Tax

Purchasing raw (unimproved) land can be a great way to get into real estate investing. 

Raw land is ordinarily cheaper than land with buildings and other improvements. Moreover, you don’t have the expense of handling building maintenance and other upkeep, not to mention the headaches of dealing with tenants if you rent improved property. 

But the tax benefits for owning raw land as an investor are much more limited than for improved property. Some expenses are deductible as itemized personal deductions. Many others aren’t deductible at all. Moreover, if you don’t itemize, you get no immediate benefit from your deductions.

Here’s what you can deduct:

• Property taxes (not limited to $10,000, as is the personal deduction for other property taxes)
• Interest on money borrowed to purchase raw land (limited to annual investment income)

Here’s what you can’t deduct:

• Other carrying costs that used to be deductible as miscellaneous itemized deductions, including legal and accounting fees, insurance, and travel expenses (these deductions may return in 2026)
• Land preparation costs (such as grading) that are “inextricably associated” with the land itself and not “directly associated” with a building or another structure.

If you don’t have enough total personal deductions to itemize, you get no current deductions at all for the costs of owning raw land. In this case, you should elect to capitalize your deductible costs—that is, add these expenses to your land’s cost basis. 

Capitalization reduces any taxable profit when you sell the property for a capital gain. This isn’t as good as a current deduction at ordinary income tax rates that are as high as 37 percent, but it’s better than no deduction at all. You need to file the election to capitalize each year.

If you have any questions about investing in raw land, call me on my direct line at 408-778-9651.

• By Leon Clinton
• August 6, 2024

As you consider the process of shutting down your S corporation, it is crucial to understand the federal income tax implications that come with it. Here, I outline the tax basics for the corporation and its shareholders under two common scenarios: stock sale and asset sale with liquidation.

Scenario 1: Stock Sale

One way to shut down an S corporation is to sell all your company stock. The gain from selling S corporation stock generates a capital gain. Long-term capital gain tax rates apply if you held the shares for more than a year. The maximum federal rate for long-term capital gains is 20 percent, but this rate affects only high-income individuals.

If you are a passive investor, you may also owe the 3.8 percent Net Investment Income Tax (NIIT) on the gain. But if you actively participate in the business, you are exempt from the NIIT. Additionally, state income tax may apply to the gain from selling your shares.

Scenario 2: Asset Sale and Liquidation

A more common way to shut down an S corporation involves selling all its assets, paying off liabilities, and distributing the remaining cash to shareholders. Here’s how the tax implications unfold.

Taxable gains and losses. The S corporation recognizes taxable gains and losses from selling its assets. These gains and losses are passed to shareholders and reported on their personal tax returns. You will receive a Schedule K-1 showing your share of the gains and losses to report on your Form 1040.

Long-term gains and ordinary income. Gains from assets held for more than a year are typically taxed as Section 1231 gains at long-term capital gains rates. But gains attributable to certain depreciation deductions are taxed at higher ordinary income rates, up to 37 percent. Real estate depreciation gains attributable to straight-line depreciation can be taxed up to 25 percent.

NIIT considerations. Passive investors may owe the 3.8 percent NIIT on passed-through gains, while active participants are exempt.

Liquidating Distributions. The cash distributed in liquidation that exceeds the tax basis of your shares results in a capital gain, taxed as a long-term capital gain if held for more than a year. If the cash is less than the basis, it results in a capital loss.

Tax-Saving Strategy for Asset Sales

Your number one strategy for tax savings is to allocate more of the sale price to assets generating lower-taxed gains (e.g., land, buildings) and less to those generating higher-taxed ordinary income (e.g., receivables, heavily depreciated assets).

Compliance and Reporting

Report asset sales and allocations on IRS Form 8594 (Asset Acquisition Statement Under Section 1060).

File the final federal income tax return using Form 1120-S, including final shareholder Schedule K-1.

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

• By Leon Clinton
• August 2, 2024

I understand that you are considering offering your timeshare to your employees as an incentive for achieving specific revenue goals and are interested in how you can create a business tax-deductible treatment for the timeshare. Below, I outline two potential methods to help you achieve the desired tax deductions for your timeshare.

Method 1: Deductible Entertainment Facility

One option is to qualify your timeshare as a tax-deductible employee entertainment facility. This approach provides a significant tax-free advantage to your employees, as using such a facility is a tax-free fringe benefit. Here’s how.

Primary use by employees generally. Your timeshare must primarily benefit your employees generally. The “employees generally” group excludes 10-percent-or-more owners and highly compensated employees (those earning over $155,000 in 2024). 

Use ratio. The “employees generally” group must use the timeshare more frequently than the owners and highly compensated employees.

Non-discriminatory use. The timeshare should be made available to all employees generally on a first-come, first-served basis. Avoid any form of discrimination in access to the timeshare.

Proof of use. Maintain a guest log or similar documentation to record employee use.

Method 2: Timeshare as Compensation

Alternatively, you can treat the use of the timeshare as “compensation” to your employees. This method allows more flexibility, including the ability to discriminate among employees if desired. Here’s how it works.

Taxable compensation. You include the fair market value of the timeshare stay (and any additional perks) in the employee’s W-2 taxable income.

Deductible costs. You may deduct the costs incurred in providing the benefit, such as depreciation, Section 179 expensing for furniture and appliances, lease payments (if applicable), and operating expenses.

Business Tax Deduction

Regardless of the method chosen, you need to follow specific steps to ensure you have the deduction correct on your business tax return.

Proprietorship (Form 1040, Schedule C). If you own the timeshare personally, deduct timeshare expenses directly on Schedule C. 

Corporation. If you operate as a corporation, submit an expense report for reimbursement to ensure that the corporation receives the deduction and that you avoid taxable income.

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

• By Leon Clinton
• July 29, 2024