Q:

Subject: Condo

Kerry,

I purchased a condo in 2005 at a sheriff’s sale as an investment.  I sold it early in 2006 for a profit.  I did not live in the condo at all (I already own a primary residence).  My understanding is the gain would be treated as a short term capital gain subject to the 25% tax rate.  I would like to verify something my CPA told me.  As part of the purchase, I paid off the former owner’s delinquent real estate taxes (about $6,000).  According to my CPA, this amount cannot be deducted as the IRS only lets you deduct real estate taxes for the time the property is owned.  Is this correct, or is this something that is equivalent to an “investment expense” I could put on my Schedule A, subject to the 2% of AGE floor?  Or could I add that amount to my basis to offset my gain on my 2006 taxes?

I did not do many upgrades or “capital improvements” to the property – mostly just painted, cleaned the carpets, etc.  My understanding is this is also not deductible on my 2005 return and also does not reduce my gain on my 2006 return (i.e. it does not change my basis).  Is that correct?  Just looking for a check on my CPA.  Thank you for your help and for the great site.

A:

You seem to be misunderstanding several key points here.

First, there is no special 25% Federal rate for short term capital gains.  Those are taxed the same as ordinary income, which has nominal rates up to 35%, plus the implicit rates of the phase-outs due to high AGI.

When you buy a property for back property taxes that had accrued under the prior ownership, it has always been the proper thing to add the taxes to your cost basis of the property, which will reduce your gain when it is sold. 

The costs you put into the property, including paint and cleaning, should also be added to the property’s cost basis.

These are all very basic concepts that any competent tax pro should understand.  If your CPA doesn’t, you may need to find one who is  more experienced with this kind of thing if you will be doing more of it in the future.

Good luck.

Kerry Kerstetter

 

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Q:

Subject: Thank you

Hello,

My name is … and I own a few small companies, I have sought to incorporate and have read quite a few of Robert Kiosaki’s books on business. They all lean to becoming a C corp but every CPa I have talked to have tried to veer me towards a S Corp.

I have stuck to my guns on the issue and have read as many books on taxes as I could on the issue and have believed that the C corp was right for me. Thanks to you I now have the backing of a professional CPA. It is a shame that there are not more of you out there.

Thanks again

A:

I’m glad you found my info useful.  You should keep in mind that there is no one size fits all arrangement that works for everyone.  In fact, for most people who have multiple businesses, the best overall strategy is often a combination of different types of business entity, including C corps, S corps, LLCs, partnerships, trusts and  sole proprietorships.

Working with a professional tax advisor who has experience with this kind of thing is a must when you are involved with so many businesses.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Primary Residence Questions

My husband and I where recently gifted a home valued at $700K.  I just learned that unless I create a permanent residency status, I would have to pay a huge tax burden upon the sale of the home.

I do understand that if I where a primary resident in the home together we can take a $500 credit and taxes would occur on everything over $500K

My question is can I live in a secondary rental, and still create a primary residence on this home.

MY documentation is needed to constitute a permanent residence.

I still want my mail to come to my secondary rental.

A:

While I do have an explanation of the rules for residence sales on my website, this is the kind of thing you really need to discuss in detail with your own personal tax professional.

There are a number of issues that you will need to discuss with your personal tax advisor, including the following.

Cost Basis – When you receive a gift, your cost basis in the item is the same as it was for the person who gave it to you (donor).  This should be documented on the Gift Tax Return (Form 709) that the donor filed with IRS.  You should get that figure because that will be crucial in calculating your potential gain when you sell the home.

In regard to qualifying for a full $500,000 of tax free profit, you and your husband will need to live in it as your sole primary residence for at least 24 months out of the 60 months before you sell it.  It cannot be a part-time residence or one of two primary residences.  One primary residence per person is all IRS will recognize as legitimate.

As with all tax matters, the burden of proving that you actually did use the home as your primary residence rests with you.  In the rare case that IRS questions your right to use the Section 121 exclusion, you will need to be able to provide an adequate amount  of documentation of this fact.  Such documentation can include such things as your voter registration, residential property tax exemptions (if applicable in your area), as well as use of that address for your normal mail.   Since any such IRS challenge wouldn’t happen until a year or two after you have reported the sale on your 1040, you should hold onto the documentation until the coast is clear for any IRS challenges (generally three years after filing your 1040).

Your personal tax pro can give you more customized advice for your situation.

Good luck.

Kerry Kerstetter

 

Gas tax on miles, not gallons, tested in Oregon – Vehicles are too fuel efficient. 

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Q:

Subject: S VS C

 

Hello Mr. Kerstetter,

 

…I am an Optometrist in Miami slightly confused on which Corp is better.  I am not sure if you answer personal questions but thought I would try.

 

By your comments it seems that a C is better but most Optometrist have a S.  I put my yearly income on about 130-150K and want to make sure I’m not paying the government more than I should. 

 

You mention that a C has a 15% tax bracket for 50K vs being taxed on the S corp total earning as sole owner .  My only concern is that a C corp is taxed twice and don’t know which one would be better.  What are considered royalty payments that are not taxed twice?  Also, I would be setting up a 401K but I’m limited to how much I can put in.  Would I be able to put my wife as an employee even though she is not doing anything for the corp and start her on a 401K? Can I put money away in a term life insurance to prevent double tax or any tax?

 

I hope that you may have some simple solutions for me.

  

Thank You

A:

There are far too many variables involved for me to be able to advise the best entity and jurisdiction to use for your particular situation via this medium.

To work out the best solution for your particular circumstances, you really need to work with a tax pro who can help you set up a strategy that will work for you.

I wish I could help you; but I already have too many clients to take care of; so we are not accepting any new ones at this time.

Unfortunately, we don’t have anyone else 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.

It does look as if you are confused over the issue of double taxation.  This only happens when income that has been taxed at the C corp level is taken out by the shareholders as dividends.  Since dividends are not tax deductible by the corp, and are taxable on the shareholder’s 1040, it is being taxed twice.  The solution to this is to only take money out in ways that are deductible by the corp.  In fact, I advise my clients to banish the word dividends from their vocabulary.  A good tax advisor should have no problem helping you use a C corp in the best manner to avoid any double taxation.  It is not difficult at all.

Good luck.

Kerry Kerstetter