Q:

Subject: Vacation Home Investment

 

Hi Kerry,

 

I plan to build a vacation rental in a couple of years.  The house will be used exclusively for business purposes and rented out by the day , weekend or week.  I will manage the property myself.  My question is . . . . is this activity a small business which I report out on Schedule C or a passive rental activity which I report out on Schedule E?  What is the determining factor(s).  If I have a choice as to how to report, what should I consider in making my decision?  My own research of IRS pubs seems to indicate that this should be treated as a small business but I keep seeing material on the web which seems to indicate otherwise.  Thanks.  You are the best.

 

Regards,

A:

That would be reported on Schedule C.  The break point is either that the average use of the property by renters is seven days or less, or 30 days or less and you (the owner) provide significant personal services along with the rental, such as cleaning and maintenance work.

As I constantly stress, trying to navigate the tax world without the assistance of at least one competent professional tax advisor is extremely dangerous. Your question, which any experienced tax pro could help you with, proves that you need to start working with one ASAP.   Any experienced tax pro can help you with that, as well as with maximizing all of the other kinds of deductions that are available for rental properties.

Good luck.  I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/30/2006 12:43:00 PM Send this post:

Q-1:

Subject: Section 179 expensing

 

Mr. Kerstetter,

 

I am writing to see if you may be able to help me with my confused state.  In 2004 I purchased an airplane with the plan of placing it into service at a local airport as a rental for student pilots.  I was advised, by my accountant, to form an S Corp and purchase the airplane.  I placed the airplane into service in the 1^st quarter of 2005 and kept it in service during all 4 quarters.  As it turns out it was not a profitable venture and I was negative approximately $15,000 (Profit/loss).  I had planned on taking a 179 expense however due to the business income limitation I cannot take the expense however I can carry it over to 2006.  As an aside a business venture such as this has no hope of ever being significantly profitable.

 

My question is would I be in the same situation if I had set up my company as an LLC?  As an LLC entity would my ordinary income be included in the business income limitation?  Is the business income limitation handled a little differently from an S Corp and a LLC?  Is there anything I can do to remedy this situation?

 

Thank you in advance for your assistance.

A-1:

Multi-member LLCs are treated essentially the same as S corps tax-wise, including with Section 179.

If you had set up a single member LLC and elected to treat it as a Schedule C sole proprietorship for tax purposes, the Section 179  expense would have been matched up against all of the earned income on your 1040, including from W-2s, most likely increasing the actual usable deduction.

Did you go over these different options with your accountant beforehand, or was he the kind who believes in a "one size fits all" S corp for everyone approach, without adequately analyzing the various factors first?

Kerry Kerstetter

Q-2:

I guess my accountant was the "one size fits all mentality."  I thought I was doing the right thing by going to him BEFORE I set up any business entity and even told him specifically (in 2004) I wanted to be able to take advantage of section 179.  I also spoke with an "aviation specialist" tax attorney who also recommended incorporation as an S Corp.

Without the 179 expense I owe $14,500 in Federal taxes, if I could (magically) be able to take advantage of the 179 expense I would have a $25,000 refund.

I have filed an extension and not have filed any returns as yet.  Do I have any options?

Best regards,

A-2:

With no income expected, it does seem rather careless to use an S corp if your goal was to maximize the Sec. 179 deduction.

What I have seen in cases just like this that I have worked on is that it often comes out okay by forgoing the Sec. 179 and just claiming normal or accelerated depreciation, which can be used to create a net loss that can flow through to your 1040 via the K-1.  If your preparer enters for Sec. 179 in his tax prep program, that will create a carry-forward for that amount and reduce the depreciable basis, resulting in much lower depreciation deduction.  While you won't get the huge Sec. 179 deduction all in one year, you will still get large losses for the depreciable life of the plane.

Good luck.

Kerry

Q-3:

Kerry,

 

Thank you. I am not sure careless is a strong enough word, as I said I was specific with my accountant that I wished to take advantage of the 179 expense.  Since the business was not profitable I "retired" the aircraft from service.  At present I am only looking at a deduction for 2005.

 

I will also be looking for a new accountant.  Can you make any referrals in the Denver area?

 

Again, thank you for your assistance.

 

Best regards,

Q-4:

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

Follow-Up:

Kerry,

 

This has been an expensive lesson for me.  My accountant has become a friend and I hope to keep him as a friend but he has proven to me that he can no longer be my accountant.  This misstep in tax planning impacted a commercial investment which hinged on the tax savings from the 179 expense; a plan I have discussed in detail with my accountant.

 

I would like to thank you again for you kind and thoughtful advice.  I can't tell you how much I appreciate it.  I have lost some sleep over my situation

but I realize I have many other blessings in my life and I am thankful for them.

Best regards,

 

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/30/2006 12:40:00 PM Send this post:

Q:

Subject: Lease from Self

I am part owner of several corporate entities, Health Care Facilities,  Fast Food stores and Real Estate.  We have owned these properties for several years, consequently the majority have been depreciated ou,t specifically the equipment.  My question is, is it possible to use a corporation to buy the equipment from the entities and lease the equipment back to them and thus re-establishing depreciation on that equipment.  Be aware that there is common ownership among these entities.  What would be the benefits of this and what would be the drawbacks or negatives.

A:

This is the exact kind of thing that you should be discussing with your personal professional tax advisor.

What you will probably find out, if your tax pro runs some numbers for you, is that your plan would end up costing you more than it saves.  In order to inflate the values of the assets for higher depreciation, the selling entities will have to report gains, including depreciation recapture, which would be immediately taxable.  The higher depreciation deductions would be spread out over the next several years of the assets' lives.  Paying lump sum higher taxes now for higher deductions over the next five plus years seems to be counter-productive.

However, your entities may have large net operating losses, or other large deductions that could offset the sale profits.  Your personal tax advisor can help you see if that is the case.  However, if s/he does decide that such a sale makes sense, you will nee to be extra diligent in documenting the values you place on the assets.  IRS automatically regards such sales (aka churning) between related parties with suspicion, especially when there will be a tax savings opportunities.

Good luck.  I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/30/2006 12:28:00 PM Send this post:

Q:

Subject: small question

 

Hi, I am 20 years old and i am trying to figure something out. I noticed you posted on google groups, so I thought you cold help.

SO, I am in college and I have had 4 jobs last year. Two on campus jobs and two jobs in the summer. For one of the on campus jobs i am paid from an off campus firm. I am paid $40 a week. I have never met the people who pay me, and they do not submit a w2 form. I noticed this when dealing with finical aid. Am I going to jail? Or doing something illegal?

A:

All income you receive is taxable, whether or not the payer submitted a W-2 or 1099.

Get with a professional tax preparer ASAP to calculate your taxes for 2005.  You probably won't owe any actual income tax, but if no tax was being withheld from your paychecks, there is a good chance you will at least owe the 15.3% self employment (SE) tax.

Good luck.  I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/30/2006 12:23:00 PM Send this post:

Q:

Subject: Rental property

 

LOve reading your blog!!!

 

i inherited my mothers house when she died.   now renting it out.   how do i figure out the depreciation on it for my taxes?   mother bought it for 61,000 in 1987 but city has it assessed for 135,000.

keep up the posts!!!

A:

Your cost basis of the inherited property is its fair market value at the time your mother passed away.  If an estate tax return was filed for her, you would use the value shown on the 706.  If the estate was small enough not to require a 706, you should ask a local Realtor or appraiser to give you a value.  Most Realtors will run a CMA (competitive market analysis) for you for free, hoping that you will remember that when you decide to sell the property.

I'm glad that you like my blog; but it seems that you are missing one of the main themes that I thought I was stressing; that trying to navigate the tax world without the assistance of at least one competent professional tax advisor is extremely dangerous. Your question, which any experienced tax pro could help you with, proves that you need to start working with one ASAP. 

Just establishing the overall fair market value of the property is just the first step.  Next, you will need to allocate that between the values for the non-depreciable land and the depreciable building and components (appliances, fixtures and other separately identifiable items).  Any experienced tax pro can help you with that, as well as with maximizing all of the other kinds of deductions that are available for rental properties.

Good luck.  I hope this helps.

Kerry Kerstetter

Follow-Up:

thanks for the quick response. i guess i should get a tax pro like you said. you know what they say -- an ounce of prevention is worth a pound of cure!!!!

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/28/2006 01:47:00 PM Send this post:

Q:

Subject: 2008 Long Term Capital Gain

I understand that the 2008 LT CG tax rate for filers in the 10 % 15% bracket is to be 0% on the LT CG.

Assume the following:
Filing status Married, filing jointly
Taxable income of $30,000 (before LT CG)
LT CG (held over 15 years) $700,000

Is the entire $700,000 LTCG at 0% tax

             OR

is it just the amount from $30,000 up to the (approx) $62,000 taxed at 0%, then at the 15% rate for LTCG for filers in the brackets above 15%

If the filer could arrange to keep their 2008 taxable income in the 10 or 15% bracket(before LT CG) this would seem to be an outstanding opportunity to sell highly appreciated capital assets in 2008.

OR, am I missing the real facts here?

A:

It is a common misconception that the special low tax rates for LTCGs apply to the full amount of gain.  A you can see in the Schedule D tax worksheet, that isn't the case.  The various tax rates are applied sequentially, to the income in the different lower tax rate brackets.

In their divine wisdom, and as part of their smoke and mirrors style of budgeting, our imperial rulers in DC have given a special deal for only 2008 LTCGs, where the gain that would normally be subject to a 5% rate will be given a zero percent rate.  This means that you would use the worksheet and substitute 0% wherever it shows 5%.  The thresholds would also need to be adjusted for guesstimated inflation over the next few years. 

It's always possible that this one year special deal will be either repealed or even extended.  it is difficult to predict what our rulers will do.

Assuming it is in place when 2008 rolls around,  the best way to really exploit this break would be to do what you can to get your non-LTCG taxable income as low as possible.  A good professional tax advisor can help you with the many ways in which to accomplish this.

I hope this clears up your confusion.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/28/2006 01:38:00 PM Send this post:

Q:

Subject: Sale of sec 179

 

Is the below comment true (specifically the 'not subject to the self-employment tax')? I want to know the penalties of a Section 179 that I made for 2005 for $32,000 and a business truck.

“If a taxpayer disposes of property on which the taxpayer has claimed the Section 179 deduction, the Section 179 deduction is subject to recapture in the same manner as depreciation. A taxpayer reports the sale of such property on Form 4797. The recapture of depreciation and the recapture of the Section 179 deduction on a sale of the property are not subject to the self-employment tax (Section 1402(a)(3)(C)).”

Found on the web here.

A:

That is true; but it nothing new.  Gains from sales of business equipment, including depreciation recapture, have always been reported on Form 4797, which is not counted as self employment income.  Section 179 is really just a form of very accelerated depreciation.

Your personal professional tax advisor can explain how this affects you in more detail.

Good luck.

Kerry Kerstetter

 

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/28/2006 01:29:00 PM Send this post:

Q:

Kerry,

 I think I have asked you before and apologise if you have already answered me.  I'm involved in a couple LLC and a couple Sub S Corporations. Currently they are all loosing money. ie interest, dev costs, etc. 06 will produce a big profit from one of the sub s's. I am about to enter into another partnership. My attorney tells me he see's absolutely no difference in the two from a liability point of view.  Do you feel there is a difference from a tax point of view?

A:

If the LLC chooses to be taxed as either a partnership or S corp, it is treated exactly the same for tax purposes as a regular S corp is.

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/28/2006 01:23:00 PM Send this post:

Q:

I  came across your website when looking for Tips on Quicken and there they were -

Can you answer a question possibly for me?  years ago I set up Quicken incorrectly and set it up literally by "Accounts" - meaning my various bank accounts !!!  since incorporating 2 years ago, now a nightmare for reports -

If I set up all the accounts correctly now, will I lose all the account info now already set up for years???

Thanks for any help you might send to this accounting-inept mind !!!

A:

I'm not really sure what you mean in regard to setting up your Quicken "By Accounts." 

To clean things up properly, there are some very basic things you need to do.  First is to import all of your Quicken data into QuickBooks and use that program instead.  I have a lot of info on my website as to why QB is vastly superior.

Next, you should be coordinating your QB chart of accounts and reports with your professional tax preparer and what s/he uses for the business tax returns.  You should be able to modify the pre-existing accounts to the proper types, including merging redundant accounts, without losing any historical data.

Any accounting pro who has experience with QB should be able to help you do this.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/27/2006 02:01:00 PM Send this post:

Q-1:

Subject: help :)

 

Hi

 

I am so happy I found your site. A bit too late to help me with 2005 taxes but live and learn. My husband and I have been incorporated in the state of Florida as an s-corp. since 1997. Our business subcontracts home framing crews to other builders (we have 4-5 crews depending on demand) we also have a cabinet shop that manufactures cabinets for builders and designers. In prior years after paying ourselves and the workers...tools etc. We would generally show a loss or a very small profit. In 2004 we had 34,000 profit that got tacked on to our taxes. Well, in 2005 109,000 got added to our 1040. We had income from W-2's of 131,000. We use a payroll leasing company to run all our payroll and had paid 16483 in taxes on that income. When our accountant told us we owed 37000 something dollars on money we had not received we weren't to happy. We did manage to put 8000 in an IRA before the filing deadline and reduced that to 34,000 something. We were not advised to do that we just were trying to reduce it anyway we could. I have at various times asked my accountant if now that we are making money wouldn't it be best to switch to a regular c-corp and he always advises against it. We take home a salary and occasional bonuses which are all run through payroll. We have had to take a draw to pay the taxes!!!. Please if you have some time could you advise me where I should go for help. My husband has a friend who's brother is a tax attorney and he was thinking of going to him. I would like to start looking into some retirement planning for the company...Roth ira.. etc but I don't know if I should first change to a regular corp.

 

Thank you for your time in reading this

A-1:

It is very frustrating that so many so called tax pros have blinders on and consider S corps the perfect solution for everyone, without doing the analysis that is required to determine the best entity for a particular situation.  Everyone's circumstances are unique.  I receive at least one email just like yours every single day.

It does sound as if you need to find a tax pro who is more open minded and not stuck in his/her ways.  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.

Something to keep in mind is that it's not an all or nothing situation, where you have to run all of your business operations through one C corp or one S corp.  There are many reason to use multiple entities, and an experienced tax pro can help you with that. 

For example, if you've seen my article comparing C and S corps, you will know that employee benefits for owners are much more lucrative with C corps, including the ability to have an unlimited medical reimbursement plan.  This can get dangerous if you also have non-family employees; so a technique that has been around longer than I have, is to set up a separate corp with just the family members as employees that can offer them the lucrative benefits, while the non-family employees are employed by the other corp, which doesn't offer the same expensive benefits.  Doctors have been doing this for decades, so as not to have to cover all of their staff.

Having both an S and a C corp also allows excellent opportunities for income smoothing, when the C corp has a fiscal year ending in a month other than December.

None of these ideas are new or very difficult.  An experienced tax advisor can help you save thousands of time his/her fee by utilizing the proper combination of entities for your situation.

Good luck.

Kerry Kerstetter

Q-2:

Kerry,

 

Thank you for your prompt reply. I will be shopping for a new tax preparer. Thank you also for the advise on multiple companies. We do have a corporation set-up that is in-active and never been used (we do pay the corp. fees each year). We were going to separate the cabinets from framing when we organized it but never did since separating the books at that time involved separate general liability, workers comp, and payroll. Also at that time we needed to have credit on our payables and most people want a few years history. I guess we should revisit that idea. If you at some later date think of someone in my area that is a good preparer please let me know. We are located in Pensacola, Florida. I will continue to visit your site. I hope one day soon to lower my taxes. One more question. Are there any good books on this subject that you could recommend?

 

Thanks again!

A-2:

Nolo Press has several good books on this kind of thing.

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/27/2006 01:54:00 PM Send this post:

Q:

Subject: Exchange Question

 

Hello,

 

I’m actually curious about guidelines in Oregon.  My parents use their home as a primary residence and as their place of business.  They have lived in the home for one year and now have some changes that may require them to sell it and relocate.  (My father was just diagnosed with depression.)  I am wondering if they would be able to sell it and not pay capital gain taxes for either of those reasons: using it for business or the health diagnosis.

 

Thank you so much!  Your website has been incredibly helpful.   

A:

Using the home for business won't allow a tax free sale.

The medical condition, if unforeseen when the home was purchased,  would allow them to use the pro-rated exclusion of  $714.28 profit per day the home was owned and used as a primary residence.

I have this all explained on my website.

Your parents should definitely consult with their personal professional tax advisor to both calculate the actual potential gain and verify whether they would qualify for the pro-rated exclusion.

Good luck.  I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/27/2006 01:45:00 PM Send this post:

Q:

Subject: question...I saw your site and thought you might be able to answer question...sorry to bother you!

I love your site. True entrepreneur----ialism...:-)

 

Listen...hope you don't mind the note here....but Quick Books support drives me out of my mind. Rather pluck my eyes out than call them or try to sift through the community...so I am taking a chance and going to ask you ...if you mind..just delete...I am sure I will muddle through for another week or two in the dark...haha...

 

anyway..

 

I have made a couple of loans to another one of my own companies from my company. Seems quickbooks makes it easy to take a loan but not give one. I read your part on that....and setting a Shareholder Loan Liability account.

 

But not sure how to do it when I make a loan....pray tell...I am thinking this is an easy answer that is why I chanced asking you.

 

Can you help me with a response. I apologize for popping in!

 

With my Regards,

A:

I don't think you would get any help from QuickBooks on this because it's a basic accounting question, and nothing really to do with the software.

Setting up a loan payable or receivable is a simple task in QB.  What you should be doing is coordinating your QB chart of accounts with your professional tax preparer and what s/he uses for the business tax returns because loans between companies, as well as loans from shareholders, can have either debit or credit balances and be show in either the asset or liability sections of the balance sheet..  The critical thing is to periodically reconcile the balances between the different company QB files to ensure they are in synch with each other.

If you aren't working with a professional tax preparer and are trying to do all of the tax returns on your own, you are crazy and will get yourself into serious trouble.

Good luck. I hope this helps.

Kerry Kerstetter

Follow-Up:

Yes..i have a CPA....but I am so grateful for your response. It helped me a lot! It helped me formulate what I was trying to ask...I am glad you understood so well....Thanks and Thanks!

I will go to that site on reforms....I am with you on that subject I think! (have not read it yet..thats why I say that:-)

With my Regards,

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/23/2006 06:24:00 PM Send this post:

Q-1:

Subject: Tax question

Dear Sir,

I was wondering if there is any way I can reject some income. If for some reason, I don't want $200 of income from a part time source, because this $200 cancels some other benefit of higher value, how can I reject this income. My part time employer has issued a W2 for this amount and given me a check. But I have not cashed this check as yet and will tear it up if needed.

One possibility is that they make a correction in their returns to the IRS when reporting their taxes collected. But if they are not willing to do this, what options do I have.

Thanks,

A-1:

It depends on when you received the paycheck.  Did you receive it in 2005 or 2006? 

Kerry Kerstetter

Q-2:

Kerry,

 

Thank you so much for this timely response. I received the first check in November 2005 but I lost it and so received another check (reissued/replacement) in February 2006.

 

The check is for $200 but the incremental taxes due to the loss of a deduction is over $200 and so I am trying to find if the tax laws or practice will in any way allow me to nullify this income. If there is no legal way I can forego this income I will file my returns on Monday. Do you think it is worth filing for an extension so I can further research this issue or have you come across similar issues earlier?

 

If there is any way I can help you please do not hesitate to contact me. Best and thank you once again for your timely response.

A-2:

You're correct that the best thing to do right now is to file for an automatic six month extension.  Rushing to meet the April 17 deadline, while there are still questionable issues, is crazy.

You should then find yourself a good professional tax preparer who can take a look at your 2005 info and see if there is a way around the problem you claim to have.  While the situation you describe is entirely possible, there are also usually ways around it by moving things around on your tax return.

If it is determined that the $200 of income will actually cost you more than $200 in extra taxes, and you did in fact lose the check during 2005, there is a way to give yourself another year's grace.  You could show the full W-2 amount on the appropriate line on your 1040 so that IRS doesn't assume that you overlooked it.  You could then deduct the $200 down in the Adjustments To Gross income section, attaching an explanation of the lost check and repayment in 2006.

On your 2006 1040, you would then have to report that $200 as W-2 income.  However, you have plenty of time to spend the money before 12/31/06 on something that is deductible and will effectively cancel out that income, such as depositing it into an IRA or donating it to charity. 

You should obviously work with your professional tax advisor to see what is the best way to go.

Good luck.

Kerry Kerstetter

Q-3:

Kerry,

 

Thank you so much for this quick reply once again. This is potentially a solution! I should have been more detailed when I asked you the question.

 

Both me and my wife are Indian students and so I use the 1040 NR. In the India-US tax treaty we can count our spouses as dependents and get the second deduction of $3200 per head.

 

It was my wife who received the $200 in November 2005, lost the check and received a reissued check in March 2006. This is all her income for the year and so she will have zero taxes if she files separately.

 

Since we (non residents) don't have the option of filing as married filing jointly in the 1040 NR, I will have to file my taxes separately but could claim the $3200 as an additional deduction of my spouse (tax treaty benefit).

 

My understanding is that if my spouse files another return I may not be able to get the second deduction of $3200. The additional taxes due to losing this deduction is much higher than than the $200 income my spouse will have to report.

 

Could we follow your idea and file the $200 as income for her as 2006 income on a separate 1040NR. For 2005 could we claim no income and I file a return with her as my dependent?

 

Thanks again for the quick reply. If I can be of any help please do not hesitate to contact me.

A-3:

Now you've gotten beyond my level of expertise.  I haven't prepared a 1040NR since my days in the Bay Area so I don't want to steer you in the wrong direction. 

Yours is a perfect example of why you should work with a tax pro who is familiar with 1040NRs rather than try to stumble through it on your own.

Good luck.

Kerry

Follow-Up:

Kerry,

 

Thank you once again. I really appreciate your time. I have filed for an extension and will research this deeper with a professional. Please feel free to contact me if I can help in any way.

 

Best,

 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/23/2006 06:16:00 PM Send this post:

Q-1:

Subject: Advice on inheritance law

I am looking for a tax form number that has to do with estate and inheritance law.

 

I know I have a $2mm lifetime exemption, meaning that my heirs can inherit up to $2million dollars from me and not pay inheritance taxes on it when I die.

 

Let say I want to give my child $500,000 now and have it count as part of my $2,000,000.00 therefore reducing the amount that can be sheltered to $1,500,000 at the time of my death.  Also this shelters my child from paying gift taxes even though it's above the annual gift limit of $12,000.00.

 

What is the tax form number and where is my understanding wrong?

 

Thanks

A-1:

While it is good that you are trying to educate yourself on matters such as this, you are venturing into dangerous territory if you think you can set up an estate or gifting plan without the counsel of experienced professionals.

I have a very brief summary of the estate tax rates and exclusion amounts on my website.  As you can see, it changes every year, making it necessary to constantly revise estate and gifting plans.

You do have some basic misunderstandings of how these taxes work.  First is the fact that they are not levied on the recipient.  Gift taxes are payable by the giver and are tax free to the recipient.  Estate taxes are payable from the decedent's estate, with the remaining assets distributed tax free to the heirs, except for some kinds of assets, such as pre-tax retirement accounts.

There are many twists that can screw up an amateur gifting plan.  First is the fact that, while the lifetime gift tax exclusion used to be the same as the estate tax exclusion, that is no longer the case.  The lifetime gift tax exclusion is only one million dollars, half of the estate tax exclusion.

The process of gifting can be tricky, depending on what kinds of actual assets are being transferred.  While after-tax cash is easy to value, it's more tenuous with other kinds of assets.  There is also the issue of how the asset's current market value compares to its cost basis.

You can download the actual Gift Tax (709) and Estate (aka Death or Inheritance) Tax (706) forms and their instructions from the IRS.gov website.  Glance over them and you should realize that you are in over your head without the services of a qualified tax pro.

Good luck.

Kerry Kerstetter

Q-2:

Dear Kerry,

Thank you for your kind response.
First, I wholeheartedly agree with you that when I get ready to act, I will only do so with the aid of an experienced estate attorney. Not just an attorney, but one who deals heavily in estate planning.  Yet, at the same time, I also know that there is still the conflict of interest on the part of someone is both advising me on a course of action AND selling me a product to allow that course of action. 

For example, an attorney has a conflict of interest when advising a client on whether to go the route of a will or an AB Trust.  The trust is more costly for the client up front, but often the fees upon executing the trust at the time of death are much, much lower, possibly even nonexistent.  The cost of a will is minimal, but the cost to probate the will and settle the estate is often quite high.  The AARP says that probating a will and settling the estate often costs 5% of the estate value.

So even a most trusted advisor has a conflict of interest.  And as altruistic as a person can be, the conflict remains.  So it's my job to educate myself so I can intelligently listen and ask questions.

Here's the actual situation I am investigating.

My wife owns 10% of a family business that may soon be sold for $40,000,000.  Her portion will be about $4,000,000.  Since the company was worth $0 when she acquired her piece of the company, the entire $4mm is taxable at long term capital gains rate of 15% or $600,000.  That's a huge hunk of cash to just hand over without exploring other options.

Here's the option I'm investigating, and here's where my thinking and knowledge are suspect.
Let's say that on September 1, my wife dies and leaves me all of her estate.
1.  I would then receive her 10% ownership at current market value or step up in value.
2.  Say on September 30, I sold the 10% at current market value, which has not changed since September 1.  In my understanding, I would not owe any capital gains taxes since I inherited them at the same value that I sold them.

Of course, in this scenario, I owe inheritance taxes on the excess $2mm dollars above the life time exemption. At the rate of about 47% or so.

My question is this, could my wife take advantage of that $2mm lifetime exemption NOW?  Could she give me the $2mm of her company NOW and completely use up her lifetime exemption?  If so, I would now own 5% of the business, I would "inherit" it while she is alive, sell it and owe no long term captial gains since I receive step up in value.

It appears that this could work from an estate side, but now the gifting rules appear to be different.  So I don't think this could work.

If you have the time to comment on this situation or strategy I'd appreciate your input. If not, I understand and appreciate your earlier advice just the same.

A-2:

You have some good points; but are also still working under some misconceptions that would be cleared up if you were to work with an estate planning pro ASAP.

You are absolutely right that there are tons of conflicts of interest in the estate planning arena, especially with insurance salespeople who conveniently steer you into high commission policies and investments.

It is true that, for most people, probate costs are much higher than are actual estate taxes; especially when a living trust is not used.  Trusts do cost some money up front; but that is usually a tiny fraction of the savings down the road.

To address your issue with your wife, and if she were to die before you, you should know that on the 706, there is an unlimited (no maximum amount) deduction from the taxable estate for assets left to a surviving spouse.  This means that there is no estate tax actually payable after the first spouse's death if everything passes to you.

This means that the full estate tax burden falls on your estate, after you pass on.  For large estates, this creates another issue.  If your wife's 706 were to just pass everything to you, and then you die shortly after (in a few years), the total exclusion for the accumulated  estate would be just two million dollars, rather than the four million dollars two people should be able to claim.  What good estate planing attorneys do in situations like this is to make sure the first spouse to die utilizes her full exclusion by having two million dollars (or whatever the current amount is) worth of assets transfer into a spousal bypass trust at her death.  The trust will file income tax returns and generally pass its income through to the surviving spouse or whoever the designated beneficiaries are.  This means that two million dollars of wealth has been exempted from the estate tax.

Then, when you pass on, your estate will be able to claim its own two million dollar exemption.  If you have remarried in the meantime, you can set up a new spousal bypass trust, and so on.

You also seemed to miss my earlier point that the lifetime gift tax exclusion is only one million dollars, not two.

You and your wife really should start working with an estate planning pro right away to clear up these issues.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/23/2006 11:59:00 AM Send this post:

Q:

Subject: new truck

 

Kerry, My son turns 16 this winter.  I'm buying him a 2001 pickup.  I believe we hold our 2 vehicles in the company and pay most of their expense (gas, ins)  out of the company.  How should i buy his truck.  would it benefit me to put him on the payroll in some labor capacity?  looking for your input.

thanks

A:

I can only address this from the tax perspective.  You should also consult with your insurance agent because there are special rules and benefits for teen-age drivers that may influence your decision here.

For tax purposes, it depends on how many miles the truck will be used for business usage.  If most of the miles will be business related, the corp can own it and pay the expenses, and any purely personal miles will have to be shown as income to your son.

If most of the miles will be personal, it will be easier to own it personally and reimburse your son for any business miles driven.

Good luck.  I hope this helps.  

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/23/2006 11:33:00 AM Send this post:

Q:

Subject: Tax information

I read your article S vs C corporations and want to thank you for clearing up some of the myths between these two type of corporations.

All my recommendations have been to setup as an S corporation without much clarification.  This information is very clear and to the

point for us new to starting up a business and I’d like to thank you for that.

 I was wondering if you would be willing to clarify a few points with me.

I started a side company up in 2005 and filed for an S corporation status.

From what I understand reading this article, since I have not filed my 2005 taxes I still have the option to convert back to a C corporation.

Am I understanding this correctly?  If so what is required to change this back?

Also on my net profits, which were $21K, under a C corporation are you saying I would pay only 15% taxes on this income?

Where as I would pay a higher tax rate with an S corporation by adding this $21K to my normal income from my job.

 I know this is a busy time of year and I appreciate any feedback you would have for me.

 Thank you

A:

You are a classic case of someone who is headed for tax disaster unless you start working with a professional tax advisor immediately.   This is not something that you can do on your own, regardless of what information you read on the internet, including anything I have written or posted.  

If IRS has approved your S election, they will be expecting an S Corporation income tax return (1120S) for the calendar year in which the S election was granted.  You cannot just change your mind and file a C corporation return (1120) instead.  When you submitted the 2553, you obligated yourself to include the corp's net income on your 1040.  You must honor that obligation, even though you obviously made it without understanding what it entailed.  That was your fault for not working with a tax pro before deciding to file for the S election.

There are procedures for revoking the S election, but that will not entitle you to change the fiscal year from 12/31.  You will need to set up a brand new C corp in order to do that.

Get with a tax pro ASAP to see what can be salvaged of your do-it-yourself mess.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/23/2006 11:29:00 AM Send this post:

Q:

Subject: Sec.179 on S.Corp - Income Limitations

Kerry,

I came across your website while searching the web for a question I had related to Section 179.

Can an S.Corp. (single shareholder), claim a Section 179 expense deduction and flow it through to its shareholder for an amount in excess of the amount of taxable income given the fact that the shareholder is also claiming a salary form the S .Corp?

Example:

Shareholder salary from S.Corp $60,000

S. Corp net income before Section 179 $50,000

Section 179 Qualifying Property $100,000

Is the max deduction $$50K or $100K?

Thank you in advance for any insight you may have.

A:

This is the kind of thing that you should be working with your personal professional tax advisor on.  If you are trying to handle S corp taxes on your own, you are asking for big problems and will most likely end up paying a tax pro more to straighten things up after the fact than if you were to use his/her services from the beginning.

Your question is a good one for educational purposes.  The S corp taxable income limit for Section 179 purposes is the net bottom line with several adjustments.  One of those adjustments is adding back the W-2 wages paid to shareholder employees.  With your example, and assuming none of the other adjustments apply, that would mean that the full $100,000 could be deducted on the 1120S, which is then passed through to the shareholder via K-1. 

Your tax pro's tax prep software should be able to make the appropriate calculations of the applicable taxable income limitations.  I also found a very handy worksheet for this on Page 5-4 in the 2005 Depreciation QuickFinder Handbook.

Good luck.

Kerry Kerstetter

 

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/22/2006 11:32:00 AM Send this post:

Q:

Subject: Quick Question

I know the gifter doesn't have to file, but does the recipient have to file on a gift that is less than the $11000 limit?  Thank you.

A:

Gifts received are one of the few types of income that are not taxable to the recipient, nor do they have to be reported anywhere.  That applies to gifts of any size, including millions of dollars.

For practical purposes, when a client has received a very large gift or inheritance (another tax free type of income) I have found it useful as a self defense measure to attach a statement explaining the receipt of the gift or inheritance so that IRS will understand why some deductions, such as charitable contributions, are so high compared to the taxable income being reported on that 1040.  To not disclose that fact up front is to invite an audit of the full 1040 when the IRS's screening ratios kick out as suspicious.

FYI:  As of 1/1/06, the current maximum annual gifts before a Gift Tax return is required is $12,000.

I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/22/2006 11:21:00 AM Send this post:

Q:

Subject: Can you help with a question

Hello Kerry:

 

I read your very informative section on rates on the web.  I personally am the executor to my dads estate that has a monetary distribution every year ($500/month) to my brother for the next 8 years. 

 

Today I am filing a 1041 - can you please tell me what is the maximum deduction I can take against the estate (and on what line of the return does it go)?  I have included the tax preparers fee from last year.   Thank you.

A:

If you've read many of my blog posts, you should know that I consider it too dangerous for amateurs to prepare their own tax returns, especially in areas where there are a variety of possible twists, such as with trust fiduciary returns.  It is far too easy to screw things up and get yourself into serious trouble with the IRS and State tax agencies.

You need to have an experienced professional tax preparer handle this.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/22/2006 11:12:00 AM Send this post:

Q:

Subject: Multiple property sales

 

Tax guru,

 

This morning I thought I was a fairly savvy real estate investor…..until my accountant called.  

 

 My first home was purchased in the fall of 2000, I lived there two years and rented it for the last three when it was sold.  After moving out of that house I moved into a condo which I had lived in for two years refurbed and sold at the end of two years when I moved into my next house which I lived in exactly two years and sold. 

 

If you followed that you can see that I sold the condo first(in 2004) and paid no capital gains on my 2005 return.  I sold my first home next(in 2005) and wasn’t expecting to pay capital gains.  I sold my most recent primary residence this year Jan ’06 and didn’t expect to pay capital gains next year. 

I met all of the IRS conditions of a primary residence, and after purchasing nearly 25 properties in the last 5 years I had never hear anyone say that you could not sell a primary residence and use the exemption more than once every two years.  Is this true? Is there any way around this?  I feel betrayed…like I’m being penalized for keeping a property.

 

Please help!

A:

The current law for primary residence sales (Section 121) was enacted in 1997 and has always had a limit that the tax free exclusion couldn't be used more than once during any two year period, unless the second sale was for an unforeseen circumstance. 

That limit has been well publicized and I am amazed that your tax advisor didn't mention it to you earlier when you were considering selling the second home within the two year window.  If you didn't ask your accountant's advice before the second sale, you learned an expensive lesson.

We've all heard the maxim that "ignorance of the law is no excuse."  There are tons of examples in the tax arena where things are so muddy that that rule doesn't apply.  However, this allowance of the Section 121 exclusion for only one tax free home sale per two year period is not a gray area.

From IRS Pub 523:

"You cannot exclude gain on the sale of your home if, during the 2-year period ending on the date of the sale, you sold another home at a gain and excluded all or part of that gain. If you cannot exclude the gain, you must include it in your income."

Depending on which sale had the higher profit, you should work with your personal tax advisor to see if amending the return with the earlier sale to have it taxed and allow the exclusion for the second sale would be a good move for you.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/22/2006 11:08:00 AM Send this post:

Q:

Subject: Glossary Terms

 

I think you have to add :

 

C- company

 

S company

 

what does it mean?

 

Thanks

A:

Those terms aren't used.

You probably mean C and S corporations, which are explained here.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/21/2006 04:54:00 PM Send this post:

Q:

Subject: tax question - child care

 

Hello,

 

If possible, could you please answer the following question for me regarding paying someone for child care...

I would like to employ my Mom to take care of our future child; one benefit I saw from this I can maximize my employer's child care spending account to $5000, which is tax deductible.  I am in a higher tax bracket and my Mom is in a lower tax bracket. What IRS relatated items would I have to do to pay someone for services, ie: would I have to get a tax number, or pay into Social Security for her, or pay into worker's compensation, would I have to set up a company, etc

 

Thank you very much,

A:

The best thing would probably be if your mother set up her own child care business that could be paid for watching your kid, as well as others.  There are many different ways in which that business can be structured (sole proprietorship, C or S corporation); so your mother will need to consult with her personal professional tax advisor to determine the best strategy for her unique situation.  

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/21/2006 04:50:00 PM Send this post:

Q:

Subject: Exchange Question

Are there any special rules that pertain to a person who is not allowed to live in what they want to be their primary residence because they are required to rent government housing as part of the job.

We took a new job which does not have government housing, which means we have to buy a primary residence at the new location  with the money obtained from the sale of our house we were not allowed to live in.

there will be a profit from the house sale but all of it will be needed to purchase a house in the new location.

Seems that there should be some kind of exception as military people probably often fall into this category.

A:

There are some special rules for people in the military and Foreign Services, as mentioned here in IRS Publication 523.

You really need to work one on one with an experienced professional tax advisor to see if any of this applies to your unique situation.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/21/2006 04:45:00 PM Send this post:

Q:

Subject: C Corp estimated tax

Hiii

Wonderful blog!

 

How do u calculate c corp estimated tax?

A:

Technically, you should estimate what the net taxable income will be for the year, calculate the tax and divide that by four to figure your quarterly payments.

Your professional corporate tax accountant can help you with this, as well as how to best utilize the safe harbor methods that are available to possibly justify lower quarterly payments.

As with all corporate tax matters, this is not something that you should be handling on your own, without professional assistance.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/20/2006 05:42:00 PM Send this post:

Q-1:

Subject: Investment Property HARD & FAST RULE

 

Good Evening .....

I came across your website tonite while doing some searches for a real estate property question I have.   It is a question that I simply cannot find the answer to.

I apologize if you do not accept questions, but figured I would give it a shot....

The Big Question:

I own 2 condos. 

They are both rented.

I would like to buy a home and eventually live in it myself.  Right now I am living with and caring for a sick uncle.

I would prefer not to get hit with the Cap Gains Tax from selling investment property.

Could I sell the condos, buy the home, rent out the home  -- so it is basically selling investment property to purchase another investment property.

Then, after a year or so, move into the home (after the tenants are gone)  ---- would this allow me to avoid the Cap Gains Taxes ??

Thank you so much for your time and I would be deeply indebted for any help you could provide.....

A-1:

With 1031's it's investment property for investment property.  Not primary residence.  Here's the link on my website that explains about primary residences.

First of all you need to get with your tax person to figure your best avenue.  If he/she suggests a 1031 you need a1031 accommodator to do your paperwork.  You CAN NOT do this yourself.  Your tax returns have to show your acquisition/purchase property as investment property.

If you decide a year or two down the road you don't want to rent it out anymore, you can convert the acquisition/purchase property into a primary residence.

IRS can drop a deal if they feel your intent was to make the acquisition/purchase property a primary residence from the start & you'd have to pay the capital gains taxes.

Hope this helps.

Sherry Lee Kerstetter, President

Tax Free Exchange Corporation

Q-2:

Thank you Sherry Lee for your rapid response and information...
 
I guess what you're saying is the IRS does not have a hard and fast rule when it comes to turning an investment property into the owner's primary residence....??
 
I have to admit that surprises me.  So if a landlord were to decide he did not want to rent out his property anymore and moved in there is no way to know if the IRS will come looking for Cap Gains Taxes ?    What if the property had been rented for 10 years ?  Certainly the IRS would not say "we think this was your plan from the start and we want our $$"  or would they ?? 
 
I would think there would have to be some guidelines for this type of situation -- no ???
  
Thanks again Sherry Lee and any more info would be greatly appreciated....   :-)

A-2:

The issue of converting a 1031 replacement property into a personal use residence has been a gray area for decades.  We in the tax practitioner community have been begging IRS for decades to give us a definite time period after which a conversion won't be challenged.  IRS refuses to do so because they want to reserve the right to second guess anyone. 

There was a slight step in the direction of defining safe time periods in 2004, when our rulers in DC specifically required people living in converted 1031 property to own it for at least five full years prior to sale if they want to use the $250,000 per person tax free exclusion of gain, as I described in this blog post.

Obviously, the longer time that elapses between the exchange and the conversion to personal use, the less likely IRS will challenge it as pre-planned.  The cases that are most suspect are the conversions that occur in less than 12 months, as well as any that can be identified as preconceived.

They key is to have plenty of documentation of your intention to use the replacement property for rental, business or investment purposes.  Any plan to eventually convert it to personal use should be kept to yourself  If you blab that to a lot of people, there is a chance that one of them may be jealous of your 1031 tax savings and try to make trouble for you by telling IRS about your preconceived plans.  The culture of envy and hating anyone else who has more than you is widespread in this country.

I hope this helps.  You should also be working with a tax pro who understands these rules and they apply to real life people.

Good luck.

Kerry Kerstetter

Q-3:

Thank you Kerry and Sherry for the info and your expertise.

I can see how it can get very complicated....

I wonder , in your opinions, do you think if I purchase a home under the 1031 Replacement Property Rule, rent it out for 2 full years, and then moved in --- would this be fairly safe from IRS suspicions ??

I get the feeling that every case is different in this situation and there are certainly no "definites" ...

Thank you !!!

A-3:

We've been doing 1031's all over the USA for over 25 years & IRS has never challenged a case from us.

There is no guarantees & the laws can change from now until then.

We can just advise you on what we know to date.

Good Luck.
Sherry

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/20/2006 05:23:00 PM Send this post:

Q-1:

Subject: Quickbooks per business?

 

On your website you recommend keeping a single Quickbooks file for each taxable business. How should disregarded entities with their own bank and credit accounts be reflected on the books?

I should think it would be desirable to run reports showing only that entities activities. Not just because you want to know if it's making a profit by itself, but because you want to avoid a colorable claim by a creditor that since you didn't keep separate (or at least *separable*) books they should be able to levy on the assets of the parent to satisfy a judgment against the subsidiary. "Entity formalities" and all that...

A-1:

It really depends on which kind of disregarded entity is involved.  For a single member LLC, which I assume you are referring to, you have some very good points and a separate QB file would be an excellent idea.

However, for  the most common type of disregarded entity, Living (aka Revocable) Trusts, there is no need to have a separate QB file because everything is treated essentially the same as being owned directly as an individual.

Your tax and legal advisors should be able to help you determine when a separate QB file is required.

Kerry Kerstetter

Q-2:

If you keep a separate QB file for the SMLLC subsidiary, how do you merge (for tax purposes) the books come tax time?

A-2:

While you could use one of the QB consolidation utilities that are available, the easier approach is to enter the details from the SMLLC onto the appropriate schedule of the 1040 or LLC and then just make a journal entry on the main entity's QB file to show the SMLLC's net income or loss for the year.

Kerry

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/18/2006 07:19:00 PM Send this post:

Q-1:

Subject: Credit Card Payments

 

Hello,

 

I just came across your helpful website.  I just upgraded once again to Quicken 2006 from Quicken 2003.  It seems different and there are some bugs with relation to prior dates.

 

World you happen to know why credit card "payments" are showing up as "income" on the income expense spreadsheet?   Most of the time I make a transfer" from a check account to the credit card account.  This is done online at various internals, not necessarily at the end of the month.

 

many thanks,

A-1:

I don't have any tips for you in regard to this because I haven't purchased the 2006 Quicken program and have moved all of my clients over to QuickBooks.  If you want to continue to rely on Quicken, you will need to contact the support folks at Intuit for help with this issue.

If you are trying to use Quicken to keep the books for a business, you really should upgrade to QuickBooks.  Several years ago, nobody was a bigger supporter of using Quicken for small business accounting.  I even produced a VHS video on how to use it effectively.  However, with each new version of Quicken, it has become less competent at properly handling accounting.  This new change in the way it handles credit card payments sounds like just another step in that evolution of the program away from a decent accounting program.

Your personal tax advisor should be able to give you better advice on the appropriate accounting program for your unique situation.

Good luck.

Kerry Kerstetter 

Q-2:

Kerry,

 

Thank you so kindly for the answer, although it does not answer my question.

 

We do use QuickBooks as well but I find that it is fatally flawed in too many areas.  So we use both.  At the end of the year we use Quicken to prepare the books.  QuickBooks takes care of inventory and ordering and day to day accounting.   We moved to the Quicken 2006 because they are trying to sunset Quicken 2003, which I think is still a better program.

 

Both are flawed.   I have never found the perfect program for a small medical office.   Finding a really good and competent accountant is about as difficult as finding a competent attorney or physician  :)

 

with regards,

A-2:

As I've frequently said, there is no one single program that can properly handle all of the various tasks of most small businesses, especially a medical one.  QB is the best for keeping track of bank accounts and paying bills. Its billing capabilities are terrible, which is why we use TimeSlips for all of our billing functions.  I haven't personally used the inventory features; but the exposure I have had to them during the annual QB certification courses gives me the impression that they are very limited in what they can handle. 

I am surprised to see you say that Quicken does a better accounting job than does QB because that is completely opposite from my experiences, as well as that of any other accountant who understands true double entry accounting and how poor a job Quicken does with that.  I have had clients send me their info in Quicken data files, which I import into QB before working on it.  I have never done it in the other direction.

Thanks for writing and sharing your story.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/17/2006 01:25:00 PM Send this post:

Q:

I sold my primary residence after living in it for more that 2 years.  I made a profit of about 100,000.  I did not use the profit to buy my new house.  I just put it in the bank.  Do I have to pay taxes on the profit. 

 

Thanks.

A:

It's all explained here.

Your personal professional tax advisor can explain any part that is confusing.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/17/2006 10:38:00 AM Send this post:

Q:

Subject: extension question

 

Dear Kerry,

 

We have filed for an extension, and need to send in an estimated payment of what we think we owe for 2005.  Since we have not yet met with our accountant we are not confident about whether we have over or under estimated?  Should we be concerned about this one way or another?  I know if we underpay we are charged interest on the difference.  What if we overpay?   Do we get this money back?  If we overpay by alot, is this an issue?

 

Thanks

A:

It's generally better to overpay, which is why I round up when doing the rough calculations for clients' extensions.

Any overpaid amount showing on the actual 1040 can either be applied to your 2006 1040 or refunded to you in a check.  There won't be any interest paid to you, but for most people, the peace of mind not worrying about underpayment penalties more than compensates.

Your personal professional tax advisor should be able to explain this to you.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/17/2006 10:35:00 AM Send this post:

Q:

Subject: A take on the S-Corporation salary question

 

I was thinking about the terms "capital intensive" and "service" as applied to partnerships, and came up with this:

 

S-Corp 1: substantially all corporate revenue is derived from services performed by employee-shareholders. I am assuming here that S-Corp 1 doesn't make significant profit from billing for the services of non-shareholder employees. This might be a consultancy or architectural firm.

 

S-Corp 2: substantially all corporate revenue is derived from the use of capital (borrowed or contributed by the shareholders). A real estate or mortgage lending firm might be good examples.

 

When considering reasonable salaries for employee-shareholders, I would think that gross revenues being equal, S-Corporation 1 should pay much higher salaries than S-Corporation 2. Do you think this analysis is a reasonable position to take?

A:

That is a good way to look at the issue, and is actually what the "reasonable salary" consideration is all about.  IRS wants to make sure that income that results from the personal services of the company's owners is reported as earned income and hit with all of the additional payroll taxes that those are subject to. 

As you know, even when you have a very logical method of determining an appropriate amount of W-2 compensation, that is no guarantee that IRS in their insatiable lust for money, won't try to increase that amount and make you fight them to use your figures.

As I've mentioned several times in my blog, this is also the exact same debate over LLC K-1 income being subject to the 15.3% SE tax or not.  Fortunately, IRS hasn't been as aggressive in reclassifying LLC income as they have been with S corps, because they don't have as much legal support for doing so with LLCs.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/17/2006 10:32:00 AM Send this post:

Q:

Subject: Investment Interest

 

Dear Mr. Kerstetter,

 

I have client who set up a family limited partnership with his children. The Partnership invests primarily in vacant land, has some debt which generates

investment interest expense.

Occasionally, the Partnership sells some of the land at fairly large capital gains; however, there are not sales in every year so that in some years there is little or no income.

My question is: is it more advantageous to expense the investment interest as incurred and defer it to years when there are gains or to capitalize the interest to the cost of the underlying properties? For example, in 2004 each of the children has approximately $58,000 of capital gain income.

The children do not have any income or deductions other than that generated by the Partnership.

A:

As you obviously know, there is no universally best answer for this kind of thing. 

However, there are some key factors that you may want to consider.

Even if you enter the investment interest on the tax return each year, what will actually be deducted may be a small part of it, or even none at all, since the actual deduction is limited to the investment income reported on that year's 1040. Nondeductible interest carries over to future years where it can be claimed when there is sufficient investment income.

Another issue to consider is the different tax rates.  Capitalizing the interest would reduce the long term capital gain (LTCG), which is taxed at the lowest rates available (5% or 15%).  A deduction for investment interest could conceivably reduce the taxes by the normal marginal rate of up to 35%.

Based on just those points, it would most likely be advantageous to forgo capitalizing the interest (increasing LTCG) and entering the interest each year as potentially deductible investment interest.

There may be other factors peculiar to your situation that would warrant a different approach.

Good luck.  I hope this helps.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/16/2006 06:14:00 PM Send this post:

From a Texas CPA:

Subject: thank you for blogging

 

just want to say thank you for blogging.

 

as a sole practitioner, i have a few cpa friends with whom to reflect.  still, this is the 2nd time

that i've taken the privilege of using your [written] blog responses to prove a tax point.

i know this uses time, and your time has a serious value, so it's only proper to say thank you.

 

sincerely,

My Reply:

I'm glad to see that you have been finding my postings useful.  Feedback such as yours is very nice to receive.

Please feel free to pass along any issues you would like to see discussed, including a "guest column" if there is something that you would like to say that I may not have covered as completely as may be needed.

I would also be glad to pass along any tips on producing a blog in case you would like to give it a try on your own.  I have learned a lot though trial and error and continue to learn new things every day about this extremely effective medium.  For any practitioner building a practice, a blog seems to be a very effective way to put yourself out there.  It is definitely less time consuming than  than the ways I used to build up my firms here in Arkansas an back in the Bay Area, traveling all around giving speeches and seminars. 

Blogging does take a bit of time; but is still much faster than podcasting, which is the next medium I am looking into.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/16/2006 06:09:00 PM Send this post:

Taxes: Who Pays, and How Much? – From free WSJ.

The U.S. tax system continues to be "progressive," which means that people with high incomes generally pay a higher percentage of their income in taxes than those with low incomes.

Just as Karl Marx wanted it to be.  His disciples sure seem to greatly outnumber those of us who believe in capitalism and private property rights.  

Are You a Clueless Investor? A Quiz...

Selling an Investment Property In a Cooling Real-Estate Market

It's April 15, and the alternative minimum tax means many unhappy returns. – How so many of our rulers can defend and maintain this insane tax is just one more example of their utter incompetence at fiscal matters.

The best advice on personal investment.  – Jonathan Clements recommends five good books on investing.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/16/2006 05:10:00 PM Send this post:

Q:

Subject: Installment Sale Income

 

I have found your insight helpful.  I was hoping you would be able to help me.

  

Purchased investment property 05/2004 secured by a bank loan.  In 9/2004, I borrowed funds from father's trust to pay off the bank loan.  I am a trustee on the trust account.  Payments were made to the trust account until 2/2005.

 

Another investment property was sold in 2002.  The Installment Sale Income, Form 6252, was used for this transaction, and since 2002 I have recieved interest income from this property.  In 2/2005, I transferred my interests in this property to father/trust in return for relief of debt to the trust.

 

It is my understanding that this Installment Sale Income, since it was disposed of, will be taxed as capital gains.  However, because the "gain" was used to purchase like property, is it a wash?  If a gain, how is the gain reported?

 

I asked my accountant and he has not gotten back to me.  I want to be sure I know what questions to ask and know what needs to happen.

 

Thanks.

A:

The proper time to research the tax consequences of an installment note payoff is before you receive the payoff.  Once that is done, it's too late to do anything about it.

A common misconception is that using proceeds from an installment note payoff to invest into new property can save on the tax bite.  That is flat out wrong.  It has no effect.

A 1031 exchange involves like kind properties.  Real property can only be exchanged for other real property. An installment note, even though originally arising from the sale of real property, is itself considered to be personal property.  Personal property is not like kind for real property.

There are ways to delay taxation on installment note payoffs by substituting new borrowers and/or collateral. It is similar to re-loaning the money.  However, this all has to be set up beforehand, with no actual payment received.  Once you receive the payoff, it is a taxable event.  What you do with the money, including loaning it to someone else or buying new property, will have no effect on the taxation of the note payoff.

Good luck.  I hope you will be more careful next time you are faced with this kind of situation. 
 
Kerry Kerstetter

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/16/2006 11:56:00 AM Send this post:

Q:

Subject: question for blog

 

I am a film/video producer and I donated a project I made for a museum (non-profit) exhibition.

I understand that I cannot deduct "services" nor can I currently deduct an "artwork" as such. My point is that

I have created a piece of property (a finished DVD) that has tangible value. It is a professional piece of work

that would normally cost around $8000.00. I am having trouble finding tax law that will enable me to donate these sorts of projects to non-profits though I have heard of examples where this has worked. An Ad agency, for instance, will shoot a few thousand feet of film for a non-profit organization and will then donate the footage to the organization. They are deducting, I suspect, more that just the value of the film stock and processing. Thanks in advance for your advice.

A:

You are very mistaken about the value of the deduction being claimed by ad agencies.  It is a common misconception that other people are getting a better deal than you are.  They are no more able to inflate the value of their donations for tax purposes than you are.

With almost all tax issues, you have to have a cost basis in an item that is being donated.  Obviously, if you purchased an item and then turned around and donated it to a charity, you could deduct what you actually paid for it.  For things that you make yourself, you can only claim the out of pocket costs that you incurred.  The profit that you would have earned under a normal sale of the product cannot be counted as a deduction, unless you want to increase your basis in the item by reporting that profit as income subject to income and self employment tax; which would end up costing you more than twice as much in taxes as the taxes you would save by the higher Schedule A charitable donation deduction.

You really should be working with a tax pro, who will explain to you that Schedule A deductions are only worth about one half the overall tax savings as are Sch. C business deductions.  You would normally be better of running your production costs through your normal business schedule under the premise that the donation is a form of advertising and promotion for your services.  That's how I have always handled my charitable tax and accounting work, and is what ad agencies and other businesses do.  

I am never shy about pointing out the many unfair aspects of the tax law.  On this issue, there is no such problem.  While it may still seem as if you should be able to claim much higher amounts for items you donate, the law as it is does make sense and is fair.

Again, your personal tax pro should be able to show you exactly what the differences would be between Sch A and Sch C deductions.

Good luck.  I hoped this helps you understand the matter.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/15/2006 07:58:00 PM Send this post:

Q-1:

Subject: Home Sale

 

Kerry,

 

My understanding regarding the $250,000/person exclusion for a primary residence home sale that had been acquired in a like-kind exchange is:

 

1. Home must be a rental for at least 12 months prior to becoming a primary residence.

2. Home must be occupied a total of 2 years in a 5 year period and have six "facts and circumstances" to establish primary residency (fed/state tax filing, voter registration, auto registration, bills and correspondence, local bank and social/religious affiliations).

3. Home can't be sold before 5 years of ownership.

 

Questions:

 

1. If the home value is $750,000 and our exclusion is $500,000 as husband/wife, is there $250,000 capital gains only or is there also deferred gain from the exchange due?

 

2. Is there depreciation recapture tax due upon sale of the house?

 

Thanks,

A-1:

Items 1 and 2 in your summary aren't actually as cut and dried as you imply. 

There is no statutory safe time frame for a 1031 replacement property to be used as rental before it can be safely be converted to personal usage without jeopardizing the 1031 exchange.  It is still a matter of intent at the time of the acquisition and is based on the facts and circumstances

Proving use as a primary residence is also not just a certain number of items,  It is based on the overall facts and circumstances, where obviously the more factors that make your case, the better off you will be in regard to defending your position against any IRS challenge.

The Section 121 tax free exclusion is up to $500,000 of profit for a married couple.  The key factor is the home's adjusted cost basis.  If you were to sell your home for $750,000 with no selling expenses, and your cost basis was somehow zero (very unlikely), you would have $250,000 of taxable long term capital gain.  Each time you do a 1031 exchange, you are required to report the adjust basis of the new replacement property on Form 8824.  If done properly, this basis will generally be the latest property's acquisition price less the cumulative deferred gains from all of the earlier properties.

Depreciation that you claimed (or could have claimed) after May 6, 1997 is subject to recapture and taxable at the special Federal rate of 25%.  With 1031 properties, this actually means that you need to trace back the depreciation on all of the previous properties that have been rolled into the one you are now selling; not just what you took on the current property. 

This can obviously get fairly complicated, which is why you need to be working with a tax pro who has experience in this area.

Good luck.

Kerry Kerstetter

Q-2:

Thank you for your response Kerry.

 

As I understand you, all depreciation claimed after May 6, 1997 is subject to recapture and taxable at the special Federal rate of 25% WHEN I SELL THE HOUSE AS MY PRINCIPAL RESIDENCE. Right?

 

thanks,

A-2:

That is correct, plus any gain in excess of the $500,000 maximum exclusion for a couple.

Kerry

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/15/2006 02:21:00 PM Send this post:

Courtesy of The Late Show:

Top Ten Reasons I Love Being An Accountant

10.  CPA training ensures I'm cool in high-pressure situations, like calculating the tip at Applebee's.

9.  While other poor losers go off to work in jeans and sneakers, I get to wear a suit.

8.  You haven't lived until you've filled out form 3277.

7.  What can I say? I'm an adrenaline junkie.

6.  I'm on such good terms with the IRS, I haven't paid taxes since '89.

5.  I like to lick the envelopes.

4.  Like the president, I only work one month a year.

3.  After April 15th, I spend the year eating Pringles and watching rasslin'.

2.  Women don't expect much in the bedroom.

1.  I fudge a couple of numbers and the next thing you know they're hauling Letterman's ass off to prison.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/15/2006 11:52:00 AM Send this post:

For obvious reasons, Andy Roth over at The Club For Growth has been compiling a list with links of various versions of George Harrison’s classic song.  I’ve been sharing the ones I’ve posted, and Andy has been sharing the ones he finds, such as this one by the late great Stevie Ray Vaughan, which he found on this blog post.  I know there are many other fans of the song out there; so this is a good chance to expand your musical library.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/14/2006 03:13:00 PM Send this post:

Q-1:

Subject: sale of residence Tax Relief Act of 1997

 

I was just reading your page on the sale of residence.

 

If I read it correctly, there is no more deferral of gains on a sale of a residence. The only thing is a $250K exclusion. But what about the taxpayer that sells a residence with more than a $250 gain, and wants to buy another residence. He's screwed. Under the old rules he could defer the gain, but under this new rule he can exclude $250, but the remaining $1 million is taxable. This isn't tax relief.

 

Did I read this correctly?

A-1:

You read that correctly.

As with most things in life, the tax code is based on trade-offs.  The multiple exclusion of gain was considered to be worth more than the previous gain deferral rule.

As for bumping up the amount of excludable gain, which hasn't changed one bit since the law was enacted in 1997, there is little to zero chance of that happening. Our society has an insidious under-tone of envy and hating the evil rich is a full time task for the DemonRats and their propagandists in the media.  This means that expecting any sympathy for having to pay tax on profits above $250,000 is a waste of time.

Obviously, the "fair" thing would be to allow people to choose between the tax free exclusion or the gain deferral by reinvesting into a more expensive home. Unfortunately, as I always have to point out, the concept of "tax fairness" is a huge oxymoron in this country.

If your sale hasn't already closed, you should work with a tax pro to see if there is another way around having to pay tax on your gain.  One common strategy is to convert the home to rental and dispose of it as a 1031 exchange for new rental property or properties and then later on, convert one of the replacement homes to personal use.  The rules for this are tricky; so working with an experienced tax pro is critical.

Good luck.

Kerry Kerstetter

Q-2:

Mr. Kerstetter,

 

Thanks for your response. I was thinking the same thing, regarding a conversion and 1031 exchange. I guess you could refinance before you convert, to pull out some equity, then use that cash to help you buy another residence.

 

The problem I'm thinking of is my old mother's residence that has much more than a $250K gain in it. Maybe I could convince her to sell it now, and exclude $250K of gain. It would seem to be better than the estate selling the property at her death and have the entire gain be taxable. She could rent it back if she wanted to stay there.

A-2:

You and your mother really should be working with estate planning CPA and attorney to work out the best game plan for her. 

Depending on the size of her estate, it is entirely possible that her residence would not be taxable.  Under current law, the heirs receive the property at its stepped up market value as of the date of death.  This means that the heirs can literally turn around and sell the property shortly after and their is no gain.  The only real potential tax to worry about is the estate tax, if the net estate is more than the excluded amount for the year in which she passes away. I have the current schedule of those exemptions on my website. 

If our rulers don't get off their butts and address the estate tax issue in the next few years, there will be a change in the step-up limits for estates created in 2010 and beyond; so no estate plan is perfect for long-term.

A good tax advisor could even help you come up with other options to take advantage of the current tax laws.  One I have seen used is to sell the home now, with a large carry-back of the sales price.  After deducting the $250,000 tax free exclusion, the remaining gain is reported on the installment plan, taxable as payments are received.  That also allows for additional estate and income tax planning opportunities if the note receivable is left to the buyer of the property, such as a child. 

There are several options available, which any experienced tax pro should be able to work with you on.

Good luck.

Kerry Kerstetter

Follow-Up:

Thanks for the info. I had forgotten about the stepped up basis. I must be losing it in my old age. For 18 yrs I was a Revenue Agent.

 

She set up a family trust, so she's in pretty good shape that way. The only problem is the exclusion amount, which she is probably a little under right now, but might exceed before the next exclusion kicks in, especially if real estate prices continue increasing.

 

Thanks a lot for your help.

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/14/2006 11:13:00 AM Send this post:

Q:

Subject: Quickbooks Classes

 

Hi!

 

After reading your page on the web on classes we are playing with combining our 12 QB data files into one. The question that we have is about sub-classes. We have 10 properties that are under the owner’s Tax ID and two other properties that we manage that have 2 different Tax IDs. Is it possible to have the first 10 as subclasses with our owner as the class and have the other 2 under their own separate classes?  Or, do we need separate data files for each Tax ID number? What is the best way for both ease of use and, more importantly, tax purposes?

 

Thanks, 

A:

I guess it would depend on what the purpose of your bookkeeping is.  If you are acting as a property manager, you could have one master data file and have a class for each owner, with subclasses for each property.  You could then print out separate P&Ls for each owner. 

This would work well for P&L purposes, but wouldn't do the job properly if you are keeping track of all of the assets and liabilities and each owner needs a balance sheet, which can't be separated by class.  In that case, a separate data file for each owner would make the most sense because you could prepare all of the different financial statements required for each owner's income tax return, as well as 1099s.

I hope this helps.  If you have more details on what accounting services you provide for the other property owners, I might be able to provide more setup advice.

Kerry Kerstetter 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/13/2006 02:03:00 PM Send this post:

Q:

Subject: I would like to get some advise

 

Dear Tax Guru,

I have come across your website after doing a google search for "S Corporation vs: C Corporation". I was so happy to find you! I started a business in 1992, and paid big bucks to an accounting firm to advise me on the best way to set up the business. They advised me to elect the "S" corp, and only explained the advantages of doing so, and none of the disadvantages. Boy was I shocked the first year I had to pay personal income taxes on $80,000 of income that I never received, and never would receive. I am not trained in accounting or finances, but even I figured out that being a c corp was more beneficial to me in many ways. No accountant that I ever talked to about this has agreed with me, or helped me figure out how to change the situation. They seem to think that the more taxes I pay, the better.

 

Therefore, I would like to set up an appointment to talk to you about my situation, and the best way for me to proceed. 

 

Thank you in advance,

A:

It does sound like you do need to find a personal tax advisor who is on the same page of wanting to help you minimize your taxes.  It is a disgrace that so many tax pros do consider it their purpose in life to assist the government in collecting more taxes.  How they can have a clear conscience when charging their clients for that kind of work has always stumped me. 

There are plenty of that type of tax pro around the country.  However, there are also plenty of tax pros who share my philosophy that we should be helping our clients to do everything legally available to minimize their taxes.

I wish I could be of more help to you; but I already have too many clients to take care of; so we are still trimming back on the difficult clients and are not accepting any new ones at this time. 

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

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/13/2006 01:58:00 PM Send this post:

From the WSJ’s free RealEstateJournal:

Large Price Increases Result In Tax Hits for Home Sellers – While many aspects of the tax code have periodic inflation adjustments, our exalted rulers in all of their wisdom, when they established the $250,000 per person tax free exclusion for residence sales, didn’t consider it necessary to allow for any such adjustments.

 

Google and Craigslist May Weaken Realtors' Hold on Home Listings – Allowing the power of the internet to be utilized in this way is an excellent step in the right direction for property owners; while obviously not so good for Realtors, who are losing their monopolies on property info. 

 

As Market Cools, Fewer Investors May Purchase Investment Homes – Is the air leaking out of the speculation bubble?

 

Real-Estate Brokers Step Up Rebates to Home Buyers – Classic supply and demand reaction.

 

The New Rules of Real Estate For a Cooling Housing Market

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/12/2006 11:41:00 PM Send this post:

Q:

Subject: Home Sales

Dear Tax Guru,

I have read your Web page, on tax issues pertaining to the sale of my primary residence, however, I have a home sale question, that I am receiving conflicting answers from friends. Could you possibly respond to my query ?

I have filed my tax return for the past 35 years as " Married Filing Individually-Head of Household "

My husband lives out-of-State, and also files "Married  Filing Individually"

My husband and I have been seperated for 35 years, and the ownership of the Home is in my name only.

When we seperated, my husband agreed to the changing of the DEED to my name solely.

We did not divorce, as he provides me with health coverage from his retirement plan.

I would like to sell my home this year and am wondering whether I am entitled to the entire $500,000 exclusion on the Sale of my Home. I am concerned about the technicalities of the IRS Regulations on the sale of my home--that is to say, that by still being married, and filing Married but Individually, my husband has the right to $250,000 Capital Gain Exemption on his tax return or am I entitled to the entire $500,000 exemption.

My husband has not resided in mmy home for 35 years. Before I sell my home in Long Island, I would like to be sure that I would be entitled to the entire $ 500,000 exemption ?

Could you advise me on this matter, as I am so confused and fearful of making a mistake. Thank you,

A:

Your first very big mistake is soliciting tax advice from friends.  That's crazy.  You should be working with a professional tax advisor on matters such as this.   I hope you don't get all of your medical advice from your friends as well.  Tax issues are just like medical ones, unique to the individual person and very technical.

From the way you described your situation, you would only be entitled to an exclusion of $250,000 of profit on the sale of your home because you are the only person who meets the tests.  If your husband had lived in the home for at least 24 months out of the 60 months prior to its sale, you would be able to claim a full $500,000 exclusion if you file a joint 1040. 

This really isn't even a gray area.   The IRS rules are very clear on this point. 

You can exclude up to $500,000 of the gain on the sale of your main home if all of the following are true.

• You are married and file a joint return for the year.
  
• Either you or your spouse meets the ownership test.
  
• Both you and your spouse meet the use test.
  
• During the 2-year period ending on the date of the sale, neither you nor your spouse excluded gain from the sale of another home.

If the house is fully in your name, the sale will be reported fully under your SSN and you will have to show the full sales price on your 1040.  Your husband won't have to show anything on his separate 1040. 

Again, you should consult with a professional tax advisor to see if there are more details in your life that would warrant a different answer.  There may also be some tax saving strategies that could help, such as adding your husband's name back onto the deed.  An experienced tax pro should be able to suggest ideas such as that.

Good luck.

Kerry Kerstetter

Follow-Up:

Dear Kerry,

Thank you for the response to my query on Home Sales, i.e., the $500m or $250M capital gains exclusion based on joint or filing
singly returns deduction. I think it was very kind and generous of you, to return an answer by E-Mail, and I want to express my gratitude
to you, for taking time to assist me. You are indeed a humanist at heart, and I grateful you have that quality.

Thank you,

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/12/2006 03:51:00 PM Send this post:

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

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/12/2006 01:09:00 PM Send this post:

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

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/12/2006 12:34:00 PM Send this post:

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

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/12/2006 12:27:00 PM Send this post:

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

 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/11/2006 06:48:00 PM Send this post:

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

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/11/2006 01:55:00 PM Send this post:

Q-1:

Subject: Particular Capital Gains situation

Hello.

From 2002 to end of 2005 I rented 2 of the 3 rooms of my house. I have always lived in one room myself.

I would like to sell the home in 2006 (this year) but first I would like to estimate the capital gains tax.

Is it true that I cannot simply claim the home (my only property) as my primary residence and thereby take advantage of the $250,000 capital gains exclusion?

Must I pro-rata the rental as a portion of the home and in that way avail of some of the $250,000 capital gains exclusion.

If pro-rata were the route to take how could it be calculated, particularly since I do not rent rooms in 2006?

Thank you

A-1:

There are to many possible scenarios involved here for me to make any suggestions.

You need to work with your personal professional tax advisor to work out the best way to handle the sale of mixed use property. 

Good luck.

Kerry Kerstetter

Q-2:

Kerry Kerstetter,

Thank you for the quick reply.

There is only one scenario. I am selling the house this year but lived in it for 10 years and rented out rooms for the last 4.
I will just ask one question then, in case you would have an opportunity to re-visit this.
Can I claim some of the $250,000 or is it an all or nothing situation?

Thank you

A-2:

It is actually much more complicated than you understand.

At a bare minimum, you will have to recapture depreciation claimed since May 6, 1997.

From the way you described it, this sounds very much like a tri-plex, where two-thirds of the units were rented out and you occupied one-third as your primary residence.  Under that scenario, you would need to report the sale on your tax return as if it were a sale of two different kinds of properties.  Two-thirds of the sales price would be shown on Form 4797 as sale of rental property, with appropriate figures for the cost basis and depreciation. 

The other one-third of the sales price would be shown on Schedule D, using the appropriate cost basis for that portion of the house.  The gain on that sale would be eligible for the exclusion of up to $250,000 of profit.

If you were to wait to sell the home until more than two full years after your tenants left, the sale could be shown as one sale of a primary residence, with the full gain eligible for the $250,000 exclusion, except for post 5/6/97 depreciation.

Another issue to discus with your personal tax advisor is the possible taxes on the sale of the rental two-thirds and whether you want to do a Section 1031 like kind tax deferred exchange on that portion, which would require you to reinvest into new business, rental or investment real estate within 180 days.  You can see the rules for that on www.tfec.com.

I hope I made my point that there are several factors to analyze, and you need to do it with a qualified professional tax advisor or you could very easily make a very expensive mistake.

Good luck.

Kerry 

Follow-Up:

Kerry,
Thank you sincerely for putting your time into this.

 

Labels: 1031

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/11/2006 11:42:00 AM Send this post:

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.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/11/2006 11:14:00 AM Send this post:

Q:

Subject: 401k Contributions (After-the-Fact)

 

Kerry,

 

I have just finished our tax return for 2005.  We owe $1,500 to the feds and $2,300 to the state (CA.).  I did notice (on our W2s) that both (my wife and I) are below the limit ($14,000) in our 401k contributions for the period.

Are we allowed to send these institutions additional funds in order to reduce our tax liability?  Or can we contribute to our IRA's at our Bank in order to reduce our liability?

Please advise.

Regards,

A:

You should be working with a tax pro on matters such as this.

401k contributions are only allowed during the year in which you are being paid because they are intended to be made directly from your paychecks and reduce the taxable income for that particular year. The time to increase your 2005 contributions was before 12/31/05 through your employer's payroll department.  Your 2005 W-2, where 401k contributions have their effects is locked in and you have to live with it.

Deductions for conventional IRAs are very small or nonexistent for people who have an employer sponsored retirement plan (including 401k) who are considered to be evil rich by our rulers in DC.  For 2005, the IRA deduction starts being phased out for couples when their Modified Adjusted Gross Income (MAGI) is $70,000 and is completely gone when MAGI reaches $80,000.  You didn't say what your AGI is, but there's a good chance that you are over those limits.

You also have the possible options of making nondeductible contributions to traditional or Roth IRAs; but neither of those would reduce your tax bills.

You can see more specific details in IRS's Pub 590.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/10/2006 11:29:00 AM Send this post:

Q:

Kerry,

The article you posted at your site was very helpful and educational... and I wanted to thank you for taking the time to post it. I need some clarification on something. I am about to sell my primary residence in Dallas. My profit is around $20K. I've only lived in this house for 8 months. Do I have to pay captical gains on this $20K even if I roll it into the purchase of a new house? Any other suggestions to avoid the capital gains tax? Thanks.

A:

It looks like you need to work with a professional tax advisor because I thought I had both of those issues explained fairly clearly on my website.

What you do with the money from your sale has absolutely no bearing on the taxability of the sale.

The only way you will be able to exclude the gain is if the reason for your sale so soon after its purchase is due to a health or employment reason or other unforeseen circumstance.

You should do a thorough accounting of your cost basis in the home, including all capital improvements.  The higher the cost basis, the lower your profit, which is also reduced by selling costs.

None of this is very complicated, so pretty much any tax pro should be able to help you.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/10/2006 11:25:00 AM Send this post:

Q:

Subject: Filing as a "S" Corporation

Good morning!

I just completed my tax filing for 2005 as a sole propriotor.  My accountant suggested I become a "S" Corporation.  I made $70,000 last year but after expenses made $20,000.  I am paying $3899 to the Federal Government and $78 to the State.

 

My accountant said "not" to file as a "C" Corporation.  Can you give me more information?

 

Thanks,

A:

There is no one size fits all for deciding which entity type is best for a particular situation. 

Your accountant should be able to explain why s/he decided that an S corp is best for you, including addressing the various issues that I mentioned in my article on the differences between C and S corps.

If your accountant just blindly decided that an S was right for you because s/he always chooses S corps (as some tax pros do), it's time to find a new tax advisor who will take the time to properly analyze your situation before reaching a decision.  Such an analysis should not be done unilaterally by the accountant and should include a lot of questions of you and any other people involved in your business.  In a way, it's similar to a doctor prescribing medication.  That can't be done without a thorough diagnosis of the patient.  Same thing for structuring a business.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/10/2006 11:21:00 AM Send this post:

Q:

Subject: capital gains

 

If my parents put their home in a realty trust in 2004 and they passed away and the gain on the sale of the house is $600,00 do I get a stepped up basis as of the time of their death or does that fact that it is in a realty trust change that?

A:

You are going to need to consult with someone who can analyze the specific facts more closely because there are many different kinds of trusts.  If it is a QPRT (Qualified Personal Residence Trust), there are different consequences depending on how long the trust was established for.  In some cases, the basis does get stepped up, while in others it remains the same as it was for your parents.

You can get a flavor for how complicated this can be by Googling for QPRT, such as in this article.

I would think that you could probably get a good answer by consulting with either the attorney who set up the trust or the accountant who has been keeping the books and preparing the tax returns for the trust, if it is one of the types that requires annual income tax returns.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/08/2006 11:15:00 AM Send this post:

Q:

Subject: S corps

Just read your article - have a couple of questions.

 

1.  Can an S corp own another S corp with the second S corp having addl shareholders?

 

2.  Is there an S corp structure that does not allow addl stockholders.  For instance - you have an S corp -as an S corp another entity is purchased - can the addl entity have additional owners or must they be the same as the parent S corp.  The purchased entity not being an S Corp.

 

I guess both of these questions are basically the same.  What I have is an S corp for sale, possibly being purchased by another S corp.....the stockholders of the purchasing S Corp have indicated they CANNOT have other stockholders for just the new purchase.  It has been indicated that the purchasing S corp is some special type of S corp....

 

Anyway - any information would be helpful.

 

Thanks!

A:

This is most definitely a very complicated area where a professional tax advisor should be involved. 

There are ways for an S corp to own another S corp as what is called a QSub (Qualified Subchapter S Subsidiary).  You can check IRS Form 8869  and see what is involved.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/08/2006 10:55:00 AM Send this post:

From WSJ’s free Startup Journal:

The Benefits Of Incorporation – Would anyone want to work with a CPA who would make the following bone-headed comment?

That said, don't fool yourself into thinking you'll reap any major tax benefits from incorporating, says Robert Caplan, a certified public accountant in Foster City, Calif. Tax liabilities for corporations are generally the same, and sometimes even much higher, than those of a sole proprietor or partnership. "I hear people all the time talk about tax benefits of incorporating, but they're just not there," Mr. Caplan says.

Formalizing Loans From Relatives, Friends – It really helps to support the deduction for an unpaid loan if there is proper documentation.  Otherwise, IRS likes to consider it a nondeductible gift, which is their beginning assumption for any money given between friends and family members.

Avoiding Pitfalls When Partnering with a Friend – Just like a pre-nup with marriages, terms of a business relationship should be well documented while everyone is on good terms.  To skip that step is just asking for an expensive mess later on.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/07/2006 03:08:00 PM Send this post:

Q:

Subject: tax guru question

 

Greetings Kerry,

I just have one question. First of all, I really enjoyed your site. Very informative. My questions is what is the penalty for filing your taxes as a single when in reality you are married. Even though I am married, I recently got seperated from my wife. I was planning to file as a single and so was she. Thanks for your help.

A:

You both are treading into dangerous territory if you are serious about filing as Single when you were legally married as  of 12/31/05.

If there are kids involved and you  meet several qualifying tests, you and/or she may possibly qualify to use the generous Head of Household status.  Your professional tax advisor can help you determine if you qualify.

If you don't qualify for HoH status, you need to either file a joint return or as Married Filing Separate, which does have several penalties built into it.  To file as Single is technically filing a fraudulent tax return, which then gives IRS a lot of power over you, including the assessment of penalties and the removal of the statute of limitations.  With a normal honest tax return, IRS has three years to come after you.   With a fraudulent tax return, they have forever to come after you.

Give those points some deep consideration before sending in a 1040 claiming a bogus filing status.

Kerry Kerstetter

Follow-Up:

Thank you very much for your help.

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 01:18:00 PM Send this post:

Q:

Subject: Property Mgmnt /QB's

Kerry after reading through your website I have come to the conclusion that you may be the only “QBGURU” that could efficiently help if you will?

 I am very familiar with QB’s but am finding it difficult to set up rental property in QB’s so that I may track income and expenses as well as the security deposits.  Without going into too much detail and wasting your valuable time maybe you are willing to help me with this?  

 Much thanks,

A:

It's very easy to do with the Class feature.  Set up a class for each property and when entering each income & expense item, assign the appropriate class.  You can also use sub-classes to group properties, such as by address or by owner if you are doing property management for other people.  When setting up your P&L, just specify that the columns should be arranged by Class and then you will get a separate side by P&L for each property.  I use this every day when working with clients' books to prepare their tax returns and it works beautifully. I explained Classes on my website.
 
Security deposits need to be treated a little differently because QB doesn't allow you to set up a Balance Sheet with columns by Class.

There are two main ways I have seen for keeping tabs on security deposits.  One way is to have a sub-account for each tenant.  The problem with this approach is that it makes the Chart of Accounts grow rather large and unwieldy.  Accounts for tenants who have left can be tagged as Inactive after being zeroed out; but there could still be a lot of accounts to wade through.

The other approach is the one I use for keeping tabs on the trust funds Sherry's exchange company is holding for client reinvestment.  There is just one current liability account called Client Trust Funds.  Each entry in and out is tagged with the customer name.  We run transaction history reports with totals by Customer in order to see a detail of each client's account.  This could just as easily be done for tenants.  In order to print out a detail for just one client (tenant), we check the box called "Page break after each major grouping" and it puts each client on a separate page.  We page though to find the client we want to print out and just print that page.

I hope this helps.  It's really pretty easy; but you can probably get some personal assistance from a QB ProAdvisor in your area.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 12:23:00 PM Send this post:

Q:

Subject: Seminar

I'd like to echo the sentiments of one of the recent emailers who said they would come to a seminar of yours. I live in Washington DC but would travel

anywhere to hear you speak and share your knowledge.

Please consider it. Thanks.

A:

I appreciate that feedback.  I am not a big fan of long distance travel, so the chances of my doing any live seminars outside of our local area are very slim.

However, I am looking into the logistics of doing some online seminars and will probably be doing a few live mini-seminars in the local area that we will tape and make available via CD and MP3 download. 

I will definitely announce anything in that regard on my blog.

Thanks for writing.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 12:12:00 PM Send this post:

Q:

Subject: Questionable taxes due for 2006?

My partner an I are co owners / co borrowers of a residence we have resided in since 2000. We are in the process of disolving this partnership and she will be buying out my share of the property and assuming all loans and debits. My question is, on the money I receive, will I need to pay taxes on it for the year of 2006? The residence was not sold nor refinanced but her att. said we needed to have the residence appraised and that the monies given to me have to be filed as income? Can you Help???

It sounds like you are selling your half of the home to your co-owner; so this will need to be reported on Schedule D of your 1040.

You didn't give any figures, but if your profit on this sale is under $250,000, it should be tax free. 

You should have been keeping tabs of your cost basis in your half of the home, starting from the original purchase and including any capital improvements you've made up until the time of your sale.  Subtract that from the value you assign for the buy-out and you will have your profit.

If the profit on your half of the home is over $250,000, you will have a taxable long term capital gain.  What you do with the money will make no difference whatsoever on the taxation of the home.

This isn't very complicated, so any tax pro should be able to help you report it properly on your 1040.  I have all of the rules on home sales on my website.

Good luck.  I hope this helps.
 
Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 12:07:00 PM Send this post:

Q:

Subject: Sub S Corp Question

Mr. Kerstetter,

First, I would like to thank you for your informative web site.  You have effectively detailed many of the pros and cons of incorporating. 

My question is, do expenses such as buying a company car offset any income acquired by the corporation?  I was reading about the man who earned 300k but only took out 30k for himself on your website.  Didn’t the corporation make the 300k profit?  If so, and it was retained within the corporation for operating capitol, why did he have to show it as income?

A friend and I are considering forming a Sub S Corp and I am trying to learn as much as I can prior to beginning the process.  As things are, I will own 49% of the stock and Eric will own 51%.  We have the potential to generate well over 500k within the first year and a half to two years.  After that, there is the potential to make literally millions.  For this to work, we will need to keep a majority of the profits within the company for the second and third phase of our business plan.  We will only be taking out 30k to 35k apiece.  Is there any way to keep the income within the company without having to pay through the nose for income that we are not seeing the benefit of?

Eric is strongly in favor of the Sub S because he says that the dividends that we are paid are not subject to social security tax.  I am concerned that he is being a little short sighted.

Thank you so much for your time.

A:

While I do appreciate the fact that you are doing research on the issues surrounding working with corporations, there is no book or online reference (including any of mine) that can substitute for the real world services of a qualified tax professional who can thoroughly analyze your particular circumstances.

You do seem to be very confused about the workings of pass-through entities, such as S corps, partnerships, and LLCs that elect to be taxes as partnerships or S corp.  For Federal income tax purposes, these entities do not pay any income taxes.  Their net income or loss is passed through to the income tax returns of the shareholders, who are required to include it on their 1040s regardless of how much actual cash (if any) the shareholders received.  The example to which you referred is a very common situation, where the S corp has a very large net taxable profit, but doesn't distribute any actual cash to the shareholders because of investment or operating requirements.  The shareholders are still required to pay income taxes on that income and come up with the cash to pay them from whatever sources they can utilize.

Depreciation and Section 179 expensing of business equipment, including some kinds of vehicles, can reduce the corp's taxable income.

A C corp pays income tax on its net taxable income, which could be high if excess cash revenues aren't spent on deductible things.

There is no easy one size fits all answer to your needs.  You should also be open to the fact that you may not want one entity to cover every aspect of your business.  Multiple C and S corps may very well work out best for you and your business partner.

Again, it can get very complicated and is something that you definitely need to work on with a competent tax pro.

Good luck.

Kerry Kerstetter

 

Labels: 179

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 12:03:00 PM Send this post:

Q:

Subject: C vs S

 

Hi Kerry,

 

Very informative site.  Which entity is better when a Company is sold?  Assuming a typical transaction would be an asset sale.

 

Thanks

A:

There are too many possible variables for there to be a universal answer to that.  It all depends on the facts and circumstances.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 11:53:00 AM Send this post:

Q:

Subject: Sale of Personal Residence 

Hi Kerry,

 

I have received conflicting advise and found you during my research on the internet.

 

I own a condo in which I have considerable equity and lived in for 17 years. Nearly 3 years ago I bought a townhome and borrowed against the condo equity for my down payment. For a variety of reasons, I didn't decide to sell the condo until this past month. Here is my dilemma:

 

At the end of May I will have been living outside of the condo for three years and will lose my exemption benefit. The condo needs some work to get full value and I fear that by the time I get the work done and can find a buyer that I will not be able to close in time to preserve my exemption. Since the condo needs work, I thought that perhaps I could sell the condo to an LLC or S or C Corporation which I control and then fix it up and sell it, essentially flipping the property. Or selling it to a relative to accomplish the same thing.

 

I've been told by one CPA that neither sale would be respected by the IRS and another says there are no rules about sales to relatives or to entities that are controlled by the seller - except for the remainder interest discussed on your site. I haven't been able to find any discussion of similar circumstances by searching the web. I'm simply looking for a way to preserve my exemption as my gain will be considerable.

 

Thanks for any insight or direction you can provide.

A:

I'm not aware of any new restrictions on sales to related parties since my earlier posting about selling a home to a controlled LLC.

One of the nice benefits of producing this blog is the volume of feedback it receives, especially if another tax pro thinks I missed something or misstated any facts.  So far, nobody has piped up with any arguments over that issue; so it seems that it should work for your particular situation.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 11:47:00 AM Send this post:

Q:

Subject: hsa

I couldn’t find any info on your site regarding health savings accounts? Could you direct me to the area so I can research? Thanks and I do enjoy the site.

Best-

A:

I haven't posted much on HSAs because I still don't have a lot of real life hands-on experience with them.

I did include some links in my blog to other resources that did have pretty good explanations of how HSAs work, such as the following.

HSA Insider website

Free WSJ article on how they work

I hope this helps.  As these plans grow in usage, and I have more chances to see how they function in the real world, I'm sure I will be posting more info about them on my website and my blog.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/06/2006 11:42:00 AM Send this post:

Massachusetts Libertarian Carla Howell has posted an original song on the joys of spending quality time preparing income tax returns on her website.  It’s a good summary of what we all feel this time of year.

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/04/2006 12:00:00 PM Send this post:

Q:

Subject: Client Accessibility

 

Mr. Kerstetter

 

I recently read about your blog in the Wall Street Journal and was reading through it last night. I enjoyed reading it.

 

You hit upon an issue that I have been dealing with for the past few years and increasingly so during tax season. We are a small 5 person firm. Clients, whether they be monthly compilation accounts, annual tax clients, or audit clients assume that I am available at a moments notice for telephone calls, draft a letter on their behalf, or as you say, drop in unannounced expecting to see me and get a question answered.

 

Being a small firm, we strive to provide very personal service and handle matters as efficiently and rapidly as possible. However, in today's age, clients think of something, call and expect to get their answer instantly. How do you politely inform the client that even though they know you are there (can see your car) or know your schedule, that you are not available? The front desk woman does her best to try and find out what they need and help if possible, but sometimes they just "need" to see me for a minute or call back multiple times requiring an answer that day.

 

In cases where it happens frequently, we have increased fees (usually in the work in process), though in extreme cases we have itemized it to make sure the message was clear. Though I can see a number of clients being upset at that and in their mind, this is one of the benefits to being with a small firm; the accessibility. Along similar lines, the tax client who requires a tax appointment to "present" you with his W-2, 1099, and 1098 and no matter how hard we attempt to get them to drop off or mail the information, they have to see you because the meeting is basically unnecessary and a waste of 30 minutes to an hour.

 

Any thoughts or advice would be appreciated if you have a moment

 

Sincerely, 

A:

That is a problem we all have.  A long time ago, when we were still back in the PRC, we had to get tough and set out guidelines, most of which we still use today.  The current version is on our website. 

We give print-outs of this to all clients as well so there is no misunderstanding.

In the near future, I will probably be posting an email exchange we recently had with a potential client who got upset at our refusal to meet with her in person.  I laid out the reasons for her.

Good luck.  I hope this helps. 

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/04/2006 11:46:00 AM Send this post:

Q:

Subject: How to reclaim dependent when someone else has claimed her?

Hello Mr. Guru,

     I have placed a copy/paste of your archive dated May 2, 2003 below my letter.

     I agree with the dratted limitations in e-filing.  And, my ex-spouse did, in defiance of the court's decree about who has custody of our child for more than half of the year, claim my 6yo daughter as her dependent.  And, sure enough, my e-filing was bounced back at me.  Now the question is:  To WHOM in IRS do I send the court decree re: child custody?  What office? at what address?  I ask because my CPA says, "What you're faced with if you simply paper-file and send a copy of the court decree is an $8/hr clerk opening your envelope and disregarding all papers except those which are the forms s/he data-enters into the IRS computer at his/her work station.  I've even heard of checks being thrown away because someone did not want to 'deal with it'."

So, how do I bring my situation to the attention of someone high up enough in IRS to amend the ex-spouse's tax filing and allow mine to be processed when we are both claiming my daughter as a dependent?  To whom do I address this?  What office? at what address?

Help me, Guru, you are my only hope!

Best to you,

A:

I would start by contacting the IRS's Taxpayer Advocate's office and explaining your situation.  They are pretty good about helping you cut through the normal red tape.

Their phone number is: 877-777-4778

Good luck.

Kerry Kerstetter

Follow-Up:

Bless your heart!  And, I mean it.  I didn't expect you'd even answer.  My CPA also suggested Taxpayer Advocate, but she didn't have the phone number.  If I find out something helpful, I'll email it back to you.

Best to you,

My Reply:

Obviously, you won't be able to e-file your tax returns with a mess like this; but it's more important to be able to file an accurate one.

Good luck.

Kerry Kerstetter

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/04/2006 11:24:00 AM Send this post:

Q-1:

Subject: Link Exchange request from Bookkeeping Services company

Hi Kerry,

 

We provide CFO Services and Bookkeeping Services to small and medium-sized businesses.  Exchanging links between our websites will help both our sites show up better in search engines, and thereby acquire more business over the web.  Therefore, I am hoping you will be interested in placing a link to my website from your site.  If you are, it should read as follows:

In exchange, I would be happy to create a link to your site.  Please let me know what you would like it to say.

 Best regards,

A-1:

We are very selective about the links we include on our websites, limiting to ones for companies with which we are familiar.

I'm not familiar enough with your company's service to be able to endorse it yet.  That could change later down the road.

I'm sorry I couldn't be more help.

Kerry Kerstetter

Follow-Up:

Thanks for getting back to me, Kerry.  Let me know if you change your mind.

Best regards,

Q-2 (From different person):

Subject: bookkeeping website

 

Hello,

 

Your website states to send you information on bookkeepers who are available for hire, however, it was last updated in 2001. Are you currently accepting information from independent bookkeepers?

 

Thank you,

 A-2:

Send me a link to you website and I'll check it out and possibly include a link to it.

Kerry Kerstetter

Follow-Up:

 ….

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/04/2006 11:11:00 AM Send this post:

From Ohio CPA Dana Stahl:

Mr Guru - I found this article from 3 years ago by Dr Jack Wheeler on the tax code.  Quite observant!

DS

The U.S. tax code is purposefully not designed to maximize economic prosperity. Its express purpose is to maximize politicians' power – power to extort contributions as protection money, and power to make people dependent on government subsidies, thus gaining the vote of those so dependent.

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/03/2006 10:36:00 PM Send this post:

From a reader:

Subject: You are so right.

On April 1 you wrote this in response to a question:

"Our tax system is such a convoluted fiasco that anyone grounded in serious logical thought processes (doctors, rocket scientists, et al) will have their brains fry trying to make sense of it."

I just wanted to say how true that is. When I was newly married, my wife and I tried to do our taxes. We didn't have much and though it should be simple enough, after all, we both have Masters degrees so we're fairly intelligent people.

After we each made several efforts and each time came up with different numbers, we decided it was worth paying a tax preparer to save our marriage.

My reply:

That was a smart move, to use a professional tax preparer.

Remember what Albert Einstein said many decades ago, when it was a piece of cake compared to the insane mess it has morphed into since his time.

"The hardest thing in the world to understand is the income tax."

"This [preparing my tax return] is too difficult for a mathematician. It takes a philosopher."


Thanks for writing.

Kerry Kerstetter

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/03/2006 03:55:00 PM Send this post:

Q:

Subject: Post-Katrina Rental

 

Kerry,

I'm trying to figure out how to account for rental income I received for renting my house in New Orleans after the storm. My wife and I own our home in Gretna, Louisiana, just across the Mississippi from New Orleans. The West Bank. We evacuated to my parents' house in College Station, Texas, about two hours north of Houston. I'm a medical student at Tulane, and after the levees broke the school decided to set up in Houston for the year, so we have stayed in College Station in my parents' house. I drive to Houston every Monday and stay until the last class on Friday afternoon, sleeping on a pull-out coach in the living room of two very charitable roommates who are grad students at Houston area schools.

Our home survived the storm well, we only lost one shingle and a water spot in the kitchen ceiling; the house is otherwise fine. Since we already knew we couldn't move back until the summer of 2006 we made our house available to a couple who lost everything and told them to name their own price. They decided to rent from us at a rate of $800 per month, plus utilities. They rented for October, November, and December of 2005. We literally signed the checks over to my parents who have really bent over backwards to help us. My mom even postponed her PhD program at Texas A&M to watch our kids while my wife works. All this means is that our bottomline finances aren't substantially different than they would have been if we'd stayed in New Orleans and Katrina had never happened.

How do I account for those three months of rental in my taxes? Is this rental property? It's certainly my primary residence, but we had just moved to New Orleans in July after I got out of the Navy and before starting medical school. Did I rent 100% of the property for 60% of the time, which was really 25% of the year?

I have a degree in Physics, interned at NASA, and did rocket science. Taxes aren't rocket science. They're worse. Please help!

Very respectfully,

A:

You will need include Schedule E with your 1040 to report the rental income, as well as the expenses for your home during the time it was rented out, including depreciation.  Because of all of the allowable deductions against the income, it is very likely that you will end up with a net loss on your Sch. E that will shelter some of your other kinds of income.

It isn't difficult for any experienced tax pro to do this; but not something anyone else should try on their own.  You should definitely not try to prepare your own tax return.  Our tax system is such a convoluted fiasco that anyone grounded in serious logical thought processes (doctors, rocket scientists, et al) will have their brains fry trying to make sense of it. A good tax pro should be able to help you reduce your taxes by much more than his/her fee; so it's a no-brainer.

Good luck.

Kerry Kerstetter

Follow-Up:

thanks!

 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 4/01/2006 06:44:00 PM Send this post: