Defer Capital Gains using Like-Kind Exchanges

If you're a savvy investor, you probably know that you must generally report as income any mutual fund distributions whether you reinvest them or exchange shares in one fund for shares of another. In other words, you must report and pay any capital gains tax owed.

But if real estate's your game, did you know that it's possible to defer capital gains by taking advantage of a tax break that allows you to swap investment property on a tax-deferred basis?

Named after Section 1031 of the tax code, a like-kind exchange generally applies to real estate and were designed for people who wanted to exchange properties of equal value. If you own land in Oregon and trade it for a shopping center in Rhode Island, as long as the values of the two properties are equal, nobody pays capital gains tax even if both properties may have appreciated since they were originally purchased.

Section 1031 transactions don't have to involve identical types of investment properties. You can swap an apartment building for a shopping center, or a piece of undeveloped, raw land for an office or building. You can even swap a second home that you rent out for a parking lot.

There's also no limit as to how many times you can use a Section 1031 exchange. It's entirely possible to roll over the gain from your investment swaps for many years and avoid paying capital gains tax until a property is finally sold. Keep in mind, however, that gain is deferred, but not forgiven, in a like-kind exchange and you must calculate and keep track of your basis in the new property you acquired in the exchange.

Section 1031 is not for personal use. For example, you can't use it for stocks, bonds and other securities, or personal property (with limited exceptions such as artwork).

Properties of unequal value

Let's say you have a small piece of property, and you want to trade up for a bigger one by exchanging it with another party. You can make the transaction without having to pay capital gains tax on the difference between the smaller property's current market value and your lower original cost.

That's good for you, but the other property owner doesn't make out so well. Presumably, you will have to pay cash or assume a mortgage on the bigger property to make up the difference in value. This is referred to as "boot" in the tax trade, and your partner must pay capital gains tax on that part of the transaction.

To avoid that you could work through an intermediary who is often known as an escrow agent. Instead of a two-way deal involving a one-for-one swap, your transaction becomes a three-way deal.

Your replacement property may come from a third party through the escrow agent. Juggling numerous properties in various combinations, the escrow agent may arrange evenly valued swaps.

Under the right circumstances, you don't even need to do an equal exchange. You can sell a property at a profit, buy a more expensive one, and defer the tax indefinitely.

You sell a property and have the cash put into an escrow account. Then the escrow agent buys another property that you want. He or she gets the title to the deed and transfers the property to you.

Mortgage and other debt

When considering a Section 1031 exchange, it's important to take into account mortgage loans and other debt on the property you are planning to swap. Let's say you hold a $200,000 mortgage on your existing property but your "new" property only holds a mortgage of $150,000. Even if you're not receiving cash from the trade, your mortgage liability has decreased by $50,000. In the eyes of the IRS, this is classified as "boot" and you will still be liable for capital gains tax because it is still treated as "gain."

Advance planning required

A Section 1031 transaction takes advance planning. You must identify your replacement property within 45 days of selling your estate. Then you must close on that within 180 days. There is no grace period. If your closing gets delayed by a storm or by other unforeseen circumstances, and you cannot close in time, you're back to a taxable sale.

Find an escrow agent that specializes in these types of transactions and contact your accountant to set up the IRS form ahead of time. Some people just sell their property, take cash and put it in their bank account. They figure that all they have to do is find a new property within 45 days and close within 180 days. But that's not the case. As soon as "sellers" have cash in their hands, or the paperwork isn't done right, they've lost their opportunity to use this provision of the code.

Personal residences and vacation homes

Section 1031 doesn't apply to personal residences, but the IRS lets you sell your principal residence tax-free as long as the gain is under $250,000 for individuals ($500,000 if you're married).

Section 1031 exchanges may be used for swapping vacation homes, but present a trickier situation. Here's an example of how this might work. Let's say you stop going to your condo at the ski resort and instead rent it out to a bona fide tenant for 12 months. In doing so, you've effectively converted the condo to an investment property, which you can then swap for another property under the Section 1031 exchange.

However, if you want to use your new property as a vacation home, there's a catch. You'll need to comply with a 2008 IRS safe harbor rule that states in each of the 12-month periods following the 1031 exchange you must rent the dwelling to someone for 14 days (or more) consecutively. In addition, you cannot use the dwelling more than the greater of 14 days or 10 percent of the number of days during the 12-month period that the dwelling unit is rented out for at fair rental price.

You must report a section 1031 exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with your tax return for the year in which the exchange occurred. If you do not specifically follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.

While they may seem straightforward, like-kind exchanges can be complicated. There are all kinds of restrictions and pitfalls that you need to be careful of. If you're considering a Section 1031 exchange or have any questions, don't hesitate to call.

Leaving a Business: Which Exit Plan is Best?

Selecting your business successor is a fundamental objective of planning an exit strategy and requires a careful assessment of what you want from the sale of your business and who can best give it to you.

There are four ways to leave your business: transfer ownership to family members, Employee Stock Option Plan (ESOP), sale to a third party, and liquidation. The more you understand about each one, the better the chance is that you will leave your business on your terms and under the conditions you want. With that in mind, here's what you need to know about each one.

1. Transfer Ownership to your Children

Transferring a business within the family fulfills many people's personal goals of keeping their business and family together, but while most business owners want to transfer their business to their children, few end up doing so for various reasons. As such, it's necessary to develop a contingency plan to convey your business to another type of buyer.

Transferring your business to your children can provide financial well-being for younger family members unable to earn comparable income from outside employment, as well as allow you to stay actively involved in the business with your children until you choose your departure date.

It also affords you the luxury of selling the business for whatever amount of money you need to live on, even if the value of the business does not justify that sum of money.

On the other hand, this option also holds the potential to increase family friction, discord, and feelings of unequal treatment among siblings. Parents often feel the need to treat all of their children equally. In reality, this is difficult to achieve. In most cases, one child will probably run or own the business at the perceived expense of the others.

At the same time, financial security also may be diminished, rather than enhanced, and the very existence of the business is at risk if it's transferred to a family member who can't or won't run it properly. In addition, family dynamics, in general, may also significantly diminish your control over the business and its operations.

2. Employee Stock Option Plans (ESOP)

If your children have no interest or are unable to take over your business, there is another option to ensure the continued success of your business: the Employee Stock Ownership Plan (ESOP).

ESOPs are qualified retirement plans subject to the regulatory requirements of the Employee Retirement Income Security Act of 1974 (ERISA). There's one important difference, however; the majority (more than half) of their investment must be derived from their own company stock.

Whether it's due to lack of interest from your children, an economic downturn or a high asking price that no one is willing to pay, what an ESOP does is create a third-party buyer (your employees) where none previously existed. After all, who more than your employees has a vested interest in your company?

ESOPs are set up as a trust (complete with trustees) into which either cash to buy company stock or newly issued stock is placed. Contributions the company makes to the trust are generally tax deductible, subject to certain limitations and because transactions are considered stock sales, the owner who is selling (you) can avoid paying capital gains. Shares are then distributed to employees (typically based on compensation levels) and grow tax-free until distribution.

If your company is a stable, well-established one with steady, consistent earnings, then an ESOP might be just the ticket to creating a winning exit plan from your business.

If you have any questions about setting up an ESOP for your business, give the office a call today.

3. Sale to a Third Party

In a retirement situation, a sale to a third party too often becomes a bargain sale--and the only alternative to liquidation. But if the business is well prepared for sale this option just might be your best way to cash out. In fact, you may find that this so-called "last resort" strategy just happens to land you at the resort of your choice.

Although many owners don't realize it, most or all of your money should come from the business at closing. Therefore, the fundamental advantage of a third party sale is immediate cash or at least a substantial upfront portion of the selling price. This ensures that you obtain your fundamental objectives of financial security and, perhaps, avoid risk as well.

If you do not receive the bulk of the purchase price in cash, at closing, however, your risk will suddenly become immense. You will place a substantial amount of the money you counted on receiving in the unpredictable hands of fate. The best way to avoid this risk is to get all of the money you are going to need at closing. This way any outstanding balance payable to you is "icing on the cake."

4. Liquidation

If there is no one to buy your business, you shut it down. In liquidation, the owners sell off their assets, collect outstanding accounts receivable, pay off their bills, and keep what's left, if anything, for themselves.

The primary reason liquidation is considered as an exit plan is that a business lacks sufficient income-producing capacity apart from the owner's direct efforts and apart from the value of the assets themselves. For example, if the business can produce only $75,000 per year and the assets themselves are worth $1 million, no one would pay more for the business than the value of the assets.

Service businesses, in particular, are thought to have little value when the owner leaves the business. Since most service businesses have little "hard value" other than accounts receivable, liquidation produces the smallest return for the owner's lifelong commitment to the business. Smart owners guard against this. They plan ahead to ensure that they do not have to rely on this last ditch method to fund their retirement.

If you need assistance figuring out which exit strategy is best for you and your business, please don't hesitate to call. The sooner you start planning, the easier it will be.

Recordkeeping for Charitable Contributions

You must keep records to prove the amount of any cash and noncash contributions you make during the year. Which records you must keep depends on the amount you contribute and whether they are cash or property contributions. New recordkeeping requirements were established for all contributions made after January 1, 2007. You cannot deduct a cash contribution, regardless of the amount, unless you keep as a record of the contribution, bank records (such as a cancelled check or bank statement containing the name of the charity, date and the amount) or a written communication from the charity.

This article discusses which records you must keep.

Cash Contributions

Cash contributions include those paid by cash, check, electronic funds transfer, debit card, credit card, or payroll deduction. You cannot deduct a cash contribution, regardless of the amount, unless it is substantiated by one of the following:

1. A bank record that shows the name of the qualified organization, the date of the contribution, and the amount of the contribution. Bank records may include: a canceled check, a bank or credit union statement or a credit card statement.
2. A receipt (or letter or other written communication) from the qualified organization showing the name of the organization, the date of the contribution, and the amount of the contribution.
3. Payroll deduction records. The payroll records must include a pay stub, Form W-2 or other document furnished by the employer that shows the date and the amount of the contribution, and a pledge card or other document prepared by or for the qualified organization that shows the name of the organization.

Cash Contributions of $250 or More: You can claim a deduction for a contribution of $250 or more only if you have an acknowledgement of your contribution from the qualified organization or certain payroll deduction records. If you made more than one contribution of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that lists each contribution and the date of each contribution and shows your total contributions.

To determine whether a contribution is $250 or more, do not combine separate contributions. For example, if you gave to the church $25 each week, your weekly payments do not need to be combined. Each payment is a separate contribution. The acknowledgment must be written and state whether you received any goods or services in return. If something was received in return, a description and good faith estimate of the value of the goods or services must be included.

For payroll deductions, the payroll records must include a pay stub, Form W-2 or other document furnished by the employer that shows the date and the amount of the contribution, and a pledge card or other document prepared by or for the qualified organization that shows the name of the organization. If the pay stub, Form W-2, pledge card, or other document does not show the date of the contribution, you must also have another document that does show the date of the contribution.

Noncash Contributions

For a contribution not made in cash, these general rules apply:

The records you must keep depends on whether your deduction for the contribution is:

1. Less Than $250
2. At least $250 but not more than $500,
3. Over $500 but not more than $5,000, or
4. Over $5,000.

Amount of contribution. In figuring whether your contribution is $500 or more, combine separate contributions of similar items during the year. If you received goods or services in return, reduce your contribution by the value of those goods or services. If you figure your deduction by reducing the fair market value of the donated property by its appreciation, your contribution is the reduced amount.

Deductions of Less Than $250

If you make any noncash contribution, you must get and keep a receipt from the charitable organization showing:

1. The name of the charitable organization,
2. The date and location of the charitable contribution, and
3. A reasonably detailed description of the property.

A letter or other written communication from the charitable organization acknowledging receipt of the contribution and containing the information in (1), (2), and (3) will serve as a receipt. You are not required to have a receipt where it is impractical to get one (for example if you leave property at a charity's unattended drop site).

Additional records. You must also keep reliable written records for each item of donated property. Your written records must include the following information.

1. The name and address of the organization to which you contributed.
2. The date and location of the contribution.
3. A description of the property in detail reasonable under the circumstances. For a security, keep the name of the issuer, the type of security, and whether it is regularly traded on a stock exchange or in an over-the-counter market.
4. The fair market value of the property at the time of the contribution and how you figured the fair market value. If it was determined by appraisal, you should also keep a signed copy of the appraisal.
5. The cost or other basis of the property if you must reduce its fair market value by appreciation.
6. The amount you claim as a deduction for the tax year as a result of the contribution, if you contribute less than your entire interest in the property during the tax year. Your records must include the amount you claimed as a deduction in any earlier years for contributions of other interests in this property. They must also include the name and address of each organization to which you contributed the other interests, the place where any such tangible property is located or kept, and the name of any person in possession of the property, other than the organization to which you contributed.
7. Any conditions attached to the gift of property.

Deductions of At Least $250 But Not More Than $500

If you claim a deduction of at least $250 but not more than $500 for a noncash charitable contribution, you must get and keep an acknowledgement of your contribution from the qualified organization. If you made more than one contribution of $250 or more, you can have either a separate acknowledgement for each or one acknowledgement that shows your total contributions.

The acknowledgement must contain the information in items (1) through (3) listed under Deductions of Less Than $250, earlier, and your written records must include the information listed in that discussion under Additional Records.

1. It must be written.

2. It must include:

• A description (but not necessarily the value) of any property you contributed,
• Whether the qualified organization gave you any goods or services as a result of your contribution (other than certain token items and membership benefits), and
• A description and good faith estimate of the value of any goods or services described above. If the only benefit you received was an intangible religious benefit (such as admission to a religious ceremony) that generally is not sold in a commercial transaction outside the donative context, the acknowledgement must say so and does not need to describe or estimate the value of the benefit.

3. You must get the acknowledgement on or before the earlier of:

• the date you file your return for the year you make the contribution, or
• The due date, including extensions, for filing the return.

Deductions Over $500 But Not Over $5,000

If you claim a deduction over $500 but not over $5,000 for a noncash charitable contribution, you must have the acknowledgement and written records described under Deductions of At Least $250 But Not More Than $500. Your records must also include:

1. How you got the property, for example, by purchase, gift, bequest, inheritance, or exchange.
2. The approximate date you got the property or, if created, produced, or manufactured by or for you, the approximate date the property was substantially completed.
3. The cost or other basis, and any adjustments to the basis, of property held less than 12 months and, if available, the cost or other basis of property held 12 months or more. This requirement, however, does not apply to publicly traded securities.

If you are not able to provide information on either the date you got the property or the cost basis of the property and you have a reasonable cause for not being able to provide this information, attach a statement of explanation to your return.

Deductions Over $5,000

If you claim a deduction of over $5,000 for a charitable contribution of one property item or a group of similar property items, you must have the acknowledgement and the written records described under Deductions Over $500 But Not Over $5,000. In figuring whether your deduction is over $5,000, combine your claimed deductions for all similar items donated to any charitable organization during the year.

Generally, you must also obtain a qualified written appraisal of the donated property from a qualified appraiser.

Qualified conservation contribution. If the gift was a "qualified conservation contribution," your records must also include the fair market value of the underlying property before and after the gift and the conservation purpose furthered by the gift.

Out of Pocket Expenses

If you render services to a qualified organization and have unreimbursed out of pocket expenses related to those services, the following three rules apply.

1. You must have adequate records to prove the amount of the expenses.
2. You must get an acknowledgment from the qualified organization that contains a description of the services you provided and a statement of whether or not the organization provided you any goods and services to reimburse you for the expenses incurred. If so, the statement must include a description and good faith estimate of the value of any goods or services (other than intangible religious benefits). If the only benefit you received was an intangible religious benefit, you must receive a statement stating this; however, the acknowledgment does not need to describe or estimate the value of an intangible religious benefit.
3. You must get the acknowledgment on or before the earlier of: (a) The date you file your return for the year you make the contribution, or the due date, including extensions, for filing your return.

Car Expenses. If you claim expenses directly related to use of your car in giving services to a qualified organization, you must keep reliable written records of your expenses. Whether your records are considered reliable depends on all the facts and circumstances. Generally, they are reliable if you made them regularly and at the time you incurred the expense.

Your records must show the name of the organization you were serving and the date each time you used your car for a charitable purpose. If you use the standard mileage rate of 14 cents a mile for 2015, your records must show the miles you drove. If you use actual expenses to complete the deduction, your records must show the costs of operating the car for charitable purposes only.

Questions about recordkeeping requirements for charitable contributions? Help is just a phone call away.

Early Retirement Plan Withdrawals and your Taxes

Taking money out early from your retirement plan may trigger an additional tax. Here are six things that you should know about early withdrawals from retirement plans:

1. An early withdrawal normally means taking money from your plan before you reach age 59 1/2.

2. If you made a withdrawal from a plan last year, you must report the amount you withdrew to the IRS. You may have to pay income tax as well as an additional 10 percent tax on the amount you withdrew.

3. The additional 10 percent tax does not apply to nontaxable withdrawals. Nontaxable withdrawals include withdrawals of your cost to participate in the plan. Your cost includes contributions that you paid tax on before you put them into the plan.

4. A rollover is a type of nontaxable withdrawal. Generally, a rollover is a distribution to you of cash or other assets from one retirement plan that you contribute to another retirement plan. You usually have 60 days to complete a rollover to make it tax-free.

5. There are many exceptions to the additional 10 percent tax such as using the money for qualified higher education expenses or unreimbursed medical expenses in excess of 10 percent of adjusted gross income. Some of the exceptions for retirement plans are different from the rules for IRAs.

6. If you make an early withdrawal, you may need to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with your federal tax return.

The rules for retirement plans can be complex, but help is just a phone call away. Call now and make sure you file the right tax forms and get the tax benefits you're entitled to.

It's Time for a Premium Tax Credit Checkup

If you have insurance through the Health Insurance Marketplace, you may be getting advance payments of the premium tax credit. These are paid directly to your insurance company to lower your monthly premium.

Changes in your income or family size may affect your premium tax credit. If your circumstances have changed, now is the time for a checkup to see if you need to adjust the premium assistance you are receiving. You should report changes that have occurred since you signed up for your health insurance plan to your Marketplace as they occur.

Changes in circumstances that you should report to the Marketplace include:

• an increase or decrease in your income
• marriage or divorce
• the birth or adoption of a child
• starting a job with health insurance
• gaining or losing your eligibility for other health care coverage
• changing your residence

To estimate the effect that changes in your circumstances may have upon the amount of premium tax credit that you can claim--see this change in circumstances estimator.

Reporting the changes will help you avoid getting too much or too little advance payment of the premium tax credit. Getting too much means you may owe additional money or get a smaller refund when you file your taxes. Getting too little could mean missing out on premium assistance to reduce your monthly premiums.

Repayments of excess premium assistance may be limited to an amount between $300 and $2,500 depending on your income and filing status. However, if advance payments of the premium tax credit were made, but your income for the year turns out to be too high to receive the premium tax credit, you will have to repay all of the payments that were made on your behalf, with no limitation. Therefore, it is important that you report changes in circumstances that may have occurred since you signed up for your plan.

Changes in circumstances also may qualify you for a special enrollment period to change or get insurance through the Marketplace. In most cases, if you qualify for the special enrollment period, you will have sixty days to enroll following the change in circumstances.

To find out more about the premium tax credit and other tax-related provisions of the health care law, please call.

Keep Track of Miscellaneous Deductions

Miscellaneous deductions such as certain work-related expenses you paid for as an employee can reduce your tax bill, but you must itemize deductions when you file to claim these costs. If you usually claim the standard deduction, think about itemizing instead because you might be able to pay less tax. Here are some tax tips that may help you reduce your taxes:

Deductions Subject to the Limit. You can deduct most miscellaneous costs only if their sum is more than two percent of your adjusted gross income. These include expenses such as,

• Unreimbursed employee expenses.
• Job search costs for a new job in the same line of work.
• Some work clothes and uniforms.
• Tools for your job.
• Union dues.
• Work-related travel and transportation.
• The cost you paid to prepare your tax return. These fees include the cost you paid for tax preparation software. They also include any fee you paid for e-filing of your return.

Deductions Not Subject to the Limit. Some deductions are not subject to the two percent limit. They include:

• Certain casualty and theft losses. In most cases, this rule applies to damaged or stolen property you held for investment. This may include personal property such as works of art, stocks, and bonds.
• Gambling losses up to the total of your gambling winnings.
• Losses from Ponzi-type investment schemes.

You claim allowable miscellaneous deductions on Schedule A, Itemized Deductions, but keep in mind, however, that there are many expenses that you cannot deduct. For example, you can't deduct personal living or family expenses.

Need more information about itemizing deductions or help setting up a system to track your itemized deductions? Don't hesitate to call.

Ten Key Tax Facts about Home Sales

In most cases, gains from sales are taxable. But did you know that if you sell your home, you may not have to pay taxes? Here are ten facts to keep in mind if you sell your home this year.

1. Exclusion of Gain. You may be able to exclude part or all of the gain from the sale of your home. This rule may apply if you meet the eligibility test. Parts of the test involve your ownership and use of the home. You must have owned and used it as your main home for at least two out of the five years before the date of sale.

2. Exceptions May Apply. There are exceptions to the ownership, use, and other rules. One exception applies to persons with a disability. Another applies to certain members of the military. That rule includes certain government and Peace Corps workers. For more information about these exceptions, please call the office.

3. Exclusion Limit. The most gain you can exclude from tax is $250,000. This limit is $500,000 for joint returns. The Net Investment Income Tax will not apply to the excluded gain.

4. May Not Need to Report Sale. If the gain is not taxable, you may not need to report the sale to the IRS on your tax return.

5. When You Must Report the Sale. You must report the sale on your tax return if you can't exclude all or part of the gain. You must report the sale if you choose not to claim the exclusion. That's also true if you get Form 1099-S, Proceeds From Real Estate Transactions. If you report the sale, take a look at the Questions and Answers on the Net Investment Income Tax on IRS.gov or call the office.

6. Exclusion Frequency Limit. Generally, you may exclude the gain from the sale of your main home only once every two years. Some exceptions may apply to this rule.

7. Only a Main Home Qualifies. If you own more than one home, you may only exclude the gain on the sale of your main home. Your main home usually is the home that you live in most of the time.

8. First-time Homebuyer Credit. If you claimed the first-time homebuyer credit when you bought the home, special rules apply to the sale. For more on those rules, please call.

9. Home Sold at a Loss. If you sell your main home at a loss, you can't deduct the loss on your tax return.

10. Report Your Address Change. After you sell your home and move, update your address with the IRS. To do this, file Form 8822, Change of Address. You can find the address to send it to in the form's instructions on page two. If you purchase health insurance through the Health Insurance Marketplace, you should also notify the Marketplace when you move out of the area covered by your current Marketplace plan.

Questions? Help is just a phone call away.

Tax Due Dates for September 2015

September 10

Employees Who Work for Tips - If you received $20 or more in tips during August, report them to your employer. You can use Form 4070.

September 15

Individuals - Make a payment of your 2015 estimated tax if you are not paying your income tax for the year through withholding (or will not pay in enough tax that way). Use Form 1040-ES. This is the third installment date for estimated tax in 2015.

Corporations - File a 2014 calendar year income tax return (Form 1120 or 1120-A) and pay any tax due. This due date applies only if you made a timely request for an automatic 6-month extension.

S corporations - File a 2014 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you made a timely request for an automatic 6-month extension. Provide each shareholder with a copy of Schedule K-1 (Form 1120S) or a substitute Schedule K-1.

Partnerships - File a 2014 calendar year income tax return (Form 1065). This due date applies only if you were given an additional 5-month extension. Provide each shareholder with a copy of Schedule K-1 (Form 1065) or a substitute Schedule K-1.

Corporations - Deposit the third installment of estimated income tax for 2015. A worksheet, Form 1120-W, is available to help you make an estimate of your tax for the year.

Employers - Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in August.

Employers - Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in August.

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