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Sale of Investment or Rental Real Estate

Posted in Uncategorized on 02/29/2016   |  Comments Off on Sale of Investment or Rental Real Estate
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Sale of Real Estate

The sale of rental property may trigger capital gains tax or may generate a loss.

Your taxable gain or loss is determined by subtracting the property’s adjusted basis on the date of sale from the net sales price. The net sales price is your sales price less commissions, closing costs, and fix-up expenses.

Your adjusted basis is essentially the amount you paid for the property when you bought it, plus the cost of capital improvements you made to the property, less depreciation you were entitled to deduct during the time you were renting out the property.

The situation can be more complicated if you inherited the property or received it as a gift, but for now we will assume you purchased the property.

One mistake people often make is to think of their gain as the net sales proceeds that go into their bank account after loan balances are paid off. But the loan payoff is not relevant to the amount of gain.

Here’s an example:

Edward and Laura both buy investment property for $100,000.

Laura pays cash for hers, and Edward makes a $20,000 cash down payment and takes out a loan in the amount of $80,000.

They each sell their property for $150,000 and have commissions and closing costs of $10,000. Laura puts $140,000 into her bank account. After paying off the loan, Edward has $60,000 to put into his bank account. But Laura and Edward both have the same capital gain of $40,000 ($50,000 gain less $10,000 closing costs).

Calculating Your Adjusted Basis

Basis is good. The higher your basis, the less your capital gains tax will be.You can increase your basis for capital improvements (for example, adding onto a building, installing a driveway, or paying assessments for sidewalk improvements).

For example, assume Laura had a water well drilling on her property, at a cost of $30,000. Laura’s basis in the property is now $130,000. If she sells it for $150,000, her gain will be $10,000 ($150,000 – $130,000 basis – $10,000 closing costs)

On the other hand, you have to decrease your basis for tax deductions you take over the years. Usually the biggest decrease is depreciation. The Tax Code allows you to take a depreciation deduction each year. The longer you own the property, the more the depreciation accumulates. If you owned the property for at least 27.5 years, your cost basis would be reduced all the way to zero, and 100% of your net sales price would be a gain.

To go back to the example of Laura, suppose that instead of investment property, she paid $100,000 for a rental property. At the time she sold the property, she had taken depreciation deductions of $8727. Her adjusted basis is $91,273, which means her gain is $48,727 instead of $40,000.

You also have to decrease the basis for sales of partial interests in the property. For example, if Laura had sold her water rights for $10,000 instead of drilling a well, her adjusted basis will be $100,000 purchase price, less $10,000 received for the water rights, and her gain on the sale of the property for $150,000 will be $50,000 instead of $40,000.

Depreciation and Writing Off the Purchase of a Business Vehicle Under Section 179

Posted in Uncategorized on 12/09/2015   |  Comments Off on Depreciation and Writing Off the Purchase of a Business Vehicle Under Section 179

land roverThe purchase of a business vehicle is a capital expenditure rather than an expense. This means that it would normally be recorded on your financial statements as a fixed asset. Instead of deducting the whole cost of the purchase in the year of purchase, you would deduct a portion of the cost of the vehicle from your income each year over the useful life of the vehicle. The accounting term for this process is “depreciation.”

The common-sense meaning of “useful life” is the amount of time an asset will serve you. For example, if you expect to drive a car for 5 years, its useful life would be five years. If you were using straight-line depreciation, you would deduct 1/5 of the cost of the car each year for 5 years.

Congress has assigned “class lives” to various classes of assets for purposes of calculating the tax deduction for depreciation. For passenger cars, the class life is 3 years; for light general purpose trucks 4 years, and for heavy general purpose trucks 6 years.

In addition to having periods for depreciation that do not necessarily match the actual useful life, you can use accelerated depreciation for tax purposes, that is to say you deduct more of the cost in the early years and less later on. This is advantageous from a tax-saving point of view.

An even better advantage would be to write off the whole cost of the purchase in year one. This is what section 179 allows you to do, with some limitations.

You cannot use the section 179 deduction for a passenger car or light general purpose truck. Instead, these vehicles must be depreciated over their class lives.

For example, if your business pays $30,000 for a passenger car to be used by the business, the depreciation schedule would look like this:

Year 1 $10,000
Year 2 $ 13,335
Year 3 $ 4,443
Year 4 $ 2,223

Certain vehicles get better tax treatment. The section 179 deduction up to $25,000 can be taken for heavy general purpose trucks.

The definition of heavy general purpose truck used to include SUV’s in previous years, but it no longer does. The vehicles that qualify include the following:

— Heavy vehicles (gross vehicle weight rating above 6000 pounds) with a cargo area at least six feet in interior length not easily accessible from the passenger area. This definition is meant to exclude SUV’s. It also excludes some extended cab, short-bed pickups, but would apply to a standard or long-bed pickup.

— Vehicles that can seat more than eight passengers behind the driver’s seat (for example, airport shuttle vans).

— Vehicles with a fully-enclosed driver’s compartment / cargo area; no seating behind the driver’s seat; and no body section protruding more than 30 inches ahead of the leading edge of the windshield (classic cargo van)

Here’s how the write-off for a $30,000 heavy pickup truck would look:

Year 1: $25,000.00
Year 2: $ 2,223.00
Year 3: $ 740.50
Year 4: $ 370.50

Note that special-purpose vehicles will fall into different categories. For example, tractors and other special purpose farm vehicles can be fully written off up to the annual limits for section 179. Likewise dump trucks, flatbed trucks, and forklifts.

How to Finance a New Business – Part 1

Posted in Uncategorized on 11/16/2015   |  Comments Off on How to Finance a New Business – Part 1

Working too hardA common question people ask me is how they can start their own business if they earn barely enough money to live on. Being in the situation of having barely enough to live on means that some sources of funding for a new business, such as the earnings of a spouse or a savings account, are not available to you. If you’ve been in the same situation for your entire career, it’s doubtful you’ll have significant funds in an IRA or 401(k), so a self-directed retirement plan is out.

One possibility is to get part-time or full-time work in addition to your current job. I did that to get the money to purchase the first dump of a house I bought and fixed up, when I was 22.  I was working the evening shift at a restaurant in the Hyatt Regency Hotel in Houston, so I got a day job in an insurance agency. My job was to sit at a desk all day and talk to people who wanted to file a claim for a casualty they’d suffered. It was very different from the evening job, and it was interesting to listen to people’s stories about their casualties.  I don’t think I could have handled two shifts of the same kind of work, but since one job involved walking around all evening, and the other was sitting, it wasn’t too bad, except for the lack of sleep. I don’t recommend this for old people. I’m pretty sure I wouldn’t be able to pull off something like that now, but healthy young people can do it for a while.

When you have two jobs, there is no time for a social life, for going to the gym, going for walks, reading, watching movies — pretty much all you do is work, eat, and sleep. Think about it: 16 hours of work a day is longer than the 12 hour work day of Victorian era factory worker.

You do, however, usually get two days off per week from each job.  When the weekends came around and I only had to work my 8 hour shift at the restaruant, I felt as though I was taking life easy. I worked two full-time jobs for about 6 months, by which time I’d saved up enough to make a down payment on a house.

Another possibility is to save money you’d otherwise be paying in taxes. If you work as an employee, your scope for tax savaings is very limited. There are retirement plans, but that’s not going to work for you, since you have barely enough money to live on already, and it’s not as though you get a dollar-for-dollar deeuction for the retirement plan contribution. If you’re in the 15% tax bracket, your taxes only go down by 15% of what you paid.  You’re just out the other 85%, and that doesn’t get you anywhere.

What you want to do is to get deductions for things you are spending money on anyway. Say your employer requires you to have a cell phone and also requires you to purchase a uniform to work. In theory, you could deduct these as Employee Business Expenses, but in reality you probably won’t get any tax benefit at all since this is an itemized deduction with a 2% of Adjusted Gross Income “floor.” (more on this later)

If you can manage to work as an independent contractor rather than an employee, you can deduct busines expenses. The downside is employers pay 1/2 of your social security and Medicare taxes, as well as paying unemployment taxes. As a self-employed person, you will not be entitled to unemployment benefits, and you’ll have to pay 100% of your social security and Medicare taxes. You may also lose any help your employer was providing to pay for medical insurance.

In part 2 I will show you how to calculate how much extra you’ll need to earn in your own business to make up for the loss of benefits you received as an employee, and Part 3 I’ll talk about how to avoid the problems people often have when they switch from being employees to working as independent contractors.