Knowing The Rules Will Save You Money-The Truth About Capital Gains and Losses

The average American taxpayer lets the chips fall where they may when it comes to reporting capital gains and losses on their tax returns. So that we all understand, let's review the rules for capital gain and loss netting. Capital gains and losses are divided into two types; long-term and short-term. A long-term transaction is one that involves the holding of a given asset for more than one year. Conversely, a short-term transaction involves the holding a given asset for less than one year. The importance of the holding periods relates to the rate of income tax to be paid on the transaction. Under current law, long-term capital gains are taxed at a maximum rate of 15%. Short-term gains are taxed at the maximum incremental rate of the taxpayer. This rate could be as high as 35%. Long-term capital gains and losses net against each other as do short-term capital gains and losses. To the extent that losses exceed gains, the capital losses will offset other forms of income up to $3,000 with the balance being carried forward indefinitely. The capital loss carry forward will maintain its respective classification as either long-term or short-term.

The tax planning opportunities for recognizing capital gains and losses are a plenty believe it or not. First of all, it is important to point out that the amount of the gain or loss to be recognized can be controlled. There are two ways to recognize capital transactions. The first in first out method (FIFO) assumes that the first or oldest asset acquisition is being sold. The FIFO method is the default method for recognizing gains and losses if the specific identification method is not used. The specific identification method allows the taxpayer to identify which asset (or block of shares) is being sold. For example, the taxpayer owns two blocks of IBM shares as follows:

September 1, 1990 1,000 shares at $30 $30,000

September 1, 2004 1,000 shares at $50 $50,000

On November 1, 2006, the taxpayer wants money to pay bills and pay college tuition. On this day, the price of IBM shares is $45 per share. Let's assume that the taxpayer does not have any capital loss carry forwards. To avoid paying long-term capital gains tax of $2,250 (15%x$15,000), the taxpayer notifies his broker in writing that he wishes to sell the September 2004 block of shares. This would create a long-term capital loss of $5,000 ($45,000 selling price less $50,000 acquisition cost). If there are no other capital transactions for the year, the taxpayer will get a $3,000 capital loss deduction against other income. Assume a 35% tax rate and this taxpayer gets a $1,050 tax savings in 2006. By knowing the specific identification rules exist, the swing in tax savings is $3,300 ($1,050+$2,250). The remaining balance of capital loss is $2,000 ($5,000 less $3,000 recognized) and is carried forward as a long-term capital loss indefinitely.

Another key tax planning tactic involves the timing in netting capital gains and losses. Let's assume that a taxpayer has the following transactions during the year:

Long-term capital loss carry forward of $20,000

Short-term capital gain on stock transactions, $20,000

Long-term capital gain on sale of land, $20,000

Taxpayer is in the top tax bracket of 35%

In this example, the long-term capital gain must first be netted with the long-term capital loss. This will eliminate the 15% tax on the long-term capital gain of $20,000. The tax due on capital transactions in the current year will be $7,000 ($20,000 x 35%). What could this taxpayer have done differently? Suppose he could have gotten a contract to sell the land in the next year. This would then allow the short-term capital gain to be reduced by the long-term capital loss. Remember that capital gains and losses must first be netted within their respective classes. After this ordering, any leftover long-term or short-term loss can be netted against the other category's gain. If the taxpayer holds off the land sale until next year, the short-term capital gain goes to zero in the current year. In the year to follow, the taxpayer will pay $3,000 in long-term capital gains tax (15% x $20,000). This not only saves the taxpayer $4,000 in tax on capital transactions ($7,000-$3,000), but postpones the payment of tax for one year.

In summary, understanding how capital transactions work can provide taxpayers with the potential to save a significant amount of income tax. Don't just let the chips fall where they may, take a look at what you have and keep records. This is a classic example of knowledge is power.

Listen to my show every Saturday morning at 10 on WBIS Am 1190. "Better Business" is the most complete business program on radio and MY WAY IS definitely BETTER.

Avoid Capital Gains Tax When Selling Real Estate

You can cut the capital gains tax out of a real estate sale with the use of Exchange 1031. Exchange 1031 provides that if you are going to use proceeds of the sale of a real estate property to purchase additional property, you can avoid paying the capital gains tax.

The idea is to bolster real estate sales by allowing taxpayers to waive this tax on your property sale if the main purpose of the sale is to purchase another property. This provision gives an incentive for both the buying and selling of property.

Capital gains taxes assessed in the sale of real estate are estimated at around 20%-30%. If a taxpayer is engaged in a "like kind" real estate purchase, the tax reduces his ability to purchase a similar property by effectively cutting the resale value of their property by 20%-30%. This, in turn, will reduce the amount of money that they are likely to spend on a "like kind" purchase of another property.

There, of course, are conditions to deferment of capital gains tax under Exchange 1031.

The value of the property you are purchasing with the proceeds from the sale of your property must be equal to or more than the net profits from the selling of your property.

The full equity realized from the sale of your property must be used to purchase the "replacement" property.

If the replacement property you purchase under an Exchange 1031 provision turns out to be of lesser value than the property you sold, you will be liable to pay an accrued tax. The amount of your tax liability will be determined by the amount the replacement property fell short of the full equity of the sold property.

In other words, the amount of tax liability you incur will depend upon your given situation and the amount of full equity you realized after the sale of your property. Therefore, part of the tax is deferred in this instance, rather than deferring all of the capital gains tax.

The hope of this provision is that such a substantial tax savings will encourage real estate sellers to purchase "replacement" property rather than invest the income from such a sale of real estate into some other venture. It is a good provision for people looking to "buy up" in the housing market.

Taxation of Professional Stock Traders

The tax rules for stock investors in general requires three steps. Step one is the netting of short-term capital gains and short-term capital losses. Step two is the netting of long-term capital gains and long-term capital losses. Step three is the netting of net short term gains/losses and net long-term gains/losses. Any capital losses in excess of $3,000 are carried forward indefinitely to offset future capital gains plus $3,000 of ordinary income every year, until the capital losses are used up. But what if you are a "day trader"? What special tax rules exist for day traders? This article will address those unique tax rules that apply to day traders.

What is a day trader? In general, a day trader, is anyone who engages in the business of trading stock. You are in the business of trading stock, and thus not an ordinary stock investor, when the frequency of your trading activity is such that it meets the "material participation" test. Qualifying as a trader under this material participation test is difficult because one must be active in the securities markets on a daily basis and attempt to profit from short-term swings in security prices. Many online investors fail this test, but some day traders (most of whom are also online investors) meet the standard. InPurvis [37 AFTR2d 76-968, 530 F2d 1332 (1976, CA-9)], the Ninth Circuit Court of Appeals upheld a prior tax court decision [Purvis, TC Memo 1974-164 (1974)] and agreed with the Tax Court that in order to be classified as trading, the activity should be performed with sufficient frequency to "catch the swings in the daily market movements and profit thereby on a short-term basis." Day traders can take a buy-and-hold approach, but most of them seek to take advantage of short-term market fluctuations and this short-term market fluctuation criteria is the linchpin in qualifying some day traders as traders rather than investors for federal income tax purposes.

What's so important about being considered a trader verses an investor?
Investor losses in excess of $3,000 a year are not deductible in the year of the loss. This excess loss amount must be carried forward. There is no time limit on the future utilization of the excess losses, but if you continue to rack up losses each year, you will be limited, each year, to this $3,000 loss limitation. Traders, on the other hand, are not limited to this $3,000 annual loss limitation. They are able to deduct their entire net loss for the year on their individual income tax return. Traders report their net gains/losses on Form 4797 as ordinary income (investors report their net gains/losses on Schedule D. Net long-term capital gains are taxed at the favorable long-term capital gains tax rates (currently 15%). Traders are also eligible for certain deductions that are not available to investors. One such deduction is the home office deduction. Traders may use their net income from trading activities to fund a SEP-IRA, and thus further reduce their taxable income. Another such deduction available only to traders is interest expense. Investors are limited to deducting interest expense incurred on debt used to finance their investment activities to investment income (gains, dividends and interest income). This limit on deducting interest expense to the extent of investment income, is not applicable to traders. Traders may deduct their interest expense as a deduction on Schedule C. Lastly, wash sale rules, which apply to investors, do not apply to traders. The wash sale rules require the deferral of trading losses, where the investor acquires substantially identical stock or securities within thirty days before or after a sale generating a loss.

So how do you make the leap once you have determined that you are in the business of trading?
Traders who desire to be treated at in the business of trading stocks make an election called the Mark-To-Market election by April15th of the current year. To be treated as a trader for 2010, a trader must make this election by April 15th, 2010, which is attached to either their 2009 Form 1040 or attached to their 2009 extension.
Election language:
Taxpayer hereby elects under IRC Sec. 475(f) to use the mark-to-market method of accounting for securities. This election will first be effective for the tax year ended December 31, 2010. The election is made for the following trades (list trades).

Once this election is made it is effective for all future tax years. The mark-to-market election requires traders to mark their stock holdings to market value at the end of the tax year. Once made, all security gains and losses are treated as ordinary income or losses and all trading securities on hand at the end of the year are deemed to be sold (and repurchased) at the year-end market value. All unrealized (unsold securities) gains and losses recognized under the mark-to-market election increase (unrealized losses) or decrease (unrealized gains) their basis in a given security.

Because making the mark-to-market election can have significant tax ramifications to future trading activities you should first consult with your CPA to determine if your trading activities meet the material participation test and, if so, if this election makes the most sense to your future trading business.

Entrepreneurs' Relief - Another Company Formation Advantage

There are many benefits of carrying out a company formation to run your new business. For those businesses with a great idea and the potential to grow their company into a large empire worth millions, there are many things to consider. Capital gains tax is one of them. For any business the future can be an exciting prospect.

You'll put blood, sweat and tears into your business and watch it grow. In the future, you want to make the most of all your efforts, without letting the taxman take a large slice. Luckily, with the current state of the economy, the government has noticed the importance of small business to the financial stability of the Country and as a result are keen to encourage growth. One of the measures they have put in place to do this is Entrepreneurs' Relief.

What is Entrepreneurs' Relief?

The Entrepreneurs' Relief scheme was originally started back in 2008 with the intention of giving some tax relief to SME's with regards to capital gains tax. An individual is given a lifetime limit (previously £1million - now raised to £2million under the new budget) under which they are given relief from capital gains tax.

What is Capital Gains tax?

Tax is charged at a rate of 18% on any capital gain made by an individual in the course of running or disposing of a business. "Capital gain" is defined by HMRC as "...the amount by which the disposal value of a chargeable asset exceeds its acquisition value." In layman's terms this means if when selling an asset you make more money than you actually paid for it, then you will be liable to pay tax on that profit at the current rate (18%).

How does Entrepreneurs' Relief help?

The Entrepreneurs' Relief scheme means that any individual making a capital gain, will not have to pay the full tax rate (18%) but instead will only be required to pay a lesser rate up to their lifetime limit. As long as they satisfy the necessary criteria.

The capital gains and capital losses must be balanced to come up with a net figure. That figure is then subject to relief, calculated thusly:

This 'net gain' is...reduced by 4⁄9 and the reduced figure is chargeable at the rate of Capital Gains Tax - 18% for 2009-10 but at an effective rate of 10%.

To clarify 4/9 is roughly 44%. So if you had a capital gain of £100,000, then you would find 44% of this figure (100,000 x 0.44 = 44,000) and that figure is then taxable at the standard capital gains tax rate, rather than the entire amount. You can see that this is quite beneficial for entrepreneurs as it provides substantial tax relief. With relief, you pay £7,920 tax on a £100,000 gain, without it you would pay £18,000! When you consider that Entrepreneurs Relief is now set to a lifetime limit of £2million you can see the Government are making a substantial subsidy for business people.

What are the qualifying criteria?

There are certain specific qualifying criteria which need to be satisfied in order to benefit from Entrepreneurs' Relief. Firstly the gain must have been made on assets used in/by the business or assets owned by the relevant person but used by the business. The claim must be submitted within a year of the disposal and apply to:

- Disposal of whole business - which the individual owned.
- Ceased business - assets sold 3 years after business ceased trading (?)
- Sale of shares of your personal company*
- Associated disposal - basically disposal from a partnership

*personal company is defined as a company in which a person holds at least 5% of the ordinary share capital (and the voting rights that go with it).

Getting there

If you've got a great idea and can see it being worth a lot in the future, then you'll need to be aware of things like this. Carry out a company formation with a formation agent and make sure you have the most tax efficient company possible. These are the first important steps to making the most of your business idea.

Tax Tips for Real Estate Investors Using IRA Funds

You've seen the advertisements and news articles. IRA funds can be used to make real estate investments. But before you jump on this bandwagon, make sure you understand some of the tax planning angles related to this opportunity.

Passive Loss Deductions

Almost always, an important component of your real estate profits comes from the tax savings associated with depreciation. These paper losses, referred to as passive losses by the Internal Revenue Code, can save both small and professional real estate investors thousands of dollars a year in income taxes. Unfortunately, passive losses from depreciation and related, similar tax deductions won't benefit real estate investors investing through IRAs.

Capital Gains Preferences

If you sell an investment for a profit--whether a stock or real estate--you get a tax break because your profit gets taxed at a preferential capital gains tax rate. In the best case scenario under current tax law, for example, your capital gains get taxed at 15% rather than at 35%.

Unfortunately, by putting real estate inside of an IRA, you lose this benefit. In effect, the appreciation you enjoy from your real estate investment gets taxed at your marginal income tax rate rather than at the capital gains rate. (Fortunately, the tax gets paid when you withdraw the money.)

Note: This "problem" also exists for other investments that produce capital gains, such as stocks and mutual funds that invest in stocks.

Unrelated Business Income Tax

In certain special circumstances, an IRA needs to pay income taxes on the profits it generates. These taxes, called unrelated business income taxes, essentially put the IRA investor in the same position as a regular taxable investor.

For example, if you're developing and then flipping properties inside your IRA, you may actually be an active trade or business. And in this case, your real estate investment--even though it's inside an IRA--may be subject to income taxes. (Your IRA custodian is supposed to report your taxable income and tax liability, and then pay the taxes but many don't...)

And here's another example of a situation where the unrelated business income tax can trip you up. If you borrow money to invest in real estate--the typical situation in any leveraged real estate investment--the profit you earn on the money you've borrowed is treated as unrelated business income. Accordingly, that profit is subject to unrelated business income tax.

Unrelated business income inside an IRA is taxed according to trust taxation rules, which means that as soon as you've made much money at all, you're taxed at the highest marginal tax rates. Ouch.

Closing Caveats

Real estate is a great investment. And real estate belongs in any investor's portfolio. But you need to think carefully about buying into the idea of using your IRA to make real estate investments. If you do decide to invest in real estate through your IRA, first consult with your tax advisor.

Capital Gains and Losses - This Year, Get it Right!

In a year in which portfolios have been decimated, it is hard to find a silver lining but controlling capital gains and losses could have significant tax consequences. As the market has declined, many investors have redeemed mutual funds and the funds needed to sell investments to meet those demands. Some of these sales may have included long-term positions in which the mutual fund may have had a significant capital gain. That means, in a year in which your mutual fund may have dropped 50% in value, you may still have significant capital gains exposure.

For retirees, that is a difficult pill to swallow. Making sure you offset these gains with losses or adjusting portfolios to take advantage of losses this year against future years gains is an important consideration. Here is a primer of what the rules are.

Capital Gains and Losses

Assets owned and then sold, or otherwise disposed of, may generate a capital gain or loss. Assets that have been held longer than one year are considered 'long-term,' while on assets held for less than a year, the gain is considered short-term. The distinction is an important one.

o The maximum tax rate for long-term capital gains is 15% for both ordinary income tax and for AMT; but long-term capital gains are preference items for calculation of Minimum Tentative Tax. Be aware that, for some investors, specifically those with lower taxable income (in 2008, $32,550 for a single; $65,100 for a married couple; and $43,650 for heads of households), tax rates on capital gains would be 0%, so the harvesting of capital losses would be wasted, since they will not be taxed on their gains anyway.

o Gains and losses on assets owned less than one year are short-term. In calculating the tax on sales of assets, a taxpayer must first net the short-term gains and losses, then net the long-term gains and losses independently. Then the short-term and long-term gains/losses are netted against one another. If a net capital loss is generated, it may be used to offset up to $3,000 of ordinary income and the unused portion (if any) may be carried forward indefinitely (expiring at the death of the taxpayer). Capital losses realized on the sale of securities may also be used to offset capital gains on other classes of assets, such as real estate and vice versa on Schedule D.

o Careful planning to harvest any capital gains or losses from sales of stock or other capital assets can minimize tax on gains and maximize the tax benefit from losses. Normally, a taxpayer should try to avoid having long-term capital losses offset long-term capital gains, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. To do this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains.

o Planning for the offsetting of gains and losses is not just a tax issue. As is the case with most planning involving capital gains and losses, investment factors need to be considered. The decision to wait to defer a gain until the next year needs to be balanced against the risk to the value of the property, whether its value may decline before it can be sold. Similarly, a taxpayer should not risk increasing the loss on property that he expects will continue to decline in value by deferring the sale of that property until the following year.

o Additionally, a taxpayer is permitted to identify which shares are sold during a given year as part of their transaction. These are called 'Versus Purchase' sales and allow taxpayers to identify which shares are sold to best advantage from a capital gains/loss standpoint.

o A taxpayer who owns appreciated mutual funds, which may also be good candidates for sale, may wish to consider selling those funds prior to the December capital gains payment made by fund managers to shareholders. A 15% capital gains rate is much better than having to pay ordinary income tax rates, which could be as high as 35%. There are also other advanced planning techniques which can be used to help defer the payment of capital gains tax. Please consult with your tax advisor to determine which may be best for you.

Make sure you consult your tax advisor before doing anything and consider the consequences of any portfolio adjustments on your asset allocation. In a year in which investors have suffered, you need to take advantage of what you can to improve your position for this and future years.

Tax Saving Strategies For Capital Gains on Rental Property

Have you recently sold any of your rental property? Are the taxes on your capital gains are a burden for you? Are you looking for some way out to reduce these taxes and keep most of the profits you made from this transaction?

Then you need to know some intricacies of capital gains tax rules.

If you had purchased rental property at a lower price and now sold it with a respectable margin on it, this difference you could get is the capital gain and the same is taxable.

Remember, IRS gives preference to home owners. An average home owner will be charged leniently as compared to a property investor. So the capital gains tax varies as per different types on property owners.

One good thing about the capital gains tax is that it is lower than the income tax. It is convenient if you buy the property and wait for one year before you sell it. This way you will have to pay taxes at an average rate of 10 to 25 %. But if you plan to sell your rental property before one year, then your earning is considered as short term capital gains and you have to pay heavy taxes on it which may be same as the ordinary income tax.

If you have your rental property overseas, you need to check the capital gains taxes rules over there. As in some countries like United Kingdom to encourage foreign investors, they do not charge any tax from them for their capital gains.

Some useful tips for saving on this tax:

You can avail the benefits on tax savings by becoming a home owner than a property investor.

To qualify to the criteria of home owner, you have to stay in your rental property for a minimum of 2 years. You may have rented it in past  but then you have to stay in it for two years out of five years block before you sell off. Then it will be considered as your own home for tax purposes.

If you are a married couple selling your own home, the profit of first $500,000 is not taxable as against a sole owner who is eligible for tax exemption on the first $ 250,000.

If your sale is just a rollover, you may be charged absolutely nothing towards your capital gains. So you are selling your rental property only to purchase a new property of that type, it will be a rollover.

This rollover refers to section 1031 of the internal revenue code. To satisfy the clauses of this section you have to finalize on a new property within 45 days of the sale and the deal has to be completed within 6 months.

Remember, selling your rental property in cash emergencies is not a good idea. Then it is difficult to reduce the liability on capital gains. And this is the reason why I advise property owners to put aside some of your funds for emergencies such as major repairs.

Tax Increase Or Tax Relief: It Is Your Choice

Pondering today's current economy and the likelihood that capital gains and income tax rates will increase next year ignites fear and confusion for countless numbers of Americans. For many taxpayers, the future appears to be downright frightful, resulting in a new wave of terror that strikes their hearts. They may even take an impaired view and see only one result when they read the letters I...R... and S. Have you ever noticed that the words "The" and "IRS" when coupled together spells "THEIRS!"?

The reality, though, is that those who view the current circumstances from this perspective are only victimizing themselves. The trick in maintaining sanity during this time of economic and tax upheaval is to forget about what you cannot control and focus on those things you can. The fact is you can manage your taxes and most likely win out in the end.

Solving Tax Problems and Gaining Greater Benefit

To illustrate, concerns about capital gains and other taxes may be troublesome. You may have owned an apartment building for several years and now would like to sell, relax and enjoy the equity and income benefits your hard work has earned you. Your CPA, however, has reported that you would be obligated to pay substantial capital gains taxes if you sold your property. What do many property owners do when they get this news? Unfortunately, they do nothing, except remind themselves of what their accountant told them: "Nothing can be done but to pay the taxes." Right? WRONG!

Before you list your property for sale, it is important for you to learn what tax planning alternatives are available to meet your specific needs. If you search them out, you will discover that tax law does offer some pretty great solutions. You may, for example, be able to defer the taxes for up to 30 years or eliminate them entirely. If your mortgage to be paid off is greater than what your basis is for the property, you'll learn that the taxes for "debt relief" can be solved. And at close of escrow, you may find that it is possible to enjoy greater income than what you had by owning the property you sold. But you will never know unless you take charge of your circumstances and learn your options. You must become proactive and find out the right solutions for you. Here is what one real estate investor experienced:

Troubled about her real estate portfolio valued at $800,000, this 54-year old lady wanted to sell the properties, replace the income she received from the real estate and reduce her income taxes. She was stunned to learn, however, that, according to her CPA, she would be obligated to pay more than $200,000 in capital gains and other taxes if she sold her properties and little, if anything, could be done to lower her income taxes. Discouraged, she mentioned her concerns to a friend who suggested that she seek a second opinion diagnosis of her circumstances by a qualified tax planning advisor. She did this and was delighted to discover that her financial condition was far different that what her CPA had thought:

1. Rather than paying $200,000 in taxes when she sold her properties, she would pay no taxes at all.

2. Her income would significantly increase above what she was receiving by owning the properties.

3. Instead of paying excessive income taxes, she would receive an immediate refund of taxes that she unknowingly overpaid; and,

4. She discovered other tax-saving opportunities that she could take advantage of about which her CPA was unfamiliar.

How could her CPA be so wrong? As is true of many accountants, he was never trained in the discipline of tax planning. In fact, according to CPAs with whom I have spoken, candidates for the Certified Public Accountant designation are not required to take tax planning courses to earn this title--and most do not bother doing so. Consequently, although they can become very skilled in identifying tax problems, few of these professionals acquire the experience and know how to solve them. They can be viewed as being "financial historians" who take what a client has done after-the-fact, filter that information through the required tax codes and generate, hopefully, an accurate tax return. This is great accounting but it is not tax planning. You are always better served when you meld together the advice of a trained tax planning professional with that of your CPA or accountant.

If you want to find the most appropriate resolution to your tax concerns, it is essential that you first learn what your true tax problem is and then search out the most viable options available to eliminate, defer or reduce the taxes for the year of sale. After you identify potential solutions and understand how each can be tailored to your specific circumstances to meet your objectives, the last step before implementation is to validate them under tax law through independent tax and legal authority. Following this approach will prepare you to be better informed on how best to approach the sale of your property and maximize your profit and income at close of escrow. Once this is done, you can confidently move forward to sell and then enjoy the benefits of the plan you implemented.

Finding effective tax remedies can be more easily achieved by following the advice of an experienced tax planning specialist who will guide you through a simple step-by-step process that works. Your tax-planning advisor facilitates the tax solutions; tax attorneys and your CPA or accountant jointly validate the solution you choose and its structure; and your real estate professional guides the sale of the property. It is a synergistic team effort that is focused on benefiting you in the most effective ways possible.

Whatever the new tax laws might be, we all should prepare ourselves to take full advantage of them. How? By plotting out a common-sense approach to tax planning through which we can:

1. Gain the foresight needed to confidently pay less in personal income taxes; and,

2. Significantly reduce, defer or eliminate the capital gains, depreciation recapture and other potential taxes you would otherwise be obligated to pay when you sell your appreciated real estate or other assets.

Here is the Good News

Taxes can dramatically cut away at any chance for you to successfully meet your financial goals and objectives. It makes no difference how old you are, if you are working or now retired. If you earn enough money or want to sell appreciated assets such as real estate, you will probably be obligated to pay taxes. The good news is you have choices.

We have all learned from childhood that it is prudent to get a second opinion if we are diagnosed with a serious illness. Wouldn't you agree that paying more in taxes than you are legally required is a serious threat to your financial health? If you have appreciated real estate or other assets that you would like to sell but are concerned about paying taxes, doesn't it make sense for you to learn what options are available to you to solve them? If you do, you will find out that you, too, have choices that can help achieve your dreams in spite of a wavering economy and changing tax law.

The Primary Residence Exclusion

One of the greatest tax gifts is the principle residence rules for capital gains on the sale of your home. So great is the principle residence tax exclusion that even married couples filing jointly are benefited to the same, if not greater, extent as single taxpayers. Now, some people may argue that there have been, are and will be greater gifts, but not much beats the simplicity of this rule. The basics of it are immensely easy to grasp: you own a house, you live in it for at least two years, you sell it and you don't pay any taxes on the gain. Gone are the days when the young homeowner (not wishing to sell and upgrade) had to save every receipt for every upgrade, every repair, every minor item bought at the hardware store. If you have lived in your own home for two years, you probably don't have to worry.

Of course, there are some technicalities associated with the general rule. They are pretty simple so first I will bullet-point the main ones:

o If you are single your capital gains exclusion is limited to $250,000.00

o If you are married your capital gains exclusion is limited to $500,000.00

o You have to own the home and it has to be your "primary residence" for two of the previous five years

What is your "primary residence"? Basically, it is a home that you personally live in the majority of the year. If you have a house in Palm Beach and one in Lake Tahoe and you spend 8 months of the year at the Tahoe home than that is your primary residence. But, keep in mind the 2 out of 5 part of the rule. Let's say that the next year you spend 7 months at the Palm Beach house. Then the Palm Beach home is your primary that year. See where I am going with this? You can primary more than one home at once over a five year period so long as each is your main home for at least two years during that five year period. Temporary absences are also counted as periods of use - even if you rent the property during those absences (but talk to your accountant about recapturing any rental depreciation).

Now don't let the five year requirement confuse you - it only takes two years to achieve the tax exclusion. The five year part is a bonus, allowing you some freedom. You don't have to personally use the home as your primary residence for two consecutive years or for the two years immediately before you sell, you just have to use it is your primary residence for two of the previous five years. But, it is also a limitation, you cannot live in a house for two years and then rent it for four years and then get the exclusion. You could live in it for two years and then rent it for three years and then sell it (so long as it is sold within the five year mark from when you first lived in it as your primary residence).

Also, bear in mind that married couples do not have to live together. So long as one spouse lives in the primary residence for the two years than the couple can take advantage of the $500,000.00 exclusion. But, they cannot primary two homes at once and get the $500,000.00 exclusion on both. If they live apart during the two year period and each sell their primary then they are each limited to the single taxpayer exclusion of $250,000.00 for each house.

If you have a home office or rental as part of your primary residence or run a business out of a portion of your property, your ability to maximize your capital gains exclusion largely depends upon whether the home office, business or rental was part of your home (in the same dwelling unit) or a separate part of your property (a separate building or apartment). If the business use of your home was contained within your dwelling unit then upon sale you will need to recapture any depreciation taken for that part of the home. But you will not lose any of the allowable capital gains exclusion ($250,000.00 for single taxpayers and $500,000.00 for married filing jointly). If the business use of your home was not a part of your dwelling unit then you need to bifurcate the sale by allocating the basis of the property and the amount realized upon its sale between the business or rental part and the part used as a home.

Remember, only one home can be sold in any two year period unless you and your spouse live apart, and even then you can each only take the single payer exclusion of up to $250,000.00. But what if you need to sell a home that you have not lived in for the full two years? The IRS tells us that in special circumstances you can sell a home before you reach the two year mark and get a pro-rated exclusion. An example of a pro-rated exclusion is, for example, if you are a single taxpayer and have to sell your primary residence for a qualified reason after living in it only one year than you could exclude up to $125,000.00. In other words, you lived in the home 50% of the requisite time so you can take 50% of the allowable exclusion. The special circumstances that qualify you for this safe harbor and allow you to take the pro-rated exclusion have to do with health (yours and certain qualified individuals such as close relatives), change of employment or what the IRS calls "unforeseen circumstances" (examples include death, natural or man-made disasters, multiple births form the same pregnancy, divorce) These circumstances also have to cause you to sell your home. Factors used by the IRS to determine causation include:

o Your sale and the circumstances causing it were close in time,

o The circumstances causing your sale occurred during the time you owned and used the property as your main home,

o The circumstances causing your sale were not reasonably foreseeable when you began using the property as your main home,

o Your financial ability to maintain your home materially changed, and

o The suitability of your property as a home materially changed.

1031 Exchanges and the Primary Residence Rule

What happens if you do a like kind tax deferred exchange (also known as a 1031 exchange) of rental property or other property held for investment and then later decide to live in the property that was purchased? It is crucial to your 1031 exchange that both the property sold and the property purchased are held for investment. The property purchased must undergo a holding period before it is resold or converted into non-investment property. That holding period should be a year and a day to avoid audit. After you have complied with the "held for investment" requirement by, for example, renting the property if it is rental property, then what? Well, you could sell the property and pay your taxes on that sale and all previous sales that were perhaps in a series of exchanges or exchange and defer the tax once again, OR you could live in the house as your primary residence. If you have a had a series of gains that you have deferred this is a way to extinguish your tax debt forever - all you have to do is move into your investment property once the holding period for it qualifying as an investment is over.

Gaining the primary residence exclusion for property that was 1031 property isn't as easy as the simpler primary residence rules talked about above, but it does allow you to take advantage of two loopholes at once! The main difference when primary residencing a 1031 exchanged property is that you actually have to hold the property for 5 years. The five year part here is a substantive rule, you cannot sell after only 2 years of ownership as you can if you were simply primary residencing a home that was not exchanged into. But that first year that you had to hold onto the home for investment goes towards the five year calculation. So, you rent it for two years and live in it for three, or vice-versa, so long as you kick the whole thing off with a one year rental period and live in it two of the remaining four years.

In this way, you can exclude up to a total of $500,000.00 worth of gain (if you are married filing jointly or $250,000.00 worth of gain if you are a single taxpayer) from the combined gains of the sale of the home you ended up living in as your primary residence, and any of the gains that you had previously 1031 exchanged. For example, say you purchased a duplex in May of 2000 for $150,000.00 and then in June of 2001 you 1031 exchanged the duplex (now worth $200,000.00) into a commercial building worth $200,000.00 (thus deferring $50,000.00 worth of gain). A few years later the commercial building is worth $300,000.00 and you do another exchange, this time into a nice single family home worth $350,000.00 (you have to put in an additional $50,000.00 to complete the purchase). You have now deferred a total of $150,000.00 worth of gain. Let's say you then choose to rent the home for the first two years that you own it and then you later decide to move into the home. You then live in the house for three years at which point it is now worth $700,000.00 and you sell it for this amount. You and your spouse have now effectively wiped out not only the $350,000.00 gain from the sale of your primary residence, but the previous $150,000.00 worth of gain as well.

Change In Capital Gains

If you own a property which you are planning to sell, be sure to consult a tax advisor or get informed about tax law before doing so. Many real estate agents also know the subtleties of property selling and taxation. Several small points can make the difference between having to pay capital gains tax or not.

Capital gains is something that not many of us worry about because we only have the one home which is often only sold in order to buy another property. Usually the next property will cost more money and will be a like-kind property so the question of capital gains tax never arises.

However, until now, there has been a little known tax clause which had taxed the most unsuspecting of people with capital gains. These people are newly widowed women, who suddenly find that they will now be taxed as a single woman. On top of losing a spouse, they also had to worry about losing a large chunk of their assets in the form of money from the sale of their family home.

When a home is sold, it has usually been the property of joint owners (most commonly husband and wife) and each owner is allowed to claim $250,000. This means that, for tax purposes, the average couple can exclude up to $500,000 of gain - provided that they have used the house as a principal residence for a cumulative two of the previous five years.

In most cases, being able to 'write off' a $500,000 profit margin means most of us are not concerned with capital gains tax.

But what happens when a spouse suddenly dies? The capital gains or the profit allowed on the sale of the house is now only one person's allowance of $250,000. If you and your husband were married in the 1940s and lived all your life in the same house, then death of one of the spouses would incur heavy taxes on the sale of the property.

The IRS has just stepped in to change this situation, but with all the mortgage rate controversy, it has slipped by almost unnoticed.

Until now, the only way to qualify for the full $500,000 capital gains allowance was to sell your home in the same year in which your spouse died. In other words, it would be the last year that you could file a tax return as a married person, so it would be the last year that any taxation could be applied to the married -deceased- spouse.

Apart from the shock of losing a spouse and thinking about selling your home all in the same time period - what happens if your spouse dies in November? You have one month to get your act together!

Theoretically, most husbands or wives inherit their spouse's share of the property at what is called a 'stepped-up' tax basis, but now that the IRS has introduced new legislation for the spousal death situation, everyone can breathe more easily.

The new change in the law, introduced at the end of 2007, now gives surviving spouses a full two years to claim the "double" allowance of $500,00 on capital gains, even though, by law, they are now single.

Avoid the Tax on Capital Gains by Donating the Property to a Charity

A taxpayer can avoid the tax on long-term capital gains by donating the property to a recognized charity. If the sale of the property would result in a long-term capital gain, but the taxpayer donates the property to charity, the taxpayer avoids the tax on the long-term capital gain and also receives a charitable contribution deduction equal to the fair market value of the property at the time of the donation.

A long-term capital gain occurs when the taxpayer sells or exchanges a capital asset that the taxpayer has held for more than one year for an amount that exceeds the asset's adjusted basis (usually cost). Most long-term capital gains are taxed at a maximum rate of 15 percent. This rate is much lower than the maximum 35-percent rate that applies to ordinary income.

However, a taxpayer can avoid even the 15-percent tax rate on a long-term capital gain by contributing the property to a recognized charity. In such a case, the taxpayer does not have to recognize the gain. In addition, the taxpayer may deduct the fair market value of the property as a charitable contribution.

For example, assume that a taxpayer bought land for investment two years ago at a cost of $6,000. The land is now worth $16,000. The taxpayer donates the land to a recognized charity. The taxpayer does not have to recognize the $10,000 ($16,000 - $6,000) long-term capital gain. In addition, the taxpayer may deduct $16,000 as a charitable contribution.

The deduction for charitable contributions of an individual is generally limited to 50 percent of the taxpayer's adjusted gross income (AGI). However, for contributions of long-term capital gain property, the limit is 30 percent of the taxpayer's AGI unless the taxpayer elects to deduct only the adjusted basis of the property rather than its fair market value.

The taxpayer may carry over any charitable contributions that exceed the annual limit to the next five tax years. The current year's contributions are deducted before any contributions carried over from a prior year.

If the property is tangible personal property, such as a work of art the taxpayer had purchased, the charitable contribution deduction is limited to the taxpayer's adjusted basis in the property. The taxpayer may not deduct the fair market value of such property if it exceeds the property's adjusted basis. In addition, the deduction for contributions of property to private nonoperating foundations is limited to the adjusted basis of the property.

If the property is ordinary income property or property the sale of which would result in a short-term capital gain, the deduction is also limited to the adjusted basis in the property. However, the taxpayer would not have to recognize the appreciation as a gain.

Taxpayers should not donate property to charity on which they would realize a loss if they sold the property. The deduction for the charitable contribution would be limited to the fair market value of the property, and the taxpayer would not recognize the loss. The taxpayer would achieve a more favorable tax result by selling the property to realize the loss and contributing the cash proceeds to the charity. Of course, losses on the sale of personal use assets such as clothing are not recognized.

While the deduction of net capital losses of an individual or married couple is limited to $3,000 a year, the taxpayer may carry over any unused net capital losses to future tax years indefinitely.

The ability to contribute long-term capital gain property to a charity to avoid the tax on the long-term capital gain while deducting the fair market value of the property as a charitable contribution is a great tax planning strategy. Taxpayers who want to contribute to charity should seriously consider using this strategy.

However, the tax law has numerous exceptions and limitations. Therefore, a taxpayer should consult a competent tax professional before donating any significant amounts of property to a charity.

Capital Gains on Homes - A Guide For Those Who Are Not MP's

As part of the 'expenses scandal', it has come to light that some MP's have been deciding which of their homes is treated as their principal residence, in order to save capital gains tax (CGT).

The rules on gains made on property are fairly clear. As far as your main home is concerned, there is no CGT to pay, provided: it was primarily for use as your home rather than with a view to making a profit; that it was your only home throughout the period you owned it (ignoring the last three years of ownership): and you did actually use it as your home. There are other rules which your financial or mortgage adviser can outline for you.

Importantly, if you are married or in a civil partnership and not separated you and your spouse or civil partner can have only one such residence between you (which may surprise some MPs). As far as second residences are concerned, you will normally be expected to pay CGT on any gain you make, after certain allowances.

Can you flip too?

The question is, of course, if MP's can decide which residence is their 'principal' one, can you do so too? The surprising answer is - at least until the government moves to close this gap - that you can. If you own and occupy more than one residence, you can choose which one is to be your primary residence for CGT purposes (subject to some restrictions).

This is particularly helpful for those who buy a holiday home with the intention of retiring to it later on. If they move to the retirement home a year or so before selling their main family home, they can still opt to have the old home treated as their principal residence, so that it is exempt from CGT. More importantly, if they decide, while still living in the main family home, that the 'holiday/retirement' home is in the wrong place, they can usually designate the 'holiday/retirement' home as their principal residence, sell it, buy another one elsewhere and then re-designate their family home as their principal residence. In this way, just as for MPs, there will be no CGT payable.

Let property

Where a second property has been let, in order to generate an income, it may be possible to obtain letting relief, which can reduce the chargeable gain by as much as £40,000 per owner. For most landlords, £40,000 represents a considerable gain that can easily be put towards additional needs such as landlords insurance.

How much will CGT be?

As indicated above, a couple can only have one principal residence at a time, but each has a personal allowance against CGT. For the current tax year, this is £10,100 per individual. So imagine that a married couple were to sell a property that did not qualify for relief as their principal residence, for £500,000 that they had bought some time earlier for £350,000. This would make a gain of £150,000. Each would be entitled to an exemption of £10,100 so, assuming equal ownership, the taxable gain would be £129,800. With the rate of CGT at 18%, this would create a tax charge, between them of £23,364 (provided no other chargeable gains had been made during the year).

If the property had been purchased with a view to passing it down the generations, making the children joint owners from outset would mean that they, too, could use their annual exemption to reduce the liability.

You should take individual professional advice before making any decision relating to your personal finances and should be aware that there may be variations for those living in Scotland and Northern Ireland. Also remember that your home may be repossessed if you do not keep up repayments on your mortgage, so you should think carefully before securing other debts against your home. Fees for mortgage advice may be charged and for details of these please contact your usual adviser.

Investors: Avoid These 5 Common Tax Mistakes

For many investors, and even some tax professionals, sorting through the complex IRS rules on investment taxes can be a nightmare. Pitfalls abound, and the penalties for even simple mistakes can be severe. As April 15 rolls around, keep the following five common tax mistakes in mind - and help keep a little more money in your own pocket.

1. Failing To Offset Gains

Normally, when you sell an investment for a profit, you owe a tax on the gain. One way to lower that tax burden is to also sell some of your losing investments. You can then use those losses to offset your gains.

Say you own two stocks. You have a gain of $1,000 on the first stock, and a loss of $1,000 on the second. If you sell your winning stock, you will owe tax on the $1,000 gain. But if you sell both stocks, your $1,000 gain will be offset by your $1,000 loss. That's good news from a tax standpoint, since it means you don't have to pay any taxes on either position.

Sounds like a good plan, right? Well, it is, but be aware it can get a bit complicated. Under what is commonly called the "wash sale rule," if you repurchase the losing stock within 30 days of selling it, you can't deduct your loss. In fact, not only are you precluded from repurchasing the same stock, you are precluded from purchasing stock that is "substantially identical" to it - a vague phrase that is a constant source of confusion to investors and tax professionals alike. Finally, the IRS mandates that you must match long-term and short-term gains and losses against each other first.

2. Miscalculating The Basis Of Mutual Funds

Calculating gains or losses from the sale of an individual stock is fairly straightforward. Your basis is simply the price you paid for the shares (including commissions), and the gain or loss is the difference between your basis and the net proceeds from the sale. However, it gets much more complicated when dealing with mutual funds.

When calculating your basis after selling a mutual fund, it's easy to forget to factor in the dividends and capital gains distributions you reinvested in the fund. The IRS considers these distributions as taxable earnings in the year they are made. As a result, you have already paid taxes on them. By failing to add these distributions to your basis, you will end up reporting a larger gain than you received from the sale, and ultimately paying more in taxes than necessary.

There is no easy solution to this problem, other than keeping good records and being diligent in organizing your dividend and distribution information. The extra paperwork may be a headache, but it could mean extra cash in your wallet at tax time.

3. Failing To Use Tax-managed Funds

Most investors hold their mutual funds for the long term. That's why they're often surprised when they get hit with a tax bill for short term gains realized by their funds. These gains result from sales of stock held by a fund for less than a year, and are passed on to shareholders to report on their own returns -- even if they never sold their mutual fund shares.

Recently, more mutual funds have been focusing on effective tax-management. These funds try to not only buy shares in good companies, but also minimize the tax burden on shareholders by holding those shares for extended periods of time. By investing in funds geared towards "tax-managed" returns, you can increase your net gains and save yourself some tax-related headaches. To be worthwhile, though, a tax-efficient fund must have both ingredients: good investment performance and low taxable distributions to shareholders.

4. Missing Deadlines

Keogh plans, traditional IRAs, and Roth IRAs are great ways to stretch your investing dollars and provide for your future retirement. Sadly, millions of investors let these gems slip through their fingers by failing to make contributions before the applicable IRS deadlines. For Keogh plans, the deadline is December 31. For traditional and Roth IRA's, you have until April 15 to make contributions. Mark these dates in your calendar and make those deposits on time.

5. Putting Investments In The Wrong Accounts

Most investors have two types of investment accounts: tax-advantaged, such as an IRA or 401(k), and traditional. What many people don't realize is that holding the right type of assets in each account can save them thousands of dollars each year in unnecessary taxes.

Generally, investments that produce lots of taxable income or short-term capital gains should be held in tax advantaged accounts, while investments that pay dividends or produce long-term capital gains should be held in traditional accounts.
For example, let's say you own 200 shares of Duke Power, and intend to hold the shares for several years. This investment will generate a quarterly stream of dividend payments, which will be taxed at 15% or less, and a long-term capital gain or loss once it is finally sold, which will also be taxed at 15% or less. Consequently, since these shares already have a favorable tax treatment, there is no need to shelter them in a tax-advantaged account.

In contrast, most treasury and corporate bond funds produce a steady stream of interest income. Since, this income does not qualify for special tax treatment like dividends, you will have to pay taxes on it at your marginal rate. Unless you are in a very low tax bracket, holding these funds in a tax-advantaged account makes sense because it allows you to defer these tax payments far into the future, or possibly avoid them altogether.

Preparing Income Taxes - How Do I Report Information on a 1099-A?

The reporting of any cancellation of debt (COD) involves two different information documents; an IRS Form 1099-A, Acquisition or Abandonment of Secured Property and an IRS Form 1099-C, Cancellation of Debt. An IRS Form 1099-A is specifically provided to both tax authority and tax payer when a lender forecloses, repossesses, or has reason to suspect property is abandoned. Whether or not you receive either of these documents in a timely fashion, you must report cancellation of debt you have owed on your personal income tax. Acts of repossession, abandonment, or foreclosure are treated as a sale or exchange of property and the rules of gain or loss apply. Any income arising from the cancellation of a recourse debt is taxable whether or not property is returned or surrendered.

The IRS Form 1099-A is information form that includes the balance of outstanding debt, the fair market value of the property involved, a description of the property, and whether the debt is classified as recourse or non-recourse. Specifically, in Box 5, a "Yes/No" check box indicates whether or not the borrower is personally liable for repayment of the debt. The information in this single box on the form is critical because, if the box is marked "No", the debt is classified as non-recourse; that is, the borrower is not personally liable for the debt. In the case of a recourse debt however, the buyer is not only liable but, under cancellation of that debt, may have a gain, and thus additional taxable income, from the removal of the burden to repay the obligation. Where a recourse loan leads to foreclosure or repossession, the Form 1099-A provides critical information about additional taxes owed on that debt-generated income.

The sale information reported on a Form 1099-A is transferred to the IRS Form 1040 Schedule D, Capital Gains and Losses if the property was categorized as personal - use and there was a reported gain; losses are not reported. If the property was considered an investment, information is entered on Schedule D and ordinary gain/loss rules apply to the transaction. If the Form 1099-A describes business property, an IRS Form 4797, Sales of Business Property is completed and the results are, in turn, transferred to IRS Form 1040 Schedule C (business, sole proprietorship), E (rental), or F(farm).

The proper transfer of information from an IRS Form 1099-A to your income tax return is best left to an experienced tax preparer. You should expect to also include an IRS Form 1040 Schedule D with your tax return. Do NOT overlook COD events when filing your income tax return. For more information, visit the IRS website, IRS.gov.

Keeping Track Of Gains With Property Management Software

There would always come a time that business people, men and women alike, would have to calculate their capital gains tax liabilities. Most likely, the anxiety of provisioning for tax liabilities would be very hard on even the most tenured landlords. The reason for this is mainly the process of tax calculation, which is, as a matter of fact not only complicated but varies through time, which makes it more confusing. It is very difficult to even create a single mistake on the figures since it would cost the businessmen more to mend it. So it is but proper to have an organized system to control the flow of money and tame the tax liabilities.

Today's alternative to the well-loved and sometimes hated process of placing everything on paper would be to input everything onto computer programs that are patterned after the management of financial, accounting and other business aspects. Examples of these are spreadsheets and word processors, which have become a part of any landlord software.

However, these may not always be the convenient way to process important information and may not often be updated to the latest trends and changes in the business world. It's a good thing that with property management software, everything is somehow rolled into one and turned into an ideal software that is designed to do various tasks.

An effective property management software can help landlords to effectively manage various aspects of their business, such as maintenance, which plays a big role in the financial state of a certain business. If this will be somehow overlooked, it might turn out to be more of a big liability, rather than a way to improve the flow of business.

Another area than needs to be focused on would be the management of rent collection. Well, a good type of landlord software should be able to track or monitor the income or the rent that are given as payment for the lease of the property. This is quite important since the whole business depends on this for financial circulation, which may lead to more investments. Basically, everything can be managed from here including the whole collection and distribution of statements and provision of rental deadlines.

As a final note, it is time to stop being shoved under a big pile of paper works, as well as it is time to think about ignoring the other programs on your computer which make it more cumbersome and complicated for you. Invest in a good property management software and in the end, that would be all you need to succeed in this business, hassle-free.

The 1031 Exchange - Good For Investors, Good For The US

A 1031 tax exchange is a tactic commonly used by real estate investors so that they may defer tax liability on the sale of a property. This is done by transferring the rights to a piece of property one would like to sell to an intermediary, who holds the funds gained from the sale of the relinquished property and uses the money to acquire a replacement that fulfills the regulations set out in Section 1031 .

Although the current interest in the 1031 tax exchange could give you the impression that Section 1031 is a recent development, this is untrue. In reality, the 1031's history stretches all the way back to 1921, although the original concept was significantly different than what we today think of as an exchange. The 1031 Exchange truly came into its own in the '70s, which saw a host of significant modifications in the manner that exchanges were conducted. These modifications resulted in a more powerful conception of the exchange process and also generated increased interest from real estate investors.

The capital gains tax deferral an exchange provides to the taxpayer might, at first glance, seem to be a kind of gift from the United States government, however it is, in reality, closer to an interest free loan, because the taxpayer is expected to "repay" the extra funds gained from the capital gains tax deferral by accepting capital gains liability on the subsequent sale of a replacement property. Additionally, this "interest-free loan" is one that may be kept by the investor indefinitely; an investor can choose to make any number of 1031 exchanges before finally sell outright, at which point capital gains taxes must be paid.

The 1031 exists as a mutually beneficial arrangement between the investor and the United States government, providing a benefit for the country's economy as well as the individual taxpayer. In looking upon the transfer of money in an exchange as a continuation of an existing investment instead of as a discrete transaction liable to be taxed, taxpayers gain the opportunity to move their money to the best possible investments. This, in turn, helps to elevate the economy by bolstering job growth.

As with anything, Section 1031 has skeptics. Some advocates of change in Section 1031 will pose the argument that the tax free income gained by to the taxpayer in a 1031 creates an unfair advantage. Another common concern is that the strict time limits attached to steps in the exchange procedure could promote a frantic rate of buying, with a resultant increase in asking prices for replacement properties. The aforementioned criticisms, however, are only tenuously linked to reality, and the odds that Section 1031 will go through any noteworthy changes in the coming years are quite low. Looking at the big picture, most will agree that Section 1031 is greatly helpful to all involved, as it allows taxpayers greater profits on the sale of property while additionally encouraging job growth and therefore the greater good of the country. There is no reason to doubt that the 1031 tax exchange is destined to remain a mainstay of the investment world for years to come.

What Are Capital Allowances?

As a business in the UK your company could be entitled to claim for capital allowances helping make financial decisions more viable and cost effective whilst helping to reduce the corporation and income tax. Capital allowances (also referred to tax allowances) can be claimed on certain purchases or investments including plant and machinery, certain building types (which includes conversions of commercial property to flats for a rental income). If these apply to your business it means you can reduce your tax bill by deducting a proportion of these costs from your taxable profits. Depending on what you are claiming for depends on the amount of allowance available.

When the government announces changes to the budget as they do, it is important to check what implications this may have on claims now and future ones.

Capital Allowances on Buildings and flat conversions

There are different areas which can provide tax relief and capital allowances with regard to buildings.
• Renovating existing flats/apartments and/or converting space above shops and commercial (qualifying) to create flats for rent.
• Converting or renovating unused qualifying business premises in disadvantaged areas.
• Constructing (or buying unused) certain commercial, industrial or agricultural buildings

Flats:
• converting underused or vacant space above commercial premises into qualifying flats
• renovating an existing flat above commercial premises into a qualifying flat

In the budget from the new coalition Government there were some changes to capital allowances however until 10 April 2012, you can claim an initial allowance of 100 per cent of the cost of:

• converting a qualifying building into business premises
• renovating a qualifying building that is, or will be, qualifying business premises
• repairs to a qualifying business premises

The building must:
• be in a disadvantaged area
• have been used formerly for business purposes
• have been unused for one year or more

The government has decided to promote business growth and investment at such an important time for the future of the country. This will enable the country to grow investment wise with businesses benefiting from financial gains in capital allowance and tax relief.

Need More Income from Your Investment Property?

The goal of every real estate investor is to see their property appreciate in value and to have it generate a positive cash flow. The appreciation normally takes care of itself if the property is of good quality, in a good location, and is held over a long enough period of time. Just like the stock market, real estate has proven to go up way more than it goes down over time.

The positive cash flow component is not always a given though. Ask any seasoned investor, and unless the property is owned free and clear, there have probably been times when he's had to dip into his own pocket to pay for some aspect of his rental. Who hasn't seen a raise in homeowner's fees, property taxes, an outlay of cash for a new roof, plumbing, paint, carpet, appliances, or a length of time supporting it between tenants.

So, what if you're nearing retirement age and see the need for increased and steady income? You may even look forward to taking a permanent break from the "joys" of hands-on property management. We all deserve to reap the rewards of our labors, right?

Basically, to meet these goals, one can do one of two things.

1. Sell the property, pay all the capital gains taxes, recaptured depreciation, etc. and pocket what is left. To receive an income, one would have to either live off whatever interest/gains your proceeds produced, or begin depleting your funds to provide you with the amount of monthly income you deem necessary. Depending on your age and financial needs and whether or not you desire to leave as large a legacy as possible, this approach may or may not work for you.

2. Employ a strategy that will defer the payment of any tax or depreciation. Let all of your gains continue to work for you throughout the course of your retirement and into the next generation. Yet, you will still get a significant and partially tax deductible monthly income.

What strategy is #2? If your property is over a million and you are not a young retiree, you might consider a Private Annuity Trust. You will get monthly income for the rest of your life, but you will be depleting your asset and only spreading out the repayment of capital gains tax over a longer period of time. That is a simplification of a complex agreement, but that is the gist.

A better option may be a 1031 exchange into a tenant in common (TIC), Basically, you exchange your property for a deeded partial interest in a grade A commercial property. You sign a contract with a property management company, and in turn receive a monthly income (typically 6-7% of your total equity). You never have to deplete your asset, and it can pass to your heirs at the stepped up basis.

The 1031/TIC exchange is a fairly new concept, sanctioned by the IRS in 2002. It is projected that the influx of property assets into this type of exchange will be close to 5 Billion dollars in 2005. That's a lot of equity. Why not let your equity continue to work for you instead of parting with a lot of profits that would take you years to replace.

Australian Tax - Capital Gains Tax and Earnout Arrangements

It was announced in the recent Australian Federal Budget (11 May 2010) that there would be a change to the way in which capital gains tax applies to earnout arrangements.

What's an earnout arrangement? This is usually encountered in sale of business situations where the parties to the contract either cannot agree on a value or are uncertain about the value of the business. Typically, a lump sum amount is paid with a further amount to be paid if the business performs to certain pre-agreed levels. For example, a business may be sold for $500,000 plus 5% of the sales for the next 12 months. There are many variations of these arrangements.

What's the problem?

On 17 October 2007, the Australian Taxation Office ("ATO") released a Draft Taxation Ruling TR 2007/D10 on this topic. The ATO considered that the contingent, earnout component of the consideration for the sale of the business was a separate asset from the underlying business. The earnout component was seen by the ATO as the vendor disposing of a right to an uncertain amount of money. In addition, the vendor was also selling the actual assets of the business (for example the goodwill) for any amount that was certain in the consideration.

This interpretation created problems. First, the value of the earnout had to be determined in order to determine the capital gain that related to that earnout. In most situations this is quite difficult to do as, of necessity, one must predict the future. Second, the earnout component was not something to which the small business capital gains tax concessions could apply. This was because the earnout right was not an "active asset".

The law is to be changed to what is referred to as a "look through" approach. This means that the law will look through to the underlying transaction - the sale of the business assets - and deal only with those assets and not treat the earnout arrangement as a separate asset.

The new law will apply from the date that it receives Royal Assent. This is after the law passes both houses of parliament and the Governor-General signs it into law.

However, Senator Nick Sherry, the Assistant Treasurer, has released a proposals paper on the topic. The purpose of this paper is to consult with the business community about the changes. The closing date for submissions is 11 June 2010. In this paper some transitional provisions are announced. Taxpayers will have the choice to apply the look-through treatment entered into between the date of announcement and Royal Asset (inclusive). Also the buyer in a standard earnout arrangement will have the choice to apply the new treatment for arrangements entered into on or after 17 October 2007.

If you are considering the sale of a business with an earnout arrangement, I strongly encourage you to obtain a copy of the consultation from the Assistant Treasurer's website.

Wishing you easier business,

John M. Jeffreys

Investing in Real Estate, Flipping Houses, and Income Taxes

Understand the tax consequences of flipping houses, rehabbing houses, and how to defer taxes with the 1031 Exchange before you get into real estate investing. Problems arise when real estate investors don't follow federal and state tax laws. This is why you need professional advice. Although I am not a tax advisor, here are some common mistakes beginning real estate investors make by not understanding tax liabilities:

Flipping Houses

The reason flipping houses is a mistake for some beginners is that they don't know the income tax consequences. One problem with flipping houses, or selling too many properties too quickly, the IRS could say that your real estate business is your trade, subject to ordinary income and self-employment taxes.

Self-employment tax, a social security and Medicare tax primarily for individuals who work for themselves, is similar to the social security and Medicare taxes withheld from the paycheck of most employees. The self-employment tax rate costs you 15.3% of your profits. (However, this may provide retirement benefits.)

Rehabbing Houses

Another common mistake that beginning investors make is selling a property after holding it for almost a year. Some rehabbers work part time on a fixer and take six months to get the house ready. Add on two months to sell with a 60 day closing, and they're up to ten months. To take advantage of the low 15% capital-gains tax rate, you must keep the investment property for at least a year before selling. If you sell before a year, your tax rate, the usual capital gains rate of 35%, could eat up a significant amount of your profits.

If you're rehabbing houses, be patient. You could save thousands in taxes by holding your property just a few more weeks.

1031 Exchange

However, the Internal Revenue Code provides real estate investors away to defer capital gains taxes indefinitely. Section 1031 of the Internal Revenue Code provides a tax-free exchange. Also known as a "like-kind" exchange, this code allows you to sell a business or investment property and defer capital-gains taxes by immediately reinvesting the gains into a similar piece of property. The key, replacing a business or investment with similar property, means that no gain gets paid to the investor. Any profit taken out of escrow gets taxed. This means that beginning investors might take out a portion of the profit after they carefully explore their tax liabilities. In other words, talk to an accountant and find out what your tax would be according to your current usual income. Many business owners take advantage of this because they have many business deductions.

The big mistake beginning real estate investors make doing a 1031 tax-free exchange, taking possession of the profits, voids the tax deferment. You must declare the sale of your property to be a part of a 1031 exchange before you sell the property. Then you have the money placed in a trust account held by an intermediary until you purchase the new investment property. You have 45 days to identify a replacement property and 180 days to close on the new investment. You can't purchase a primary residence or a vacation home with funds from an investment property and defer taxes in a 1031 exchange.

The best advice for beginning real estate investors:
Talk to an accountant.

Would you be better off making extra money, even if you must pay taxes?

© 2005 Jeanette J. Fisher.

Tax Saving Strategies with Stock Trading

If you trade in stocks, you need to have tax savings strategies in place, or come April 15, your profits will look a lot smaller after the IRS has taken its share.

However, the good news is that there are certain tax savings strategies with stock trading that you can implement to reduce your taxes.

Although we use investor and trader as we please, in the world of taxes these to words have different meanings and your taxes will be affected according to the meaning you put. Therefore, it is better to understand how the IRS views a trader and an investor so that you can benefit from it.

If you spend you days buying and selling stocks, then you are trader. If you are a trader, you save yourself a lot of money when it comes to paying taxes. As a trader, you can deduct all your investing expenses from your tax returns. These expenses can be newsletter subscription, home office and computer equipment.

Now how can you decide whether you are a trader or an investor? There is no guideline laid out to distinguish between a trader and an investor other than the several court cases. According to these court cases, you are a trader if you spend a lot of time trading and you do not have a regular full time job. But you can also be part time trader but you would have to buy and sell stocks on a daily basis. In addition, you are a trader if you have established a regular and continuous pattern for trades, and you ultimate aim is to profit from short-term market swings rather than keeping stocks for long-term gains.

However, you can be both a trader and investor. But you should separate your long-term investments from your short-term investments so that you are not caught by IRS for cheating.

From the IRS's perspective, a trader is self-employed and you can deduct all your expenses on Schedule C. Write offs in Schedule C reduces your adjusted gross income and you can fully deduct your personal exemptions While an investor has to account for all his expenses on Schedule A, and they can only write off the amount that exceeds 2 percent of the adjusted gross income.

In addition, as a trader you can deduct margin account interest on Schedule C and take an immediate write off of up to $128,000 for 2008 and $125,000 for 2007 for equipment you used in your trading activities for more than fifty percent of the time. Plus, you will not have to pay self-employment tax on your net profit because capital gains are exempt from it.

Australian Tax - Bamford Decision and the Streaming of Income to Trust Beneficiaries

Due to the decision impact statement on the Bamford High Court decision and recent statements by high ranking Australian Taxation Office ("ATO") officers, there is a great deal of uncertainty concerning the future ability of a trustee of a trust to stream different classes of income to different beneficiaries of the trust.

First some background. The trustee (or trustees) is the legal owner of the assets of the trust. The trustee derives income from the assets of the trust. This can be just about any type of income that you can think of. It can include interest, dividends, distributions from other trusts, capital gains, trading income and so forth. The trustee must apply that income for the benefit of the beneficiaries and in accordance with the powers given to the trustee under the trust deed. In a discretionary trust, the trustee has the absolute ability to decide how much is to be distributed to each beneficiary and how much is not to be distributed.

It is usually the case that the beneficiaries of the trust have different marginal tax rates and different tax rules can apply to them, depending on what type of taxpayer they are. It is prudent for the trustee to direct certain types of income to certain types of beneficiaries in order to lower the overall tax payable by the beneficiaries on the income derived from the trust. Accordingly, the concept of the streaming of income to beneficiaries has been a widely accepted part of trust administration for some years. This concept came particularly to the fore when the dividend imputation and capital gains tax rules were enacted in the mid 1980's.

The ability to stream income to beneficiaries rests on the assumption that income of different types can be separately identified by the trustee. Further, the expenses that relate to that income can also be separately identified. Alternatively, the expenses of the trust may need to be apportioned over the various types of income. So, the underlying assumption is that income can retain its character, and therefore its tax characteristics, as it flows into and then out of the trust.

Streaming was approved (in a sense) by the ATO when it issued a public ruling in 1992 on the distribution by trustees of dividend income under the imputation system. This was TR 92/13. The ruling referred to the dividend imputation legislation as it existed at that time. This legislation has since been repealed and replaced with another set of dividend imputation rules.

The Bamford Decision

What's all this got to do with the Bamford decision? On one view, nothing. The High Court did not refer to the issue of streaming in the Bamford decision. But, due to the statements that the High Court made in relation to the method by which Sub-section 97(1) of the Income Tax Assessment Act 1936 operates when determining the taxable income of a beneficiary, the ATO considers that TR 92/13 must be withdrawn. Nevertheless, the ATO states that tax returns for the 2009/10 income years and earlier years which are/were reasonably prepared on the basis of TR 92/13 "will not be disturbed".

Why does the ATO consider TR 92/13 should be withdrawn? This is because, according to the High Court, under Sub-section 97(1), a beneficiary is assessed in the following manner:

[1] The beneficiary's percentage share of the trust law income for a particular income year is determined.
[2] The taxable income of the trust is determined.
[3] The percentage under [1] is applied to the taxable income in [2] and the resultant amount is the taxable income of the beneficiary.

In the above process, on one view, there is no regard to the classes of income that have been received by the trustee and whether the trustee has decided to allocate certain classes of income to certain beneficiaries. But there are other provisions in the income tax law that refer to the taxation of the beneficiaries of a trust in relation to certain classes of income. Regard must also be had to these provisions.

Is streaming dead after 30 June 2010?

I think that it is a bit early to say that streaming is dead, although perhaps casket measurements should be taken. I have attended two recent seminars. At one seminar, the speaker (non-ATO) said that the ATO would no longer sanction streaming. At another seminar, there was a senior ATO technical officer speaking. There was no indication from him that streaming was definitely not going to be permitted by the ATO. There is to be a review of the area by the ATO and this will include the scheme of the law in the current imputation provisions and relevant capital gains tax provisions.

Unfortunately, nothing can be said about the future of the streaming of income to beneficiaries with any certainty. We will have to wait for future ATO pronouncements and possible changes to the law. Based on past experience, this will also create further uncertainty. But, this is the Australian tax system.

Wishing you easier business.

John M. Jeffreys

About Income Taxes; Tidbits

1812

The first attempt to impose an income tax on America occurred during the War of 1812. After more than two years of war, the federal government owed an unbelievable $100 million of debt. To pay for this, the government doubled the rates of its major source of revenue, customs duties on imports, which obstructed trade and ended up yielding less revenue than the previous lower rates.

And to think that the Revolution was started because of Tea Taxes in Boston?

Excise taxes were imposed on goods and commodities, and housing, slaves and land were taxed during the war. After the war ended in 1816, these taxes were repealed and instead high customs duties were passed to retire the accumulated war debt.

What is Taxable Income?

The amount of income used to arrive at your income tax. Taxable income is your gross income minus all your adjustments, deductions, and exemptions.

Some specific taxes:

Estate Taxes:

One of the oldest and most common forms of taxation is the taxation of property held by an individual at the time of death.

The US still has Estate Taxes, although there are proposals to do away with them.

Such a tax can take the form, among others, of estate tax (a tax levied on the estate before any transfers). An estate tax is a charge upon the deceased's entire estate, regardless of how it is disbursed. An alternative form of death tax is an inheritance tax (a tax levied on beneficiaries receiving property from the estate). Taxes imposed upon death provide incentive to transfer assets before death.

Canada no longer has Estate Taxes.

Most European countries have Estate Taxes, one prime example is Great Britain which has such high Estate Taxes that it has just about ruined the financial well-being of most of Britain's Nobility which has been forced to sell vast Real Estate holdings over time.

. Such a tax can take the form, among others, of estate tax (a tax levied on the estate before any transfers). An estate tax is a charge upon the decedent's entire estate, regardless of how it is disbursed. An alternative form of death tax is an inheritance tax (a tax levied on individuals receiving property from the estate). Taxes imposed upon death provide incentive to transfer assets before death.

Capital Gains Taxes

Capital Gains are the increases in value of anything (including investments or real estate) that makes it worth more than the purchase price. The gain may not be realized or taxed until the asset is sold.

Capital gains are normally taxed at a lower rate than regular income to promote business or entrepreneurship during good and bad economic times.

Tax Consequences when Donating a House on Your Property to the Fire Department for Practice?

Well, every once in a while you have a piece of property that is actually worth something, but the old run-down building or house on top of it, makes it impossible to do anything with. Getting permits to demolish stuff can be as aggravating as getting permits to build something sometimes. Of course, if you have the blessings of some of the local municipal higher ups and a little political influence, you can make at least some headway.

Okay, with that in mind let me tell you an interesting story. Donated an old farm type house (very old) to the fire department for training and got a property tax gift, they burnt down the place, at least 15 times in practice. Finally there was nothing left, and "they" tilled under all the ash. Great, got rid of the place, without demolishing permits and didn't have to haul away any junk. Good deal right?

Well, here is the kicker; got the commercial zoning change, property was re-assessed and now there is no junky home on the property it's suddenly worth more. No problem right, next year, higher property taxes, but the new buyer is gonna build on it anyway, but that is only half the issue. What other issues need to be addressed, it's a done deal right?

Ah, but now that the property is worth more creating a capital gain, so that negates the "donation gift" that was taken and deducted last year. Since it was a gain and no longer a gift, which in reality is true, the gift was made in order to gain. It's just unfortunate, would have been nice to have the cake and eaten it too!

Home Sellers Partial Exclusion

One of the major dilemmas that both married and unmarried home owners face is what happens to the $250/500k capital gains tax exclusion if you sell your home after owning it or living in it for less than two years? And what happens if you've sold another home in the last two years?

In these situations above you may be denied the $250k/$500k exclusion and have to pay tax on your home sale profits. If you have owned the home for less than a year you may even have to end up paying tax at your top income tax rate (up to 35%), instead of at the 15% long-term capital gains rate.

However there is hope, because you may qualify for a partial exclusion. You may not receive the full $250k/$500k but you could get something very close, and it could still be enough to safeguard you from paying any tax.

For example, those who purchased homes less than two years ago (and therefore do not qualify for the maximum exclusion) probably won't yet have $250,000 or $500,000 worth of capital gains that could be taxed. That includes many luxury homeowners as well.

Example

Ben and Jennifer purchased a $1 million house one year ago. Since then it has risen in value by 20%. The couple only need $200,000 out of their $500,000 maximum exclusion to protect them from paying tax. Owners of smaller homes, or homes that have risen in value by less, require an even smaller 'piece' of the maximum exclusion.

You may be asking yourself 'How do I qualify for a partial exclusion?' Partial exclusion is only available if the primary reason for your home sale is one of the following:

1. A change in work location

2. Health problems

3. 'Unforeseen circumstances'

As the IRS can never be 100% certain why you sold your home, they have introduced a number of 'safe harbors'. These are easy to apply tests which help you determine whether your home sale qualifies for tax-free treatment if you sell for work or health reasons or because of unforeseen circumstances.

If your home sale doesn't qualify under one of the safe harbors you may still qualify for a reduced exclusion if the evidence shows that your home sale was primarily due to a change in your work location, for health reasons or due to unforeseen circumstances. For example:

o Did the change in your work location happen while you owned and used the property as your home? If you lived somewhere else you'll struggle to claim the exclusion.

o Did you sell your home to help diagnose or treat a disease, illness or injury or to provide medical or personal care? If so you may qualify.

o Did you suffer a natural or man-made disaster causing you to sell your home?

To conclude, you must be prepared to defend your position if you have an audit. If the IRS thinks that, based on the facts and circumstances, you don't qualify you will have to pay back taxes, interest and penalties.

We hope that you have found this article a good introduction to partial exclusions. For more in-depth information may be interested in our guide Tax Loopholes for Home Sellers. Inside we explain the latest and best tax saving techniques and strategies that you can use today, plus dozens of clear examples.

Wash Sale Rules Keeping Short Term Capital Losses Deductible

One of the worst surprises an investor can get is a big tax bill at the end of the year. A big hit from capital gains taxes can turn an otherwise very profitable investing year into one that is only marginally profitable, or even worse, can turn a year of positive returns into an overall loss for the year. Avoiding this unpleasant event takes year-round tax planning. Unfortunately, however, creating a tax problem can take just one mistake.

Short-Term Capital Losses Deduction - Offsetting Capital Gains

Most investors are aware that they have to pay taxes on the profits that they generate while trading securities such as stock, bonds, ETFs, and mutual funds.

These taxes are divided into two major categories: Short-Term Capital Gains and Long-Term Capital Gains.

Long-term gains benefit from a reduced tax rate that encourages longer term investing. Short-term gains, however, are fully taxed at the investor's nominal tax rate. The difference can be substantial depending upon the investors tax bracket and where the taxpayer's income comes from overall.

The long-term capital gains tax rate is just 15% for most investors, although certain investors with lower incomes can benefit from an even lower long-term capital gains rate. Many successful investors are in the 30% or 35% tax brackets. This means that the difference in taxes for a short-term gain and a long-term gain can be as much as 20% more taxes for short-term capital gains.

Avoiding these much higher income taxes is why investors look so hard to generate short-term capital losses whenever possible to offset short-term gains, particularly near the end of the tax year. However, going about generating a capital loss in the wrong manner can actually ruin the ability to deduct the loss.

What Is a Wash Sale? IRS Wash Sale Rules

A wash sale occurs when the investor sells a security and then repurchases the same, or substantially similar, security within 30 days. In other words, if a taxpayer sells 1,000 shares of IBM stock on November 10th and then repurchases 1,000 shares of IBM stock on November 25th, a wash sale has occurred.

The problem with a wash sale is that if it generates a capital loss, whether a short-term loss, or a long-term investing loss, that loss cannot be used as a tax deduction. More specifically, the loss from a wash sale cannot be used to offset capital gains in the investor's portfolio.

While IRS wash sale rules apply to both short-term capital losses and long-term capital losses, they can be particularly devastating to taxpayers hoping to avoid short-term capital gains taxes.

Avoiding Wash Sales To Save Money On Taxes for Investors

Wash sales occur only when the same, or substantially similar, securities are sold and repurchased. The rules about what constitutes a similar security are complex, but do eliminate the ability to use proxies or other stand in investments such as stock options to get around wash sale rules. However, that does not mean that a savvy investor has no options when it comes to generating short-term investing losses that are usable for tax saving purposes.

When it comes to securities like exchange traded funds, or ETFs, or mutual funds, investors often have other investments that can be purchased that would not trigger the similarity features of wash sales. For example, an investor looking to generate a short-term capital loss to offset short-term capital gains could sell 1,000 shares of a S&P500 Index ETF at a loss to generate the short-term loss desired. The investor could immediately purchase an equal dollar amount of shares in a S&P100 Index ETF or a S&P1000 Index ETF.

While these investments are not the same (which is the whole point) over a 30-day period, such investments could be reasonably expected to perform in a very similar manner to the original investment in the S&P 500 Index. After the 30 day wash sale period is up, the investor could sell the replacement ETF and repurchase the original ETF investment without fear of triggering wash sale rules.

In this way, an investor can generate money saving short-term investing losses without creating wash sales that can cause long lasting tax headaches.