Carroll Tax Firm

09/26/2023

Should I put my rental property in an LLC?

The limited liability company will provide protection from contract based debt against personal assets of the owner of a single or (multi-) member LLC, assuming no personal guarantees have been made and no fraud was conducted by the owner. Contract based debt for a rental property could include utilities, general contractor repairs, and appliance purchases. These creditors would likely be limited to recovering their debt from LLC assets. Personal guarantees will likely be required for mortgages taken in the name of a newly formed LLC with no credit history.

The LLC will not likely provide personal asset protection from non-contract based debt, like negligence and fraud. A non-contract debt originating from an act or omission that the owner of a single member LLC, or one of their agents, participated in can be recovered from the personal assets of this owner. If you are the owner of a multi-member LLC, and can prove in court that the act or omission which caused the non-contract debt is independent from your duties to the LLC, then your personal assets are likely protected from this debt.

Yearly fees for an LLC will be about a hundred dollars to your secretary of state. Multi-member LLCs, in some states, will pay their state an additional entity tax based on yearly profit, which, in Connecticut, will be partially credited back onto your state individual income tax return. Multi-member LLCs must also file a separate entity income tax return but will be taxed on the rental profit on their individual income tax returns. Single member LLCs will have no change in income tax treatment or reporting of rental profit.

Yearly premiums for hazard (or homeowner) insurance on a rental property (aka landlord insurance) is higher than on a residence. But, merely transferring title of the rental property to an LLC should not change your yearly insurance premiums when compared to insurance on an individually owned rental property.

Your individual name and residence address will not be hidden from the public, in Connecticut, when you create the LLC or when you title rental property in the name of the LLC. The local land records will show the LLC name and, if there's a mortgage, the mortgage will show the LLC owner's name. The LLC yearly "report" with the Connecticut Secretary of State will show the owner's name and personal residence address unless you can show good cause that publishing your residence address would put your personal security at significant risk.

The limited liability company will provide protection from contract based debt against personal assets of the owner of a single or (multi-) member LLC, assuming no personal guarantees have been made and no fraud was conducted by the owner. Contract based debt for a rental property could include util...

09/19/2023

Does putting my house in a trust save on taxes?

If you're using a revocable living trust, meaning you can change the trust and you keep possession of house that's inside the trust, then the local property tax assessor will ignore the trust and send you the annual property tax bill, while you're alive. So there's no property tax savings by putting your house into a trust.

When you sell the house, in this revocable living trust, (obviously before you die) the IRS will ignore the trust and you can use the $250k ($500k if married) home sale exemption just like you would if the house was not in a trust. (see https://www.carrolltaxfirm.com/post/income-tax-on-the-sale-of-your-home). So there's no income tax savings if you sell the home before you die with your house in a trust.

If the irrevocable living trust (now irrevocable because you're dead and can't change it) sells the house, then the IRS will tax the trust on the gain (the difference between the sale price and the house value on the date of your death). The IRS could instead tax the trust beneficiaries (perhaps your kids) if the trust is written to allow this. (see https://www.carrolltaxfirm.com/post/should-an-estate-asset-be-sold-after-it-is-distributed-to-estate-beneficiaries-or-before). So there's a potential larger income tax bill if the trust sells the home after you die and you have not written the trust properly.

If the trust distributes the house to its beneficiaries and they then sell the house, the IRS will tax the trust beneficiaries on the gain using, again, the difference between the sale price and the house value on the date of your death. So there's no income tax savings if the house is sold after your death by your trust beneficiaries.

The primary reason for placing your home into a trust is to allow the house ownership to transfer to your children without probate court approval.

https://www.carrolltaxfirm.com/post/does-putting-my-house-in-a-trust-save-on-taxes

If you're using a revocable living trust, meaning you can change the trust and you keep possession of house that's inside the trust, then the local property tax assessor will ignore the trust and send you the annual property tax bill, while you're alive. So there's no property tax savings by putting...

09/01/2023

What happens when I start renting my house?

When you convert your former residence to income-producing use then your rental depreciation deduction is based on the lower of the building's fair market value or its adjusted basis. You will need to exclude the value and basis of the land that the home is on for this comparison. The fair market value can be found using an real estate appraisal as of the day of conversion. The adjusted basis is generally the initial purchase price plus any capital improvements minus property losses and credits that were reported on prior year income tax returns.

Upon the sale of this property, a gain results if the sale proceeds are greater than the adjusted basis before conversion minus depreciation. A loss results if the sale proceeds are less than adjusted basis after conversion and after depreciation.

Example 1:
Year 1 = $200,000 purchase price [adjusted basis before conversion]
Year 10 = $250,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $100,000 sale proceeds
Year 20 = $28,000 capital loss [100 - (200 - 72)]

Example 2:
Year 1 = $200,000 purchase price [adjusted basis before conversion]
Year 10 = $250,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $300,000 sale proceeds
Year 20 = $172,000 capital gain [300 - (200 - 72)]

Example 3:
Year 1 = $250,000 purchase price [adjusted basis before conversion]
Year 10 = $200,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $100,000 sale proceeds
Year 20 = $28,000 capital loss [100 - (200 - 72)]

Example 4:
Year 1 = $250,000 purchase price [adjusted basis before conversion]
Year 10 = $200,000 fair market value when renting begins
Year 10 = $200,000 depreciable adjusted basis after conversion
Year 20 = $72,000 for depreciation over ten years
Year 20 = $300,000 sale proceeds
Year 20 = $122,000 capital gain [300 - (250 - 72)]

When you convert your former residence to income-producing use then your rental depreciation deduction is based on the lower of the building's fair market value or its adjusted basis. You will need to exclude the value and basis of the land that the home is on for this comparison. The fair market va...

08/07/2023

How much can I offset my income with rental losses?
By rental losses, I mean that your rental expenses (after allocating between rental and personal expenses) exceed your rental income.

You can offset all of your rental losses against your other income, if you are considered a real estate professional (defined later), you have participated materially (defined later), and your personal days at the property were less than the greater of 14 days or 10% of rental days.

You can offset up to $25,000 of rental losses against your other income, if you actively participated (defined later), your personal days were less than the greater of 14 days or 10% of rental days, and your adjusted gross income was less than $150,000.

You can offset some of your rental losses against your other income, if your personal days were more than the greater of 14 days or 10% of rental days. The fully deductible rental expenses here include the rental portion of mortgage interest, real estate taxes, rental agency fees, and advertising. The remaining rental portion of your rental expenses will be carried forward to next year.

Rental circumstances outside of the above paragraphs will result in all rental losses being carried forward to next year. When the rental property is finally sold, all unused rental losses can be deducted.

Real Estate Professional = More than 750 hours of your services during a tax year and more than 50% of your services performed in all/any business during a tax year were for a real estate business (defined below) in which you materially participated.
Real Estate Business = Real estate re/development, re/construction, acquisition, rental/leasing, operation, management, and brokerage.

Material Participation = Any of the following may be satisfied to fulfill this test:
1 - more than 500 hours of your yearly services were for the relevant activity
2 - your participation was substantially all of any participation in the activity
3 - more than 100 hours of your services were for the relevant activity and no one worked more than you on the activity
4 - more than 100 hours of your services were for the relevant activity and you worked a total of 500 hours for other activities where you also worked more than 100 hours
5 - you met 1 of the other 6 tests for material participation for 5 of the last 10 years
6 - you materially participated in this personal service activity for any of the last 3 years [personal service as opposed to income generated from capital holdings]
7 - your participation was regular, continuous, and substantial based on facts and circumstances

Active Participation = You (and your spouse together) have at least 10% ownership in the property, and you make management decisions like approving new tenants, deciding on rental terms, approving and arranging rental expenditures. You must have more control than just the ability to hire, fire, and approve decisions made by the actual property manager.

By rental losses, I mean that your rental expenses (after allocating between rental and personal expenses) exceed your rental income. You can offset all of your rental losses against your other income, if you are considered a real estate professional (defined later), you have participated materially...

07/21/2023

What can I expense against my rental income?

In general, you can deduct expenses that are ordinary and necessary to operating a residential rental property. However, expenses for the purchase of assets and improvements must be capitalized (by spreading the expense over multiple years) unless you can use an exception. Assets include any real or personal, tangible or intangible property and improvements. Improvements include material additions and corrections, major replacements of substantial parts of property, and property use conversions.

Ordinary and necessary deductible expenses usually include annual property taxes, property insurance premiums, mortgage interest, utilities, and recurring expenses to keep the building in its ordinary condition (or routine maintenance). The routine maintenance expenses include cleaning and replacing damaged or worn parts with comparable parts. The new "parts", unlike capitalized improvements, do not make the property materially better, nor do they return the property to its ordinary condition after being in disrepair. You also must reasonably expect to perform the deductible routine maintenance expense at least twice within the 10-years after acquiring the building property.

An exception to the capitalization rule for the purchase of tangible property is the de minimus safe harbor, which allows you to deduct a purchase of tangible property if the expense amount is low enough and if you report that you're using this safe harbor on your tax return. Currently, this expense amount cannot exceed $2,500 per item on an invoice when have no financial statement that is independently audited or filed with the SEC or state government or agency. You also must treat this expense amount as an expense on your books and you cannot choose to capitalize any purchase that is eligible for this safe harbor in the year that you report using the safe harbor.

Another exception to the capitalization rule for the purchase of improvements is the safe harbor for small taxpayers. You must have a 3-year average annual gross receipts of less than $10,000,000 and the unadjusted basis for the building property must be less than $1,000,000. Also, before you may deduct the expense of an improvement with this safe harbor, your total annual amount paid on the building for all improvements, repairs, and maintenance, cannot exceed the lessor of $10,000 or 2% of the unadjusted basis for the building.

If your annual expenses are too high for the safe harbor for small taxpayers, and the item price is more than $2,500 for the de minimus safe harbor, and the asset or improvement does not qualify for routine maintenance, then you might be able to use the section 179 deduction or the section 168(k) bonus depreciation deduction for purchases except for the cost of the actual building.

In general, you can deduct expenses that are ordinary and necessary to operating a residential rental property. However, expenses for the purchase of assets and improvements must be capitalized (by spreading the expense over multiple years) unless you can use an exception. Assets include any real or...

07/12/2023

How much tax will I owe when I flip a house?

Your tax will depend on several factors that determine if you are in the flipping business or the investment business. What the IRS will look at includes:
- whether you buy property to fix, improve, and sell it (flipping) or
- whether you buy property to hold and maybe rent it and
- how frequently you flip properties and
- how much of your total income is from flipping properties.

If you are frequently flipping properties, then the sale profits will be taxed ordinarily with your other income and separately at 15.3% as self employment income. The property will be treated as non-depreciable business inventory and the materials, supplies, and labor expenses are reported on Schedule C. Income from a house flip, for taxpayers under the income limits, will be eligible for the qualified business income deduction.

The income from the sale of properties held for an investment (or not held by a "flipping business") will be reported on Schedule D and, if held for longer than 1 year, will receive favorable long-term capital gains treatment. Income from the sales of properties held for investment for less than 1 year will be short-term capital gains and will be taxed along with your other ordinary income (salary and interest income).

Your tax will depend on several factors that determine if you are in the flipping business or the investment business. What the IRS will look at includes - whether you buy property to fix, improve, and sell it (flipping) or - whether you buy property to hold and maybe rent it and - how frequently yo...

07/10/2023

Are there benefits to gifting your home before you die?

If you own your home on the day of your death, or created a life tenancy, then before the home can be sold to a third party, your estate must go through probate. The Connecticut probate fee might based on the value of the entire home; so an estate with only a home worth $500,000 pays about $1,900 in a probate fee and a probate attorney can cost between $1,500 to $7,500. However, when the estate beneficiaries' sell the home to a third party, that sale might not add income to the beneficiaries' income tax return that year. If any, the amount of that added income would be the difference between the sale price to the third party and the value of the home on the day of your death. (aka the home value had a step-up in basis when you died). For sales occurring shortly after death, the amount of this added income should be small.

Alternatively, if you gifted your home before your death to your child (usually by way of quit-claim deed), then there's no estate issue and no probate fee or probate attorney cost associated with the home. However, if the person that you gift the home to does not live in the home, then when the home is ultimately sold to a third party then that person's added income from the sale could be larger. Instead of the added income being based on the value of the home on the day of your death, it is based on your original purchase price and any major improvements since your purchase. Adding any amount of income to your tax return might increase your income taxes more than the cost of the probate if you had not gifted the home. And although the federal government taxes this added income, as long-term capital gains, at lower rates than ordinary income (like salaries) most states provide no special treatment for this added income.

Income Tax Comparison:

Own Home At Death
1960 - purchase price = $100,000
1960-2017 - major improvements = $100,000
2023 - value on day of death = $500,000
2023 - sale to 3rd party = $500,000
2023 - long-term capital gains = $0
2023 - CT probate fee = $1,900 + Attorney Fee = ~$3,500

OR

Gift Home Before Death
1960 - purchase price = $100,000
1960-2017 - major improvements = $100,000
2017 - value on day of GIFT to kids = irrelevant
2023 - value on day of death = irrelevant
2023 - sale to 3rd party = $500,000
2023 - long-term capital gains = $300,000
2023 - federal income tax filing as single on LTCG $300k = $40,000

2023 - CT income tax filing as single on LTCG $300k = $19,750

If you must gift your home before your death, then to reduce income tax when the home is sold, your child (or other gift donee) must reside in the home for 2 years prior to the sale to take advantage of the home sale exclusion.

If you own your home on the day of your death, or created a life tenancy, then before the home can be sold to a third party, your estate must go through probate. The CT probate fee might based on the value of the entire home; so an estate with only a home worth $500,000 pays about $1,900 in a probat...

09/29/2022

Do I have to file a Gift Tax Return?
Yes, any time you make a gift to someone in an amount larger than $16,000.

You report the gift amount that is more than $16,000 on a gift tax return. (For a gift of $17,000 cash, the reportable gift is $1,000).

If you're married, each spouse can gift $16,000 to the same person before needing to file a gift tax return. Gifts between spouses generally never require a gift tax return. One married couple can gift a 2nd married couple $64,000 before being required to file a gift tax return. (Each spouse makes two $16,000 gifts, totaling four separate gifts of $16,000 or $64,000.)

You pay no gift tax when you file a gift tax return. The reportable gift is, instead, just remembered and then added to your estate after you die. If your estate and gifts are more than $12.06 million in 2022, then you pay estate taxes.

The gift tax return is due April 15th in the year after the gift. You will need to file a federal gift tax return and maybe a state gift tax return, depending on your residence. Connecticut and New York require a separate gift tax return.
https://www.carrolltaxfirm.com/post/do-i-have-to-file-a-gift-tax-return

09/20/2022

Income tax on the sale of your home?

Maybe; if you bought it for almost nothing and it's value has increased a lot.

If you're married, then you can exclude $500,000 of gains for the sale of home.
Gain = sale proceeds - [minus] your initial purchase price.

Example: In 1990, you & your spouse paid $100,000 for your house, then in 2022, you both sold your house for $400,000. Gain = $300,000 (so, no income tax in this example).

However, if, instead, you both sold your house for $700,000, then gain = $600,000 and taxable gain = $100,000 (gain - [minus] $500,000 exclusion mentioned above).

For this issue, sale proceeds are not reduced by a mortgage payoff but they are reduced by realtor fees, attorney fees, conveyance taxes, and any credits given to the buyer from the seller.

Also, either spouse can own the house when it's sold but both spouses must have lived in the home as their main home for 2 of the last 5 years.

If you're not married, then you can only exclude $250,000 of gains.

Maybe; if you bought it for almost nothing and it's value has increased a lot. If you're married, then you can exclude $500,000 of gains for the sale of home. Gain = sale proceeds - [minus] your initial purchase price. Example: In 1990, you & your spouse paid $100,000 for your house, then in 2022, y...

02/13/2020

Do I have to report money I inherited on my income tax return?

No, but if you put that money into a bank account that earns interest then you'll report the interest income. If you stuff that money in your mattress, it's not earning anything, so you report nothing on your tax return. That money would have been reported on the estate tax return of the person that passed away.

If, instead of money/cash, you inherit stock or a rental real estate, then you still don't report the receipt of that property as income. It's only when the stock earns dividends or the rental real estate is producing rental income do you report the dividends and rental income on your tax return.

Then, obviously, when you sell the stock or rental real estate, you'll have income that needs be reported on your tax return. The income you report on that sale will be the difference between the money you received in the sale and fair market value of the stock or rental real estate on the date of death of your family member/friend. (For the sale of rental real estate, you'll also factor in depreciation.)

02/10/2020

How does the IRS catch your cash-only side business?

If a client pays you more than $600, they are supposed to file a 1099-MISC with the IRS. Now maybe that 1099-MISC never made it to you because you moved or the envelope got lost. If you don't report what the client reports to the IRS, you will get an IRS letter.

If you're parking cash in a interest-earning bank account, the bank should file a 1099-INT with the IRS. The IRS may wonder why you're earning more in interest in that account than someone should be earning with your reported income.

The IRS/US Treasury tracked Al Capone's lavish expenses by checking the records at local jewelry stores, hotels, car dealerships, and department stores. Then the Treasury raided a suspected Capone gambling hall and found ledgers with references to "Al". The handwriting on the ledgers matched bank deposit slips of a Capone associate, who ultimately ratted Capone out.