Q:

Subject: Schedule E Improvements vs Repair Expenses

 

Mr. Kerstetter,

 

How are you today?  I need your “guru” thoughts on improvements versus expenses on a residential real estate rental.  I saw your website and though I would see if you could give me your thoughts on this.

 

If you buy a new oven/dishwasher for a condo rental because the ones currently in the rental are not functional is this a repair or do these items have to be depreciated as seperate assets?  It is really black and white when you buy a furnishing like beds and couches for the rental- because those aren’t repairs they are adding value.  But on the replacement of a fridge/oven/microwave/dishwasher/washer/dryer that already existed in the apartment it seems as though this could be considered a repair expense.  Your expert thoughts would be greatly appreciated?

  

Best Regards,

A:

You really need to be working on matters such as this with a tax pro so that you don’t screw things up on your own.

New appliances do need to be set up on the depreciation schedule and deducted over their useful lives.  Trying to deduct them as repair expenses is one of the fastest ways to have your tax return flagged for an audit.

This actually balances out if you set the rental property up properly on the depreciation schedule when you first placed it into service.  While not all people do this, you are allowed to separate out the values of the appliances and other assets that are separately identifiable from the overall purchase price and put them on their own lines of the deprecation schedule, with their own lives, which are usually much shorter than the 27.5 years that you have to use for the structure.

This technique isn’t very complicated and has been around for decades.  Any tax pro who is experienced with properly handling rental properties can assist you with this, including how to adjust for a failure to do a proper allocation several years after the original purchase, such as is probably the case for you.

Good luck.

Kerry Kerstetter

 

(Click on image for full size)

Q:

Subject: Starting a new business

 

Dear Kerry,

I am a wedding/event planner and I would like to open my own business in Florida.

I read your article about C vs. S corporation… how much of that would apply to my case?

I am not planning to have any employees (at least for the first 6-12 months) and, seen the nature of the business, I would not begin to take in high amounts for that same length of time… should I just begin as a sole proprietor?

I understand I will eventually need a CPA working with me but, at the moment, I do not know one I can fully trust to make the right decision for me. So I thought that, if I had your opinion, I could then have some ground to stand on when talking to or choosing  a CPA.

I hope you have a couple of minutes to spare on this matter. I understand you must receive a lot of emails and I greatly appreciate your time.

Sincerely,

A:

It’s not true that you will eventually need to work with a CPA.  You need to do that right now.  If you don’t get started on the right path from the very beginning, it may be too late for any tax pro to properly help you later on.

There are far too many options to consider and possible scenarios that can be used to achieve your goals for me to even begin via this medium.

You will need to work directly with an experienced tax pro who can analyze your unique circumstances.

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

 

Q:

Subject: long term capital gains

 

Gentlemen,

I have a question.  Lets say a person has adjusted gross income of $14,000.  Lets also say that he sold common stock and had a gain of $60,000. Long term gains.  Would he be taxed on this gain at the lower tax rate or would the gain jump him up to the higher rate and and the gain taxed at the higher rate?  Also would his adjusted gross income be increased causing him to pay the higher tax on this income also?

thank you for your answer.

A:

While the nominal rates for long term capital gains (5% and 15%) are lower than normal income tax rates, the actual effective rate on a gain can be much higher because of the dozens of penalties levied on people with higher AGI. 

This is especially bad for senior citizens who are forced to pay Federal income taxes on 85% of their Social Security benefits if their AGI, including capital gains, puts them in the “evil rich” category of $25,000 for a single person and $32,000 for a married couple. 

You personal professional tax advisor can assist you in more detail with how this would affect your particular situation.

Good luck.

Kerry Kerstetter

 

From Tom Briscoe

Q:

Subject: Your Realestate Blogs sale of home

Hi,

Sorry I could find no other way to post to your http://www.taxguru.org blogsite (i am new to blogging).

 

I started construction on a home for myself in 2004.  I was supposed to be taking over a local business that would serve as my income to afford this home.  The business venture fell through and I was unable to afford the home.  I put the home up for sale prior to its completion to make sure I could sell it a.s.a.p. so as not to get stuck with the conversion loan, and its costs.  I sold the completed house in March of 2005.

 

 Since I never occupied the home it was never my main home.  Is there a way to include all the interest paid on the construction loan to the homes basis?  I used to be an accountant and all costs associated with acquiring an asset were part of the cost of that asset.  This would include the interest on the construction loan, and the commission paid to the brokers on the construction loan.  Is this not the case?  According to an  IRS phone advisor, the interest isn’t included in the basis of the home.    

 

I had no income and paid no taxes in 2004 and the over $7,000.00 in interest payments were paid in 2004, is this expense just …lost because the IRS feels it’s not part of the cost of building the home and asset?

This just doesn’t sound right… The interest on the loan was a necessary expense to actually build the home and therefor a cost.  This is not the mortage interest, this is a construction cost.  Am I wrong… if so, is there anyway to recup this expense

A:

You have illustrated why it’s a waste of time to try to get tax advice from the IRS on the phone.  Half the time, they are completely wrong with their answers.  Even when they are correct, they will not stand behind what they tell you.  Any info they give you over the phone has as much weight against any future IRS dispute as getting the same info from the clerk at your local 7-11 store.

You should be working with a professional tax advisor who will stand behind his/her advice.

Any experienced tax pro will confirm that it is very proper to capitalize interest on construction loans as part of the cost basis of the property.  In fact, that is a very common IRS audit adjustment, where they reclassify interest payments from immediately deductible expense to a capitalized cost.  That approach increases your tax bite because you only recover your interest expense in later years, and possibly against long term capital gains, which are subject to a lower tax rate than ordinary deductible interest expenses.

There are other tips on how to increase your cost basis and reduce your gain, which I don’t have time to detail; but any experienced tax pro can help you with.

Good luck.

Kerry Kerstetter

Follow-Up:

Sir,

 

I sincerely thank you very much for your time and consideration in ansewering my question

 

 

From an alert reader:

Subject: Salvation Army Link

Kerry,

You have a great Web site that’s proven to be very useful to me in obtaining tax information.  I noticed on your Charity page that the link to the value of non-cash donations (Salvation Army Web site) is bad.  The correct address is: 

    www.satruck.com/ValueGuide.asp

Look forward to visiting your site often.

My Reply:

Thanks for that update.  I’ve updated the link on my website.

With the internet constantly changing, it’s a never-ending job keeping web links current; so I appreciate your noticing that outdated one for me.

Kerry Kerstetter

 

I always enjoy the weekly Politickles I receive via  email from F.R. Duplantier.  As always, he has an excellent one for this time of year.

YOURS, MINE & THE/IRS
Our bureaucracies do us disservice
When they try to coerce and unnerve us;
We must bring to an end
What no one can defend:
The Internal Revenue Service.

Also, check out his much longer Taxpayer’s Lament.