Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for March 16th, 2008

Capitalizing Interest?

Posted by taxguru on March 16, 2008

Q:

Subject:  Question on Selling Investment Property (Land)

Kerry, in ’07 I sold a vacant lot that I had owned for 2+ years.  Originally, I intended to build on it, but a job took me elsewhere and I sold.  Can I book a deduction for all the mortgage interest paid to date as part of the adjusted cost basis to offset the net proceeds?  This wasn’t clear for me as I read through the IRS documents.

 

Regards,

A:

You really should be discussing this kind of thing with your own personal professional tax advisor who can assist you better than I possibly could. You shouldn’t be trying to interpret the tax laws in matters such as this.  That is what tax pros are for.

There are a number of ways in which to handle the interest paid on investment property.  It can be deducted on Schedule A as investment interest via Form 4952.

Another option is to capitalize it as part of the cost of the property and thus later on reduce the capital gain when it is sold.  Here is how this is explained on Page 4-14 of The TaxBook via their WebCD:

Carrying Charges—Election to Capitalize Interest and Taxes

A taxpayer may elect to add real estate taxes and interest to the cost basis of unimproved land rather than claim a current deduction.
Situations where this election might benefit the taxpayer include:

Standard deduction. If a taxpayer claims the standard deduction, the deduction for interest and taxes is lost. The taxpayer will benefit from the election to capitalize the amounts, which will increase the basis of the property.

AMT. If taxes reported on Schedule A would be added back to income as a preference item for AMT, the taxpayer may not realize a benefit from the deduction. In this case the election to capitalize and add the amounts to basis would benefit the taxpayer.

A statement listing the expenses capitalized must be attached to the original return for the year the election is made. The election is made on a year-by-year basis. (Reg. §1.266-1)

This is for background info only and should be applied in your case consistently with your previous years’ tax returns and with the assistance of a professional tax advisor.

It looks like you may have screwed up the treatment of the interest on the earlier tax returns and amended returns may be required.  Again, a professional tax advisor should be used to help you with this.  Don’t compound your mistakes by continuing to try to stumble your own way though the tax maze.

Good luck.

Kerry Kerstetter

 

 

 

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Forced to convert to S corp?

Posted by taxguru on March 16, 2008

Q:

Subject:  C corp to S corp

Hello,

 

I am an investor/shareholder in a California “C” Corp.  The President of the corporation just informed me that he was going to convert to “S” Corp.  He advised me the stock certificate (issued under the C corp) which is in the name of my living trust would have to be reissued into the name of an individual(s).

 

Why would one change the status of the corporation.  Does this work in my (the shareholder’s) benefit?  What about the inability to hold this asset in my trust.

 

After reading your article…I’m uncertain of why he would make this change.  Sounds a bit fishy.

 

I have a call into my CPA…but it is tax time and I just wanted a quick review if you have time.

 

Thanks a bunch,

 

A:

There must be more to this story than you’ve recounted here because some of it is literally impossible to do.

Specifically, one person can’t unilaterally change a C  corp to an S unless he is the sole 100% owner.  The election form requires the signed consent by every single stockholder because this election obligates each stockholder to report his/her share of the corporate income on his/her own 1040. How is the president of a corp of which you are part owner forcing you to sign the election form without your being able to analyze its impact on your unique situation?

After discussing the pros and cons of making the S election with your own personal professional tax advisor, you can decide whether to go along with it or not.  I have no way of knowing if it makes sense for you or not.  There are too many issues to consider.

Assuming the election makes sense for you and you are going to sign the  IRS form, the next issue seems to be whether your shares can be titled in the name of your living trust.  This depends on exactly what kind of trust you have.  If it’s a normal revocable living trust, which is generally considered to be a disregarded entity for tax purposes while you are alive, it shouldn’t make any difference whether the shares are in your own personal name or the name of your living trust because both will be using your SSN for identification purposes.

If it is a different kind of trust, especially one that has its own FEIN and files its own 1041 tax returns, there are limits and restrictions on S corp ownership.  There are also special kinds of trusts that can own S corp stock if that is appropriate for your situation.  Your personal professional tax advisor can help you with that issue.

Good luck.  I hope this helps.

Kerry Kerstetter

 

 

Posted in corp | Comments Off on Forced to convert to S corp?

Tax Saving Strategies

Posted by taxguru on March 16, 2008

Q:

Subject:  minimizing overall tax liabilities among related entities

Kerry,

I am a CPA practicing in Texas and I am interested in an issue you have discussed on your blog.  It involves the legal shifting of income and deductions between at least three (or more) entities, say a C corp with a fiscal year-end, an S corp with a calendar year-end, and an individual owner of both corporations.  I understand the why, the timing, and the benefits of the shifting.  My philosophy in dealing with clients and the IRS is similar to yours.  I am not afraid of taking an aggressive position on my clients’ tax returns, even in light of the changes to the Circular 230 rules and the IRC Section 6694 penalty provisions.  But the hesitancy in using this strategy is my possible inability to have enough solid reasons to convince the IRS that there is a valid business purpose for the arrangement.  I am a bit nervous about the IRS asserting that the entire arrangement is a sham thereby collapsing the two corporations into one and destroying my tax planning.  It would be helpful if you could reveal at least a portion of your strategy for developing the rationale for using this method of tax planning.  If that would be too intrusive and not something you would like to divulge, would I get some of my answers by using TAX Coach?  At your recommendation, I subscribed to their service but have not run an analysis for a client yet.  How successful have you been in defending your clients who are using this tax planning strategy when they were audited? 

 

Thank you, have a good tax season, and I hope you won’t tell me “I really should be working with my own professional advisor on this matter” (ha).

   

A:

As you’ll see in an upcoming post, there seems to be a lot of self censoring by tax pros whose imaginations have obviously gone wild about encountering the nastiest IRS auditors who will disallow anything that could have possibly saved the clients money on their taxes.  The result is a fear to recommend very basic tax savings strategies, such as multiple entities, and thus forcing their clients to pay more in taxes.

Having encountered every possible kind of IRS auditor there is over the past 30+ years, from real hard-asses to wimpy ones who literally allowed me to have my own way with everything, this fear is crazy and smells of professional paranoia.

As long as a valid business connection is there, such as leases, commissions, royalties, salaries, etc., and the amounts being passed between the owners and the entities are consistent, IRS will have to accept the figures.

I have had cases where IRS auditors have seen monies being passed around different entities, and they only cared that all entities were using the Cash basis of accounting and that the amounts were consistent.

As part of the Clinton Family’s attack on me for being critical of them in my newsletters, IRS came after Sherry and my personal tax returns and had no problems with the monies we shuffle around our different corps when I showed the figures were consistently treated on our 1040 and the 1120s.

About four or five years ago, a client’s 1040 was selected for audit based on huge interest expense deductions. When the auditor saw a lot of money passing back and forth among the client and his several wholly owned C and S corps, all he asked me was whether the corps were all on the Cash basis.  When I explained that they were all using the Cash basis the auditor said that was good and he wouldn’t need to look at the books for any of the corps.  He said that if any of the corps had been on the Accrual basis, he would have had to perform a full blown audit on the corp as well.

Using corps to shift money around to minimize the overall tax burden has been around for longer than I have and will always be a perfectly valid technique.  I guess I was lucky in the fact that one of the CPAs I worked for at the beginning of my career was using this strategy for his own and his clients’ finances; so I got an early start with it and have been working with it ever since.  It is a shame that there are too many tax pros today who are afraid of it.

While I haven’t used them for any of my clients, TaxCoach does have some nice reports that you can generate to show clients how using corps can work to reduce their overall tax burden.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

Kerry,
Thanks very much for your reply.  It was just what I needed to hear in order to boost my confidence enough to begin recommending this strategy to my clients.

 

TaxCoach Software: Finally! Plain-English Tax Planing That Builds Your Business!

 

 

Posted in corp | Comments Off on Tax Saving Strategies