Tax Guru – Ker$tetter Letter

Q:

Subject: When is my AIG NOT really AIG?

 

I  have tried to do a section 179 on my business expenses for 2006. It seems as thought I cant exceed the 22k that was reported on my W-2’s even though the IRS is saying my early withdrawal of IRA funds is being reported, taxed, and penalized as 2006 income. My total income was about 67K but i cant go higfher in my business losses than the 22k reported on my W-2? Something doesnt seem right here. The IRS is counting my 1099 income as income only when it is beneficial to them? Why wont they count it as income for my business losses?

 

  Thanks in advance,

A:

The rules are very clear. The kind of income that qualifies as an offset to Section 179 is “earned” income, which is the kind that is subject to Social Security taxes.  IRA withdrawals are not subject to SS tax, and thus do not count, even though they are subject to normal income taxes.  The same thing applies to all other kinds of unearned income, including pensions and investments (interest, dividends and non-business capital gains).

You should be working with a professional tax advisor before making any of these kinds of moves so that you aren’t surprised by the consequences.

Good luck.

Kerry Kerstetter

 

Q:

Subject: 1031 Exchange Question

 Dear Sir:

    I wish to sell my house  in Los Angeles, which is an investment property now, and in which i have not lived for over 3 years, for about a million dollars in a few months, and then within 180 days i wish to have closed escrow on a 600,000 dollar property, planning in time to knock down the shabby building on it, but borrowing a million dollars to build 8 units where that shabby property was within the 180 day period of the sale of my original property. 

 

Question 1.  It I have bought the new cheaper property, and received the construction loan to build on the site where that shabby property is, within the 180 days of selling my original home, will this quality as a 1031 exchange?  Or is such a project not covered by the 1031 program since it would take more than 180 days to build the 8 units, or for any other reason?

 

Question 2.  I bought my original home long time ago for 275,000, and i invested 100,000 dollars in renovating it.  But now I owe 540,000 on this property since i refinanced it in the interim.   If i sell this original house for a million dollars, satisfying all relevant 1031 exchange requirements,  are these following steps  the steps which would occur in this transaction?  First, the 540,000 loan is paid back, and then my net return now  due to me after the sale of my original home, which should probably be a million dollars minus the 540,000  ( and also minus  real estate commissions), is put into the new building or real estate project, plus a new loan is obtained for whatever additional moneys are needed to get into the new building or real estate project, keeping in mind that the new project would need to exceed the one million dollar value of the original building?

 

I thank you in advance for your answers to these 2 questions, and any helpful further thoughts which you may have on my planned project.  I will also keep you in mind for all my 1031 exchange needs, including conveyances, and facilitations.

Sincerely,

A:

You really need to be working on this kind of plan with your own personal professional tax advisor who can look at your actual figures.  In fact, we always advise people contemplating a 1031 exchange to have their tax advisors do the calculations on the tax effect of a full cash sale in order to see if an exchange makes economic sense.

With the brief description that you gave, it will probably be worthwhile to look into an exchange. One of the issues that you need to discuss with your personal tax advisor is the adjusted cost basis of the original property.  If you did take out equity via a mortgage, and did not use that money to make capital improvements, it is very likely that the current loan balance is much higher than the cost basis, especially after reducing the basis for depreciation.

In regard to the rules for reinvesting the exchange proceeds, it isn’t required that the new property be completely finished within the 180 days.  You just have to spend, via cash and debt, an amount equal to or higher than the net proceeds within the 180 days.  With unfinished construction projects, you need to be very careful in regard to prepaying the contractor because there have been plenty of cases where the contractor disappears without finishing the job.   

Good luck.

Kerry Kerstetter

 

Q:

Subject: tax question

 

thanks for your interesting blog.

 

i have question for you.

 

suppose i invest 10k in an oil well.do i get to write it off? is the income it produces, say 5k/yr deductible against my initial investment?

 

regards

A:

There is no one size fits all answer because of the multiple varieties of investments that could be involved.

For example, if you are purchasing oil drilling equipment, it could possibly be expensed under Section 179.

If you are buying the royalty rights to a well, there is a potential to deduct the investment over time as the oil is extracted, as a depletion allowance.

You really need to be working with your own personal professional tax advisor who can look at your proposed investment and give you more accurate advice for that particular situation. 

As I’ve pointed out in other examples, the last person you should trust for this kind of tax advice is the person trying to sell you the investment.  Those kinds of high commission sales people will tell you anything to make a sale and will be long gone when you discover that the lucrative tax deduction was a lie.

Good luck.

Kerry Kerstetter

 

Q:

If I intentionally left $10,000 out of the reinvestment leg of my 1031 exchange, is my only downside the paying of the tax on that $10,000?

A:

First, if you were wondering whether holding out any cash would nullify the 1031 exchange, that would not be the case.  The only real issue is how much, if any, of the case held back would be taxable.

As Sherry said, the taxability of any cash taken out of the exchange isn’t a cut & dried answer.  It hinges on the numbers involved, as worked out on the 8824 worksheet, which we have posted on our website for downloading.

From a simplistic viewpoint, if there is no debt involved in the new purchase, and you end up with cash, that will generally be taxable.

If there is debt taken on the new property, any cash received on the deal is generally only taxable to the extent it exceeds the exchange expenses, which are the total closing costs from all of the exchange legs.

The tax rate on any taxable boot (cash) will be based on a number of factors.  If there was depreciation recapture on the old property, it will be taxed first at the special 25% Federal rate.  Next is the capital gain, which is taxed at ordinary tax rates if the original property was held less than 12 months or the special  long term capital gain (LTCG) rates (5% and/or 15%) if the property was owned for more than a year.  Arkansas tax will also be applicable to any taxable gain.  This is usually 5% for LTCG and 7% for other types.

I hope this helps you understand the issue.  Your own personal tax advisor should be able to more precisely calculate any potential tax for your particular situation.

Kerry