Your Questions Answered

Question: How much time should be devoted to studying tax planning? Can’t I just select a software providing Artificial Intelligence to Inform Me What to Do? Answer: To answer this question Dear Reader, I’ll ask a question in response. Are you a user of TurboTax or a similar software tool? Chances are as a reader of Think Outside the Tax Box, you use something (or someone) different than software purchased at a big box store. The answer to this question may be a similar situation to a semi-regular TikTok viewer of DIY household construction projects. Does the job require a router or a Dremel tool? If you’ve heard me talk about tax planning before, no doubt you’ve heard me describe tax planning software as an instrumental tool. It can provide valuable insights such as data extracted from your tax returns, calculation of minimum required estimated tax payments, and even a few tips to save annual tax. Whether you are a do-it-yourselfer braving a construction project in your home or a new business owner or novice tax planner, the answer depends on the nature of the job you are doing. Is it possible for this experienced Tax Planner of more than 20 years with an advanced degree and thousands of tax plans to complete a bathroom remodel in just a weekend with a Dremel tool? Certainly. I’ve even got the pictures to prove it. Just like the bathroom-in-a-weekend, it is possible with an off-the-internet-software to develop a few ideas to save some tax dollars. But if you look closely at my personal photos – you’ll notice the glue expired on my “driftwood” mirror frame. The recycled wood tiles failed to stay up with the shower moisture in the air, and while the dimensions of my replacement countertop – the walls were just a hair too uneven in my old house. In the end, my weekend project took more than 4 weekends of my precious free time, more than $1,200 in the after-the-fact hired help to fix my handywork, and a little of my pride revealing this online to a public audience. To read about when it is a DEAL BREAKER to rely on AI tax planning software, click here to continue reading.

Karin Slaughter’s novel False Witness focuses on a lawyer in a prestigious Atlanta firm gearing up for a criminal trial. Coincidentally we have this week the outcome of her own legal drama, which likely only excites the tax blogosphere. Her appeal to the Eleventh Circuit of a 2019 Tax Court decision confirming that she owed almost $190,000 in self-employment tax for 2010 and 2011 was unsuccessful. Read on to find out what we can learn from this lesson!

Question: Can I avoid depreciation recapture by not claiming it before I sell? Answer: Nice try. You may save yourself unnecessary worry and fear about so-called recapture, but it won’t save you any tax impact when you do sell. If you want to learn the truth about depreciation, keep reading to learn more.

A frequent question for tax pros is, “Can I put my primary residence in an LLC?” It is well known that owners holding rental real estate in a limited liability company want to ensure they’re receiving all their entitled benefits. The problem is, simply placing a personal residence in an LLC does not change the fact that the residence is for personal use and not for business. If you’re hoping that using an LLC will help you gain tax advantages, the LLC might not be the right choice for the property. The main purpose of an LLC is asset protection. Aside from this valuable benefit, many choose an LLC to hold their business activity. However, simply using an LLC for anything personal not only doesn’t provide additional tax benefits, but it may also cost you the available benefits for your home. If, however, you’re thinking of locking in the tax advantages you currently have while converting your home to a rental, consider selling it to an entity you own before you make it available for rent. To learn how to avoid losing tax breaks and gaining more, keep reading.

Question: I have a fully depreciated rental property that I purchased more than 40 years ago. What are some tax planning strategies I should consider? Answer: Congratulations! You defied the odds and the thousands of advertisements claiming that real estate investing is an easy way to get rich. But now that your precious “paper losses” a.k.a. depreciation is long gone, it’s time to search for a new way to create tax advantaged income. There are some fun ways to “re-depreciate” your investment again, and even put some of those carryovers to use. But before jumping into tax, let’s also consider your investment returns since you achieved this milestone. One issue I see many real estate investors face is that they tend to be short-sighted with their goals. You might, initially, have a goal to get rental income sufficient to cover your mortgage payments. You might have a longer-term goal of eventually having rental income pay off your mortgage. Often, when either of these events occur, I notice some investors sit back to enjoy their success. While success specifically means something different for everyone, from a wealth and tax perspective it is important to also evaluate your choices and returns on your investment. Examining the cash-on-cash return on investment is especially important for real estate investors who may not consider more than their initial down payment as their own investment. In addition, identifying loopholes which allow you to re-depreciate your property can also create significant tax benefits you cannot afford to miss. Keep reading to learn more…

Question: I understand the concept of paying just 21 percent tax through a C corporation. This makes sense if my tax rate is higher than, say 25 percent or 35 percent. But isn’t this money taxable to me as a dividend as soon as I withdraw it from the corporation? I don’t understand; won’t that actually cost me more tax? Answer: You have identified the exact reason C corporations can be what we call “high maintenance.” You’re right. Done in the wrong way, using a C corporation can actually cost more in tax than using a pass-through entity and paying tax at your individual rate, even if that rate is, say, 35 percent. By the time you pay qualified dividends tax on any withdrawals, you can wind up paying 45 percent or even 50 percent, depending on your individual tax rate. The key is to use smart planning. Rather than simply withdrawing the funds from your C corporation as a taxable dividend, use one six ways to withdraw tax-free instead. Doing this will help you lock in the low 21 percent flat rate and permanently save you from your high individual tax brackets. Keep reading to learn more.

Question: How do community property states affect tax returns? Answer: While fairly easy to determine your filing status when married (either joint or separate), tax rules get more complicated when you live in a community property state. Generally, the state laws where you live govern whether you have community property and community income or separate property and separate income for federal tax purposes. Not only do these rules affect how much income is taxable to you, but they also impact rules in things such as deductions, credits, taxes and payments, basis for things like capital gains, and participation rules. In some states, the income you earn after you separate and before a final divorce decree continues to be community income. In other states, it is separate income. Under special rules, income that can otherwise be characterized as community income may not be treated as community income for federal income tax purposes in certain situations. This year particularly is important for evaluating whether or not to file separately if married, especially if there is a big difference in each spouse’s income. What may appear on the surface to qualify for stimulus and child tax credits, may, in fact, be disqualified once you report community property income. Click here to see if these disadvantages impact you and how to avoid them.

No doubt you’re familiar with taxes arising from the sale of real estate. Capital gains tax applies whenever anyone sells an asset for profit. A capital gain is the sale price minus your “adjusted basis.” ● The “basis” starts at the price paid for the property; and then: ● ADD the amount that was put into improving the property and; ● SUBTRACT the amount, if any, that you may have “written off” based on depreciation. ● Short term capital gains (within one year of purchase) are taxed as ordinary income. ● Long term capital gains are taxed at a lower rate. (15 percent if your taxable income is less than $501,600.) You’re probably also familiar with the homeowners’ gain exclusion for the sale of your primary residence. This is the spectacular Section 121 exclusion that allows you to exclude up to $500,000 of profit related to the sale of your home ($250,000 if you are single). But you may not be aware of how to claim this exemption on two homes – and you can do it on nontraditional homes such as boats or motorhomes and even vacation homes. Continue reading to learn how.