Month: August 2022

Do you own investment property? What about a small business? Sooner or later, you will probably want to sell.

One of the downsides of selling a business or investment property is the huge tax bill at the end. Profits are likely subject to the capital gains tax—perhaps at a much higher rate than you expect.

A seller-financed installment sale enables you to defer taxes to one or more later years, which is almost always a good idea.

And the installment sale could cut your tax bill if spreading out your profits over multiple years puts you in a lower tax bracket.

But as with most programs that can lower your taxes, your lawmakers and the IRS impose a number of limitations.

What Is an Installment Sale?

An installment sale is a sale of eligible property where you receive at least one payment after the close of the taxable year in which the sale occurs. If you make a profit on an installment sale, you report part of your profit when you receive each payment.

You document the buyer’s obligation to make future payments to you, with a deed of trust, note, land contract, mortgage, or other evidence of the buyer’s debt to you. You should also secure the debt.

Although you can’t use the installment method to report a loss, you can choose to report all of your gain in the year of sale.

Installment Sale Advantages

An installment sale offers a number of advantages for you as a seller, as well as for your buyer:

1. You can negotiate the sale without the need for the buyer to pay the full sale price when you finalize the sale.
2. You and the buyer can finalize the sale agreement without waiting for the buyer to qualify for third-party financing.
3. You and the buyer can tailor the terms of the sale to meet your needs without having to get approval from a third-party lender.
4. You can defer taxes on your gain, and potentially pay a lower tax rate in a later year.
5. The buyer receives full basis in the property.

How Is an Installment Sale Reported?

Payments that you receive from an installment sale consist of three parts:

1. Interest
2. Taxable part (gain or profit)
3. Non-taxable part (return of basis)

Each year you receive a payment, you pay taxes on the interest and taxable part. The part of the payment allocated to your basis is not taxable. Basis is the amount of your investment in the property for installment sale purposes.

After you’ve determined how much of each payment to treat as interest, you next determine the taxable portion of the remaining payment.

No Installment Sale in These Instances

There are certain types of property and transactions for which the installment method cannot be used, such as:

• The sale of inventory consisting of personal property. But this rule does not apply to property used or produced in farming.
• The sale of real property held for sale to customers in the ordinary course of a trade or business. But dealers of timeshares and residential lots can treat certain sales as installment sales and report under the installment method if they elect to pay a special interest charge.
• The sale of stock or securities traded on an established securities market.
• The sale of depreciable property to a related buyer, unless you can show to the satisfaction of the IRS that the sale was not made for tax avoidance.

If you are thinking of an installment sale and would like to discuss it, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 30, 2022

You may have joined the Great Resignation, maybe temporarily or maybe for good.

Or your non-working status might have nothing to do with the Great Resignation. For instance, you could be a stay-at-home parent.

In any case, as a spouse with no tax-defined earned income, you might want to continue saving for retirement in a tax-favored fashion by making contributions to a traditional or Roth IRA.

An IRA set up to receive contributions by a non-working spouse is known as a spousal IRA.

The working spouse can make IRA contributions to it too.

Non-Working Spouse: Traditional Spousal IRA Contributions

For the 2022 tax year, you (the non-working spouse) can make a deductible contribution of up to $6,000, or up to $7,000 if you’ll be age 50 or older as of December 31, 2022, to a traditional spousal IRA set up in your name.

To make a traditional spousal IRA contribution, you must file a joint Form 1040, and you and your spouse must together have earned income—typically from your working spouse—at least equal to the sum of your contribution plus your spouse’s contribution, if any.

Note that taxable alimony received by you or your spouse under a pre-2019 divorce agreement counts as earned income for IRA contribution eligibility purposes.

Now It Gets Tricky

If your working spouse is covered by a tax-favored retirement plan, via a job or self-employment, the deductibility of your traditional spousal IRA contribution is phased out, for the 2022 tax year, between joint adjusted gross income (AGI) of $204,000 and $214,000.

Joint AGI is the sum of most taxable income items and gains, reduced by so-called above-the-line deductions. These include

• the deduction for contributions to a self-employed SEP, SIMPLE, or other self-employed retirement plan;
• the deduction for 50 percent of self-employment tax;
• the deduction for self-employed health insurance premiums;
• contributions to a health savings account (HSA);
• alimony payments required by a pre-2019 divorce agreement;
• the deduction for up to $250 of unreimbursed expenses for K-12 educators; and
• the deduction for moving expenses for eligible members of the Armed Forces.

If your working spouse is not covered by a tax-favored retirement plan, via a job or self-employment, you (the non-working spouse) can make a deductible traditional IRA contribution regardless of how high your joint AGI might be.

Working Spouse: Traditional IRA Contributions

If neither you nor your working spouse participate in a tax-favored retirement plan, via a job or self-employment, your working spouse can make a deductible contribution of up to $6,000 for the 2022 tax year to a traditional IRA set up in his or her name (regardless of your joint AGI level), or up to $7,000 if your working spouse will be 50 or older as of December 31, 2022.

You as a non-working spouse can make a deductible contribution to a traditional spousal IRA set up in your name, subject to the same limits.

But you and your spouse must together have enough earned income to at least match the combined amount of your contributions. All the requisite earned income can come from your working spouse. Once again, note that taxable alimony received by you or your spouse under a pre-2019 divorce agreement counts as earned income for IRA contribution eligibility purposes.

On the other hand, if your working spouse participates in a tax-favored retirement plan, his or her ability to make a deductible traditional IRA contribution for the 2022 tax year is phased out between joint AGI of $109,000 and $129,000.

If you have questions on your or your spouse’s ability to make IRA contributions, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 23, 2022

The Fed is finally taking aggressive action to fight inflation, but will it work?

Where’s the stock market headed?

Who knows?
Real estate might be a good inflation hedge, but it’s a non-liquid asset and no sure thing.

Clearly, this is not a great environment for investors or retirement savers.

If you are thinking of investing conservatively but in a way that also offers some inflation protection, here’s an option to consider.

Treasury Inflation-Protected Securities

U.S. Treasury Inflation-Protected Securities (TIPS) are a special variety of Treasury bonds that are adjusted for inflation.

Specifically, in times of inflation, TIPS principal balances are adjusted upward twice a year, based on changes in the Consumer Price Index.

In contrast, significant inflation can punish the conservative investment strategy.

Okay, sounds interesting. How do TIPS work?

TIPS Basics

TIPS are sold at original issuance with terms to maturity of five, 10, and 30 years. They pay cash interest twice a year at a fixed rate that’s set at issuance.

Also, as we mentioned above, during times of inflation, TIPS principal balances are adjusted upward twice a year.

You receive the following if you hold a TIPS bond:

1. Cash interest payments twice a year at the stated fixed rate. Each semiannual payment equals half the stated rate times the inflation-adjusted principal balance at the time of the payment. So, cash interest payments go up with inflation because they are based on the increasing inflation-adjusted principal balance.
2. At the date of maturity, you receive the inflation-adjusted principal balance.

The Deflation Scenario

While deflation might seem highly unlikely at the moment, nothing is certain these days. Right?

During periods of deflation, TIPS principal balances are adjusted downward twice a year. The twice-yearly interest payments are also adjusted downward—because they are based on a declining adjusted principal balance. The stated fixed interest rate itself doesn’t change.

But even in the worst-case scenario of significant deflation during your ownership period, the results of owning a TIPS bond won’t be catastrophically bad, as long as you hold the bond to maturity. That’s because you’re guaranteed to receive at least the face value of the bond at maturity, even if the adjusted principal balance has fallen below that number. If the inflation-adjusted principal balance exceeds the face value, you’ll receive the larger inflation-adjusted number.

Best Way to Invest in TIPS

You can purchase TIPS upon original issue directly from the government, through the online TreasuryDirect program. If you invest this way, your principal is never at risk.

The TreasuryDirect option is available only for TIPS purchased for taxable accounts. You cannot use a tax-favored retirement account, such as an IRA, to buy TIPS upon original issue via TreasuryDirect.

If you buy a newly issued TIPS bond via TreasuryDirect, you’ll receive at least the face value of the bond if you hold it to maturity, even if there’s significant deflation. In other words, if you buy $100,000 of bonds via TreasuryDirect and hold them to maturity, then you receive no less than $100,000. Your principal is never at risk.

TIPS Tax Considerations

Cash interest payments from TIPS and non-cash increases in the principal of TIPS are subject to federal tax at ordinary income rates, but exempt from state and local income taxes.

TreasuryDirect reports the TIPS amounts subject to the federal income tax on two information forms:

• Form 1099-INT shows the sum of the semiannual cash interest payments made to you in a given year.
• Form 1099-OID shows the amount by which your TIPS principal amount increased or decreased due to inflation.

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

• By Leon Clinton
• August 16, 2022