Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for April, 2006

Bad Planning

Posted by taxguru on April 30, 2006

The same applies to tax planning.

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Vacation Rental

Posted by taxguru on April 30, 2006

 

Q:

Subject: Vacation Home Investment
 
Hi Kerry,
 
I plan to build a vacation rental in a couple of years.  The house will be used exclusively for business purposes and rented out by the day , weekend or week.  I will manage the property myself.  My question is . . . . is this activity a small business which I report out on Schedule C or a passive rental activity which I report out on Schedule E?  What is the determining factor(s).  If I have a choice as to how to report, what should I consider in making my decision?  My own research of IRS pubs seems to indicate that this should be treated as a small business but I keep seeing material on the web which seems to indicate otherwise.  Thanks.  You are the best.
 
Regards,

A:

That would be reported on Schedule C.  The break point is either that the average use of the property by renters is seven days or less, or 30 days or less and you (the owner) provide significant personal services along with the rental, such as cleaning and maintenance work.

As I constantly stress, trying to navigate the tax world without the assistance of at least one competent professional tax advisor is extremely dangerous. Your question, which any experienced tax pro could help you with, proves that you need to start working with one ASAP.   Any experienced tax pro can help you with that, as well as with maximizing all of the other kinds of deductions that are available for rental properties.

Good luck.  I hope this helps.

Kerry Kerstetter

 

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Sec. 179 Via S Corp

Posted by taxguru on April 30, 2006

 

Q-1:

Subject: Section 179 expensing
 
Mr. Kerstetter,
 
I am writing to see if you may be able to help me with my confused state.  In 2004 I purchased an airplane with the plan of placing it into service at a local airport as a rental for student pilots.  I was advised, by my accountant, to form an S Corp and purchase the airplane.  I placed the airplane into service in the 1st quarter of 2005 and kept it in service during all 4 quarters.  As it turns out it was not a profitable venture and I was negative approximately $15,000 (Profit/loss).  I had planned on taking a 179 expense however due to the business income limitation I cannot take the expense however I can carry it over to 2006.  As an aside a business venture such as this has no hope of ever being significantly profitable.
 
My question is would I be in the same situation if I had set up my company as an LLC?  As an LLC entity would my ordinary income be included in the business income limitation?  Is the business income limitation handled a little differently from an S Corp and a LLC?  Is there anything I can do to remedy this situation?
 
Thank you in advance for your assistance.

A-1:

Multi-member LLCs are treated essentially the same as S corps tax-wise, including with Section 179.

If you had set up a single member LLC and elected to treat it as a Schedule C sole proprietorship for tax purposes, the Section 179  expense would have been matched up against all of the earned income on your 1040, including from W-2s, most likely increasing the actual usable deduction.

Did you go over these different options with your accountant beforehand, or was he the kind who believes in a “one size fits all” S corp for everyone approach, without adequately analyzing the various factors first?

Kerry Kerstetter

Q-2:

I guess my accountant was the “one size fits all mentality.”  I thought I was doing the right thing by going to him BEFORE I set up any business entity and even told him specifically (in 2004) I wanted to be able to take advantage of section 179.  I also spoke with an “aviation specialist” tax attorney who also recommended incorporation as an S Corp.

Without the 179 expense I owe $14,500 in Federal taxes, if I could (magically) be able to take advantage of the 179 expense I would have a $25,000 refund.

I have filed an extension and not have filed any returns as yet.  Do I have any options?

Best regards,

A-2:

With no income expected, it does seem rather careless to use an S corp if your goal was to maximize the Sec. 179 deduction.

What I have seen in cases just like this that I have worked on is that it often comes out okay by forgoing the Sec. 179 and just claiming normal or accelerated depreciation, which can be used to create a net loss that can flow through to your 1040 via the K-1.  If your preparer enters for Sec. 179 in his tax prep program, that will create a carry-forward for that amount and reduce the depreciable basis, resulting in much lower depreciation deduction.  While you won’t get the huge Sec. 179 deduction all in one year, you will still get large losses for the depreciable life of the plane.

Good luck.

Kerry

Q-3:

Kerry,
 
Thank you. I am not sure careless is a strong enough word, as I said I was specific with my accountant that I wished to take advantage of the 179 expense.  Since the business was not profitable I “retired” the aircraft from service.  At present I am only looking at a deduction for 2005.
 
I will also be looking for a new accountant.  Can you make any referrals in the Denver area?
 
Again, thank you for your assistance.
 
Best regards,

Q-4:

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.:

Good luck.

Kerry Kerstetter

Follow-Up:

Kerry,
 
This has been an expensive lesson for me.  My accountant has become a friend and I hope to keep him as a friend but he has proven to me that he can no longer be my accountant.  This misstep in tax planning impacted a commercial investment which hinged on the tax savings from the 179 expense; a plan I have discussed in detail with my accountant.
 
I would like to thank you again for you kind and thoughtful advice.  I can’t tell you how much I appreciate it.  I have lost some sleep over my situation
but I realize I have many other blessings in my life and I am thankful for them.

Best regards,

 

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Leasing To Self

Posted by taxguru on April 30, 2006

 

Q:

Subject: Lease from Self

I am part owner of several corporate entities, Health Care Facilities,  Fast Food stores and Real Estate.  We have owned these properties for several years, consequently the majority have been depreciated ou,t specifically the equipment.  My question is, is it possible to use a corporation to buy the equipment from the entities and lease the equipment back to them and thus re-establishing depreciation on that equipment.  Be aware that there is common ownership among these entities.  What would be the benefits of this and what would be the drawbacks or negatives.

A:

This is the exact kind of thing that you should be discussing with your personal professional tax advisor.

What you will probably find out, if your tax pro runs some numbers for you, is that your plan would end up costing you more than it saves.  In order to inflate the values of the assets for higher depreciation, the selling entities will have to report gains, including depreciation recapture, which would be immediately taxable.  The higher depreciation deductions would be spread out over the next several years of the assets’ lives.  Paying lump sum higher taxes now for higher deductions over the next five plus years seems to be counter-productive.

However, your entities may have large net operating losses, or other large deductions that could offset the sale profits.  Your personal tax advisor can help you see if that is the case.  However, if s/he does decide that such a sale makes sense, you will nee to be extra diligent in documenting the values you place on the assets.  IRS automatically regards such sales (aka churning) between related parties with suspicion, especially when there will be a tax savings opportunities.

Good luck.  I hope this helps.

Kerry Kerstetter

 

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Reporting Income

Posted by taxguru on April 30, 2006

 

Q:

Subject: small question
 
Hi, I am 20 years old and i am trying to figure something out. I noticed you posted on google groups, so I thought you cold help.

SO, I am in college and I have had 4 jobs last year. Two on campus jobs and two jobs in the summer. For one of the on campus jobs i am paid from an off campus firm. I am paid $40 a week. I have never met the people who pay me, and they do not submit a w2 form. I noticed this when dealing with finical aid. Am I going to jail? Or doing something illegal?

A:

All income you receive is taxable, whether or not the payer submitted a W-2 or 1099.

Get with a professional tax preparer ASAP to calculate your taxes for 2005.  You probably won’t owe any actual income tax, but if no tax was being withheld from your paychecks, there is a good chance you will at least owe the 15.3% self employment (SE) tax.

Good luck.  I hope this helps.

Kerry Kerstetter

 

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Renting Out Inherited Home

Posted by taxguru on April 28, 2006

 

Q:

Subject: Rental property
 
LOve reading your blog!!!
 
i inherited my mothers house when she died.   now renting it out.   how do i figure out the depreciation on it for my taxes?   mother bought it for 61,000 in 1987 but city has it assessed for 135,000.

keep up the posts!!!

A:

Your cost basis of the inherited property is its fair market value at the time your mother passed away.  If an estate tax return was filed for her, you would use the value shown on the 706.  If the estate was small enough not to require a 706, you should ask a local Realtor or appraiser to give you a value.  Most Realtors will run a CMA (competitive market analysis) for you for free, hoping that you will remember that when you decide to sell the property.

I’m glad that you like my blog; but it seems that you are missing one of the main themes that I thought I was stressing; that trying to navigate the tax world without the assistance of at least one competent professional tax advisor is extremely dangerous. Your question, which any experienced tax pro could help you with, proves that you need to start working with one ASAP. 

Just establishing the overall fair market value of the property is just the first step.  Next, you will need to allocate that between the values for the non-depreciable land and the depreciable building and components (appliances, fixtures and other separately identifiable items).  Any experienced tax pro can help you with that, as well as with maximizing all of the other kinds of deductions that are available for rental properties.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

thanks for the quick response. i guess i should get a tax pro like you said. you know what they say — an ounce of prevention is worth a pound of cure!!!!
 

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2008 Cap Gain Rate

Posted by taxguru on April 28, 2006

 

Q:

Subject: 2008 Long Term Capital Gain

I understand that the 2008 LT CG tax rate for filers in the 10 % 15% bracket is to be 0% on the LT CG.

Assume the following:
Filing status Married, filing jointly
Taxable income of $30,000 (before LT CG)
LT CG (held over 15 years) $700,000

Is the entire $700,000 LTCG at 0% tax

             OR
is it just the amount from $30,000 up to the (approx) $62,000 taxed at 0%, then at the 15% rate for LTCG for filers in the brackets above 15%

If the filer could arrange to keep their 2008 taxable income in the 10 or 15% bracket(before LT CG) this would seem to be an outstanding opportunity to sell highly appreciated capital assets in 2008.

OR, am I missing the real facts here?

 

A:

It is a common misconception that the special low tax rates for LTCGs apply to the full amount of gain.  A you can see in the Schedule D tax worksheet, that isn’t the case.  The various tax rates are applied sequentially, to the income in the different lower tax rate brackets.

In their divine wisdom, and as part of their smoke and mirrors style of budgeting, our imperial rulers in DC have given a special deal for only 2008 LTCGs, where the gain that would normally be subject to a 5% rate will be given a zero percent rate.  This means that you would use the worksheet and substitute 0% wherever it shows 5%.  The thresholds would also need to be adjusted for guesstimated inflation over the next few years. 

It’s always possible that this one year special deal will be either repealed or even extended.  it is difficult to predict what our rulers will do.

Assuming it is in place when 2008 rolls around,  the best way to really exploit this break would be to do what you can to get your non-LTCG taxable income as low as possible.  A good professional tax advisor can help you with the many ways in which to accomplish this.

I hope this clears up your confusion.

Good luck.

Kerry Kerstetter

 

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Sec 179 Recapture

Posted by taxguru on April 28, 2006

 

Q:

Subject: Sale of sec 179
 
Is the below comment true (specifically the ‘not subject to the self-employment tax’)? I want to know the penalties of a Section 179 that I made for 2005 for $32,000 and a business truck.

“If a taxpayer disposes of property on which the taxpayer has claimed the Section 179 deduction, the Section 179 deduction is subject to recapture in the same manner as depreciation. A taxpayer reports the sale of such property on Form 4797. The recapture of depreciation and the recapture of the Section 179 deduction on a sale of the property are not subject to the self-employment tax (Section 1402(a)(3)(C)).”

A:

That is true; but it nothing new.  Gains from sales of business equipment, including depreciation recapture, have always been reported on Form 4797, which is not counted as self employment income.  Section 179 is really just a form of very accelerated depreciation.

Your personal professional tax advisor can explain how this affects you in more detail.

Good luck.

Kerry Kerstetter

 

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LLC vs S Corp

Posted by taxguru on April 28, 2006

 

Q:

Kerry,
 I think I have asked you before and apologise if you have already answered me.  I’m involved in a couple LLC and a couple Sub S Corporations. Currently they are all loosing money. ie interest, dev costs, etc. 06 will produce a big profit from one of the sub s’s. I am about to enter into another partnership. My attorney tells me he see’s absolutely no difference in the two from a liability point of view.  Do you feel there is a difference from a tax point of view?

A:

If the LLC chooses to be taxed as either a partnership or S corp, it is treated exactly the same for tax purposes as a regular S corp is.

Kerry

 

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Posted by taxguru on April 27, 2006

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