Month: February 2023

In 1986, lawmakers drove a stake through the heart of your rental property tax deductions.

That stake, called the passive-loss rules, causes myriad complications that now, 37 years later, are still commonly misunderstood.

The Trap

In 1986, lawmakers made you shovel your taxable activities into three basic tax buckets. Looking at the buckets from a business perspective, you find the following:

1. Portfolio bucket for your stocks and bonds
2. Active business bucket for your material participation business activities
3. Passive-loss bucket for your rentals plus other activities in which you do not materially participate

This letter explains three escapes from the passive-loss trap so that you can realize the tax benefits from your rental losses.

Escape 1: Get Out of Jail Free

Lawmakers allow taxpayers with modified adjusted gross incomes of $100,000 or less to deduct up to $25,000 of rental property losses. Once your income goes above $100,000, the get-out-of-jail-free loss deduction drops by 50 cents on the dollar and disappears altogether at $150,000 of modified adjusted gross income.

Escape 2: Changes in Operations

If you, or you and your spouse, have modified adjusted gross income that exceeds the threshold, you need a different plan to obtain immediate benefit from your rental property tax losses.

To begin, let’s review how the tax-benefit dollars get trapped in the first place. As you may remember, to benefit from your rental property tax loss, you must either

1. have passive income from other properties or another source, or
2. both qualify as a real estate professional and materially participate in the rental property.

Example. Say the taxable income on your Form 1040 is $200,000 and you have one rental property. Say further that rental has produced a tax loss of $10,000 a year for the past six years, none of which you have been able to deduct because you have no other passive income and you do not qualify as a tax-law-defined real estate professional.

So here you sit: $60,000 in tax deductions trapped in the passive-loss bucket—not available for deduction against the income from the other buckets.

Not Lost, Just Waiting

This is sad, no doubt, but there’s some good news even in this bucket as you now see it. The $60,000 is not going to drown, disappear, or lose its tax-deduction attributes in some other way. That $60,000 simply waits in the bucket for you to give it an escape route.

Here are four possibilities for the escape route:

1. Generate passive income.
2. Change the character of the rental to non-passive.
3. Change your status to that of a real estate professional, and pass the material participation test for this property.
4. Sell the property, as explained in Escape 3 below.

Escape 3: Total Release

The $60,000 that’s trapped in the passive-loss bucket is like money in the bank. You can tap the trap when you want to release the deductions. It’s really quite easy.

Here we are talking about releasing the entire $60,000 at once (a major jailbreak). You might want to do this right now, or you can wait. You have many options, and the good news is that you are the one in charge of this total release of your passive losses.

To release the losses, you need to make a complete disposition. For example, say you sell 100 percent of the property to a third party. Presto! You now deduct the entire $60,000 in trapped passive losses.

Takeaway

The one thing to know is that if you have rental property losses that are trapped by the passive-loss rules, you have some strategies available.

If you would like to review your rental properties with me, please call my direct line at 408-778-9651.

• By Leon Clinton
• February 24, 2023

I wanted to provide an update on the status of the proposed regulations from the IRS regarding tax deductions for payments made to health care sharing ministries.

On June 10, 2020, the IRS issued a proposal to treat these payments as payments for health insurance. However, this proposal was met with opposition from organizations such as the Alliance of Health Care Sharing Ministries and the National Association of Insurance Commissioners.

As of February 1, 2023, there has been no word from the IRS regarding the finalization or withdrawal of these proposed regulations. Currently, payments made to health care sharing ministries are not considered allowable as reimbursable expenses under Section 105 medical plans or other health reimbursement accounts.

We will continue to monitor the situation and provide updates as they become available.

In the meantime, it is important to remember that payments made to health care sharing ministries are not tax-deductible as medical expenses.

If you have any questions or concerns, please do not hesitate to reach out. My direct phone number is 408-778-9651.

• By Leon Clinton
• February 21, 2023

I hope this letter finds you well. Today, I would like to introduce a new business strategy that can help you build net worth by using depreciable antiques in your business.

The strategy is simple: buy low, depreciate to zero, and sell high. You can achieve this by incorporating antiques into your business. For example, let’s say you’re deciding between purchasing an antique desk or a regular one for your business. Both desks sell for $5,000.

The antique desk not only adds a touch of elegance to your office but also offers a better financial outcome. After 10 years of use, you can sell the antique desk for $15,000, whereas your friend who purchased the regular desk only sells it for $500.

When considering the after-tax numbers, you come out 36 times ahead of your friend. Your federal taxes on the $15,000 proceeds from the sale of the antique desk are $1,500 on the $10,000 capital gain and $1,750 on the $5,000 of depreciation recapture. After taxes, you’re left with $11,750, whereas your friend only pockets $325 after taxes.

Antiques provide a unique opportunity to increase your net worth by acquiring beautiful assets that you can use in your business and expense under Section 179. Currently, you can expense up to $1,160,000 of qualifying costs using Section 179 expensing.

The concept of using depreciable antiques in business has become possible thanks to two musicians who fought hard for this change. Brian Liddle, a professional violinist, and Richard Simon, who played violin for the New York Philharmonic Orchestra, both used antiques in their careers and were able to depreciate their antique instruments to zero and trade them for even more valuable antiques.

I encourage you to give serious consideration to the use of antiques for your business. Not only do they create aesthetic appeal, but they also offer financial benefits that can increase your net worth.

If you have any questions or would like to discuss this opportunity further, please do not hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 16, 2023