains this year to offset the full $38,000 of losses, you can claim $3,000 of losses above the gains, and carry the unused losses over to your next year's tax return, and so on.
While it wouldn't make any sense to do this in your case, there are some people who try to intentionally recognize capital losses by selling off deflated stocks and then repurchasing them. IRS has a weapon against this kind of manipulation called the Wash Sale Rule. Under this rule, if the same stocks are repurchased within 30 days after their sale, no capital loss from the sale may be claimed on your tax return. The loss would have to be added to the cost basis of the replacement stock. Again, this shouldn't apply to your case because, if the stocks are already so terrible that selling is the wisest move, there would be no reason to repurchase them.
I hope this covers the points you were after.
Rapid Home Sale
Kerry, I have a capital gains tax question that I need answered. My wife and I are thinking about selling our new home I say new home because we have only lived in it for 3 months now. If I sold it tomorrow I would make about $96,000 In my pocket (after selling fees). We want to sell our home because my wife physically cannot handle her job anymore and I cannot solely handle the bills we have. She has been plagued by health conditions last year alone she had 4 separate surgery's we thought it was all over after her hysterectemy last September. We thought she would be ok to return back to work. After her surgery and 6 week healing time we figured she was ready to go back to work and she felt great so we sold our current home and 6 months later moved into our current home. Now she is feeling more pain the Dr's think it is kidney related now she can barely cope with being a mother to our 2 children let alone her 30 hour a week job. Now we want to sell our home and pay off our 2 vehicle payments and some other debt. Unfortunately since home prices have been skyrocketing here in AZ we would not be able to find a cheaper house payment. I have been doing tons of reading under the IRS website on unforeseen circumstances related to "A change in employment that leaves the taxpayer unable to pay the mortgage or basic living expenses". I guess my question is what is considered basic living expenses? Is paying off all my debt so my wife does not have to work qualify for this? It says transportation expenses. Either way I will most likely sell my home but if I can avoid the 20k capital gain tax that would make things a lot easier on us.
I would rather know up front and pay the taxes so a few years down the road I do not get surprised by a piece of mail saying I owe x amount of dollars to IRS. Can I avoid part or all of the capital gain tax?
From your description, it sounds as if you would qualify for the pro-rated tax free exclusion based on the health issue. Selling in order to pay off debt wouldn't make as much sense as a rationale for the pro-rated exclusion as would the health and employment reasons.
As I described on my website, the prorated tax free exclusion works out to about $684.93 per day for a married couple. Assuming your estimate of a net gain of $96,000 is accurate, you would need to live in the home for at least 140 days in order to have all of your profit exempt from tax. If you move out and sell sooner than that, part of your profit will be subject to ordinary income tax rates since you will have owned the house for well less than the 12 months required for lower long term capital gains rates.
I hope this helps. You should obviously work out the figures in more detail with a tax pro. My guess is that your calculation of the $96,000 gain may be seriously off, as most people don't understand how to properly figure their true cost basis.
Wow thanks for the quick response. Basically I should select had to move for health reasons? What kind of proof would I need to provide in the event I would be audited. Also how likely would it be for me to be audited?
Again, your should really be working with your personal tax advisor to better take into account your unique circumstances.
However, if your wife's medical condition is as bad as you described, the health reason seems perfectly appropriate. While it's not required, my philosophy with unusual circumstances is to attach a lot of explanation and documentation of the issues to the original tax return so that IRS screeners can see it up front and not waste their (and your) time calling you in for an audit. His is the main reason that I have steadfastly refused to electronically file any tax returns. There is no ability to attach additional info to e-filed returns.
In regard to what should be attached, I would include a narrative description, such as in your earlier email to me, plus some doctor's statements. That should be more than enough to convince IRS that your wife's health is bad enough to warrant moving out of that home so soon after you moved in.
Leased Equipment And Section 179
I read on your website that equipment acquired through $1.00 purchase option capital leases qualify for Section 179 treatment exactly the same as a cash purchase. Would the tax treatment be any different if the lease had a mandatory 25% purchase requirement? The purchase requirement is considered a put (balloon). The Lessee must purchase the equipment at lease maturity and cannot return the equipment.
It depends on how the buyer/lessee records the acquisition on his books. If he sets it up as a purchase with the present value of the loan as the offsetting credit, and posts subsequent payments to principal and interest instead of lease expense, he would have a good case to claim the Section 179 in the first year. The value to be used would not be the sum total of the lease payments because the obligation to the lessor would have to be discounted for the interest rate that is built into the monthly payments.
If, as many lessees want to do, he doesn't show the debt on his balance sheet, and wants to expense the monthly lease payments, no Section 179 or depreciation would be appropriate.
IRS actually addresses this issue on its website:
Minimum Holding Period For 1031 Exchange
I have a question that I have gotten many different answers on. I bought my 1st investment property on March 15th (it was a pre-construction home and that is the date of the closing). I am selling the property and it will be closing on May 4th. I was told that 6 weeks is too short of a time period to hold a property to be exchanged. I was told also that it could be done, but it is a very high risk and if you get caught there are penalties to pay.
I also am considering starting a small business (C corp) to funnel the sale through the corporation and then I can also re-invest the money and claim some expenses. I am new at this and could use some advice.
Thanks in advance for any info you can give me. I live in the state of Florida and the investment property is also in Florida.
There is no minimum holding period for property that is involved in a 1031 exchange.
What is a potential concern is if you start doing a lot of rapid purchases and sales and you or your corporation do nothing but that. That would make you a real estate dealer, with the properties considered to be inventory. Dealers are not allowed to use any of the tax saving techniques that investors can, such as Section 1031, installment sales, or the special lower capital gains tax rates. In addition, profits are subject to the additional 15.3% self employment tax. There is no statutory explicit number of deals that will classify someone as a dealer. It is a very gray area in taxation and should be addressed with a tax pro who knows how to avoid the dealer tag.
Using a corporation has a lot of tax saving potential. However, it is not a do-it-yourself area. You need to consult with a tax pro who understands how to best utilize them in order to avoid the common and very costly mistakes that people constantly make when going it alone.
I received this from a reader regarding my Section 179 info.
I’m on your website and for 2006 & 2007 you have “+ COLA”. What exactly is cola?
COLA = Cost Of Living Adjustment
This is a standard term to designate adjusting something for inflation, usually based on something like the Consumer Price Index (CPI).
Investing In Bubbles
As strong a supporter as I am in real estate as the best type of investment, I am well aware of the fact that people can get carried away in feeding frenzies, such as we are seeing in parts of the country right now. It can stop abruptly; so be careful.