Author: Leon Clinton

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

If you own a timeshare and use it only for personal and business lodging, you have a unique opportunity to maximize your tax benefits.

Big Benefit

The IRS allows timeshare owners who do not rent their property to claim deductions for business-related lodging without being subjected to the grim vacation-home rules.

Guidelines for Maximum Tax Benefits

1. Exclusive use for business and personal lodging. With no rental, you maintain eligibility for business and personal tax advantages without suffering from the vacation-home rules.
2. Business deductions for lodging expenses. Under IRC Section 162(a)(2), ordinary and necessary business expenses such as timeshare lodging are deductible when traveling for business.
3. Personal use. Personal use of a deeded timeshare does not qualify for business deductions, but it can qualify as a second home eligible for second-home mortgage interest deductions.

Records Strategy

Keep detailed records of your timeshare use, separating business from personal days to audit-proof your deductions and ensure compliance with IRS requirements.

Relatives

Here’s a good rule to know for timeshares: days of rental to a defined relative count as personal use days by you. In other words, the tax code does not recognize as rental days the days you rent your timeshare to a defined relative (close relatives such as parents, brothers, children).

Next Step

If you want my help examining your timeshare use, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 12, 2024

If you want to convert your home to a rental property, you can improve your tax benefits by selling it to your S corporation.

Benefits of Selling Your Home to Your S Corporation

• Tax savings on home sale profit. By selling your home to your S corporation, you can utilize the home-sale profit exclusion—up to $500,000 for married couples—to avoid taxes on gains from the sale, assuming you meet the eligibility criteria.
• Increased depreciation deductions. The transaction increases the depreciable basis of your property, resulting in higher annual depreciation deductions.

Addressing Common Doubts

• Property tax concerns. While the sale may increase property taxes due to reassessment at the current market value, the overall financial benefits from tax savings on the gain and increased depreciation often outweigh these additional costs.
• Homestead exemption. Selling your home will indeed result in losing any homestead exemption benefits. But the same is true if you convert it to a rental property. Thus, the homestead exemption is a non-issue because you lose it in either case.
• Related-party sale concerns. Although selling to your S corporation is a related-party transaction, it is legitimate under tax law. The impact for you is that the profit on the sale is subject to ordinary income treatment. But to the extent you can use your home-sale exemption against the profit, you don’t pay federal taxes on that ordinary income.

Implementation Steps

• S corporation. You have the best flexibility by creating a separate S corporation to hold your old home as the S corporation’s rental property.
• Appraisal. Obtain an independent appraisal to establish fair market value for the transaction.
• Formal procedures. Use professional services for title transfer and legal documentation to ensure the sale mirrors an arm’s-length transaction.
• Documentation. Maintain proper records and documentation to support the transaction’s validity, should the IRS ever want to examine it.

Conclusion

Selling your home to your S corporation before converting it into a rental property can offer substantial financial advantages. While there are considerations such as increased property taxes and the loss of the homestead exemption, the potential tax savings and increased cash flow typically provide a net positive outcome.

If you want to explore this strategy with me, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• June 10, 2024