Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for January 14th, 2006

Charter Boats & Sec. 179

Posted by taxguru on January 14, 2006

Q:

Subject: Section 179

I assume you get hundred of random dumb emails so I would like to apologize if this is just another one.  To minimize the inconvenience I have attempted to keep my questions short.

I am trying to understand the 179 rules as it pertains to a business opportunity which is being promoted in the boating world.

1. My question is can you deduct the boat under 179 if used in a S or LLC structure. The purpose would be for a sailing charter business.

2 The vessel is currently in a S corp, and for sale at 550K.  Would it make sense to purchase the S Corp instead of a asset purchase and book the asset (the Boat) at 400K and the Goodwill at 150K. Thus meeting the 430,000 limitation on 179.

3. For the purpose of building basis, does making monthly payments into the corporation and have the corporation pay the finance company allow me to build basis as paid in capital.

4. Does signing for the note personal negate the 179 because of limitations on converted assets or does it act as paid in capital , once the boat is listed as a corporate asset?

Thank you for your time.

A:

You most definitely need to be discussing all of these points with your own personal professional tax advisor.  As I have to continuously warn people, this is not a place for do it yourselfers, especially when you get into S corps and dollar figures that large.  Without competent professional help, you are pretty much guaranteed to screw things up and get yourself into big trouble with IRS, which is currently undertaking a special examination program of S corps and their shareholders.

Some points in your email that you will need to discuss with your personal tax pro include the following.

1.  Purchasing assets to be leased, such as expensive boats, is very often done through the use of an LLC or S corp.  How much actual deduction the shareholders or members will receive depends on too many things (many of which are covered on my website) to be able to give anything close to a “one size fits all” answer. 

2.  Section 179 can only be claimed on newly acquired assets that are being placed into service.  If you were to buy the corp stock, no new Sec. 179 could be claimed for assets that it already owned.   If you were to set up a new LLC or S corp and it purchased the boat from the previous owner, a new Sec. 179 deduction is possible.

3 & 4.  Shareholder basis in S corp stock is far too complicated for me to detail here.  However, you are correct that the more money you pay into your corp capital account, the higher your personal basis would be.

Kerry Kerstetter

 

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More Confusion Over S Corps

Posted by taxguru on January 14, 2006

Q:

Subject: I liked your article

I liked your article.  I’m still a little naive.  Today I just sent in the S corp 2553 form my accountant gave me, signed and all, to the Dept of commerce of the state of utah.  And now after reading your article I’m a worried I should have put my foot down and demanded a C corp filing.  Up until it gets filed in a few days I’m just, and have been for the last couple of years, a sole proprietor, DBA, or what ever you call it.  2004 I made only 95k and this year I think I’ll only barely break 100k.  For what I make do I still have to be worried and switch to a C corp.  I origionally thought the C corp was the way to go but when I told my accountant this he just said, “oh you don’t want to be double taxed,…so we’ll go with an S corp.”  Me not knowing any better I just agreed. 
 
I am a consultant in that I contract directly (as apposed to subcontract) with clients to go in and help them out with back-log stuff.  I charge them an hourly fee and every week I submit my invoice and they pay me a couple weeks later.  I’m 34, married, and in 2 months will have 3 kids, and travel all over the U.S. twice a month.  So what should I do as far as my S or C corp. filing?

 

A:

Only your personal tax advisor can properly assess which entity type is best for your particular situation.  As I’ve noted, many tax and legal do take a “one size fits all” approach and set up S corps without properly looking at the big picture.  You should have your accountant go over the points I raised in my article and make sure he has properly addressed them for your circumstances.  You should be concerned if you hear a lot of “oh, I didn’t think of that” from him.

From the confusing way you describe things, it may not be too late to choose a C corp status.  Form 2553 is filed with IRS after the corporation has been chartered by your state, and a Federal ID number (FEIN) has been obtained.  Until the 2553 is sent to IRS, and it is accepted, the corp is a normal C corp.

Good luck.

Kerry Kerstetter

Follow-Up:

Thanks for responding.  I have already dropped the Articles of Incorporation with the 2553 form in the mail,..so its on its way to be filed as an S corp.  I’ll print off your article and go over it with him.  Thanks again

 

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Gifting Property

Posted by taxguru on January 14, 2006

Q:

Subject: Gift & Estate Tax

First, let me say thank you for posting your website.
It is very informative and I appreciate the time it took to provide this information on the web. 

If I may, I do have a couple of follow-up questions?

I and my father are residents of another state.  He is now 75 yrs. old and owns property in AR with a current estimated value of $600,000.  His total estate is less than $1M.  He is planning on gifting the property to me now.  I understand the value of the property would be subject to Gift Tax, but could be used against his lifetime exclusion (2006 at $2M).  Are there any AR State taxes that would come into play now or upon the sale of the property?  Thank you for your time.

A:

You and your father really should be working with a competent professional tax advisor to work out the best plan because there are some big issues to consider. 

Mainly is the issue of cost basis.  While gift and estate taxes are based on the property’s fair market value, the basis of the property for you as recipient will be the same as it was for your father.  This means that you will be accepting responsibility for future capital gains taxes (Federal + Arkansas) if you sell it.  This is very different from the cost basis you would have if you were to inherit the property from your father’s estate.  In that case, under current law, your cost basis would be the fair market value as of the date he passed away, essentially wiping out all of the accumulated gain.

There is a very simple and frequently used method to transfer property while your father is alive and avoid the basis problem.  He could sell it to you at the current market price and carry back the sales price as a note.  This would establish the higher cost basis for you.  You could then either pay off the note or your father could gift you forgiveness of all or parts of its balance.  Any competent tax advisor could help you structure this technique.  

If you all and your advisor do decide to do a straight gifting of the property, you will have to file a Federal Gift tax Return (Form 709).  Arkansas does not have a gift tax. 

You are mistaken on the lifetime exclusion amount for gifts.  It did used to be true that this amount was the same as the estate tax exclusion.  For some reason, our rulers in DC decided to uncouple the two figures  While the estate tax exclusion is $2,000,000 for people passing away in 2006, the lifetime gift exclusion is still only one million dollars and will not be increased in future years, even though the estate tax exclusion will be going up in the future, until it drops back down to one million dollars in 2011 if our incompetent lazy-ass rulers in DC don’t take any action. 

I hope this gives you some ideas of what you and your father should be discussing with your personal tax advisor.  Good luck.

Kerry Kerstetter

Follow-Up:

From your message I take it that there is an AR tax on the gain from a sale of the property?  thanks

My Reply:

That’s correct.  It normally works out to be 5.0% for long term capital gains.

KMK

 

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Posted by taxguru on January 14, 2006

Q:

Subject: Exchange Question

I’m selling a property for a more expensive one. I’m thinking about doing a 1031, a friend of mine told me I wont have to pay taxes on it if I deferr the income as personal income over a 5 year period. Reason being I lost my job because of a accident and can’t work so I have no income except for the money from this property I’m selling, part of the money will be used to buy the new property/ Can this be done or is he wrong? Should I go ahead and do the 1031? also on the new land Im buying I will be building a house to live in for two years then I’ll built another on the same property and do the same again…….Thank You

 

A:

You really need to be working with a tax pro who can go over all of the options you have.  There are several issues involved here.

The next best thing to a 1031 exchange is an installment sale, where you receive the sale price over multiple years and then report a pro-rated portion of the gain on your tax return. 

You can do a combination of a 1031 exchange and installment sale; but this usually results in 100 percent of the installment note principal payments being taxable in the year received.

In regard to reinvesting 1031 proceeds into a property that you intend to use as a primary personal residence, that is not allowed.  The replacement property has to be used for business or investment purposes.

You weren’t really clear on the type of property you are selling.  In case it is your primary residence, Section 1031 doesn’t apply.  There are entirely different rules, which you can see explained here.

Any competent tax pro should be able to help you with exactly what your situation is.

Good luck.

Kerry Kerstetter

 

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Stock Tender Offers

Posted by taxguru on January 14, 2006

Q:

Subject: Tender Offer for Cash
 
Recently BASF announced a tender offer of $37/share in cash for Engelhard.
For a long time shareholder of the latter, this takeover can be a capital gains tax nightmare. Is there a provision in the tax law which would allow for an even exchange with no tax consequences if the proceeds were invested in BASF?

Thank you.

A:

There would be a tax free swap if BASF were to give you shares of BASF stock in exchange for your Engelhard stock.  However, if you actually receive cash, that will be a taxable event; even if you turn around and buy the BASF shares on your own.

Kerry Kerstetter

Follow-Up:

Thanks for the info; another income tax disaster when long time holders are bought out for cash; reminds me of the 1994 cash buyout of American Cyanamid by American Home Products  – another capital gains windfall for the IRS. Although I regard it as an involutary conversion the IRS would say otherwise.
 
As a side note, BASF bought the American Cyanamid division from American Home Products in 2000 for $3.8 billion in cash.
 
 

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