Archive for the ‘carryover’ Tag

Back to Basics – Part VIII – Schedule D

Originally published in the Cedar Street Times

January 23, 2015

Imagine yourself on Antiques Roadshow and they tell you that an old porcelain mug you found in your attic last summer is worth $8,000-$10,000 dollars!  You are of course elated, and decide to sell the mug.  Fast forward to February, and your accountant starts asking you questions about this sale, such as your adjusted cost basis and your holding period.  You really have no idea how you even got it.  You know it was in the family for a long time, and you think that maybe it was in a box of things your mom left for you when she moved to Palm Springs where she now resides.  What do you do?  I don’t know exactly, but I know this much – it will go on your Schedule D in some form.

In this issue, we are discussing Schedule D – Capital Gains and Losses.  Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.

Schedule D is used to report gains or losses from the sale or exchange of capital assets.  Capital assets consist of a variety of things.  The personal use items you own – such as your home, your vehicles, household items etc. are capital assets.  Gains from the sale of personal items are taxed.  Losses, however, are generally disallowed. Your personal investments such as stocks, bonds, or real property held as an investment are also capital assets.  Gains and losses are allowed on personal investments.

The same types of items used in your trade or business, however, would be reported on a Form 4797 and would be taxed differently as well.

Assets that have a mix of personal use and business use can have elements reported on both forms.

To determine your gain or loss on a capital asset, you must know your cost basis in it.  If it is something you bought, your cost basis is generally the amount you paid for it; if it is something you inherited, your cost basis is often the fair market value at the date of death; or if it was something given to you, your cost basis is generally the same as that of the prior owner.

There can also be adjustments to this basis, such as when you make improvements to your home – the money you spend would be an adjustment upwards.  Once you know your adjusted cost basis, you simply subtract it from the sales price to determine your gain or loss.  If you scrapped it, your sales price is zero.  Sometimes it can be quite challenging to determine the cost basis, especially if records no longer exist.  Technically, if you cannot prove your basis, the IRS can take the position that your basis is zero.  This could be very unfavorable, especially if you just sold a $10,000 mug with unknown origins!

It is also important to know the length of your “holding period.”  The date you purchase the property is generally the beginning of your holding period and the date you dispose of the property is the end of your holding period.  For property received as a gift, you include the holding period of the person who gave it to you.

If your holding period is over a year, it is subject to favorable long-term capital gains rates – basically a 15 percent federal rate for most people.  (Although it could be as low as zero percent or as high as 20 percent depending on your tax bracket and the amount of capital gains you have.  Also, collectible items you sell such as old coins or antique vehicles are taxed at a 28 percent rate.)  If your holding period for the asset is a year or less, it is considered a short-term holding and is taxed like ordinary income (a higher rate for most people).  Inherited property is always considered to have a long-term holding period.  California does not have a special rate for long-term holdings and treats all capital gains as ordinary income on its tax return.

As mentioned before, there is no deduction for losses on your personal use items.  You can, however, take a loss on your personal investments.  They would reduce any other capital gains, first, and then if there are still losses remaining, you can use $3,000 to offset any other type of income you have on your tax returns.  The rest would get carried over to future years.

The Schedule D itself is essentially a summary of capital gain and loss activity that are mostly determined by other forms that feed into the Schedule D.  Part I summarizes short-term gains and losses, and Part II summarizes long-term gains and losses.  Form 8949 is the main supporting form used in both of these sections.  It was added a few years ago after changes to broker cost basis reporting requirements occurred.  The Form 8949 sorts out long-term and short-term transactions for which cost basis is reported to the IRS and not reported to the IRS, and handles the actual transactional reporting.

Parts I and II also have areas were short-term and long-term gains can be reported from other forms such as installment agreements, business casualty and theft losses, like-kind exchanges, as well as pass through entities such as partnerships, S-corporations, estates, and trusts.  Long-term capital gains distributions from mutual funds on a 1099-DIV are reported in Part II.  (Short-term capital gains distributions from mutual funds are actually included as ordinary dividends on the 1099-DIV, and are reported on Schedule B instead.)  In addition, short-term and long-term loss carryovers from prior years are added into their respective parts on Schedule D.

Part III nets the short-term gains or losses against the long-term gains or losses.  It then helps you determine the gain or loss to enter on the 1040.  It also walks you through several worksheets to determine the amount of tax and tax rates you will pay on any gains.

So what would you do about the mug?  Hopefully mom would have some recollection of the history.  Maybe there was a somewhat recent time when it was passed by inheritance and would have received a step-up in basis.  Of course, you should have figured that out before you sold it, and then had an appraisal done to support it!  Otherwise, if it had just been gifted from one person to the next, the mug probably had very little if any cost basis, and you might be stuck with a big taxable gain.

In two weeks we will discuss Schedule E – Supplemental Income and Loss.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Home Office Part III – How Big is My Deduction?

Originally published in the Cedar Street Times

August 23, 2013

Four weeks ago, I discussed a new simplified option for calculating the home office deduction that is effective for 2013.  Two weeks ago I discussed the rules to qualify for a home office deduction.  In this final installment on home office deductions, we will discuss the standard method of determining your deduction, which will still yield the greatest benefit for most people – especially in high cost localities.  (If you missed the prior two articles, you can find them on my website at www.tlongcpa.com/blog.)

The standard method of calculating your home office deduction is done on a Form 8829 or on tax worksheets.  It typically starts with a square footage calculation of the livable space in your home, and a calculation of the portion used exclusively for your business activity, to determine the percentage used by the business.  You can use a calculation based on the number of rooms in the house if they are similarly sized, but in practice hardly anybody uses this method.

The next step is to gather your expenses and multiply them by the business percentage you just determined.  Add up in separate categories your utilities, water, trash/recycling service, janitorial (house cleaner), repairs and maintenance, homeowner’s or renter’s insurance, and any other recurring expenses used to maintain your house.   If you regularly meet with clients at your house, you can generally do the same for your landscape maintenance expenses as well.

If you rent your home, you add up your total rent and multiply it by the business percentage.  If you own, you apply the business percentage to your mortgage interest and real estate taxes (the balance go on Schedule A).  Some people will throw their internet access fees on the 8829, but often a better deduction is obtained by thinking about actual business use versus personal use, as square footage is not a great metric for internet use.  You could then put that directly on your schedule C if you run a business, or Form 2106 if you are an employee with a qualifying home office.  If you buy furniture or equipment exclusively for your office, that is generally put on a depreciation schedule and often linked directly to your Schedule C or Form 2106 instead of running it through your business use of home form.

The first telephone line into the house is not deductible at all.  A second line could be, however.  But in that case it is typically a dedicated business line, and you would put that on your schedule C or Form 2106 in full to get a better deduction.  Your cable or satellite service is probably off limits for most people since there is such a high degree of personal use and it is an area subject to abuse.  Based on facts and circumstances some people may be able to build a case for part of it – such as a day trader that depends on the financial channels, or if you have a waiting area which clients regularly use to watch television.

If you own the home you need to set up the home and and any improvements on a 39-year depreciation schedule (not 27.5 like a rental home – common mistake) and run depreciation deductions through your business use of home calculation (beyond the scope of this article).  Many people fail to do this thinking it is a choice.  It is not.  There is a use or lose it rule, and you are responsible for depreciation recapture taxes upon the sale of the home whether or not you claimed the deduction.  So you might as well take it!

Facts and circumstances and reasonableness will generally rule the day as an overarching principle to the application of all of these rules.  Technically, if you only painted your office, you can take 100% of the cost into consideration for your business use of home deduction.  On the flip-side, if you painted everything but your office, you shouldn’t really take any deduction.  In practice, records are generally not kept that precisely, and the dollar figures are not that large, so  you often end up applying the business percentage to everything in that category for the year for practical purposes.

Even after calculating the deduction, there is another hurdle you must pass – you cannot create an overall loss on your Schedule C from business use of home expenses with the exception of real estate taxes, mortgage interest, or casualty losses which would be deductible on Schedule A regardless.  If you have a loss, the excess business use of home expenses will get suspended and carried over to a future year when your business is profitable.

Employees have a different hurdle since their home office deduction is an employee business expense which is a miscellaneous itemized deduction subject to a two percent of adjusted gross income floor.  So if their total miscellaneous itemized deductions exceed two percent of their adjusted gross income, then the excess is an itemized deduction, and if their itemized deductions exceed the standard deduction, then they can benefit!

Of course there are many other considerations that can come into play depending on your circumstances such as separately metered properties, or separate structures, multiple offices in the same home, or different homes, a daycare home office, etc.  This article should be enough to give you the gist, but it is always best to consult with a professional to ensure you are complying with the laws as well as getting all the deductions you deserve.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Home Office Part I – New Option for 2013

Originally published in the Cedar Street Times

July 26, 2013

In January, the IRS issued Revenue Procedure 2013-13 which discusses a new option for calculating the home office deduction.  (You may want to clip this article and put it in your tax file as a reminder.) Instead of tracking the actual expenses of operating your home office such as water, utilities, garbage, repairs and maintenance, depreciation, etc., you can now elect a safe harbor $5 per square foot of qualified office space, up to 300 square feet ($1,500).  It is kind of like taking a standard mileage deduction on your car instead of tracking gas and repair receipts, and calculating depreciation expense.  Unlike vehicles, however, you can switch methods back and forth from one year to the next.

There are a few interesting provisions that will make it a good option for some people, and a bad option for others.  In other words, when preparing your return you will need to analyze the short and long term impacts, and determine which method is best each year. Since the $5 per square foot figure is not adjusted by region or for inflation, individuals living in high cost states like California are at a disadvantage.

If there is more than one person in the house, such as a spouse or roommate, they can each use the safe harbor as long as they are not counting the same space.  If one person has more than one office in the home for more than one business, the person can either use actual expenses for all the businesses, or the person must use the safe harbor for all the businesses.  However, the maximum deduction allowed is still $1,500 for all the businesses in the home combined, which may have to be allocated pro rata to the businesses based on square footage used by each. If one person has qualified home offices in more than one home, the person can use the safe harbor for one home, but must use actual expenses for the other home.

When claiming the safe harbor deduction, you are allowed to take your property taxes and mortgage interest in full as itemized deductions on Schedule A as well as claiming the safe harbor deduction.  On the surface this sounds like a plus, but for self-employed individuals you are effectively converting expenses that used to be on your Schedule C reducing self-employment taxes to itemized deductions which do not reduce self-employment taxes, and perhaps do not even reduce income taxes if you do not itemize.

Another big difference when claiming the safe harbor deduction is that no depreciation expense is allowed to be taken.  Traditionally, any depreciation expense taken on your home is required to be recaptured at the time you sell your house, and you must pay tax on it.  Even the section 121 exclusion ($250,000 tax-free gain for single/$500,000 for married couples) when living in the house for two out of the last five years will not exempt you from recapture taxes.  Occasionally that can produce negative results, but it is usually helpful because it often helps people avoid income AND self-employment tax which are typically higher than recapture rates.  Nonetheless, I regularly see tax returns where no depreciation was taken on a home office, to “avoid recapture.”  This is incorrect as recapture rules require you to recapture any depreciation “allowed or allowable.”  It does not matter whether you took the deduction or not, you are technically still on the hook for the recapture.

One other notable exception in the 15 pages of new rules explaining the safe harbor is that carryover expenses are not allowed for safe harbor years.  Ordinarily, if your business produces a loss, you are not allowed to create a bigger loss from business use of home expenses with the exception of the portion of mortgage interest, property taxes, or casualty losses which would have been allowed as itemized deductions even if you had no business.  The rest of the expenses get carried over to future years until you make a profit and can use the losses.  Using the safe harbor, any loss generated by the safe harbor disappears forever.  You would be better off in these years using actual expenses in order to preserve the losses for the future.

At the end of the day, you might as well just continue to track the actual expenses, and let your tax professional figure out which method will give you the best benefit each year.

In two weeks, we will go over the basic requirements in order to claim a home office deduction.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.