Tax

Consider this happy scenario: You purchased one Bitcoin for $15,000 14 months ago and another six months later for $40,000. Today, you sell one Bitcoin for $60,000. You’re a genius! But is your taxable gain $45,000 or $20,000? 

It all depends on your crypto accounting method.

Many crypto owners are enjoying substantial gains at a time of surging cryptocurrency prices. When you sell multiple crypto units in the same year, you reduce your taxable gains using a crypto accounting method that provides the highest possible tax basis for each unit sold, resulting in the lowest taxable profit.

As you might expect, the default method approved by the IRS doesn’t always provide the highest basis, resulting in higher taxes. The IRS made FIFO (first in, first out) the default method. It requires you to calculate your basis in chronological order for each crypto unit sold. With FIFO, your basis in the above example is $15,000, and your taxable profit is $45,000.

You can use a method other than FIFO. The other methods are called “specific identification methods” and include HIFO (highest in, first out) and LIFO (last in, first out). With HIFO, you are deemed to sell the crypto units with the highest cost basis first; your basis in the above example would be $40,000, and your taxable profit only $20,000.

Because HIFO sells your crypto with the highest cost basis first, it ordinarily results in the lowest capital gains and the largest capital losses. But using HIFO can cause loss of long-term capital gains treatment if you have not held the crypto for more than one year.

Using HIFO or LIFO is more complicated than FIFO. You must keep records showing

• the date and time you acquired each crypto unit,
• your basis and the fair market value of each unit at the time it was acquired,
• the date and time each unit was sold or disposed of, and
• the fair market value of each unit when sold or disposed of.

If you lack adequate records, the IRS will default to the FIFO method during an audit, which could result in more taxable profit.

It’s next to impossible to manually create the needed crypto records, particularly if you have many trades. Most crypto owners use specialized crypto tax software that automates the basis and gain/loss calculations and can even fill out the required tax forms.

You can change your crypto accounting method from year to year without obtaining IRS permission—for example, you can change from FIFO to a specific identification method such as HIFO. You don’t have to disclose which method you use on your tax return.

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

• By Leon Clinton
• September 3, 2024

You may own an S corporation with a rental property as its sole asset.

A common concern with this approach is what happens when the owner passes away, specifically regarding the step-up in basis.

I’m pleased to inform you that while technically the rental property itself doesn’t receive a step-up in basis upon your death, your heirs will achieve the same outcome. Here’s why:

• Your heirs inherit the S corporation stock at its stepped-up fair market value.
• When the S corporation sells the rental property, it recognizes a gain.
• The gain on the rental property increases your heirs’ basis in the S corporation stock.
• Upon liquidation of the S corporation, your heirs recognize a capital loss that offsets the earlier gain.

The result is that your heirs can potentially sell the property without incurring any tax liability, effectively achieving the same outcome as they would with a traditional rental property basis step-up.

If you’d like to discuss how this might apply to your situation, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 30, 2024

As you likely know, S corporations can offer numerous advantages, such as tax efficiency, ease of ownership, and operational simplicity.

But there are specific pitfalls associated with an S corporation owning an aircraft. Here are the top pitfalls, along with strategies to mitigate the tax issue.

Basis Limitations

The tax code imposes significant restrictions on deducting losses for S corporation owners. If your S corporation purchases the aircraft and uses third-party debt, you get no basis increase for the debt. Thus, third-party debt can destroy many of the write-offs you hoped for.

Tip. Avoid third-party debt financing for aircraft purchases by an S corporation. Instead, use cash, or take a personal loan and contribute the proceeds to the S corporation to increase your basis.

Depreciation Recapture

Your S corporation aircraft must have over 50 percent business use to create substantial first-year depreciation deductions. If business use falls below this threshold during the aircraft’s depreciable life, your S corporation faces depreciation recapture, which converts prior deductions into ordinary income.

Tip. Ensure that business use of the aircraft remains above 50 percent.

Cost-Sharing Arrangements

The tax code does not allow S corporations to allocate aircraft expenses based on use by owners. For example, if you and a friend own an S corporation 50/50 but use the aircraft at different rates (e.g., 20 percent versus 80 percent), the corporation cannot allocate expenses accordingly.

Tip. Consider using a partnership structure if you need flexible cost-sharing arrangements.

Choosing the entity structure for aircraft ownership is crucial to maximizing your tax benefits and avoiding unnecessary complications. If you want to discuss your aircraft, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 27, 2024