Q-1:

Subject: Tax info on your blog

 

Kerry, I found your blog and feel you are the only person I have found who is up on the question I need answered. Here is what I have:

 

First off, I am a Real Estate Broker. I own my own business and work out of my house. (write off a portion for business) I bought a 2004 Nissan Armada in November 2003 to get in on the tax break. It was priced at I think 33,300 but with tax it was around 35,000. My tax person said I got most of the writeoff but not all. I didn’t understand. I don’t think he gave any bonus depreciation if there was any then. He said I can only write off actual expenses such as tires, gasoline, oil changes repairs. Of course, it is under warranty so the expenses are low except gas. I was hoping to get mileage but he says I can’t. Also besides the first year, I got no further depreciation I was told. Again, I am pretty sure there was no bonus depreciation in 2003. Maybe there wasn’t supposed to be, I don’t know.

 

So the one time break was good but now it is hurting me. I called him a couple of weeks ago and asked him how long I had to keep it before I could do it again. And also what is considered to be the useful life? He said I can buy again in 2008 (5 years) and do it again but this is the example I got. If I trade it in on a 45,000 SUV (which I have to have) and get a 20,000 trade-in, I can only write off the 25,000 difference. Thats it. Then I don’t get mileage still. Is there a point, it is said to be at the end of its useful life as far as recapture goes? Or say if I were to sell it, do I have to pay a recapture back? I am not planning on doing that without getting something else as it is a business vehicle. I have 3 others at home to drive. I haul signs etc, and show multiple people so need the 3rd row seating. No way for me to go back to something smaller so I want to take advantage any way I can of tax breaks. The article below said I can write off mileage if I office at home.

 

I found an article on Smartmoney.com that says this:

 

Next, Play the Home-Office Angle

As mentioned above, the lucrative Section 179 write-off is available only when you use your heavy SUV, pickup or van over 50% for business. Your business-use percentage is based on your business and personal mileage.

Unfortunately, this over-50% business-use test can be difficult to pass. You’re much more likely to clear the hurdle if you can also claim a principal place of your business is an office located in your home. Why? Because then all the commuting mileage from your home office to various temporary work locations (client sites, etc.) will be considered business mileage. Ditto for commuting mileage between your home office and any other regular place of business — such as another office you keep in the city. (Frustratingly, if you only have an office outside your home, your drives between home and office won’t count as business mileage.) You can also treat all the mileage between your other regular place of business (that office in the city) and your various temporary work locations (client sites, etc.) as additional business mileage. Source: IRS Revenue Ruling 99-7.

More business mileage also means a bigger first-year Section 179 deduction. For example, a $60,000 heavy non-SUV used 100% business means a $60,000 first-year write-off (100% x $60,000 = $60,000). In contrast, 70% business use cuts your deduction down to $42,000 (70% x $60,000 = $42,000).

Last but not least, your home-office deduction counts as a business write-off as well. As such, it reduces your federal income-tax and self-employment tax bills. And as if that’s not enough, you’ll probably also get a state-income-tax write-off.

All that — plus the option of showing up for work in your pajamas. You just can’t beat it.

Making Your Home Office a Principal Place of Business

So how do you make your home office a principal place of business if you haven’t done so already? The tax law gives the self-employed types (sole proprietor, partner or LLC member) two ways to qualify:

1st Way: You conduct most of your income-earning activities in the home office.

2nd Way: You conduct your administrative and management functions in the home office. However, to take advantage of this taxpayer-friendly qualification rule, you can’t make substantial use of any other fixed location (like that other office downtown) for your administrative and management chores.

For either qualification rule you must use your home-office space regularly and exclusively for business purposes during the year in question.

 

I just feel like since I don’t know exactly how this works, I am leaving money on the table. Maybe I am wrong and am getting correct information, but when I ask, it usually takes me a couple of weeks to get an answer from someone he consults with. He is an auditor for the State of Texas health systems and also does taxes. He was a client of mine I sold a house to years ago so I got him to do my taxes. They were easy and basic at the time. Now they are more complicated and we are making more money. We need as much tax write offs as we can get. Taxes are going to eat us alive this year as we will be hitting probably well over the 200k mark this year. the (including wife making 100k or more)

 

My house is almost paid for and will be paid for this year. That was my goal. It was paid down so low anyway, I didn’t pay that much in interest. Maybe 4,500 a year and going down each year. I still pay taxes and insurance of course and usual business expenses. Sorry for this long message. Again, I was glad to find your blog as I could tell you knew what you were talking about. I am impressed.

 

My wife is upset with me and wanting me to get someone else to do my taxes. It is very awkward and I just need to know this has been done correctly. If you need any more info I can provide it. I am not sure you even answer questions like this. I need these specific answers and not general ones which I have been finding.

 

Plus for 2008 is there the same tax break or would I need to do something this year? Again, my tax guy says 5 years, not sure why as I sell Real Estate and don’t understand this suff. If you can answer these questions or direct me where to go, I would greatly appreciate it.

A-1:

It’s very obvious that you have outgrown your current tax pro and need one who is full time and experienced in working with clients to reduce their taxes, as well as explain simple issues to you like the topic of vehicle depreciation.  There is nothing complicated with any of the topics you raised in this email; so there is no excuse for your tax pro having to find answers from someone else.  Any competent tax pro should know every one of these points off the top of his/her head.

If you are making that kind of money in real estate, the vehicle deductions are small potatoes in comparison to other very easy tax savings strategies that you should be using.  For example, using a C corp could easily reduce your annual taxes by over $20,000.  I have seen this happen with several clients who are real estate pros.  A good tax pro should have no problem finding ways to save you huge amounts of money.  Only you can decide if it’s worth $20,000 a year in easily avoidable taxes in order to not hurt the feelings of your current part time tax advisor.

There are obviously some basic factors involved with your vehicle depreciation that you are very confused about.  As I said, a good personal tax pro will be able to explain these in more detail with your specific numbers; but here are a few key points that seem to be messing you up in your understanding of how vehicle deductions function.

While the cost of business vehicles above what has been expensed via Section 179 is required to be depreciated over five years, there is no minimum amount of time that you have to keep a business vehicle.  You must be misunderstanding your tax guy in regard to having to wait until 2008 to buy a new business vehicle.  You can sell it or trade it in at any time.   I used to have a Realtor client who traded in his vehicles every six months for new ones because the image of new vehicle was more important to him than the thousands of dollars he was losing on each one. 

The tax consequences will be different under each scenario,  Before decoding whether to sell or trade, what is critical to know is the adjusted cost basis of the vehicle; which is generally its purchase price less depreciation and Section 179.  If the sales price is higher than the adjusted cost basis,  you will have taxable gain on the depreciation recapture.   If the sales price is less than the adjusted cost basis, a sale could generate a deductible loss, depending on the business usage percentage.

On the other hand, if you trade in the vehicle on a new one (new to you that is), any gain from the trade-in value exceeding the cost basis is not currently taxable, but reduces the cost basis of the replacement vehicle.  This is calculated on Form 8824.  If your trade in allowance is less than the adjusted costs basis, the loss isn’t currently deductible, but is added to the cost basis of the new vehicle, also on Form 8824.  

As in your example, the Section 179 expensing can only be claimed on the excess over the trade-in allowance because this is the value of the newly acquired asset.  As with any mixed use assets, the deduction can only be claimed for the business usage percentage of the newly acquired value.

Another area of confusion you have is with which method of vehicle expense deduction you can use.  The IRS standard per mile rate includes an amount for depreciation based on the straight line method.  If you choose to claim accelerated deprecation, which includes Section 179 expensing, that vehicle is not allowed to use the standard mileage rate and must continue to use the actual expense method for as long as you own that particular vehicle.   This is quite fair because to allow you to switch would effectively allow you to over-depreciate the vehicle.

I have been maintaining a page on my main website dealing with Section 179, with the annual limits, for several years now.
 
You can see what the maximums will be at least through 2010, subject to any future changes in the tax law.

I hope you find these comments useful. Most important, you need to work one on one with a full time tax professional who can help you save on your taxes.

Good luck.

Kerry Kerstetter

Q-2:

Kerry thanks so much. I really appreciate this and it is alot to absorb. I had a friend who is a home inspector. A few years ago we were talking and he said he formed a C corp. I asked him why and he said he is saving on taxes. We talked further and after we talked, I discovered we made the same exact amount of money that year which was a coincidence. He told me how much he has paid in taxes and said he had very little write offs except miles as his work doesn’t use materials only his expertise. Plus he didn’t advertise. I had tons of deductions and paid twice in taxes what he did. I called my tax guy and he said it would not benefit me to do it. At the time, I wasn’t making a huge amount, just average. I will be making over 100k a year just myself, probably quite a bit more as it usually is. I am at 40k already this year, and my wife makes about 125k. So we will be hitting closer to 250k a year this year on. This opened my eyes.

 

He did tell me I had to wait 5 years to trade but he must have meant in order to not get a big tax penalty. I do need to sit down with someone and learn this stuff so I am more educated about this end since taxes are for sure going to be a huge issue. Here is what I thought:

 

If I trade in my vehicle that I paid 35,000 for say for a 45,000 vehicle and drove it five years (although don’t know where that came from) I know that I took the up front deduction in 2003 for my current vehicle so that was 35k but I have to confirm that as he had told me we didn’t take the whole thing the first year. It has been a while so I need to investigate. I know we haven’t done any further depreciation after year 1. That much I know. I figured after the up front ne time write off was it. I know for a fact that is the only time we wrote anything off on it except actual expenses. Here is what I was wanting to do possibly.

 

I bought in November of 2003 for 35,000 total including tax. I want to buy a vehicle around 45,000 (or more) in 2008. I thought if I wrote the first year off and it sold for say 20k, and I bought a vehicle for 45k, I could take the 25k exemption that year. (the difference) Plus I am not sure how it would depreciate out after that. So this is what I thought. I really didn’t want to trade anyway until 2008. I think he said I would have a huge recapture if I traded any earlier than 5 years so the longer I have it, I guess the less it is worth was his thinking also. And yes, I could have misunderstood some of these things. 

 

You for sure know your stuff and it will hard to find someone so educated about this stuff. I wonder how much money I have lost already. Thanks again, I really appreciate your taking the time out of your busy schedule to answer these questions for me. I will talk to another CPA this week for sure. One that does it for a living.

A-2:

Your tax person is sounding more and more “dangerous” to your financial health with each comment you make.

He is obviously one of the many “tax pros” who are scared and uneducated on how corporations work; so they tell their clients they are a waste of time.  The fact that a properly used C corp could very easily save you over $20,000 per year doesn’t seem to be a concern of theirs. 

The very ironic thing is that C corporations are very easy to work with.  I have gone through this learning curve with several people who have worked for me who were scared of corporations when I assigned them their first ones; and then discovered that they are actually much easier to work on than individual 1040s.

You are still making some misstatements regarding vehicles that I need to clear up for your benefit and that of my readers.  You should have a depreciation schedule showing how much has been claimed in Section 179 and normal depreciation for that vehicle as of 12/31/06.  Subtract the accumulated depreciation figure from the original cost of the vehicle to arrive at your adjusted cost basis (aka Book Value).  If you sell that vehicle for any more than that figure, there will be taxable depreciation recapture.  This applies to a sale in six months or 20 years.  There is no “waiting out” period where you can sell an asset for more than its adjusted cost basis without having a taxable gain.

If the vehicle is traded in, the gain is deferred into the replacement vehicle and not currently subject to tax.  Again, this applies to a trade at any time.

The only actual time triggered issue has to do with a vehicle on which you claimed Section 179.  If you still own it and its business usage drops below 50 percent within five years, you will have to recapture a proportionate amount.  This time triggered issue does not apply if the vehicle is sold or traded within the five year period.

Again, these are all very basis tax concepts that any competent tax pro should be able to explain to you off the top of his/her head.  You need to start working with one ASAP. 

Good luck.

Kerry Kerstetter

Q-3:

Thanks Kerry, For sure I am going to get this resolved this week and have someone professional do my taxes and set me up a corporation. That is not even a question in my mind anymore. Ok, I just pulled the depreciation schedule from 2005 taxes. It has some stuff listed under the part about 179 but I have equipment so I went to page 2 and found my vehicle listed.

1. 2003 Armada it says (it is really a 2004), Date placed in service is listed at 12/12/2004. I placed it in service November 28 I think, of 2003 so I could get the 2003 writeoff.
2. Business use – 96.11 percent
3. Cost or other basis 27,000. Not sure how I got that unless he took my old vehicle I sold my brother for 6,750 and added that to the 27,000 which would be about right. I had the other one 5 years or so.
4. Basis for depreciation – 0
5. Recovery period – 5 years (now you see where I got the 5 years from)
6. Method/Convention – 200DB/HY
7. Depreciation Deduction – 0

He goes to section B and lists my miles but he doesn’t give me a write off for miles. That he has told me. You said that was correct also.

So from reading over this, it seems I got a one time deduction up front of 27,000 in year one and that was it. Now you see where my misstatements came from.

On page one it had listed computer equipment I bought for 179 deduction, no carryover listed in line 10 (carryover of disallowed deduction from line 13)

So now you have all the info. This was 2005 and I bought the vehicle in 2003. I got the 27k up front and that was it. Nothing showing on here unless I am looking at the wrong part but there isn’t much to this and I think I am looking correctly.

Now I guess you can use me as an example of what not to do? Oh and I do have the home office depreciation which is pretty small. I guess when he started this my house was worth less. He has it listed as 175,000 including land. Basis of building 165,000. Actually our market is up and my house is worth around 275,000, not 175,000. Still I don’t care as much on the home office as I won’t be here but maybe another 5 years and am not keen on giving that money back when I sell. It is a case of pay me now or pay me later isn’t it?

A-3:

So, this proves that your Armada’s adjusted cost basis is zero.  This means a sale for any amount of money at any time will result in taxable recapture of Section 179.  A trade-in at any time will not trigger any taxable recapture.

Any time you buy a new piece of business equipment, such as a vehicle, you have the choice between deducting its full cost in the first year under Section 179 or spreading the cost deductions out over the item’s useful life.  You obviously chose the quickie first year deduction for your Armada.  The trade-off for that decision of yours was zero depreciation for the rest of the time you own that particular vehicle.  This should have been explained to you by your tax advisor before you submitted your 2003 1040.

While you may no longer be entitled to any depreciation on this vehicle, you can still deduct its operating costs, prorated to the business usage percentage.

Don’t fall into the trap of buying things that you don’t really need just for the deductions.  That is just plain counter-productive (aka stupid) because the tax savings don’t fully reimburse you for the amount you had to spend. As long as the vehicle is doing its job, keep it. When it is no longer suitable for your needs or becomes a “money pit,” you should trade it in on a new one.

In regard to your home depreciation, this can only be claimed based on your actual cost basis in the home.  Any appreciation in value while you own it is completely irrelevant for depreciation purposes.  It only becomes a relevant issue when you sell the home. 

Your new tax advisor should explain to you the principles of basis for tax purposes. 

I am sure that your experiences are not unique and hopefully this exchange will help others in a similar situation as yours.

Good luck.

Kerry

Follow-Up:

Well at least he did this part right. I knew it would be done up front. He told me that part. This really answers all of my concerns. Now I don’t have any incentive for trading next year as I love my current vehicle and unless something happens, I would like to keep it. So I just need to not sell it and when the time comes, just trade it in to avoid triggering a recapture. I don’t need an extra vehicle but I guess if I did drive it a few more years and then just keep it and buy a new one, it works the same way. This isn’t an issue though as I won’t do that.

 

I am deducting operating costs as he told me this. Gas, oil changes, everything else to do with it. Just not mileage. Now this all makes sense so he didn’t do everything wrong after all. He still should have helped me set up the C corp. That alone is huge. 

 

On the home depreciation part it seems he got that right also. I understand now that the appreciation doesn’t matter. Trading in not triggering a recapture is great if I need to do it as I guess I just write off the difference between what I wrote off (27,000 one time) and the new vehicle of say 45k. So in this instance 18k I can write off again. That is still good. You are right. It is foolish to trade for the sake of trading. I was actually thinking about it as I thought it would benefit me tax wise. Now I see. Again, I really appreciate your taking the time to explain this to me. It all makes sense now. I think this topic for sure would help others as you have been so thorough.