Tax

Have you sold, or are you planning to sell commercial or rental property?

To avoid immediately paying capital gains tax on your profit, you have options:

• Deferring the capital gains tax using a Section 1031 exchange
• Deferring the capital gains tax using a qualified opportunity zone fund

With a Section 1031 exchange, you sell your property and invest all the proceeds in

another like-kind replacement property of equal or greater value.

With a qualified opportunity fund, you don’t acquire another property. Instead, you invest in a corporation, partnership, or LLC that pools money from investors to invest in property in areas designated by the government as qualified opportunity zones. Most qualified opportunity funds invest in real estate.

Which is better? It depends on your goals. There is no one right answer for everybody.

A Section 1031 exchange is preferable to a qualified opportunity fund investment if your goal is to hold the replacement property until death, when your estate will transfer it to your heirs. They’ll get the property with a basis stepped up to current market value, and then they can sell the property immediately, likely tax-free.

In contrast, your investment in a qualified opportunity fund requires that you pay your deferred capital gains tax with your 2026 tax return. That’s the bad news (only four years of tax deferral).

The good news: if you hold the qualified opportunity fund for 10 years or more, there’s zero tax on the appreciation.

In contrast, if you sell your Section 1031 replacement property, you pay capital gains tax on the difference between the original property’s basis and the replacement property’s sale amount.

And if you’re looking to avoid the headaches and responsibilities that come with ownership of commercial or rental property, the qualified opportunity fund does that for you.

If you’re looking for liquidity, the qualified opportunity fund gives you that because you need to invest only the capital gains to defer the taxes. With the 1031 exchange, you must invest the entire sales proceeds in the replacement property to avoid any capital gains tax.

Of course, you want your investment to perform. Make sure to do your due diligence, whatever your choice.

If you want to discuss Section 1031 exchanges or opportunity funds, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 13, 2022

All good things must come to an end. On December 31, 2022, one of the best tax deductions ever for businesses will end: 100 percent bonus depreciation.

Since late 2017, businesses have used bonus depreciation to deduct 100 percent of the cost of most types of property other than real property. But starting in 2023, bonus depreciation is scheduled to decline 20 percent each year until it reaches zero in 2027.

For example, if you purchase $100,000 in equipment for your business and place it in service in 2022, you can deduct $100,000 using 100 percent bonus depreciation. If you wait until 2023, you’ll only be able to deduct $80,000 (80 percent).

Does this mean you should rush out and purchase business property before 2022 ends to take advantage of the 100 percent bonus depreciation? Not necessarily. For many businesses, an alternative is not going away: IRC Section 179 expensing.

IRC Section 179 expensing and bonus depreciation both allow business owners to deduct in one year the cost of most types of tangible personal property, plus off-the-shelf computer software. Both can be used for new and used property acquired by purchase from an unrelated party. Both also can be used to deduct various non-structural improvements to non-residential buildings after they are placed in service.

Moreover, the two deductions aren’t mutually exclusive. You can apply Section 179 expensing to qualifying property up to the annual limit and then claim bonus depreciation for any remaining basis. Starting in 2023, when bonus depreciation will be less than 100 percent, any basis left after applying Section 179 and bonus depreciation will be deducted with regular depreciation over several years.

But there are some significant differences between the two deductions:

• Section 179 expensing is subject to annual dollar limits that don’t apply to bonus depreciation. But the limits are so large that they don’t affect most smaller businesses.
• Section 179 expensing requires more than 50 percent business use to qualify for and retain the Section 179 deduction. For bonus depreciation, you face the more than 50 percent business use requirement only for vehicles and other listed property.
• Unlike bonus depreciation, Section 179 expensing is limited to your net taxable business income (not counting the Section 179 deduction) and cannot result in a loss for the year.
• The 2022 Section 179 deduction is limited to $27,000 for SUVs. There is no such limit on bonus depreciation.
• You can use bonus depreciation to deduct land improvements with a 15-year class life, such as sidewalks, fences, driveways, landscaping, and swimming pools.

Generally, there is no great need to purchase and place the property in service by the end of 2022 to take advantage of 100 percent bonus depreciation. But there can be exceptions.

For example, if you own a rental property and want to make substantial landscaping or other land improvements, you’ll get a larger one-year depreciation deduction using 100 percent bonus depreciation in 2022 than if you wait until 2023, when the bonus will be only 80 percent.

If you would like to discuss bonus depreciation or Section 179 expensing, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• October 8, 2022

Do you qualify for the employee retention credit (ERC)? Did you claim it?

It’s not too late. You can still amend your 2020 and 2021 payroll tax returns.

Remember, this can be worth up to $5,000 per employee in 2020 and up to $7,000 per employee per quarter for the first three quarters of 2021, for a 2021 total of $21,000 ($26,000 per qualifying employee for 2020 and 2021 combined).

Example. Let’s say you have 10 employees who fully qualify for the credit. That’s a $260,000 tax credit (think cash): ($5,000 + $7,000 + $7,000 + $7,000) x 10 = $260,000.

Who Must Aggregate Businesses?

When you own more than one entity, you face special rules when it comes to the ERC.

And you don’t have to own the other entity entirely to face the special rules.

Here are just a few examples of who has to aggregate businesses for purposes of the ERC:

• Howard operates his dental practice as an S corporation, and he also owns three rental properties that he deems businesses.
• Carla Corporation operates 11 subsidiary corporations located in seven states.
• Jack, Jake, and Jim own one-third of four corporations.

Okay, So What?

When you aggregate the business entities into one for the ERC, you have to consider the following questions:

• Are you now (because of the aggregation) a small or a large employer under the 100 (2020) or 500 (2021) large-employer test?
• What does the aggregation of the businesses mean for your qualifying under the decline-in-gross-receipts test?
• What is the effect of a government COVID-19 shutdown or modification order on one of the entities, and how does it affect the aggregated group?
• How do you treat employees who work for more than one of the entities?

A Little More

In most cases, identifying the group to aggregate is going to be straightforward, but it can get pretty complicated with some entities. The bottom line is that it’s likely worthwhile to aggregate and see what’s possible for the ERC.

When you aggregate, you look at gross receipts compared with 2019, and you also look to government shutdown orders. Obviously, you use the best results you find with either (a) the gross receipts drop or (b) the shutdown orders.

There’s a pleasant surprise with the government shutdown order, because if that order affects one entity in the group, the IRS says it affects the entire group. For example, Sam owns five retail corporations. One was shut down by governmental order. That shutdown applies to all five corporations and can create tax credits with each of the five.

If you would like to discuss the ERC, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 23, 2022