Month: March 2022

Let’s say you own the building. 

Now, let’s say that you rent this building to your business.

With no tax planning, you have a self-rental, and that

• makes rental income from this building nonpassive, meaning that it cannot offset any passive losses (very bad); and
• makes rental losses from this building passive losses, meaning that you likely cannot deduct the losses this year (also very bad).

So, there you have it: with no tax planning, you get the worst of both worlds.

Solution

But wait—there’s a solution (often overlooked).

Under a special grouping rule, you can qualify to group your separately owned rental building with your separately owned business and treat the two of them as one activity for purposes of the passive loss rules.

Ownership

Rental. Your ownership of the rental might be as an individual, an S corporation, or an LLC. For this strategy, you can use any of these forms for your ownership. 

Business. You can own the business as a proprietorship, an S corporation, or an LLC—all these forms work for this strategy.

Note that the C corporation does not work. 

Two into One

What makes two into one possible? Your ownership!

The regulations say that if each owner of the business has the same proportionate ownership interest as each owner of the rental, then the taxpayers may group the business and rental activities as one activity.

Technically, the rental and the business need to pass the appropriate-economic-unit test, which gives great weight both to the extent of common control and to the extent of common ownership. 

You have no problem here because you have both 100 percent control and 100 percent ownership of both the business and the rental. This puts you home free on this test.

And if you are married, you can include your spouse in the mix.

If you would like to discuss the self-rental rules, please call me on my direct line at xxx-xxx-xxxx.

• By Leon Clinton
• March 31, 2022

Do you have a beach or mountain home that you rent out?

If the average period of rental is less than 30 days, you likely have a choice—either

• claim the income and expenses on Schedule C, or
• claim the income and expenses on Schedule E.

When Is Schedule C a Good Choice?

If you show a tax loss on your rental property, Schedule C is a great choice because it allows you to deduct your rental losses against all other income (assuming you materially participate in the rental property).

If you show taxable income on the rental property, Schedule C is not good because it causes you to pay self-employment taxes.

When Is Schedule E a Good Choice?

If you show taxable income on the transient rental, Schedule E is best because you don’t pay any self-employment taxes on Schedule E income.

If you show a loss on your transient rental and you materially participate, you can deduct your losses against all other income, but those Schedule E losses do not reduce self-employment income.

Okay, now you know how to play the game.

IRS in Summary Mode

In recent advice, the IRS stated that rentals of living quarters are not subject to self-employment tax when no services are rendered for the occupants.

But if services are rendered for the occupants, and the services rendered

1. are not clearly required to maintain the space in a condition for occupancy, and 
2. are of such a substantial nature that the compensation for these services can be said to constitute a material portion of the rent, 

then the net rental income received is subject to the self-employment tax.

If you would like to discuss the transient-rental rules, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• March 27, 2022

Imagine this: your Schedule C business buys a home at the beach, uses it solely as an entertainment facility for business, pays off the mortgage, and deducts all the expenses. 

Now say, 10 years later, without any tax consequence to you, you start using the beach home as your own.

Is this possible? Yes. Are there some rules on this? Yes. Are the rules difficult? No.

Okay, so could you achieve the same result if you operate your business as a corporation? Yes, but the corporation needs to rent the property from you or reimburse you for the facility costs, including mortgage interest and depreciation—because you want the title to always be in your name, not the corporation’s name.

The beach home, ski cabin, or other entertainment facility must be primarily for the benefit of employees other than those who are officers, shareholders, or other owners of a 10 percent or greater interest in the business, or other highly compensated employees. In this situation, you create

• 100 percent entertainment facility tax deductions for the employer (you or, if incorporated, your corporation), and 
• tax-free use by the employees. 

The employee facility deduction is straightforward. It has three splendid benefits for the small-business owner:

1. You deduct the facility as a business asset.
2. Your employees get to use the facility tax-free.
3. You own the property and can use it personally without tax consequences once you no longer need it for business use. (Note that when you sell, you will have a gain or loss on the sale and some possible recapture of depreciation.)

If you think the entertainment facility could work for you, please give me a call on my direct line at 408-778-9651, and I’ll help you put this facility in place.

• By Leon Clinton
• March 23, 2022