Month: October 2023

I hope this letter finds you well. I am writing to bring to your attention some recent developments regarding the “hobby loss rule.” Given that you have diverse sources of income, some of which might be considered hobbies, I believe this information could be of great importance to you.

What Is the Hobby Loss Rule?

The hobby loss rule might apply to you if you have any activity that results in a tax loss. Under this rule, you might lose out on your deductions and end up paying taxes on the income you earned from the hobby.

For instance, if you earned $200,000 from a hobby and incurred expenses of $350,000, the rule would lead you to pay taxes on the $200,000 of hobby income, even though you suffered a net loss of $150,000. That would be unpleasant, since you would be out of pocket $150,000 and paying taxes on $200,000.

Recent Developments

A significant recent case resolved in 2023 involves Carl and Leila Gregory, who chartered their yacht, Lady Leila, in 2014 and 2015, not for profit but as a hobby. Even though they generated income from this activity, they also had significant expenses. The IRS denied the deductions, and the courts agreed, which resulted in the Gregorys owing an additional $267,221 in taxes.

The takeaways from this case are:

• Depth of Impact. The hobby loss rule can have profound tax implications for individuals, partners, and S corporations if they are involved in activities that produce a tax loss.
• Income Irrespective. The hobby loss rule applies irrespective of the income generated—be it $20,000 or in the hundreds of millions.
• Understanding Is Crucial. The Gregory case applied to 2014 and 2015 when the hobby loss rule allowed hobby deductions up to the amount of hobby income but made the expenses itemized deductions subject to the 2 percent of adjusted gross income floor. Things are worse today: you can’t deduct any hobby expenses other than the cost of sales.

What Should You Do?

If you have any activity that might be considered a hobby from a tax perspective, call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 11, 2023

In our continuous effort to provide value, here are some crucial insights into depreciation, particularly regarding business or rental assets.

When Does Depreciation Start?

Technically, depreciation begins not when you use an asset but when it’s ready and available for its intended purpose. For instance:

• A rental property begins depreciating when it’s available to rent, even if it hasn’t been rented yet.
• A farming tool is set to begin depreciation when you receive it, regardless of when you’ll use it.
• A business vehicle begins to depreciate when bought for business purposes, even if not driven yet.

Best Practices

To prevent any ambiguity, if a property is ready for rent, list it. For business vehicles, it’s ideal to drive them for business soon after purchase. This ensures there’s no question about their intent and use.

Assets That Are Vacant, Idle, or Standing By

Even if your asset is temporarily not in use, it doesn’t mean you stop claiming its depreciation. The continued depreciation applies to machines that are momentarily idle due to a lack of demand or a vacant rental property while you search for tenants.

When Does Depreciation End?

Business and rental properties typically remain depreciable until you remove them from their designated use, often when you sell or dispose of them.

Should you have any questions or require a deeper discussion on depreciation, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 6, 2023

I have great news! You can have in your real estate portfolio both investor and dealer properties. This distinction is significant for tax purposes.

Here’s a snapshot of the potential tax differences:

Suppose you profit $90,000 from a property sale:

• As a dealer, your tax could be up to $46,017.
• As an investor, it might be only $21,420.

That’s a potential savings of $24,597 in taxes for investors!

You look at every property individually to determine its classification and make sure you identify each property in your records as either an investment or dealer property. Not doing so can lead to complications with the IRS, and believe me, you don’t want to rely on the IRS for “mercy.”

How the courts determine your classification:

• The primary factor is your intention when purchasing and holding a property. Your records play a pivotal role in illustrating this intent.
• Properties meant for sale to customers are dealer properties. If you frequently buy and sell properties within a year, they’re likely considered dealer properties.
• Properties purchased to renovate and sell usually fall under dealer properties.
• Subdividing properties also leans them toward dealer classification unless they meet the specific criteria of IRC Section 1237.

On the other hand, if your goal with a property is appreciation or rental income, it’s considered an investment property.

Remember, each property’s classification is determined independently. So, whether it’s you or your corporation, owning both dealer and investor properties is possible.

Need assistance classifying your properties? Please call me directly at 408-778-9651.

• By Leon Clinton
• October 3, 2023