Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for June, 2005

Partial Exchange

Posted by taxguru on June 30, 2005

Q:

Subject: Exchange Question

Yes, an exchange question…

I am debating 1031 vs cap gains, and wondering about the middle ground, a partial exchange.

I bought the property for 180 +20k improvements – 8300 in depreciation.

The selling price is 475k. Fees are 25k approx.

The state tax rate I believe is 9.3 in California as it is taxed at ordinary income.

The fed rate is 15% I think. At any rate I come up with a cap gains tax of 63k, ouch.

What if I purchased a 250k home with a 70k loan? What would my cap gains be reduced to?

Is that a good question?

A:

It’s impossible for anyone but your personal tax advisor to give you a precise figure on your possible taxes from the proposed partial exchange because it is not a simple calculation.  There are other factors that could affect your tax, such as capital losses, suspended passive losses, and carry forward investment interest.

From your figures, you are looking at a possible taxable gain of $200,000, representing the amount you are missing the target replacement price by (450-250).  The tax on that will include a 25% Federal tax on the depreciation recapture, in addition to the 15% rate on the additional gain.

To see whether a 1031 exchange with such a huge trade-down in value makes sense, have your tax person plug your numbers into his/her tax program to run the figures for you.

Good luck.

Kerry Kerstetter

 

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Income Shifting

Posted by taxguru on June 30, 2005

Q:

Subject: Question about your income shifting technique

Dear Mr. Kerstetter,

Thank you for your informative web site.  I don’t understand the income shifting technique described at taxguru.org/corps/scorp.htm, a portion of which is quoted:

“One of the most useful tools in the tax game arsenal is the ability to shift income between taxable years. … Toward the end of your personal fiscal year (12/31), you bleed off some of your taxable income to your C corp by paying it for something like rent or marketing services.  In January, your corporation can pay it back to you.  Near the end of the corp’s fiscal year, bleed its net profits out by paying yourself.”

I assume this income shifting technique requires me to own two businesses: a sole proprietorship and a C corp.; otherwise, the IRS would disallow my 1040 schedule A itemized deduction for rent or marketing payments to the C corp. as personal expenses and not business expenses. 

I further assume that my sole proprietorship needs a source of (at least occasional) income separate from my salary, bonus, or dividends as an employee/stockholder in the C corp.; otherwise, the IRS would argue that my sole proprietorship is really a hobby.  For example, if all my 1040 income originates from my C corp. and every year I file a 1040 schedule C with deductions for rent or marketing payments to the C corp., eventually the IRS is going to audit and penalize me.

I already own a C corp., so I know how it generates revenue.  But, what business is my hypothetical sole proprietorship supposed to be in and where does it get its separate income that doesn’t originate from the C corp.?  Should I have some of my customers pay my C corp. and others pay my sole proprietorship?  Wouldn’t the IRS view that as a scam?

I also fear that the money my hypothetical sole proprietorship would be paying the C corp. would be so large that the IRS would view the deduction for rent or marketing services as unreasonable. 

How do I implement this income shifting technique without getting audited and penalized?

Regards,

 

A:

There are various ways in which income can be shifted back and forth between your 1040 and an 1120. You will need to work with a professional tax advisor who understands how to properly use C corps in order to set up the best strategy for your particular situation.

A lot does depend on where the original income is from.  If it’s as W-2 wages, your options are more limited than if they are as a 1099 independent contractor.  Generally, if all income is from W-2, the income would need to be shifted via Misc. Schedule A deductions.  This is why it’s a good idea to work with your employer to convert all or part of your compensation to 1099.  That would allow you to easily use Schedules C and E, which have much greater tax saving opportunity than does A.

Good luck.

Kerry Kerstetter

 

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Houseboats As Real Property

Posted by taxguru on June 30, 2005

Q:

Subject: Exchange Question

I have a piece of bare land (investment property) that I want to exchange for a floating home. I am being cautioned that this floating home, even if we use it for investment purposes, does not qualify for 1031 exchange because it is considered personal property and therefore not a like-to-like exchange. (This may be similar in principle to exchanging for a mobile home that is in a long-term (30 year) lease.)
The best argument we’ve heard thus far is that in California, there is a law on the books where for tax assessment purposes, floating homes are considered real property. I’m told 1031 respects state law over federal.  Further, I understand it is unlawful for a person to have to pay real property tax on personal property, therefore (sort of a “if a=b and b=c then a=c” thing) we feel we would have a good argument should we be audited.
Our title company, 1031 exchange agent and real estate agent all are comfortable with the transaction. Are we taking too much of a risk?
 
Thanks for your help!

 

A:

At first, I thought you were going to say that your exchange facilitator was refusing to accept the houseboat as a suitable like kind replacement property.  I agree that a permanently docked houseboat, such as you often see in places like Sausalito, which is taxed by the county as real property, would be appropriate like kind property as long as it will not be used be you personally and will be held for rental, business or investment purposes.

This is a similar situation to mobile homes.  RVs and other large living quarters that move around a lot would definitely be considered as personal property; while permanently mounted mobile homes that are taxed by the county as real property would meet that test for 1031 purposes.  

A boat that is not permanently moored, even with living facilities, would be considered personal property and not suitable replacement property for the disposal of land.

It sound like you are on the right track. 

Good luck.

Kerry Kerstetter

 

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Karmic Justice

Posted by taxguru on June 30, 2005

This is almost as good as the developer who wants to teach anti-constitutional Justice David Souter a lesson by taking his home to convert into a hotel.

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Posted by taxguru on June 30, 2005

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Pressure on property owners to produce maximum tax revenue

Posted by taxguru on June 30, 2005

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Posted by taxguru on June 30, 2005

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How risk tolerant are you?

Posted by taxguru on June 29, 2005

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Where we are headed?

Posted by taxguru on June 28, 2005

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Alternative payment plan?

Posted by taxguru on June 28, 2005

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