Home conversion not a taxable event...
Subject: 1031 Exchange
Back in 2005 we sold a vacant property and had a gain of $130K and bought a $180K house using a 1031 exchange.. We have had it for a rental for 4 years.
Due to our financial situation, we have to sell our primary residence at a loss of $40K and move into our 1031 rental house and make it our residence house.
Do we have to pay taxes on the original deferred gain on our rental house? .
Converting a business asset to personal use is not a taxable event, so no tax will be due for the year of the conversion.
However, down the road when you sell this property, you will need to possibly pay tax on some of the gain. The law was recently changed to require a five year look-back period. If you occupy the home as your primary residence for a full five years before selling it, you will be allowed to exclude up to $500,000 of profit on its sale. If you sell the home after less than five years of personal occupancy, the tax free gain will be prorated according to the amount of time it was used as a primary residence.
Your own personal professional tax advisor should be able to explain this to you in more specifics for your unique circumstances.
Subject: Exchange Questioncan I exchange a retail business for another retail business?
It is a little trickier than just selling one business and reinvesting into another one.
When a business is sold, the sale price is allocated between the different assets being transferred, such as real estate, fixtures, equipment, goodwill, inventory and covenant not to compete.
The profits from some of those assets can be deferred via a Section 1031 exchange if that portion of the proceeds is used to acquire like kind assets of equal or higher value within the statutory 180 day reinvestment period.
For example, if $100,000 of your sale price was allocated to the business real estate, you could defer the gain on your original real estate by acquiring $100,000 or more of new (to you) investment or business real property.
The like kind rules and definitions are also a little tricky. Real estate has the widest scope of like kind status, with any kind of investment or income producing property being eligible on both sides of the exchange. Equipment and fixtures have to be the same kind.
Goodwill in one business cannot be classified as like kind for goodwill in any other business; so it is not possible to defer any of that profit.
Same thing for a covenant not to compete. That will be taxable income as it is received and cannot be exchanged tax free for anything else.
This is why, if you are considering reinvesting business sale proceeds into another business, it is critical that you work with your own professional tax advisor ASAP to have the gains and possible taxes calculate for each type of asset involved and to assist you in negotiating the allocation with the buyer of your old business and seller of your new one. The allocations you use must be reported consistently on everyone's books.
This is a quick and dirty answer to your questions Your own personal professional tax advisor should be able to give you more specific advice with your actual figures.
Possible restrictions on 1031s for real estate?
As a means of saving huge amounts on taxes, 1031 exchanges of real estate have always been in the cross-hairs of our rulers looking to generate more tax revenue. Rather than completely repeal Section 1031, the more likely approach is to whittle away at its usage. I recently came across two such attempts that are in the works.
Federal regarding farm land: 1031 Proposal In The Farm Bill Update
In California, a frequently proposed idea has resurfaced, to disallow referral of gain on the disposal of Calif. property when the replacement property is not also in Calif. Some other states have already implemented this kind of restriction, and if Calif does this, we can only expect many more states to follow.
We recently received the following news item in an email from Wachovia Exchange Services:
I recently received some information about California that might interest some of you. Hopefully, we will never see this proposal get
enacted. And I would hate to think that it might give any other states the same idea.
California, like a number of states, is faced with a severe budget shortfall. The legislature is therefore looking at a number of proposals
to raise revenues and reduce expenditures. As part of this effort, the California Legislative Administrative Office has proposed a revenue
raiser wherein an exchange of California property for out-of-state commercial property would not be eligible for deferral as a like-kind
California currently has a claw-back regime where California property is exchanged for non-California property. In such case, while the gain is deferred, if the replacement property is subsequently sold, the deferred gain is subject to California tax. The reason for the proposal is the administrative difficulty in taxing the gains once the property has left the state.
This is just a proposal at this time; however, it should be noted that California has a history of non-conformity with the federal tax rules,
so it would not be out of character for it to have different rules for like-kind exchanges.
Unreinvested Exchange Proceeds
Subject: Exchange Question
Will I invalidate the 1031 exchange if I don't use all the money held in escrow to buy replacement property?
Not reinvesting the full amount of your disposal leg proceeds won't invalidate the 1031 exchange if everything else has been done properly.
However, it will, in most cases, not allow you to roll all of the gain from the original property into your replacement property. The actual calculation for the Form 8824 worksheet is a little messy; but the quick and dirty way to look at is that the unreinvested funds will be taxable in the year that you receive them. For example, if your disposal leg happened in 2007 and the 180 day reinvestment period expires in 2008, and you are sent the remainder of the funds in 2008, the taxable portion of the gain will be shown on your 2007 tax return as a deferred installment sale, with the actual gain subject to tax on your 2008 tax return. If both ends of the exchange happened inside the same tax year, the unreinvested potion will be subject to tax on that year's tax return.
The tax rate that the unreinvested funds will be hit with will be the highest rate applicable to the property's disposal. This normally works out to be the 25% Federal depreciation recapture rate, plus the comparable state rate, if you or the property are located in a taxable state.
I hope you're picking up on the fact that the actual tax calculations are very tricky and are not something you should even think about attempting on your own. The services of an experienced professional tax preparer will more than pay for themselves in a case like this.
Good luck. I hope this helps.
IRS to Tighten Enforcement of Like-Kind Exchange Rules
Courtesy of the most recent email bulletin from ACAT.
If you are considering a like-kind exchange (also known as a Section 1031 or Starker exchange), you need to review the IRS regulations that apply…and do it right.
Like-kind exchanges allow investors to defer taxes when they dispose of property they currently own and replace it with similar property. However, the Internal Revenue Service plans to increase audits and enforcement of these exchanges beginning mid-2008.
Usually when a business or investment property is sold, the seller must pay tax on any profit. The tax varies depending on the type of income and the current tax rate. For example, if you purchased land for $100,000 and sold it for $200,000, you could expect to owe $15,000 federal income tax on the transaction, assuming a current capital gains tax rate of 15%.
With a like-kind exchange, it is possible to purchase property for $100,000, sell it for $200,000, buy another like-kind property for at least $200,000, and avoid income taxes on that sale. But you have to follow the IRS rules precisely, and this requires planning prior to the transaction.
First, the property sold and the replacement property must be “like-kind.” IRS rules and regulations offer guidance to help determine what qualifies as like-kind property. For example, you can exchange a single-family home for an office building, or an apartment complex for a shopping center. But you can’t exchange your home for an oil well and you can’t exchange real property for a business.
Second, many like-kind exchanges will require the assistance of a qualified intermediary in order to comply with all of the requirements for a tax-free exchange. You can usually find a qualified intermediary in your area by checking the Yellow Page listings under “Title Companies.”
All like-kind exchanges must be reported to IRS by filing Form 8824 with your federal income tax return.
Sounds confusing? Studies by the IRS and the Government Accounting Office have found consumers don’t understand the rules. But help is on the way.
The IRS has updated Publication 17 “Your Federal Income Tax” to better tell taxpayers about like-kind exchanges. Additional information about the like-kind exchange process is found in IRS Publication 544 “Sales and Other Dispositions of Assets,” and in the instructions for Form 8824.
There are significant savings you can realize. But the best advice is to get your accountant involved at every step.
This information is provided as a public service, and should not be construed as individual accounting or tax planning advice. For information on how these general principles apply to your situation, please consult an accounting or tax professional.
Selling gifted property
Subject: Tax QuestionKerry,
First, thanks for your blog. You’re a great resource for all of us out there. I have a question regarding some gifted property- I’m grasping at straws at this point, but I’m hoping that you can help:
First, my wife and I live in California and make ~$150K/year. We just bought our first house and we have no children. Just in case these detail help.
Now to our “problem” – in Nov. 2005, my wife’s parents gifted us a piece of land worth ~$700K on which to build a home. This is bare land, purchased in ~1978, and has a basis of ~$10K. After spending ~$60K on permits, engineering, and architecture we decided against building a home on the land. We’re now planning to sell the land and we’re trying to minimize our tax exposure.
I think that we did this in the worst possible way, as I think we’re going to take the cap. gain hit on the delta between my in-laws’ basis and the sales price (minus our expenses) and my in-laws estate will be hit for the full $700K against their $2M of tax free estate (yes, they’re likely to exceed that $2M). Other than a 1031, is there any way to minimize either the taxes or the amount counted toward my in-laws estate? Are there creative ways to minimize the state or federal tax exposure? Is there anything that would allow us to invest any/all of this money in a tax-free retirement account? I know that I’m grasping at straws.
Is there anything we can do????
If you have been reading my stuff for any length of time, you should know that you need to be working directly with a professional tax advisor to ensure that you do things properly.
You do have a bit of a messy situation here in regard to the built in capital gain you accepted from your in-laws.
You do really need to review various scenarios with a tax pro to see if any of them could assist.
A 1031 exchange could possibly be appropriate if you can make the case that the old property was used for investment and not personal purposes. You would then have to work with an exchange accommodator to use the proceeds to acquire new business or investment real estate; not personal use property.
I'm a little confused by your wording as to the status of your in-laws. Are they still alive or have they passed away? Another option that you may want to explore if they are still alive is to give the property back to them and possibly have them sell the property to you rather than gift it. That could get messy; so their professional tax advisor would definitely need to be in on those discussions. There are special tax breaks for them and you if they were to sell the property to you on the installment basis (carryback note) and then have that note as part of their estate after they pass away.
If you do sell the property, another way to spread the tax bite out is to carry back as much of the price as you can so that taxes can be spread out over the years in which you collect the payments.
These are just a few of the issues that you all need to discuss with your own professional tax advisors.
Selling mixed use property
Subject: Exchange QuestionMy wife and I live in the front house. When does the rental back house cease becoming a 1031? Does not receiving rent make it no longer a 1031(for how long)? Is there a statute of limitations for it to qualify as exempt? I don't want to pay a capital gain tax on it when I sell this 2on1 Calif. property.Tx,
This is the kind of thing you really need to be handling with a professional tax advisor to ensure that you are doing things properly.
From your very short description, it sounds like you have what's called a mixed use property; part residential and part rental. For IRS purposes, it is treated the same as two separate properties, with the personal residence portion of interest and property taxes deducted on your Schedule A and the expenses for the rental portion on Schedule E. The actual allocation of joint expenses may not be 50/50 if the two halves of the property are not equal in size and/or value. An experienced tax pro can help you come up with an appropriate allocation between the two halves. The cost basis of the property also needs to be allocated between the personal residence and rental portions, with deprecation claimed on the rental portion, which will reduce its cost basis (aka book value).
In regard to the treatment of a sale of the property, the portion of the sales price that is allocated to your primary residence will be treated as a Section 121 possibly tax free sale, as I have explained on my website.
The portion of the sales price allocated to the rental half will not be eligible for the tax free exclusion, and will need to be set up as a Section 1031 exchange if the taxable gain warrants it.
If I'm reading into your question properly, and you are asking how long it will be until the rental portion of the property can become eligible for the tax free Section 121 treatment, the answer is never, as long as it is being rented. If the tenants leave and you convert the rental part to be an extension of your own primary residence, the clock can start on the personal use test, which is generally two years.
You didn't say how you acquired this current property. As an added twist, if you acquired it via a 1031 exchange, you will have had to own it for at least a full five years prior to its sale in order to be able to utilize the Sec. 121 tax free exclusion. Again, an experienced tax pro can assist you with this rule.
I hope I hit on your situation. Working directly with a professional tax advisor will result in more usable numbers for your precise situation than the generalities I have to use.
IRS Steps Up Scrutiny On Popular Tax Strategy – Thanks to an alert reader for the heads up on this article about upcoming IRS scrutiny of 1031 exchanges. A big stumbling block for IRS will be in educating its agents on the proper application of 1031 rules, especially the fact that different kinds of real estate qualify as like kind. I’ve lost track of the number of IRS agents I’ve had to train on this and other 1031 related issues.
Is a 1031 exchange needed?
My parents are both deceased and I am presently under contract to sell the farm. I have made my intention to perform a 1031 exchange known to the potential purchaser.
I would like for you to advise me on the best course of action involving this matter. My desire is to reinvest the portion of the sale which would be subject to capital gains tax.
As a brief history; the farm was purchased in 1995, my mother died in May 2002, my father in November 2003.
I have always lived here since 1995.
I don't know how to establish the new value basis for the farm or how the exemption on the sale of my primary residence will affect my overall tax liability.
The purchase price will be substantially more than average requiring, I believe, an exchange to avoid capital gains tax.
As it stands now the closing date could be anywhere from September of this year to February of next year. An investment group is purchasing the farm and other adjacent properties for a commercial venture and there are certain contingencies which make it impossible to know the exact closing date.
So I basically need to know where I stand so I will be prepared if the sale concludes as expected.
It's critical that you consult with a professional tax advisor because there are a number of issues that need to be considered.
First is the determination of your cost basis in the property in order to determine how much potential profit you would be looking at with a sale. This depends on how you acquired legal title to the property, which wasn't clear in your email. The three most common ways to acquire title would be by purchase, gift or inheritance. Each one gives a very different cost basis amount.
For example, if you purchased it from them while they were alive, that would be your cost, plus improvements and less depreciation.
On the other hand, if they gifted the property to you while they were alive, their cost basis carries over to you even though Gift Tax returns are based on the property's fair market value at the time of the gift. If you received the property as a gift, you would start with their adjusted cost basis and add in any capital improvements and subtract any depreciation you have claimed to arrive at your current cost basis.
Finally. if the title to the property was transferred to you as a result of your parents' death, your cost basis in it would be its fair market value as of the date they passed away, or an alternative date (usually six months later) if that was used on their estate tax return.
If you did inherit the property, with the cost basis being established based on its value in 2003, your potential gain shouldn't be as high as it would be if you had purchased the property or received it as a gift.
The other big issue that you need to work on with a professional tax advisor is how much of the property qualifies as your primary residence so that the sale price can be properly allocated between it and the farm portion. As you probably know, up to $250,000 of gain from the sale of a primary residence is tax free; $500,000 if you are married. I have a full explanation of this extremely useful tax break on my website.
I hope these points are useful in deciding if you have a tax problem to worry about, in which case a 1031 exchange would be a wise move.
Be careful when choosing 1031 service
I can’t help using the old cliche – Penny Wise, Pound Foolish - to describe how so many supposedly intelligent people can risk literally millions of dollars in order to save a few hundred.
It’s no secret that my wife owns and operates a company to handle Section 1031 like kind exchanges for real estate investors. She frequently mentions that potential clients try to get her to lower her fees based on lower rates being charged by newbies who don’t know what they are doing. Of course, she is just like I am and refuses to participate in such a “whore’s market” and doesn’t work with anyone who doesn’t understand that quality comes with a price.
As these articles covered by Paul Caron indicate, cutting corners on a 1031 fee can end up costing much more in the long run, as several 1031 facilitators have filed bankruptcy while holding 151 million dollars of investor funds. I wonder how many of those investors chose to use those companies based on lower fees than what reputable firms charged. They are each now looking at the very likely prospect of losing hundreds of thousands of dollars because they wanted to save a few hundred dollars.
This reminds me of a similar situation when I owned an exchange company back in the Bay Area. We were losing a lot of exchange business to a new company that wasn’t charging anything for its services, supposedly as a means of getting a foot-hold in the area’s real estate market. The fact that they were operating out of a motel room should have been a dead tip-off to the end result. The slime-balls amassed a few million dollars of investor funds and then skipped town.
I hate to sound cruel, but anyone who is willing to entrust his/her real estate equity with a stranger rather than someone who has been successfully handling 1031 exchanges for decades, just to save a few hundred dollars on the service fees, doesn't have much chance of being considered a “sophisticated investor.” Short-sighted fool would be the more appropriate description of such a person.
Sec. 1031 & 121
Subject: Exchange QuestionWe are considering doing a 1031 exchange on a single family rental, which has been held for 32 years, and is owned free and clear.The idea would be to exchange this rental home for TWO single family homes, and use them as rentals (like/kind). Then, after 3 years, move into one of the rentals and live in it for two years, meeting the five year holding requirement & 2 year residency requirement .... Then we would sell new Rental Property #1 as a personal residence, and then move into the Rental Property #2 as a permanent residence, and live in it indefinitely.Each of the newly exchanged properties would be rentals - the first one for 3 years (then move in for 2 years), for a total of 5 ... and the next exchange property would be a rental for 5 years until we could meet the time requirements.This is hard for me to explain, but I hope you can get a grasp of what I'm trying to do. Trade one rental for two, and live in the two rentals (over a period of five years before moving into rental #2) so as not to pay capital gain taxes. Would these time lines work?
That plan could work, assuming our rulers in DC don't mess with the tax laws over the next five years to change any of the timing details, which you have correct for the laws as they stand now.
I have one very big word of caution for you. Keep your intention to reside in one of the new rentals to yourself. Blabbing around to a lot of people that you had that plan from the beginning could jeopardize your 1031 exchange because an aggressive IRS agent could classify the house as personal at the time of the exchange. I have seen and heard of cases where people shot themselves in the foot by bragging about plans such as yours. All it takes is one jealous person to turn you in and you're cooked. The decision to move into the rental has to appear to be made long after you take ownership of it.
Other than that, it sounds as if you are looking at things creatively, which is what makes the tax game so much fun.
1031 of LLC Property
Subject: Exchange Question
Dear Tax Guru,
I own a residential rental property in AZ under an LLC with a partner. We are in the process of selling it after two+ years of ownership.
Am I able to do a 1031 exchange with the proceeds of this sale into a commercial property that I am looking to invest in under a different LLC with another partner?
Thanks for your help.
It depends on the official ownership title for the property. If it's in your individual names, you can each use your share of the proceeds for whatever you want, 1031 exchange or taxable sale.
If the property's title is in the name of the LLC, and you don't all want to reinvest into new property, you will need to get your share out of the LLC's name and into your own name before the disposal, so that you can do a 1031 with your share of the proceeds. This is a common event and any experienced title company or abstract attorney can handle this.
You also need to coordinate with your and the LLC's tax preparers to keep track of the property's cost basis, the distribution to you, and the reporting of the 1031.
Jointly Owned Property
Subject: Sale of home question
Hi Tax Guru,
Found your website while browsing for an answer to my question about a sale of a home I own with my parents. Here's the situation:
Here are the circumstances:
My brother and I own a property with my parents. We are all on title as joint tenants (1/4 undivided interest to each of us and 50% undivided interest to my parents). The house was bought in 2000, my parents supplied the down and my brother and I have payed for the mortgage and taxes since. We've split the deductions every year between the two of us. My parents have used this as their primary residence since 2000 while my brother and I do not. We have considered it our 2nd home as we each own our own primary residence. We are now interested in selling the home and are wondering what is the best way to reduce the tax implications for everyone. I estimate the capital gains on the home to be approximately 300K.
Since my parents use it as their primary residence, would they be able to "claim" all the capital gains (300K) or do the gains have to be divided equally among the 4 owners? If it has to be divided, is there any way to get off the title so that my parents can take advantage 500K exemption without triggering gift tax consequences for my brother and I? Any suggestions on how we can either structure the title or the sale such that taxes are minimized for all parties? My parents income is low while my brother and I are in much higher brackets if we had to pay taxes.
Appreciate any insight you might have on mitigating the tax burden.
Thanks very much!
This is an issue that you all really need to work on with the assistance of an experienced professional tax advisor because there are a number of ways in which it can be handled and several factors that need to be considered, such as the following.
It is obvious that your parents can qualify for the Section 121 tax free exclusion of the gain on their one half of the home's net gain. The gain on the half that you and your bother own is a much more complicated issue.
Let me address the gifting option. You and your brother could gift your shares of the home to your parents. However, this would require you both to file gift tax returns to report it and either pay gift tax or use up part of your million dollar lifetime exclusion. Your parents would assume your cost basis in the 50% of the home they are given and would essentially be accepting full responsibility for your and your brother's gain.
The half of the home that your parents are given will not qualify for the Section 121 tax free exclusion because the law requires the seller to both own and occupy it is their primary residence. While your parents have obviously met the occupied test, they would fail the ownership test and would thus be required to report the gain on their "new" 50% share as taxable long term capital gain (LTCG). Because they had been using all of the home for personal purposes, its sale cannot be structured as a Section 1031 like kind exchange, which is only available for business and investment property.
If you and your brother keep your share of the house, the gain is potentially taxable, depending on how you and he are classifying its ownership, which should be consistent with how you have been reporting the deductions for interest and property taxes on your 1040s.
If you have been treating the home as investment property, you can structure your disposal of your share of the home as a Section 1031 like kind exchange, which will require you to use the services of a neutral third party facilitator to reinvest the proceeds into new (to you) business or investment property within 180 days. These rules are all explained at tfec.com.
If you have been reflecting that you have been personally using the home, it will not qualify for Section 1031 and you will have a taxable LTCG.
You and your brother don't necessarily have to report this in exactly the same way. The strategy for each of you and your brother could be different depending on your unique situations. For example, one of you may qualify for a Section 1031 exchange, while the other may not.
The actual tax hit on any taxable gain could be spread out over several years under the installment method if part or all of the sales price is carried back. Your personal professional tax advisor can show you how that would work with your numbers and sales terms.
I hope this gives you some idea of the various details that you all need to be evaluating with your personal professional tax advisors.
Informing Clients About 1031 Exchanges
Subject: Exchange QuestionHello,I was never informed by my Realtor of this 1031 rule. Now, after the exchange, I was just notified by my accountant that I owe a large amount of money. Has anyone won lawsuits against Realtors for mistakes made by not even mentioning that I should contact a tax specialist when asked if we are doing everything correctly in this transaction?Thanks,
That's a very interesting question because in all of my speeches and seminars to Realtors over the past decades, I have always made a big point of stressing that if they ever smell any possibility of a 1031 exchange being relevant with a client's property, they should advise that client to consult with his/her personal professional tax advisor to see if in fact the deal should be structured as a 1031.
It is not the Realtor's job to actually advise on the feasibility of a 1031 for a particular client because that is well outside their area of expertise and responsibility, and they couldn't possibly have enough specific information to render a competent analysis.
I always warn Realtors that if a client were to learn after the fact about 1031s, and that subject was not mentioned, s/he could try to sue the Realtor for the taxes that had to be paid. Many Realtors accused me of being an alarmist by discussing this possibility; but I assured them that it was based on real life situations that I have seen, as well as calls and emails such as yours.
I am not a big believer in litigation for every little thing that happens; so only you can decide if it's worth it to you. Over the past 30 years, I have seen instances where Realtors have been sued for this kind of alleged negligence. The results have been all across the board. In some cases, the judges awarded nothing because they believed that the taxes would have been due some time anyway and that the clients were at fault for not being smart enough to consult with their own tax advisors before selling a highly appreciated property. In some cases, Realtors were required to reimburse clients for some or all of the taxes they had to pay because Section 1031 wasn't used. In other cases, there were out of court settlements for compromised amounts.
I am not an attorney, but my understanding of the current trend in regard to this kind of issue is that, since 1031s have been around for so long now, it is becoming more difficult to convince a court that an experienced real estate investor has never heard of it. You would most likely have a better case of winning if you can convince the court that you are not a frequent real estate seller and are not very knowledgeable in tax saving strategies. If it is true that you have just now learned about 1031 exchanges for the first time, that must be the case.
There is no way to know how your case would turn out. You will need to discuss the merits of your case with an attorney and/or the managing broker in the office of your listing Realtor.
1031 Identification Deadline Is Firm
Subject: Exchange QuestionNew question from a client, that I have not encountered before. If 3 prospective replacement properties were identified for an exchange within 45 days of the sale of a property and none of the 3 remain available for purchase, can my client substitute a replacement prospect, close on it within the 180 day time frame and still defer the capital gains tax consequence?
Based on the way in which you described your client's situation, the answer is a very big NO.
The only statutorily eligible reasons for an extension of either the 45 or 180 day deadlines are when the property has been affected by a Presidentially declared disaster or if the taxpayer is on active duty in a combat zone.
If the taxpayer just dawdled and let other people buy up those listed properties, IRS has no sympathy for him.
This is why we have always advised working diligently on the acquisition phase of the exchange as early in the process as possible; ideally while the disposition phase is still in progress.
Hopefully, this lesson won't be too expensive for your client and he will be more on top of things the next time he attempts an exchange. If the potential tax bill is substantial, your client may want to make the new owners of the properties substantially increased offers so that he can still acquire them within the 180 day deadline.
Tax free sales of rental homes
Subject: Tax QuestionHi Kerry -I was wondering if you could help me with a residence tax question. I currently live in a Primary Residence in MI, and have a condo in AZ that I am renting out. If I sell the house in MI and move into the condo after the current renters lease is up, and live in the condo for 2 years, can I avoid capital gains? It is currently a rental property for me. If not, do you have any idea how I could avoid capital gains on the condo?Thanks,
Ever since the current law regarding residence sales was enacted in May 1997, this has been a very common strategy; to convert rental homes into primary residences and sell them tax free after two years, again and again. I used to call it the "conversion game." Others have called it "serial home selling."
This strategy is still available today, except in the case of rental homes that had been acquired as replacement property for a 1031 exchange. As I explained in my blog, you need to have owned the home for at least five years in order to use the Section 121 tax fee exclusion, in addition to meeting the two year residency test.
Most of these issues are explained on my website.
As always, before implementing any tax saving strategy such as you are proposing, you must consult with an experienced tax professional to ensure that you do everything properly and don't shoot yourself in the foot.
ACAT's Year End Tax Tips
I just received an email from ACAT with an attached doc file of tax tips to be shared with clients and local media outlets. Since this blog is my local media outlet, I am sharing those tips here.
The Twelve Tips of Business Year-End Tax Planning
Before business owners celebrate the Twelve Days of Christmas, they should first take a moment to review these Twelve Tips of Business Year-End Tax Planning. These could save the average business thousands of dollars!
It’s important to act quickly – once the bell tolls for the New Year, these opportunities for potential savings will be gone!
1. Accelerate deductions from 2007 into 2006. A business can do this by making payments this year for expenses such as office supplies, repairs, maintenance, and advertising.
2. Consider setting up a qualified retirement plan. It is one of the best ways for businesses to save on taxes. There are many options, so picking the right plan for your business is the key. Some plans are required to be set up by year end.
3. Reduce or defer year-end income. For cash basis businesses, deferring billing for services until the end of December or January can shift the income into the next year, as the income is reported in the year it is actually received. Also, delaying shipping of merchandise until January moves income into the next year.
4. Accelerate purchase of equipment. If you anticipate business income to be higher in the current year versus next year, it makes sense to accelerate the purchase of equipment and other assets into this year. The benefits of Section 179 depreciation can mean large tax deductions, thus making the tax savings significant. Businesses can elect to “expense” part or all of qualified assets purchased during the year, up to the annual limit of $108,000 for 2006. There is a limit based on taxable income and an annual purchases threshold amount to qualify.
5. Review fringe benefit plans. A Section 125 “cafeteria” plan can benefit both the employee and employer with pre-tax savings for health and dental insurance, out-of-pocket medical costs, dependent care, and other benefits.
6. Write off bad debts. Businesses that use the accrual basis method of accounting may have uncollectible past-due accounts. These businesses can deduct these bad debts when they become partially or totally worthless. These accounts should be identified before year-end and the business should keep a detailed record of the debt-collection efforts.
7. Write off old inventory. Review the business inventory for obsolete and un-sellable items. A business may write down inventory below market if in the regular course of business the company has offered the merchandise for sale at below-market prices.
8. Review building depreciation. If your business has purchased or substantially renovated a building in the last 10 years, conduct a Cost Segregation Study. The study analyzes the components of a building or renovation to gain larger depreciation deductions based on shorter depreciation lives.
9. Explore like-kind exchanges. If you are considering replacing old equipment or buildings with newer ones, take advantage of the like-kind exchange rules. Trading assets is one of the best tax shelters available to businesses and investors. The section 1031 like-kind exchange rules are very strict and must be followed exactly.
10. Review your business entity classification. Check to see if your business classification (sole proprietorship, C-corporation, S-corporation) and your accounting method options (cash basis vs. accrual basis) are the most advantageous for your business. Tax laws change constantly and reviewing the alternatives could significantly impact your taxes. Any change in ownership of the business is also a good time to review your options.
11. Finalize the budget. Compare income and expenses for the current year to the previous year and prepare a budget for the coming year. A budget will help a business reach its goals.
12. See your accountant or tax advisor. There are many ways to save tax dollars and consulting with a tax professional who is experienced and familiar with the latest tax law changes can help you minimize taxes and maximize your bottom line. Effective tax planning can make a material difference in your company’s cash flow.
This information is provided as a public service, and should not be construed as individual accounting or tax planning advice. For information on how these general principles apply to your situation, please consult an accounting or tax professional.
Heed the Top Ten Year-End Tax Tips To Save on 2006 Taxes “If I had only known about that new tax law, I would have done something before the end of the year!” This common lament of taxpayers is often the result of simply not staying on top of the latest changes to the increasingly complex tax laws. But it doesn’t have to be that way! Avoid surprises and maximize tax savings with these “Top Ten Year-End Tax Tips”: 1. Take stock of your stocks. Review your current year stock and mutual fund sales to determine if you have a net gain or loss. If you have a net gain, then selling stocks that would produce a net loss may make sense. A net capital loss of up to $3,000 can be deducted against other income, such as salary. Any excess losses can then be carried forward to future years. 2. Watch out for the estimated tax penalty. The IRS requires individuals to pay their taxes throughout the year with quarterly estimates, tax withholding, or both. If you don’t pay enough during the year, you can be hit with an estimated tax penalty, which is equal to the interest rate for underpayments. Although it may be too late for this year, adjusting your income tax withholding can eliminate or reduce the penalty. 3. Consider stock donations. If you want to donate to your favorite charity but are short on cash, check out your stock portfolio. If you own stocks that would produce a large capital gain, consider donating them before you sell them. You can deduct the market value of the stock as a charitable contribution and you pay no tax on the appreciation. 4. Reducing the tax on Social Security benefits. People who receive Social Security benefits can be taxed on a high percentage of their benefits. Investing in T-Bills or CDs that don’t mature until next year can lower the provisional income in the current year and lower the tax rate. Also, investing in growth stock that produces little income can have the same result. 5. “Kiddie Tax” update. The new tax law raises the age threshold for the “kiddie tax.” For 2006, any unearned income (interest, dividends, capital gain, etc.) received by a child under age 18 (previously age 14) that exceeds $1,700 is subject to federal tax at the parents’ top marginal tax rate. You might want to shift investments into growth stocks that produce little income, tax-free municipal bonds or municipal-bond funds, Series EE bonds, or CDs that mature in the next year. 6. Installment sale of property. If you are considering the sale of real estate property that was held for investment purposes, you could spread out the tax hit over several years with an installment sale. If you structure the sale into two payments, one in December and one in January, you spread the tax over two years instead of one. The second benefit may come from a lower adjusted gross income. 7. Shift timing of deductions. Consider maximizing your itemized deductions by “bunching” deductions. In order to get a tax break from itemizing deductions, you must have more in deductions than the standard deduction allowed by the IRS. For 2006, this is $10,300 on a joint return and $5,150 on a single return. If you are close to the standard deduction each year, consider accelerating all possible deductible expenses into every other year. Shift payments of medical expenses to the year they will exceed 7.5 percent of your adjusted gross income, pay two years of personal property tax and real estate tax in one year, or double up on your charitable contributions into one year. 8. Watch business expenses. If you deduct employee business expenses, your deduction is reduced by 2 percent of your adjusted gross income and you may lose the deduction totally because of the alternative minimum tax (AMT). The best strategy is to set up an “accountable plan” with your employer to cover all your business expenses in lieu of wages for the same amount. The reimbursements you receive will be tax-free, not subject to payroll taxes or alternative minimum taxes. 9. Defer income until next year. If it is possible to defer receiving income until the next year, you not only defer income tax on that income for another year but you may increase the value of your deductions for the current year if you have adjusted gross income limitations. Consider postponing bonuses, investment gains, or elective distributions from retirement accounts. 10. See your tax professional. Make an appointment with your tax professional before year end. Opportunities missed can mean cash in the bank. Don’t be one of the many taxpayers that look back and say, “If I only knew about this before the year end.” Tax laws change every year, so it’s always a good idea to review all your options while there’s still time to take action,” explains Paul V. Thompson, EA, ABA, ATA, ECS, Senior Tax Manager for Shaw & Sullivan, P.C., Alexandria, VA. “You should also not assume that your tax withheld from your W-2 wages or the tax estimates you are paying are enough to cover your tax liability or avoid a penalty.” This information is provided as a public service, and should not be construed as individual accounting or tax planning advice. For information on how these general principles apply to your situation, please consult an accounting or tax professional.
Heed the Top Ten Year-End Tax Tips To Save on 2006 Taxes
“If I had only known about that new tax law, I would have done something before the end of the year!” This common lament of taxpayers is often the result of simply not staying on top of the latest changes to the increasingly complex tax laws. But it doesn’t have to be that way!
Avoid surprises and maximize tax savings with these “Top Ten Year-End Tax Tips”:
1. Take stock of your stocks. Review your current year stock and mutual fund sales to determine if you have a net gain or loss. If you have a net gain, then selling stocks that would produce a net loss may make sense. A net capital loss of up to $3,000 can be deducted against other income, such as salary. Any excess losses can then be carried forward to future years.
2. Watch out for the estimated tax penalty. The IRS requires individuals to pay their taxes throughout the year with quarterly estimates, tax withholding, or both. If you don’t pay enough during the year, you can be hit with an estimated tax penalty, which is equal to the interest rate for underpayments. Although it may be too late for this year, adjusting your income tax withholding can eliminate or reduce the penalty.
3. Consider stock donations. If you want to donate to your favorite charity but are short on cash, check out your stock portfolio. If you own stocks that would produce a large capital gain, consider donating them before you sell them. You can deduct the market value of the stock as a charitable contribution and you pay no tax on the appreciation.
4. Reducing the tax on Social Security benefits. People who receive Social Security benefits can be taxed on a high percentage of their benefits. Investing in T-Bills or CDs that don’t mature until next year can lower the provisional income in the current year and lower the tax rate. Also, investing in growth stock that produces little income can have the same result.
5. “Kiddie Tax” update. The new tax law raises the age threshold for the “kiddie tax.” For 2006, any unearned income (interest, dividends, capital gain, etc.) received by a child under age 18 (previously age 14) that exceeds $1,700 is subject to federal tax at the parents’ top marginal tax rate. You might want to shift investments into growth stocks that produce little income, tax-free municipal bonds or municipal-bond funds, Series EE bonds, or CDs that mature in the next year.
6. Installment sale of property. If you are considering the sale of real estate property that was held for investment purposes, you could spread out the tax hit over several years with an installment sale. If you structure the sale into two payments, one in December and one in January, you spread the tax over two years instead of one. The second benefit may come from a lower adjusted gross income.
7. Shift timing of deductions. Consider maximizing your itemized deductions by “bunching” deductions. In order to get a tax break from itemizing deductions, you must have more in deductions than the standard deduction allowed by the IRS. For 2006, this is $10,300 on a joint return and $5,150 on a single return. If you are close to the standard deduction each year, consider accelerating all possible deductible expenses into every other year. Shift payments of medical expenses to the year they will exceed 7.5 percent of your adjusted gross income, pay two years of personal property tax and real estate tax in one year, or double up on your charitable contributions into one year.
8. Watch business expenses. If you deduct employee business expenses, your deduction is reduced by 2 percent of your adjusted gross income and you may lose the deduction totally because of the alternative minimum tax (AMT). The best strategy is to set up an “accountable plan” with your employer to cover all your business expenses in lieu of wages for the same amount. The reimbursements you receive will be tax-free, not subject to payroll taxes or alternative minimum taxes.
9. Defer income until next year. If it is possible to defer receiving income until the next year, you not only defer income tax on that income for another year but you may increase the value of your deductions for the current year if you have adjusted gross income limitations. Consider postponing bonuses, investment gains, or elective distributions from retirement accounts.
10. See your tax professional. Make an appointment with your tax professional before year end. Opportunities missed can mean cash in the bank. Don’t be one of the many taxpayers that look back and say, “If I only knew about this before the year end.”
Tax laws change every year, so it’s always a good idea to review all your options while there’s still time to take action,” explains Paul V. Thompson, EA, ABA, ATA, ECS, Senior Tax Manager for Shaw & Sullivan, P.C., Alexandria, VA. “You should also not assume that your tax withheld from your W-2 wages or the tax estimates you are paying are enough to cover your tax liability or avoid a penalty.”
Converting Rental To Residence
Subject: Exchange questionWhat is the test of intent in an exchange. Suppose someone exhanges an apartment rental building for a single family home, their true intent is to eventually turn the home into a personal residence. They have told numerous people city building officials that their intent is to remodel the home for their use as a personal residence. Before they purchased this replacement property, they arrange with the broker and seller of the property to convert the property to a rental in order to qualify as a rental property under 1031 rules. This seems like a scam the IRS would frown upon.
You are absolutely right that somebody who announces right up front the intention to personally occupy the home is setting himself up for serious problems with IRS accepting that property as proper like kind for a 1031 exchange.
Conversion from a rental to personal use is allowed, but it has to appear that the decision to do so took place after the completion of the exchange. I have long advised people who have a long-term goal of exchanging into a rental home and later on converting it to personal usage to keep that plan to themselves. The more they announce that intention to other people, the more damage they are doing to their case for a valid 1031. Loose lips sink ships, etc.
As a tax practitioner, I always keep in mind the way in which everything would play out in real life. Any audit by IRS of a 1031 exchange would normally be a few years after the actual exchange took place. If the taxpayer is already occupying that home when the audit occurs, it will be a much tougher case to make that it was acquired with the intention of being for rental usage. That wouldn't be an impossible argument to win; but each bit of evidence the IRS auditor could find indicating prior intent to occupy it, the more difficult it would be. Obviously, the more people who had been told of this previous intent, the more damaging the evidence against the validity of the 1031 exchange.
The moral of the story is that anyone stupid enough to be bragging around about his intention to only appear to be acquiring a rental property probably deserves to lose the tax savings from a 1031 exchange.
Thanks for writing.
1031 Carryover Calculations
Subject: Exchange Question
How do I determine the basis of the new property with consideration of both properties being mortgaged? (Increase in net or decrease in net)
Is there a gain realized if the property’s FMV I am receiving is less than that of the property I disposed of?
When you prepare the 8824 to report the exchange to IRS, it will end up with the basis of the new replacement property. The 8824 is a complicated and convoluted schedule; so most tax prep software programs have worksheets to assist in putting the right figures in the right place, including the amounts of debt on both the original and replacement properties.
Some other programs also have handy 1031 worksheets, such as the TaxTools program from CFS. There are links to both the 8824 and a separate worksheet here.
Depending on the amount of exchange expenses incurred in the deal, it possible that trading down may or may not result in a currently taxable gain on the exchange. The 8824 and worksheets will give that result.
Residence Converted To Rental
Subject: capital gains on principal homeAloha Tax Guru!
I have a question for you. We purchased our Lahaina Hawaii home 12 years ago for $240,000. We had to move to Lanai (another island) for work, but had plans to move back to Lahaina. We have been renting a house here and renting out our home in Lahaina. We now want to sell our home in Lahaina and buy one in Lanai. We found out homes in the Lahaina area are going for $650,000. If we sell, we would make a profit of $410,000, well under $500,000 allowed for married couples. However, does our home we are selling count as a primary residence if: !)We are renting a home to live in on Lanai 2)We are renting out our home in Lahaina 3)We only own one home.Mahalo for your help!
You left out the most critical bit of information in determining whether or not you can use the tax free sale of your former residence. Specifically, how long ago did you move out of that home and convert it to rental?
As is explained on my website and in the referenced links, if it was less than three years prior to the sale, you should be able to use the Section 121 tax free exclusion. If it was longer than that, you are no longer eligible and will be selling a rental property.
You absolutely must work with a professional tax advisor on this matter. If you do qualify for the exclusion, there will still be some depreciation recapture to pay tax on.
If you don't qualify for the exclusion, your advisor can hopefully help you reduce the tax hit via something like a Section 1031 exchange or an installment sale.
Carryover Cost Basis
Subject: 1031 Cost Basis vs. Actual Price - Accounting QuestionDear Guru:I would appreciate ANY help you could spare! My question is this:My corproation bought "Vacant Lot A" in 2003 for $5,000.00. In 2005 my corporation sold "Vacant Lot A" for $40,000.00, using a 1031 Exchange. With the 1031 Exchange proceeds, my corporation bought another investment property, "Vacant Lot B" for $40,000.00. What is the "book value" I should show as my corporation's asset for "Vacant Lot B"? Would it be the cost basis of $5,000.00 or the actual purchase price of $40,000.00??
I don't know who else to ask! I would greatly appreciate you pointing me in the right direction!
If you've ever read any of my blog postings, you should already know in what direction I will be pointing you; into the arms of a professional tax advisor. It is crazy and downright irresponsible for you to attempt to operate a corporation without the appropriate guidance of trained professionals. I'm assuming that you are the 100% owner of this corp because any co-owners could bring an action (lawsuit) against you for fiscal malfeasance if you have been risking their investment without proper professional support services.
The terminology in your email also raises some concerns about the validity of your 1031 exchange. To be valid, your corp should not have actually received any of the proceeds form the first property, but had them held by a neutral third party exchange facilitator. Hopefully, you had an exchange facilitator and didn't try to handle the 1031 sale and reinvestment on your own, in which case, there would have been a taxable sale.
Assuming there was a valid 1031 exchange via an appropriate facilitator, there is a tax form (8824) that needs to be attached to your corporate tax return documenting the details of the 1031 exchange. Part of that form includes a calculation of the cost basis of the new replacement property. This calculation takes into account the cash given, the cash received, the debt assumed or paid off on the old property, the debt assumed on the new property, as well as the adjusted cost basis of the old property.
Using simplistic numbers and assuming that you essentially swapped one property for another that was worth $40,000, the adjusted basis of the replacement property on the corp books will be the exact same basis as the old property. In this case, that means it would be $5,000. A 1031 like kind exchange is technically a tax deferred exchange. This means that if you were to sell (not exchange) the new replacement property for $40,000, the gain from the original property would pop up and be taxable.
This is a very basic principle which any competent professional tax advisor should have no problem explaining to you.
Good luck. I hope this helps.
Residence Converted From Rental
Subject: 1031/primary residenceDear Mr Kerstetter,
I very much enjoy reading your information and I have a question about Primary/1031 combo.
We moved into one of our rentals just over one year ago (7/05) and now my husband has a job offer in TX.
My tax man says if we sell now we must recapture $27K and have a cap gains around $100K . Since we have not had the property for 5 years. Since we have not lived in it for 5 years the 2 year exemtion does not even come into play, not even a portion.
Is this your take on the IRS ruling? If not what is the ruling?
More Info Please:
Was the former rental property that you are now living in acquired as a replacement property in a 1031 exchange?
The answer to that will determine my response to your query.
Yes we did a 1031 in 7/03 then moved into the house in 7/05.
I did read your information on resident/1031 and see that it agrees with our accounting that we need to keep it 5 years. So here is the final link to the question. Since we will be moving out before our 24 months in the property due to a new job in TX and this does fit into the exclusion. How long is the exclusion recognized. Can we move out before our 24 months under the exemption and then keep it until our 5 years is up and then sell it and use the exemption at that time? Or do we need to rent it and then 1031 into another rental.
You are feeling the effect of the recent law limiting the use of the Section 121 exclusion for homes that were originally acquired as part of a 1031 exchange. This means that the home you are currently occupying is statutorily ineligible for the tax free exclusion if it is sold any time before July 2008, five years after you acquired it. This provision of the law does not allow for the pro-rated exclusion, which would be available to you if you had just purchased the home directly instead of as a part of a 1031.
As I'm sure your tax advisor showed you, a sale of this home before that date would not only subject the gain on this home to taxation, but all of the previously deferred gains from the earlier properties as well. This will include the higher rate on depreciation recapture, as well as California state taxes.
There are some different options for you to consider. Holding onto the house until July 2008 and then trying to use the Section 121 exclusion is a slight possibility; but not a completely safe one. As you can see in IRS Pub 523, most of the language describing qualifications for the reduced exclusion mention a job related sale and not a job related change in occupancy. It's obviously a fine distinction, but one that could cause problems with a sale so long after you vacate the home.
Depending on how much your gain is, the pro-rated exclusion maximum may not be enough to shelter all of the profit. However, if the Texas gig doesn't last long and you move back into the Calif home, you have a potential to meet the 2 out of 5 year rule for real.
You would also still have some depreciation recapture to pay taxes on. You also need to decide what you will do with the Cal home while you wait out the time until July 2008. If you rent it out, you will add to the depreciation recapture, plus make the property's character more positively appear as rental than personal. For example, if you were to sell it in late 2008, looking back five years previously, most of the time would have it used as rental, with a small percentage as your primary residence.
If, on the other hand, you leave it empty as a personal second home, you may have a cash flow problem if there are mortgage payments to make.
While there is obviously no perfect answer to this quandary, you may want to give serious consideration to converting your home back to rental and then disposing of it via a 1031 exchange into rental property or properties in Texas, which will be easier for you to manage.
Anyway, those are the thoughts that came to me as I reviewed your emails. I hope they help you work out a suitable strategy. Good luck.
Good Morning Mr. Kerstetter,
My husband and I are amazed at how simply and complete you have made the explanation so we can understand our options. Thank you.Now maybe I have one other option. The house is free and clear! I am a real estate broker here in CA, so I list the property but it doesnot sell for 1.8 years. As you know our market is very slow. In my neighborhood we have only had one closed escrow this year.So before we move I list the property and rent it to a tenant with the understanding that it is on the market for sale. But do to the market the house does not close escrow until July or Aug of 2008. Would that show our intent to sell the house upon acceptance of the job but market trend did not allow us to sell. Would that show intent to keep the use of Section 121?
Even if the job in TX does not last we intend to keep TX as our primary do to no State Tax we are both 58 and our $$ is in bank accts. and not all our rentals have been 1031 into TX. We will come back and buy a condo in CA for a 2nd home in a few years when the market settles.
PS. Are you sure you don't have room for one more client. My tax man says I am always coming up with situations that challenge him.
You can try that approach; but you had better maintain extra tight documentation of the fact that you were honestly trying to sell the home for a reasonable price for the area. As you should know, the burden of proof that you are entitled to use the reduced Sec. 121 exclusion rests completely with you; so you need to feel very confident that you have plenty of documentation to support your case. Your tax advisor should be able to help you compile that documentation so that it is sufficient to provide him/her with the confidence to be able to claim the exclusion.
You should clarify with your current tax pro the meaning behind his comment. A good tax advisor should welcome challenging issues such as yours. They are what help us learn and grow as tax practitioners. I learn new things about the tax laws every single day, from work with my clients, as well as from emails from readers. If your current advisor is telling you that because he doesn't want to have to deal with anything new, it is time to find a new tax pro. If he is saying that to point out that you are making him stretch his brain, that's not a reason to be concerned. I say that a lot to some of my clients whose transactions force me to delve into new and interesting areas of taxation that I would never otherwise be involved with.
Thank you for all your advise and information.
1031 & Residence
Subject: 1031 as primary residence
I recently sold my rental as 1031 exchange. I had separated from my spouse and was living in an apt. My husband did not want to reconcile the marriage. since I have a chronic sickness, I can only work parttime as a substitute teacher. thus I had to give up my apt and move into the 1031 as my primary residence 3 months after selling it. I know I have to pay taxes to the state and Fed geovernment, but I do not have the money. How do I ciontact the government and tell them about my situation? Who and where do I contact them? Will they allow me to pay on installment? Please let me know.
There are far too many issues to go over for me to be able to cover everything that needs to be addressed; so you should be working with an experienced tax professional.
Unfortunately, we don't have anyone 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.
Your email is a bit confusing in regard to the actual chain of events. It can be interpreted in different ways. if you did a 1031 exchange and then moved into the replacement property, effectively converting it into your primary residence, that event doesn't constitute a taxable event. If you then sold that property, there would be some taxes to worry about; but if you still own it, there would be no taxes at stake.
If you were in the middle of a 1031 exchange and cancelled it because of your marital problems, that would create a taxable event.
A good tax pro can untangle what really happened and help calculate your taxes to be the lowest legally required. If that result ends up with a balance owing to the IRS and/or State, they will accept installment payments (with interest added) until you are paid in full. The absolute worst thing to do is not file an income tax return because you don't have the money to pay.
Your email doesn't say in which year you sold the property; so I don't know whether this tax issue is a current one (sale in 2005 or earlier) or a future one (2006) that you will have plenty of time to prepare for since 2006 taxes aren't due until April 16, 2007
I wish I could be of more assistance; but I wish you the best of luck.
SUV Trades & Sec 179 Recapture
From a Reader:
Subject: suvI have spent 2 days trying to nail down the answer with my accountant and on the internet. You have a question posted on your website that’s similar to my question-but of course not quite. I think this is a problem that a lot of people are going to be coming up with because of gas prices.I have an SUV, over 6000 lbs purchased in 2003 for $50,000 using the section 179 SUV 6000lb deduction. I now would like to trade it in for another SUV that does not weigh 6000+lbs. If I trade the car in, it will be traded in for about $30,000 and the new SUV will be purchased for $22,000 with the left over trade in value (after p/o of loan) going towards the $22,000. Will I have to pay recapture on the full $30,000 (trade in value), or just on the difference between the $22,000 and the trade in value?Sincerely,
I need a little more clarification before I can provide an answer. You have Section 1031 issues here, as well as possible Section 179.
What is the current loan balance on your 2003 SUV?
What is the total purchase price of the new SUV - $22,000 or $52,000?
What will be the total of the loan you assume on the new SUV?
What percentage of the miles you drive the new SUV this year will be for business?
Thanks for replying. I filled in the answers below.Sincerely,
What is the current loan balance on your 2003 SUV? $24k
What is the total purchase price of the new SUV - $22,000 or $52,000? The new suv would be $22k
What will be the total of the loan you assume on the new SUV? I will receive $8k for the trade in and that will be put towards the new suv-making the loan amount $14k
What percentage of the miles you drive the new SUV this year will be for business? 100% I have a second car that's used for personal miles
I read on the internet that you cannot trade in a 6000lb suv for one under 6000lb as a like kind exchange-is that true as well?
Thanks for the additional info.
It sounds as if you are under the impression that there could be Section 179 recapture based on one or both of the following.
1. Trading a vehicle that weighs more than 6,000 pounds for one that weighs less because the lighter one only qualifies for a much lower maximum Section 179 deduction. That on its own would not trigger a recapture unless the new vehicle were to be used less than 50% for business. What would happen is the zero rollover basis from the old SUV would leave very little to nothing available for future 179 or depreciation on the new one.
2. Trading a vehicle that weighs more than 6,000 pounds for one that weighs less because they are not considered to be like kind for full Section 1031 deferred gain treatment. This is also not true. Vehicles less then and over 6,000 pounds are considered to be like kind by IRS. Whoever told you otherwise was wrong.
However, from the figures you provided, there will be approximately $10,000 of Sec. 179 recapture because you are failing to meet the equal or higher cost requirement for your trade. You are essentially selling your old SUV for $32,000 ($24,000 loan payoff + $8,000 equity) and reinvesting only $22,000. The remaining $10,000 of unreinvested proceeds will be taxable as Section 179 recapture. Looked at in a slightly different way, with the exact same results, your $24,000 relief of debt is $10,000 lower than the new debt you are taking on, triggering a taxable recapture.
I'm not sure how locked in you are to the $22,000 SUV. While I am not an advocate of spending money just to increase deductions, it is a fact that many people in this situation would seriously consider buying a new vehicle that costs at least $32,000 so that there would be no taxable recapture to worry about. You should have your personal tax advisor crunch some numbers to estimate how much Federal + State tax that $10,000 recapture will probably cost you. The actual taxes will be based on your expected tax brackets.
I hope this helps. Good luck.
Hi Kerry,Thank you so much! I really appreciate your time to answer my question. I feel a bit better-though disappointed I can't get the car I want. To funny-considering I'm going from a Volvo to a Honda element. So basically I have to choose a car that costs more. Who would've thought. Anyway, I forwarded your info on to my accountant and will have him run numbers for me so I make the best decision. One thing I did consider was buying 2 of the elements, but I'll talk to my accountant about that. Thank you again and have a cool summer!Sincerely,
Fully tax free exchanges have always required acquiring replacement property costing at least as much as the net sales price of the old one.
There is no requirement to go from one vehicle to one. You can exchange into multiple ones. However, you have to be careful that each of the replacements is used more than 50% for business or else it will trigger some Sec. 179 recapture.
Kerry,Do you do taxes for people in Maryland?Sincerely,
I wish I could help; but I already have too many clients to take care of properly; so we are still trimming back on the difficult clients and are not accepting any new ones at this time.
Unfortunately, we don't have anyone 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.
I wish I could be of more assistance; but I wish you the best of luck.
Thank you Kerry,And I will be sure and save you in the favorites!Sincerely,