Month: January 2022

Tax

Self-Directed IRAs – Are They for You?

Tax-advantaged retirement accounts such as IRAs are a great way to save for retirement. 

But when you establish a traditional IRA with a bank, a brokerage, or a trust company, you are ordinarily limited to a narrow range of investment options, such as CDs, publicly traded stocks, bonds, mutual funds, and ETFs. The IRA custodian will not permit you to invest in alternative investments such as real estate, precious metals, or cryptocurrency.

A self-directed IRA could be for you if you want to walk on the wild side and invest your retirement money in assets such as real estate or cryptocurrency.

You can invest in almost anything other than collectibles such as art or rare coins, life insurance, or S corporation stock with a self-directed IRA. Investment options include, but are not limited to the following:

  • Real estate
  • Private businesses
  • Trust deeds and mortgages
  • Tax liens
  • Precious metals such as gold, silver, or platinum
  • Private offerings
  • LLCs and limited partnerships
  • REITs
  • Livestock
  • Oil and gas interests
  • Franchises
  • Hedge funds
  • Cryptocurrency
  • Promissory notes

Aside from he vast array of investment options, a self-directed IRA is the same as a traditional IRA and subject to the same rules. The income the investments in your IRA earn is not taxed until you take distributions, but distributions before age 59 1/2 are subject to a 10 percent penalty unless an exception applies. 

You can also have a self-directed Roth IRA for which distributions are tax-free after five years.

But you must avoid self-dealing and other prohibited transactions or your self-directed IRA could lose its tax-advantaged status.

Establishing a self-directed IRA need not be too difficult. You first open an account with a custodian that offers self-directed investments. You can also acquire checkbook control over your self-directed IRA by forming a limited liability company to own all the IRA investments.

Investing in alternative assets such as cryptocurrency is riskier than stocks, bonds, and mutual funds. 

  • The rewards can be great, as you’ve seen with recent returns for cryptocurrency investors. 
  • And the damage to your investment portfolio can be substantial, as we’ve also seen over the years.

When it comes to alternative investments, you need to know what you are doing or have an investment professional you trust to do this for you.

If you have any questions or need my assistance, please call me on my direct line at 408-778-9651.

Tax

Little-Known Rule Can Reduce Your Principal Residence Tax Break

Once upon a time, you could convert a rental property or vacation home into your principal residence, occupy it for at least two years, sell it, and take full advantage of the home sale gain exclusion privilege of $250,000 for unmarried individuals or $500,000 for married joint-filing couples. 

Unfortunately, legislation enacted back in 2008 included an unfavorable provision for sales that occur after that year. The provision can make a portion of your gain from selling an affected residence ineligible for the gain exclusion privilege. 

The Non-Excludible Gain

Let’s call the amount of gain that is made ineligible the non-excludable gain. The non-excludable gain amount is calculated as follows. 

Step 1. Take the total gain and subtract any gain from depreciation deductions claimed against the property for periods after May 6, 1997. Include the gain from depreciation (so-called unrecaptured Section 1250 gain) in your taxable income. Carry the remaining gain to Step 3.

Step 2. Calculate the non-excludable gain fraction. 

The numerator of the fraction is the amount of time after 2008 during which the property is not used as your principal residence. These times are called periods of non-qualified use. 

But periods of non-qualified use don’t include temporary absences that aggregate to two years or less due to changes of employment, health conditions, or other circumstances specified in IRS guidance. 

Periods of non-qualified use also don’t include times when the property is not used as your principal residence if those times are

  • after the last day of use as your principal residence, and
  • within the five-year period ending on the sale date. (See Example 4 below.) 

The denominator of the fraction is your total ownership period for the property.

Step 3. Calculate the non-excludable gain by multiplying the gain from Step 1 by the non-excludable gain fraction from Step 2. 

Step 4. Report on Schedule D of Form 1040 the non-excludable gain calculated in Step 3. Also report any unrecaptured Section 1250 gain from depreciation for periods after May 6, 1997, from Step 1. The remaining gain is eligible for the gain exclusion privilege, assuming you meet the timing requirements. 

Some Examples

Overly complicated federal income tax rules create a lot of taxpayer confusion, so let’s consider the following examples that illustrate how to calculate non-excludable gains from principal residence sales.  

Example 1. Dan, a married joint-filer, bought a rental property on January 1, 2001. On January 1, 2016, he converted the property into his principal residence and lived there with his spouse from 2016 through 2021. 
On January 1, 2022, Dan sells the property for a $600,000 gain, including $50,000 of depreciation deductions claimed for the 15-year rental period (January 1, 2001, to December 31, 2015). 
Dan must report the $50,000 of gain attributable to depreciation deductions—the unrecaptured Section 1250 gain—on his 2021 federal return. That gain is subject to a maximum federal rate of 25 percent, plus another 3.8 percent if the gain is hit with the NIIT.   
Dan’s remaining gain is $550,000 ($600,000 – $50,000). 
Dan’s total ownership period is 21 years (2001-2021). The seven years of post-2008 use as a rental property (2009-2015) result in a non-excludable gain of $183,333 (7/21 x $550,000). Dan must report the $183,333 as a long-term capital gain on his 2021 Schedule D. 
He can shelter the remaining $366,667 of gain ($550,000 – $183,333) with his $500,000 gain exclusion.
Example 2. Claudia, a married joint-filer, bought a vacation home on January 1, 2013. 
On January 1, 2017, she converted the property into her principal residence, and she and her spouse lived there from 2017 through 2021. 
On January 1, 2022, Claudia sells the property for a $600,000 gain. Her total ownership period is nine years (2013-2021). 
The four years of post-2008 use as a vacation home (2013-2016) result in a non-excludable gain of $266,667 (4/9 x $600,000). Claudia must report the $266,667 as a long-term capital gain on her 2022 Schedule D. 
She can shelter the remaining $333,333 of gain ($600,000 – $266,667) with her $500,000 gain exclusion.      
Example 3. Same basic facts as in the preceding example, except this time assume that Claudia has $10,000 of unrecaptured Section 1250 gain from renting out the property before converting it into her principal residence. 
Therefore, the total gain on the sale is $610,000. Claudia must report the $10,000 of unrecaptured Section 1250 gain on her 2022 Schedule D. 
She must also report the non-excludable gain of $266,667 [4/9 x ($610,000 – $10,000)] on her 2022 Schedule D. 
She can shelter the remaining $333,333 of gain ($610,000 – $10,000 – $266,667) with her $500,000 gain exclusion.      
Example 4. Gary is a married joint-filer. He bought a vacation home on January 1, 2013. On January 1, 2016, he converted the property into his principal residence and lived there with his spouse from 2016 through 2019. 
He then converted the home back into a vacation property and used it as such for 2020 and 2021. 
Gary then sells the property on January 1, 2022, for a $540,000 gain. 
His total ownership period is nine years (2013-2021). The first three years of post-2008 use as a vacation home (2013-2015) result in a non-excludable gain of $180,000 (3/9 x $540,000). Gary must report the $180,000 as a long-term capital gain on his 2022 Schedule D. He can shelter the remaining $360,000 of gain ($540,000 – $180,000) with his $500,000 gain exclusion. 
Key point. The last two years of use of Gary’s property as a vacation home (2020-2021) don’t count as periods of non-qualified use because they occur
after the last day of use as a principal residence (December 31, 2019) and  within the five-year period ending on the sale date (January 1, 2022).
Therefore, Gary’s use of the property as a vacation home in 2020 and 2021 doesn’t make his non-excludable gain any bigger. Good!

If the sale of your home will rub against these rules and you would like me to figure out your taxable gain, please call me on my direct line at 408-778-9651.

Tax

Six Tax Credits for Schedule C Businesses without Employees

Obtaining a tax credit is the next best thing to paying no taxes at all. 

The tax code contains over 30 non-refundable tax credits for businesses. These are part of the general business tax credit and are claimed on IRS Form 3800, General Business Tax Credit, and on Schedule 3 of Form 1040. The general business credit is not itself a tax credit, but rather an overall limitation on the total credits that a business can claim each year.

What if you’re a Schedule C business owner who doesn’t have employees and isn’t involved in one of the niche businesses that come with a credit? You’re not necessarily left out of the tax credit bonanza. Here are six tax credits that many Schedule C businesses with no employees can claim (and of course, you can qualify for these credits with employees, too).

1. Credit for Increasing Research Activities

The credit for increasing research activities is intended to encourage businesses to invest in scientific research and experimental activities. 

Any technological research qualifies, so long as it relates to a product’s new or improved function, performance, reliability, or quality. The research must involve the physical or biological sciences, engineering, or computer science. 

You don’t have to have employees to get this credit, because you can claim the credit for 65 percent of the cost of hiring third parties to perform research activities on your behalf, such as outside contractors, engineering firms, or research institutes. 

Calculating the credit is complex.

2. Qualified Plug-In Electric Drive Motor Vehicle Credit

If you purchase a new electric vehicle, you may be able to claim a credit. These include fully electric vehicles (EVs) and plug-in hybrid EVs (PHEVs).

The maximum credit is $7,500, and the minimum is $2,500. But the actual amount depends on the size of the vehicle’s battery. EVs generally get the maximum $7,500, while PHEVs often qualify for less. For example, a Ford Mustang Mach-E qualifies for a $7,500 credit, while a Subaru Crosstrek Hybrid gets only $4,502. 

Unfortunately, the credit phases out the year after a manufacturer reaches 200,000 total EV car sales in the U.S. 

Tesla and General Motors are the only two manufacturers so far to reach the limit, and the credits for their EVs are now completely phased out. So you won’t get a federal credit if you purchase a Tesla or a Chevy Volt. Toyota and Ford will probably be next to cross the 200,000-EV threshold.

You can find a list of credit-eligible models and their amounts by clicking here. The IRS updates this page frequently.

When you claim the credit for a business vehicle, you reduce the vehicle’s depreciable basis by the credit amount. You then depreciate the remaining adjusted basis as you would for any other business vehicle.

3. Disabled Access Tax Credit

The Americans with Disabilities Act (ADA) prohibits private employers with 15 or more employees from discriminating against people with disabilities in the full and equal enjoyment of goods, services, and facilities offered by any “place of public accommodation”—this includes businesses open to the public.

The disabled access tax credit is designed to help small businesses defray the costs of complying with the ADA. But you don’t have to have employees to claim the credit. The credit may be claimed by any business with either

  • $1 million or less in gross receipts for the preceding tax year, or
  • 30 or fewer full-time employees during the preceding tax year.

The amount of the tax credit is equal to 50 percent of your disabled access expenses that exceed $250 in a year but are not more than $10,250. Thus, the maximum credit is $5,000.

4. Business Energy Tax Credit

There is a business energy credit based on the cost of qualified energy property used in a trade or business or for the production of income, such as a residential rental building. The credit ranges from 10 percent to 30 percent of the cost of such property. 

The credit can be claimed for various types of renewable energy installations, including thermal and geothermal energy, wind turbines, and fuel cells. 

But small businesses most often claim the credit for the cost of installing solar panels and related equipment to generate electricity to provide illumination, heating, or cooling (or hot water) in a business structure, or to provide solar process heat. 

Unlike the solar credit for homeowners, there is no dollar limit on this business credit. The credit is 26 percent of the cost of solar property whose construction begins in 2020, 2021, or 2022. 

The tax code reduces the credit percentage to 22 percent if construction begins during 2023. 

5. Rehabilitation Tax Credit

The rehabilitation tax credit helps defray part of the cost of rehabilitating historic old buildings. The credit is available only if you rehab a certified historic building or a building located in a registered historic district. The credit can be claimed for commercial, industrial, agricultural, and residential rental historic buildings.

The secretary of the interior must certify to the secretary of the treasury that the project meets their standards and is a “Certified Rehabilitation.” If your building is not already registered as historic but you think it should be, you can nominate it for historic status by contacting your state historic preservation office. 

6. New Energy-Efficient Home Credit

If you’re a building contractor who builds homes, there is a tax credit just for you. You can get a credit of up to $2,000 for building an energy-efficient home. 

The credit is available for all new homes, including manufactured homes, built between January 1, 2018, and December 31, 2021. To meet the energy savings requirements, a home must be certified to provide heating and cooling energy savings of 30 percent to 50 percent compared with a federal standard. 

A reduced credit of $1,000 is available for manufactured homes with a heating or cooling consumption at least 30 percent less than a comparable house and with the Energy Star label.

Are More Credits on the Way?

In the news, you have been reading and hearing about the Build Back Better bill that passed the House and is being considered by the Senate. There are lots of tax credits in the bill. But there are three things to know as of December 1, 2021.

  1. The Senate will likely create and try to pass its own version of this bill.
  2. If the Senate passes the bill in a different form, the bill will go to a conference with both House and Senate members, who will make more changes.
  3. Regardless of what happens, we don’t see any changes in the current bill or expect any changes that will affect the information in this article. The changes, if any do become law, will apply to 2022 and later.

If you would like my help in qualifying for any tax credits, please call me on my direct line at 408-778-9651.

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