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Archives for Tax Planning Tips

Flipping the Script on Expenses for Real Estate Investors

By Eric Little, CPA – 

If you’re trying to make money by buying, improving, and reselling homes—known colloquially as house flipping—it pays to pay attention to taxes. A lot of things go into whether you can make a profit flipping, and not all of them are predictable, but taxation often is. If you know how real estate business taxes work, you can make plans that minimize your tax burden and maximize your profit.

Your Properties Are Considered ‘Inventory’ For Tax Purposes

The IRS considers most flippers real estate dealers, because, as Nolo explains, buying and improving homes for sale is their usual business. As small businesses, real estate dealers must worry about business taxation on their inventory—the real estate they plan to sell. The IRS considers homes inventory for this kind of business, just like a seller of orange juice or t-shirts would count those items as inventory when doing their taxes.

This rule used to cause problems for real estate dealers, who, under IRS rules, couldn’t deduct their high-cost home purchases as an expense until they were sold. If they made a big purchase right before tax time, too bad; no deduction until the sale. That situation can make budgets very tight for a smaller business.

New Rules for High-Cost Inventory Change The Game For Small Businesses

However, in late 2017, the Tax Cuts and Jobs Act changed the rules on that, raising the threshold for using the accrual method from $1 million (for an inventory-based business) to an average of $25 million over the prior few years.

That new rule instantly changes things for small house flippers, who are unlikely to go over $25 million in gross receipts. Now, flippers who are below the threshold can deduct inventory using (in relevant part) “the taxpayer’s method of accounting.”

Small business accounting firm Catching Clouds says this seems to mean treating your inventory/properties consistently with the rest of your accounting. Thus, at least in theory, you can use any method of accounting you want, including one that allows you to deduct the price of the real estate after you pay it, as long as you follow it consistently.

Many CPAs would advise caution here. The IRS reserves the right to challenge any taxpayer’s accounting methods, and if you get it wrong, you may be charged back taxes and penalties. Before taking full advantage of this opportunity, you may wish to talk to an experienced small business CPA with experience in real estate investing.

Talk to our Charlotte CPAs today

New tax laws like the increased threshold for accrual-based accounting means that your financial strategy may need to shift significantly. If you are a real estate investor or have passive real-estate investments, this new change could potentially impact your business.

Our tax & financial planning professionals at LBJ CPAs have the experience, knowledge and creativity needed to stay ahead of all tax code changes and to help keep the regulatory burden off our client’s shoulders. Call our office today and schedule your free consultation with LBJ CPAs today to learn more about how your real estate portfolio could be affected by the new IRS inventory reporting methods.

 

 

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The Underappreciated Magic of Qualified Small Business Stock

By Eric Little, CPA – 

Money is a common stumbling block for startup businesses. Business leaders need it to hire employees, rent an office and eventually sell their products. But startups, almost by definition, don’t have a lot of extra cash around. That slows their growth—and therefore, their profitability.

Attracting “angel investors” can be tough, which is why startups trying to raise capital should consider offering a little-known but attractive benefit: Qualified small business stock. Under the right circumstances, investors in a small business can cash out their QSBS completely tax-free, even if they had big capital gains. This makes QSBS a fantastic reward for ground-floor investors who stick with a company throughout its climb to success.

How Qualified Small Business Stock Works

Qualified small business stock is stock class issued by a C corporation (not an S corporation or any other business form) from the United States.

As the Internal Revenue Code says, the stock must be original-issue, not resold, which is why this is a great mechanism for early-stage investors. The corporation must not have more than $50 million in assets at the time the stock is issued—also not likely to be a problem for many startups.

During most or all of the time the investor holds the stock, the business must remain a C corporation, and at least 80% of the corporation’s assets must be used in the active conduct of a qualified business*, as defined by the IRS:

  • Every trade or business of such entity is the active conduct of a qualified business within an empowerment zone
  • At least 50 percent of the total gross income of such entity is derived from the active conduct of such business
  • A substantial portion of the use of the tangible property of such entity (whether owned or leased) is within an empowerment zone
  • A substantial portion of the intangible property of such entity is used in the active conduct of any such business
  • A substantial portion of the services performed for such entity by its employees are performed in an empowerment zone
  • At least 35 percent of its employees are residents of an empowerment zone
  • Less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to collectibles (as defined in section 408(m)(2)) other than collectibles that are held primarily for sale to customers in the ordinary course of such business
  • Less than 5 percent of the average of the aggregate unadjusted bases of the property of such entity is attributable to nonqualified financial property.

*IRS Qualified Business list courtesy of law.cornell.edu

Deciding what’s a qualified business can get complicated, and we welcome inquiries from business leaders about it, but a technology startup is likely to be a qualifying business. Once all these classifications are met, the real advantage of the QSBS goes to the medium-term holder of the stock.

If the investor holds the stock for at least five years and it goes up in value, the tax code exempts that increase from the capital gains tax!

This is assuming that the investment was made after September 28, 2010, which is likely for current startups.

States may still charge capital gains taxes, so QSBS doesn’t make a windfall from a stock sale completely tax-free. But it does reduce the seller’s tax burden very substantially—and that’s a great enticement for people with money to invest. For startups, incorporating as a C-corporation can be a great way to finance the rapid growth they need to get to market and—eventually—realize a great profit on their ideas.

Talk to our Charlotte CPAs today

Rule updates like the QSBS mean that your financial strategy may shift significantly, to keep up with the best opportunity for your money. Our tax and financial planning professionals at LBJ CPAs have the experience and creativity needed to stay ahead of all tax code changes and to help keep the regulatory burden off our client’s shoulders. Call our office today and schedule your free consultation with LBJ CPAs today to learn more about QSBS and other forms of early startup financing.

 

 

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Year-End Planning Tips

Here are a few things you can do before the end of the year to keep your income taxes as low as possible.

  1. Due to the new tax legislation, many people are taking the new standard deduction.  If you are still itemizing, you can still do the following to help reduce your tax bill:
    1. Pay your property taxes.
      Real estate taxes and vehicle taxes are tax deductible. If your property tax bill is due early next year, you might want to pay it now and take the deduction.  Please remember that the new cap on state and local tax deductions are $10,000 per year.
    2. Donate to charity. It pays to be charitable, especially at the end of the year. Donating cash is always a good idea (fully deductible up to 60% of your adjusted gross income). You can also donate household goods, clothing, and other items. Under the Pension Protection Act, you will need a written receipt for all charitable donations, and donated items must be in good or better condition. You can also deduct the cost of driving for charity at 14 cents per mile. You cannot take a charity deduction, however, for the value of your time or services when volunteering.
    3. Pay doctor bills, insurance premiums, buy eyeglasses, or stock up on prescription medications during the year. You can take a deduction for medical expenses exceeding 7.5% of your adjusted gross income.
  2. Tax Harvesting. To offset capital gains, investors can lower their capital gains taxes by selling securities that have lost money. Losses offset gains dollar for dollar, and losses in excess of your gains can be deducted, up to $3,000 per year.
  3. Max out your retirement savings. Contributions to a retirement plan reduce your taxable income.
  4. Max out your Health Savings Account (HSA). If you have a Health Savings Account, make sure you are maxing it out for 2019. HSAs work similar to IRAs, you can make contributions towards them up through April 15th, 2020 and have contributions retroactively applied to your 2019 tax return.
  5. Boost business expenses. Business owners and independent contractors can buy office supplies, invest in new equipment, or pay bonuses to their employees. They should also review their retirement plans or decide about setting up a retirement plan. Many retirement plans need to be established by the end of the year if owners want to make tax-deductible contributions for the year. You will want to review what constitutes a legitimate business expense just to make sure it will be tax-deductible.
  6. 20% qualified business income deduction. Sec 199A provides for a 20% deduction with respect to “qualified business income” and certain other types of income. The deduction may be taken by individuals, estates, and trusts. The deduction for qualified business income is set to expire for tax year beginning after Dec 31, 2025.
  7. Sole-Proprietors should evaluate becoming an S-Corporation.  Those who are self-employed, taxed as sole-proprietors should consider whether it makes sense for their business to be taxed as an S-Corporation.  S-Corporations can provide considerable tax relief under the right conditions.
  8. Organize your financial records. Good record-keeping can really pay off at tax time. Not only will it make your tax preparation easier and faster, but you might uncover enough tax deductions to be able to itemize. More importantly, the IRS will require receipts and other records in the event of an audit. Business owners should be using accounting software such as Peachtree, QuickBooks, or Microsoft Office Accounting to ensure that all their income and expenses are recorded properly. Individual taxpayers may want to use Microsoft Money or Intuit’s Quicken to keep track of their personal spending. As an added bonus, these programs provide reports that summarize your tax deductions for faster tax preparation.

If there is anything we can help you with, please feel free to let us know.

Very truly yours,


LB&J Certified Public Accountants

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