Author: Leon Clinton

When it comes to taxes, your ownership of a timeshare comes with some tax implications, and they depend on how you use the timeshare:

• Personal use only
• Rental use only
• Both personal and rental use

Business use is a separate subject because you treat it separately under the business rules. You first deduct business use and then consider timeshare personal and rental use.

Mortgage Interest Deduction

You can deduct mortgage interest on your main home and one additional home. Your timeshare can qualify as a second home if

• it is used solely for personal purposes, or
• it has rental use, but your personal use qualifies it as a second home.

Co-Owners and Rental Complications

When you don’t rent your timeshare, you can disregard the co-owners and consider it your second home. But if you rent it out, the rental rules become complex, and you must account for the co-owners’ activities as well.

Passive Loss Rules

If your timeshare is classified as a rental property and shows a tax loss, it will be subject to passive loss rules, which can limit your deductions unless certain conditions are met.

Key Thoughts

• Avoid renting. This simplifies your tax situation, allowing you to focus on business and personal uses.
• Use the property for business and personal reasons instead. This avoids the complicated vacation home rules and allows for potential mortgage interest deductions.
• Consider the tax implications of renting. While rental income offsets costs, this addition of cash flow introduces complex tax rules and may not provide tax shelter benefits.

If you want to discuss your timeshare, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 25, 2024

The IRS allows you to write off the old roof or component when you replace it on your rental property. The write-off of the old component creates three major tax benefits for you:

• Immediate ordinary loss write-off. You can claim an immediate deduction for the loss, provided the passive loss rules do not delay it.
• Conversion to capital gain. You convert otherwise unrecaptured Section 1250 gain to capital gain.
• Time value of money. Investing the tax savings from the write-off can generate additional revenue over time.

Example

Consider a building purchased for $4 million seven years ago. You replace the roof and other components. The replacements create a $660,000 ordinary loss. If you’re in the 40 percent tax bracket, your immediate cash savings by claiming the deduction is $264,000.

If the passive loss rules delay your deduction until you sell the building, the $660,000 deduction remains available and continues as an ordinary loss at the time of sale.

Time Value of Money

Investing the $264,000 savings at 5 percent after taxes can significantly increase your earnings over time. For example, in 30 years, this grows to $1,086,660.

Additional Savings upon Sale

When you sell this building, the partial disposition election to write off the replacements helps you avoid the 25 percent tax on unrecaptured Section 1250 gain for the disposed assets. This results in additional tax savings at the time of sale.

Making the Election

The process to make this partial disposition election is simple. Calculate the write-off, claim depreciation on the new asset, and deduct your loss on the old asset in your timely filed tax return.

If you want to discuss repairs to your rental property and how they can increase your cash benefits, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 19, 2024

As you consider shutting down your sole proprietorship or your single-member LLC treated as a sole proprietorship for tax purposes, it’s crucial to understand the tax implications of this decision. Here’s an overview of key points you need to consider.

1. Asset Sale Tax Implications

When you sell a sole proprietorship, you sell its assets, not the company. Federal tax rules tell you how to allocate the total sale price to specific business assets. This allocation is critical as it impacts the calculation of taxable gain and loss.

2. Taxable Gain and Loss

• Gain. You have a taxable gain if the allocated sale price exceeds the asset’s tax basis (original cost plus improvements minus depreciation/amortization).
• Loss. You incur a deductible loss if the tax basis exceeds the sale price.

3. Special Rules for Depreciable Real Estate

For depreciable real estate, specific federal income tax rules apply:

• Section 1250 ordinary income recapture. The portion of the gain on sale attributable to tax-code-defined “additional depreciation.” It’s taxed at ordinary income rates.
• Section 1231 gains. Gains from the sale or exchange of real estate used in a trade or business, which the tax code treats as long-term capital gains if the gains exceed any non-recaptured Section 1231 losses from the previous five years.
• Unrecaptured Section 1250 gain. The portion of gain from the sale of real estate attributable to depreciation deductions previously taken on the property that were not recaptured as ordinary income under Section 1250. The unrecaptured 1250 gain is taxed at a maximum rate of 25 percent.

4. Other Depreciable or Amortizable Assets

Gains attributable to depreciation or amortization deductions are recaptured and taxed at higher ordinary income rates. Remaining gains on assets held for more than one year are taxed at lower long-term capital gains rates.

5. Non-Compete Agreement Payments

Payments received under a non-compete agreement are treated as ordinary income but are not subject to self-employment tax.

6. Tax-Saving Strategies

To minimize tax liability, strategically allocate more of the sale price to assets generating lower-taxed long-term capital gains and less to those generating higher-taxed ordinary income.

7. Tax Return Reporting

Report gains and losses on IRS Form 4797 and Schedule D for capital gains and losses. Use IRS Form 8594 to allocate the sale price and IRS Form 8960 to calculate the net investment income tax, if applicable (not likely).

8. State Income Tax

You may also owe state income tax on gains from the sale of your business.

Takeaways

Properly managing the shutdown of your sole proprietorship or single-member LLC involves careful planning and accurate reporting to optimize tax outcomes.

If you want to discuss the sale or shutdown of your proprietorship, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 14, 2024