Q. Do I still have a valid 1031 Exchange if disposing of a 4-unit rental into a 6-unit rental I intend to occupy one unit of the new property as my home?
A. If you follow this plan the Fair market Value of the unit you occupy for personal use does not qualify for like-kind exchange treatment. It is taxable as “boot” in the still valid exchange for the rest of the transaction (reported on Form 8824).
Q. I am a performing artist, receiving W2’s from several places, but don’t own a home (mortgage), or give a lot to charity, and I am healthy so I don’t have enough to itemize deductions. How do I keep from losing my artist-related deductions since I don’t have a Schedule A?
A. If you are a “Qualified Performing Artist,” as defined by IRS Code, you can deduct your employee business expenses as an adjustment to income rather than as a miscellaneous itemized deduction on Schedule A. You must file Form 2106 or Form 2106-EZ if you are a qualified performing artist claiming performing-artist-related expenses. You can use the shorter Form 2106-EZ instead of Form 2106 if both of the following apply: (1) You are not reimbursed by your employer for any expenses; and (2) You are using the standard mileage rate for your vehicle expenses.
Q. I am a contractor and allow a couple of fellow (unlicensed) contractors to “borrow” my license (actually I charge them a fee for this). Now IRS says in a CP2000 Notice that I owe taxes on their income (amounts billed to their customers under my contractor’s license). What is going on?
A. Your License as a billing number is tied into YOUR FEIN (Federal Employer ID Number or Social Security Number) and that is pointing the income (and finger) at you. In the future you need to report all “their” income on your tax return and issue them checks and Forms 1099 for such amounts. For now reply to the IRS CP2000 Notice explaining the situation and give them the names, FEINs/Social Security Numbers of the individuals and the amounts applicable for each. If you cannot provide their information because they won’t cooperate you will have to eat their taxes.
Q. We just got a Notice of Default from our Mortgage Lender, how soon will they move to take us out of the house?
A. It all depends, could be a few months or a year. The actual date is going to depend on whether the Lender is able to sell the property or is forced by market conditions to hold it. Some local welfare (community assistance) programs will not help you if you move before you have to. If in time your circumstances get better, you may be able to “cure the default” (bring the mortgage current and pay off the fees), or renegotiate with the Lender, and get the house back Under some states’ “Redemption Laws” you may be allowed some time to redeem the property even after the sale. Stay put.
Q. I refinanced my Home Mortgage, can I deduct the loan costs?
A. “Points” are “interest” (often called loan origination fees or loan discount fees). Other “loan costs” (title fees, escrow fees and such) are not interest. Points paid to obtain a home mortgage in connection with home purchase are deductible as mortgage interest when you itemize on Form 1040, Schedule A. Points paid on an original home mortgage are fully deductible in the year paid, provided the purchase loan does not exceed $1,000,000. Points paid to refinance are only deducted over the life of the loan. However, if part of the refinanced mortgage money was for improvements to your home, the points associated with the home improvement are deductible. If the property is a rental or the building in which you actively conduct your business, then the points and loan costs may be deducted over the life of the loan.
Q. I am self-employed as a contractor and do all my work at customers’ homes/offices. Can I still get an Office in the Home Deduction?
A. Yes, if you actually use part of your home regularly and exclusively for activities related to your business of being a contractor. For example, you probably store tools and parts in your home/garage, and also use one room regularly and exclusively, to keep your administrative records, receiving calls and scheduling appointments. You are entitled to take a tax deduction for a PORTION of the home operating expenses as a business deduction. No, it is not going to be a “tax problem” when you sell the home (that part of the law changed in 1997)–we just reduce your Basis by the depreciation that was taken or allowed. The bigger benefit of an Office in the home is the increased range of options for deductible business miles. Ask for our worksheet to see if you qualify.
Q. Can I exclude gain from the sale of land on the lot my residence occupies (or an adjacent lot with separate parcel number)?
A. If for example the single-family dwelling that is your home sits on an undivided 20 acre lot, that lot and home share a single assessor’s parcel number and legally comprise a single property–your home. If you bought an adjoining lot (so none would build on it and block your view), then no gain is required to be recognized on a sale of that land IF you owned and used it as part of your residence (for a patio, pool, garden, etc.), and IFthe dwelling itself is sold within two years before or after sale of the land. In order to qualify for this special treatment, the land sold must be adjacent to land containing the dwelling and all parts of the sale must meet the two-years-out-of-five requirement. One exclusion will apply to the combined sale of land and dwelling.
Q. Can I exclude gain from the sale of my residence if I own it with someone to whom I am not married?
A. Joint owners of a residence who are not married, and who sell their interest in a dwelling that has been their primary residence for at least two years out of the preceding five, may each exclude up to $250,000 of gain.
Q. If I transfer my principal residence to my already wholly owned corporation and the only thing the corporation has to do in return is pay the remaining mortgage, how is this reported? (The fair market value is $550,000, basis $75,000, and the remaining mortgage is $300,000.)
A. The transaction is reported as a part gift, part sale. The gift portion is $250,000 ($350,000 Fair Market Value minus $300,000 mortgage). The sale portion is reported as the amount of mortgage the corporation assumes. Therefore, you will report receiving sales proceeds of $300,000 with a realized gain of $225,000. The $225,000 gain may be eligible for the §121 exclusion if you meet the 2 out of 5-year ownership and use requirements. A gift tax return, Form 709, must be filed to report the $250,000 gift. This is often referred to as a gift of equity. The corporation’s basis is the greater of the donor’s basis ($75,000) or the amount it is considered to have paid for the property ($300,000). In either case, the corporation’s Basis is increased by any gift tax paid.
Q. Another individual and I registered with the CA Secretary of State as “Registered Domestic Partners” (‘RDP’) so that I could be covered under my partner’s employer-provided health benefits. One of us is over age 62, and we are roommates, but we are not of the same gender and both are heterosexual. Now I hear that we must file our CA tax returns for 2007 as “Married.” What is that all about?
A. You have heard correctly. Regardless of your reasons for registering with the Secretary of State as RDP’s, regardless of your respective genders, and regardless of the true nature of your relationship, you and your partner (and the State’s other 80,000 RDP’s) are, for CA income tax purposes only, “married” in the eyes of the Franchise Tax Board (FTB) and MUST file accordingly–in accordance with FTB Publication 737. The State filing will be complicated by the fact that at the federal level the RDP status does not exist and federal law does not recognize it even though the State does. You and your partner will need to calculate two versions of your federal Form 1040 – one for real and a hypothetical one for State purposes. If you currently use different tax preparers, each tax preparer will have to have the complete information on both of you in order to be able to do your CA Married-Separate return–because of CA Community Property rules.
Q. I am not rich, so I was shocked to see the Alternative Minimum Tax (AMT) apply on my last tax return–it wiped out my expected refund–what’s that all about?
A. Although the AMT, created in 1986, was intended to apply to only some 1,000 very high-income taxpayers who take advantage of loopholes (called “tax preferences” in tax lingo), it now applies to millions of middle-income taxpayers who are not wealthy and do not operate businesses but whom inflation has pushed into a higher bracket and who also have:
- large numbers of personal exemptions (here is an excuse to get rid of the free-loading relatives that qualify as dependencts)
- large amounts of state and local taxes paid (the CA 3.5% withholding on real estate sales that are not your primary residence could trigger this)
- large miscellaneous itemized deductions, such as large employee business expenses not reimbursed by employers
- large medical/legal expense deductions (if you win a $1,000,000 lawsuit but pay your attorney $750,000 you could end up owing more AMT tax that the remaining settlement you received)
- incentive stock options (ISOs)
- large capital gains or investment income
Write your Congressman/Senator about eliminating this unfair tax–or at least increasing/indexing the exemptions it allows.
Q. I have been told that I should incorporate my business to save on self-employment tax and reduce income tax liability. Should I form an S-corporation or an LLC? What about doing it in Nevada (Delaware, Florida, Texas, etc.)?
A. Both the LLC and the S-corp provide liability protection. Both provide for pass-through of profits or losses to the shareholders so there is no “double taxation” on dividends. Which one you select depends in part on whether profits or losses are to be distributed on basis different than ownership share – permitted in the LLC but not in the S-corp.
If you as a shareholder-officer are an active participant in the business functions of the S-corp you must pay yourself a wage and it must also be a “reasonable wage” Rules of Thumb: Pay yourself what you would pay someone else to do your work; Pay yourself what your State requires Exempt, Management employees to earn (in California that is double the hourly Minimum Wage on a 40-hour per week basis).
If a “reasonable wage” is less than your total profits you will save yourself the self-employment tax on the difference–as a sole proprietor you would have paid self-employment tax on all of it up to $94,000. If your S-corp does not make enough in sales to pay your salary, have the S-corp borrow the money so it can pay your salary–if it was someone else’s corp you would still expect to get paid for your work, wouldn’t you?
As a general rule, your corporation or LLC should be situated (i.e., organized or registered to do business) in the State where your business/rental property is physically located. Otherwise you may not have the full protection you seek within that State and you could end up with much higher costs when your home State catches up with you.
California is currently looking at out-of-state corporations not registered there whose Officers/shareholders live in California. They reason that if the shareholder-officers live in California they are making “executive management” decisions in California and, in their eyes, that means the corporation is “doing business” there.