Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for August, 2007

Vehicle Depreciation Recapture + Leasing

Posted by taxguru on August 31, 2007

Q:

Subject: Thanks and a Question

Kerry,

Just discovered your website today.  Very nice.  Thanks for the hours you must devote to keeping this up to date.

I found your site by researching a question on recapture rules for SUVs used in a business.  You’ve probably already thoroughly addressed this, but I’m afraid I couldn’t find the answer.  So, here’s the situation:

Client placed into service a large SUV (greater than 6,000 lbs gross vehicle weight) on 12/1/03.  He took advantage of the generous Section 179 election available back then, so has no basis left in the vehicle.

Business use has never dropped below 50%.  He is considering selling the vehicle, which has a current value of around $25,000.  Questions:

1.      What is the earliest date he could sell the vehicle without being exposed to recapture?  Is it 5 years from the in-service date (12/1/08)?

2.      Even if client waits long enough to avoid any recapture, is he still subject to tax on the sale?  If yes, is it capital gains or ordinary income?

3.      Client would prefer to lease his next business vehicle rather than trade this one in on another purchased vehicle. Is there a better way to get the next business vehicle? 

 

Thanks so much for your time.

A:

I have discussed the recapture rules on several occasions, which you can probably find by searching my blog. However, a quick review may be handy here.

For some reason, you seem to have the mistaken impression that it is possible to wait out the recapture requirements.  That is the case for the Section 179 recapture requirement while still owning the vehicle.  However, that is not possible for a sale.

It is always important to keep tabs on the adjusted cost basis (aka book value) of business assets so that you can know what any potential gain or loss would be triggered by its sale.

Basically, the book value is the original cost of the asset less the depreciation (including Sec. 179) claimed up to the point of sale.  In your case, if you expensed the entire cost of the SUV, its book value is zero, which means the full amount of any sales price will be taxable at the 25% Federal depreciation tax rate, plus state tax if you are in a taxable state.  This would be the case if the sale took place now or 50 years from now.

Before a sale, there is a potential taxable partial recapture of the Section 179 if the asset’s business usage slips below 50% in the first five years after you place it into service while still owning it.

If you are disposing of the SUV in order to acquire a newer model, there will be no taxable recapture if you trade in your existing one on the purchase of a new one costing at least as much as the old one is worth and you receive no cash or net relief of debt.

Replacing the SUV with one on an operating lease won’t qualify for any tax break.  A disguised purchase lease may qualify.

I have never been a fan of leasing from a financial perspective and have longed warned about how much of a rip-off it is.  With very few exceptions, I have found that operating leases of vehicles are by far the most expensive way to finance their acquisition; often incurring an implicit interest rate of well over 30% APR.  This is even before the exorbitant charges assessed by leasing companies for such things as excess mileage and excessive wear and tear. 

Unlike conventional vehicle loans, which are required to make full disclosure of the interest rates, leasing companies are allowed to camouflage their implicit rates and even lie about  what it is.  I have actually heard employees of leasing companies deny that there is any interest charge built into their monthly lease payments.  However, since any financially competent analyst can very easily compute exactly what those charges are, I have amazed clients with the truth about what they are being charged.  This is useful in saving them a lot of money when they ask for my advice before signing up for a lease; but is disheartening news when they tell mine about the lease after they have committed to it and are faced with the reality of how much they are being screwed over.  A lease with a 30% built-in interest rate simply doesn’t seem like much of a bargain compared to a purchase loan of zero to five percent.

These are all extremely basic tax and financial principles that any competent tax person should have no problem explaining to you and your clients; so before disposing of the old SUV or acquiring a new one, a tax pro should be consulted.

Good luck.  I hope this helps.

Kerry Kerstetter

 

 

 

Posted in Vehicles | Comments Off on Vehicle Depreciation Recapture + Leasing

Reporting S Corp Income On 1040

Posted by taxguru on August 31, 2007

Q:

Subject: general question

Hi Kerry,

I have a general question pertaining to S-corps and taxes. I came across your website in my search for answers. I’m hopeful you may assist.

I have a S-Corp and the IRS recently requested I send a 1040 form for a previous year.

Must I complete the 1040 form using all of my information from the S-Corp filing – (redundancy) or may I use just my K-1 schedules and fill in the 1040.

The IRS has my S-corp submissions

Thanks Kerry for your thoughts

A:

I don’t mean to pick on you here, but you appear to be a perfect example of getting in over your head by setting up an S corp without knowing how they function tax-wise, as well as trying to handle your taxes without the assistance of a professional tax advisor.

If your S corp’s 1120S was prepared properly, its K-1 should have all of the information that needs to be entered onto the various schedules of your 1040.  There is no need to enter the individual income and expenses items that are shown on the 1120S.

Before you prepare your 1040 for 2004, you should have a professional tax advisor review the 1120S to make sure that doesn’t need to be amended.  S/he should then be used to prepare your 1040 for that year as well.

Good luck.

Kerry Kerstetter

 

 

 

Posted in corp | Comments Off on Reporting S Corp Income On 1040

Annuities Cashed In

Posted by taxguru on August 31, 2007


Q:

Subject: Annuity question

I recently had to cash in/surrender an annuity with a insurance company.  Naturally, I had to pay a surrender charge.  Is all or part of this charge a deduction using schedule D of capital gains/loss form?  Thanks.,

 

A:

I’m assuming this annuity was in your personal name and not in an IRA or other kind of retirement account.

Just like a commission and other selling costs, the surrender charge would be added to the annuity’s cost basis figure on your Schedule D; thus reducing the net taxable gain.

You really should be asking your personal professional tax advisor questions like this.  This is especially important for planning the best use of capital gains and losses for the year.

Good luck.

Kerry Kerstetter

 

 

 

Posted in CapGains | Comments Off on Annuities Cashed In

2007 California Tax Rate Schedules

Posted by taxguru on August 31, 2007

Unlike with the annual inflation adjustment for the Federal individual income tax brackets, which are released well before the next year, the California Franchise Tax Board doesn’t release its new brackets until well into the subject year. They have just now released the 2007 rate schedules

Based on previous years, the 2008 Federal tax schedules should be out in about three weeks and will be posted on my main website shortly thereafter.

 

Posted in StateTaxes | Comments Off on 2007 California Tax Rate Schedules

Posted by taxguru on August 31, 2007

The FairTax – distortions and lies – Another response to Bruce Bartlett’s hatchet job on the FairTax proposals.

 

Posted in FairTax | Comments Off on

Posted by taxguru on August 29, 2007


(Click on image for full size)

Posted in comix, TaxBurden | Comments Off on

Posted by taxguru on August 29, 2007

From the latest email issue of the Intuit ProConnection Newsletter:

Divorces Are Bad Enough. Tax Slip-ups Can Make Them Worse – Includes sample doc letter to send to clients.

 

Posted in Divorce | Comments Off on

2007 Section 179 Limits

Posted by taxguru on August 27, 2007

Q:

Subject: Section 179 2007 Limit

Hi, I love the website.  I have a quick question regarding the 2007 deduction limit for Section 179.  I see that you note the limit is $125K this year, so do other sites, but the IRS website under 2007 changes notes the limit is $112K.  Is there a quick explanation for the difference?  Is it related to Gulf Zone property?

A:

I covered the 2007 increase in this blog post from May.

I have no idea why the IRS webmasters can’t keep their info properly up to date; but this is another good example of why it is dangerous to rely on IRS for tax info rather than professional tax advisors, who are more current in their knowledge of the tax laws.

Kerry Kerstetter

 
Follow-Up:

Thanks

 

 

Posted in 179 | Comments Off on 2007 Section 179 Limits

Posted by taxguru on August 26, 2007

Fair Tax, Flawed Tax – Bruce Bartlett on the attack against the FairTax plan. If northing else, it’s good to see this as an openly discussed issue in the lead-up to the presidential election.  I’m sure we’ll hear and see the rebuttal to Mr. Bartlett’s comments from Neal Boortz before long, especially this item, which I had never heard before, and suspect is bogus:

It was originally devised by the Church of Scientology in the early 1990s as a way to get rid of the Internal Revenue Service, with which the church was then at war (at the time the IRS refused to recognize it as a legitimate religion). The Scientologists’ idea was that since almost all states have sales taxes, replacing federal taxes with the same sort of tax would allow them to collect the federal government’s revenue and thereby get rid of their hated enemy, the IRS.

 

[Update]  Neal Boortz actually posted his response to the Scientology accusation in a rare Sunday posting to his blog

SCIENTOLOGY?  ARE YOU KIDDING ME?

Frankly, it looks to me like some K Street opponent of the FairTax got to Bartlett, and Bartlett, or one of his researchers, simply failed in their due diligence. It takes no time at all on the Internet to debunk this absurd notion.  My guess is that Bartlett will be issuing an apology to Leo Linbek, Bob McNair, John Linder, Americans for Fair Taxation and hundreds of thousands of FairTax volunteers before too many day pass.

You’re asking me if I will address this on Monday’s show?  Absolutely.  See you there.

 
This should be interesting.  I must have missed the vocal support of the FairTax plan by such A-List Hollywood celebrities as Tom Cruise and John Travolta. 

 

Posted in FairTax | Comments Off on

Sec. 179 For Leased Motorhome

Posted by taxguru on August 25, 2007

Q-1:

Subject: re: Section 179

I have a question regarding Section 179 that I seem to be struggling with on getting a straight answer (assuming one exists…)

My wife and I are going to purchase a motor home and would like to supplement financing by leasing it to a third party.
The question I have is, would this be applicable to Section 179 (expensing in 07′) if I purchase before the year end and issue it into service (available for rental)?

There seems to a lot of confusion on this particular topic.  I did find a case where the court ruled in favor of the tax payer, Robert D. Shirley, TC Memo 2004-188.
What is your opinion in this matter and has there been any further clarification by the IRS?

Thanks,

 

A-1:

I have discussed this very issue in a number of earlier blog posts.

Here is the applicable quote from the QuickFinder Depreciation Online Handbook:

Leased property. For noncorporate taxpayers, leased property is not eligible for Section 179 expense, unless:

1)    The taxpayer manufactures (or produces) the property to lease to others.

2)    The taxpayer purchases the property to lease to others and both the following tests are met:

  The term of the lease (including options to renew) is less than 50% of the property’s class life.

  For the first 12 months after the property is transferred to the lessee, the total business deductions on the property exceed 15% of the property’s rental income.

You really need to be working with an experienced professional tax advisor who can help you work out the most appropriate way to handle this, including what business entity makes the most sense for your unique circumstances.

Good luck.

Kerry Kerstetter

Q-2:

Kerry,

Thanks for the information.

One follow up question I have as I took your advice on talking to a tax advisor (have appnt. tomorrow).  However she brought up the point that I need to “recapture” any gains I have through the sale of the motor home.  I thought she meant that if I purchase the motor home for 100k and sell it for 80k, I essentially need to claim the 80k as gains on the subsequent filing.  Is this true?

I read (on your blog!) that I only need to claim the difference between the sale and book value…am I reading that right?

 

A-2:

It is always important to keep tabs on the adjusted cost basis (aka book value) of business assets so that you can know what any potential gain or loss would be triggered by its sale.

Basically, the book value is the original cost of the asset less the depreciation (including Sec. 179) claimed up to the point of sale.  In your case, if you expensed the entire cost of the motorhome, its book value is zero, which means the full amount of any sales price will be taxable at the 25% Federal depreciation tax rate, plus state tax if you are in a taxable state.

Your tax pro should also advise you of some other factors to consider. 

Even before a sale, there is a potential taxable partial recapture of the Section 179 if the asset’s business usage slips below 50% in the first five years after you place it into service.

If you are disposing of the motorhome in order to acquire a newer model, there will be no taxable recapture if you trade in your existing one on a new one costing at least as much as the old one is worth and you receive no cash or net relief of debt.

These are all extremely basic tax principles that any competent tax person should have no problem explaining to you.

Good luck.

Kerry Kerstetter

 

 

 

Posted in 179 | Comments Off on Sec. 179 For Leased Motorhome