Tax

The tax code says, “The term ‘net earnings from self-employment’ means the gross income derived by an individual from any trade or business carried on by such individual . . .” 

The Supreme Court ruled that to be in a trade or business, you need to be involved with continuity and regularity and that a sporadic activity does not qualify.

In Batok (T.C. Memo 1992-727), the court ruled that John Batok’s installation of windows did not rise to the level of a trade or business. Mr. Batok’s activity, although engaged in for profit, was neither continuous nor regular. He had never installed windows before this effort nor at any time after that. 

The court ruled that Mr. Batok’s activity was a “one-time job” not subject to self-employment taxes.

The one-time project can avoid having your child on the payroll, and it can give you the best of all worlds. 

For example, say you are in the 40 percent federal bracket, and you pay your 20-year-old college student $23,225. You deduct the $23,225 and save $9,290 on your taxes.

Your child pays $1,028 in taxes.

If you would like to discuss this strategy, please call my direct line at 408-778-9651.

• By Leon Clinton
• January 28, 2022

When you own rental property, depreciation is your best friend. 

One reason depreciation is so valuable is that, unlike deductible rental property expenses such as interest and maintenance, you get to claim depreciation year after year without having to pay anything beyond your original investment in the property. 

Moreover, rental real property owners are entitled to depreciation even if their property goes up in value over time (as it usually does).

The basic idea behind depreciation is simple, but applying it in practice can be complex. Indeed, the annual depreciation deductions for two properties that cost the same can be very different.

For example, if you own a motel with a depreciable basis of $1 million, you get to deduct $25,640 each year for depreciation (except the first and last years). If you own an apartment building with a $1 million basis, your depreciation deduction is $36,360. 

Why the difference? A motel and apartment building are both rental real estate. Shouldn’t they be depreciated the same way? Not according to the tax law. An apartment building is a residential rental property, while a motel is a commercial rental property. There are different depreciation periods for commercial and residential property: it takes far longer to depreciate commercial property fully.

For this reason, you should always make sure you correctly classify your property as commercial or residential. Such classification can be more challenging than you might think, especially for mixed-use property. If you rent to residential and commercial tenants, the tax code classifies the building as residential only if 80 percent or more of the gross annual rent is from renting dwelling units. 

Even properties rented only for residential use may have to be classified as commercial if a majority of the tenants or guests are transients who stay only a short time. This rule can adversely impact the depreciation deductions for property owners who rent their property to short-term guests through Airbnb and other short-term rental platforms.

If you’ve been using the wrong depreciation period for your residential or commercial rental property, you should correct the error by filing an amended return or IRS Form 3115 to fix depreciation errors more than two years old.

If you have any questions or need my assistance, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• January 25, 2022

Tax-advantaged retirement accounts such as IRAs are a great way to save for retirement. 

But when you establish a traditional IRA with a bank, a brokerage, or a trust company, you are ordinarily limited to a narrow range of investment options, such as CDs, publicly traded stocks, bonds, mutual funds, and ETFs. The IRA custodian will not permit you to invest in alternative investments such as real estate, precious metals, or cryptocurrency.

A self-directed IRA could be for you if you want to walk on the wild side and invest your retirement money in assets such as real estate or cryptocurrency.

You can invest in almost anything other than collectibles such as art or rare coins, life insurance, or S corporation stock with a self-directed IRA. Investment options include, but are not limited to the following:

• Real estate
• Private businesses
• Trust deeds and mortgages
• Tax liens
• Precious metals such as gold, silver, or platinum
• Private offerings
• LLCs and limited partnerships
• REITs
• Livestock
• Oil and gas interests
• Franchises
• Hedge funds
• Cryptocurrency
• Promissory notes

Aside from he vast array of investment options, a self-directed IRA is the same as a traditional IRA and subject to the same rules. The income the investments in your IRA earn is not taxed until you take distributions, but distributions before age 59 1/2 are subject to a 10 percent penalty unless an exception applies. 

You can also have a self-directed Roth IRA for which distributions are tax-free after five years.

But you must avoid self-dealing and other prohibited transactions or your self-directed IRA could lose its tax-advantaged status.

Establishing a self-directed IRA need not be too difficult. You first open an account with a custodian that offers self-directed investments. You can also acquire checkbook control over your self-directed IRA by forming a limited liability company to own all the IRA investments.

Investing in alternative assets such as cryptocurrency is riskier than stocks, bonds, and mutual funds. 

• The rewards can be great, as you’ve seen with recent returns for cryptocurrency investors. 
• And the damage to your investment portfolio can be substantial, as we’ve also seen over the years.

When it comes to alternative investments, you need to know what you are doing or have an investment professional you trust to do this for you.

If you have any questions or need my assistance, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• January 23, 2022