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Your Questions Answered
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.
Question: My client is just now paying the PTET for California with a timely filed election. Can they deduct the tax payment if they are an accrual basis taxpayer?
Answer: Based on face value, unfortunately, the answer is no.
Both cash and accrual basis passthrough entities would need to pay the tax by 12/31/21 (assuming calendar year-end) to get the deduction on the 2021 tax return.
This answer is based on IRS Notice 2020-75, stating that an entity could take a deduction in the year paid. While the guidance did not specify cash or accrual in the definition, unless the IRS comes out with any other guidance stating otherwise, it is a federal deduction so it works the same as accrued state taxes, which the taxpayer must pay by the end of the tax year to deduct the amount following the economic performance rules.
However, what if your client is an accrual basis taxpayer? While Notice 2020-75 does not specifically distinguish or reference method of accounting, there may be a way to fix your 2021 state tax deductions if you missed the 12/31 deadline.
Click here to keep reading.
Question: I’ve had clients ask and, of course, heard at cocktail parties the discussion about claiming a pet’s medical expenses and other costs. But what is the citation that prevents these deductions?
Answer: Wouldn’t it be nice if you could get a little tax help from the government by deducting your dog? Aside from the enormous price breeders charge for designer pets, there are vet bills, food (some people even have their pets eat raw or vegan), obedience classes, clothing, exercise, and daycare to name a few!
While today’s is a softball question, I thought we could all use a break from the continuation of the never-ending tax season of 2020. It also raises the issue of citations and documentation. Have you tried finding the one that says you cannot deduct pet expenses? What about the one that says you can?
Keep reading to learn how.