Brian Borawski CPA, PC

Archive for the ‘Capital Gains’ Category

This is part two in a series of article explaining the changes that happened when the American Taxpayer Relief Act of 2012 was enacted.  Like Individual Income Tax rates. the changes to the capital gains rate only changed for those who exceed a certain income threshold.  The news 20% rate applies to individuals making more than $400,000, couples who make more than $450,000 and head’s of household who make more than $425,000.  Anyone under those amounts will pay a capital gains rate based on their income that ranges from zero to 15%.  For a look at the new capitals gains rates, please click through to this article which provides the specific brackets.

Selling an asset can be taxing and sometime you run into problems when you sell an asset and you don’t collect all of the money at once.  Let’s look at an extreme example.  You have a building that’s worth $1 million but you’ve owned it for so long that it’s fully depreciated so if you sell if for $1 million, you’re going to have quite the gain.  Since it’s a long term capital asset and you sell it by the end of this year, your gain would be 15%, or $150,000.  You had a hard time finding a buyer and the one you finally found is cash strapped and they put 10% down and you seller-finance the rest.  The problem here is, your tax ($150,000) is actually more then the cash you received ($100,000) so you’re left with a shortfall.

That’s where the installment sale rules come in.  You can elect to report your gain on an installment basis if you expect payments in a tax year after the year of sale.  This is done on Form 6252 and the first thing you need to do is compute the gross profit percentage. In our example, since there’s no longer any depreciable basis, the gross profit percentage is easy because it’s 100%.  That means whenever you collect principal payments, you pay tax on 100% of the amount received.  In our example, the down payment would result in a $100,000 or $15,000 in tax (assuming this year).  If you collected $50,000 in principal next year, that would be your gain in that year and so on until the note is paid off.

One interesting quirk this year is capital gains are expected to go up in 2013 so you might want to actually pay the tax on the entire amount rather than wait and potentially pay a higher tax rate in the future.  The good news is, you elect the installment method when you file your return so you could potentially put off the decision until you have a better handle on what tax rates will be.

Many people feel that the two absolutes in life are death and taxes.  In my experience, if there’s something that comes to close to a third absolute it’s that you should never hold real estate within a structure that’s taxed as a corporation.  I can give you some examples of where it works out okay but still not as well as under a structure taxed as a partnership but I can give you a few different examples of where you can have some disastrous tax circumstances when holding real estate in a corporation.  The primary pair of reasons are basis rules and distribution rules.  As always, I’m keeping this simple so if you have a specific situation that applies to you, be sure to contact a professional.

Let’s say you get a great deal on a property.  You’re able to buy a $1 million piece of property for $500,000 and because of the great purchase price, you’re able to finance the entire $500,000 with  a bank loan.  Let’s take a look at what happens in two years when you try to distribute this piece of property out of your legal entity.

If you bought the property under an LLC that’s taxed as a partnership, you’d be in pretty good shape.  You’d probably (it would depend on the bank note) be able to pass through any losses from the partnership because your debt has given you basis.  In two years, if you distribute the property out of the LLC, it’s a tax free transaction and the property would come through with its basis and carrying period intact.

If you bought the property under a C-Corporation, you’d have a mess.  When you distribute property, it’s the same as if you sold it then distributed the proceeds so you’d have about a $500,000 gain that the C-Corporation would have to pay (plus any depreciation that you took in those two years).  On top of that, the distribution would be taxable to the shareholder at the value of the property or in this case, $1,000,000.  Those two layers of tax that will chew into that $500,000 in savings you picked up when you bought the property pretty quickly.

While not as bad as the C-Corporation example, if you had put it under a corporation that had made a Subchapter S election, you’d still have some tax to pay.  You wouldn’t have any basis in the corporation because the debt from the bank note isn’t eligible as basis.  You’d have the capital gains hit that would occur at the S-Corporation level (which would ultimately flow through to the owner’s personal return) but not the second layer of tax because the dividend would come through tax free.

In short, putting into an LLC is pretty much a no lose situation.  Putting into a corporate structure, you could have a tax mess on your hands.  Be sure to discuss your personal situation with you tax adviser.

The year 2012 and leading into the year 2013 could be potentially the most challenging year I’ve known to do tax planning.  We have several provisions expiring, we have an election year and we have a fractured Congress.  Word on the street is that very little in the tax arena will be addressed until after the election so we’re looking at November and December to get changes or renewals done before the end of the year.   Based on the current tempo of government, I’d bet we’re hung out to dry but I’ll be looking at some of the rules and how they’ll change if nothing is done.

First we will be looking at the long term capital gain rate.  Right now, the tax rate on long term capital gains is 15% and it’s zero if you fall into the ten or fifteen percent  tax bracket.  If there is no action and the current provision expires, the long term capital gains rate will go up to 20% and it will be 10% if you’re in the fifteen percent tax bracket (the ten percent bracket will also go away).

What does this mean?  You really want to look at your capital gains transactions at the end of the year.  You might want to accelerate the gain on a stock you own to get the better rate and you also might want to defer any losses until 2013 since they’ll be more valuable.  If you’re out of basis in your S-Corporation stock and you want to pull some money out and take the tax hit, you might want to do it sooner rather then later to get the better rate as well.  You also might want to put off a like kind exchange and pay the tax on a transaction knowing this might be as low of a tax rate as you’re going to get.

As always, talk to a tax professional but if you’re sitting on some gains, you want to be extra careful and do a little bit more planning this year than in any other year I can think of.

This is a twist on my New Forms series because while Schedule D (the form where you report capital gains) has changed, they’ve also modified Form 1099-B as well as added a new form.  First off, just by looking at the new Schedule D, you notice the form has changed quite a bit and there’s several references to a Form 8949.  No longer do you report the detail of the your capital gains and losses on Schedule D but you do it on Form 8949 and this information then flows into the more streamlined Schedule D.

And then this all ties into the revised Form 1099-B.  Now brokerage firms are required to report cost basis.  This is just one more way the IRS is cracking down on things.  Before, this information wasn’t reported to the IRS and it was left up to you to compute.  Since the IRS isn’t very trusting these days, cost basis is now being reported to the IRS so they can make sure you’re reporting the full extent of your gain.  On a good note, since everything is right there on the Form 1099-B, it’ll make filling out the form a little easier because you just drop the appropriate numbers into the right boxes.