Month: September 2022

If your business loses money during the current year those losses may provide some tax relief. The losses can be used to save income taxes in future years. The losses are considered net operating losses (NOLs). NOLs occur when business deductions exceed business income. The tax law allows individuals and C corporations to carry these losses forward indefinitely to reduce taxable income. During the past few years there have been significant changes to the NOL rules.

Overview

If your business is operated as a partnership, LLC, or S corporation, your share of the business’s losses is passed through the business to your individual return and deducted from your other personal income. However, if you operate your business through a C corporation, you cannot deduct the entity’s loss on your personal return. It belongs to the corporation.

The Tax Cuts and Jobs Act of 2017 (TCJA) revised the NOL rules. It imposed an 80% limitation on NOLs and removed the ability to carry back the NOL to a prior tax year to obtain a refund. However, under the new law, NOLs can be carried forward indefinitely. Also, The TCJA placed an additional limitation on losses for individuals, known as the excess business loss limitation (EBL). Both the NOL and EBL applied to tax years beginning January 1, 2018. However, the CARES Act suspended the application of the NOL and EBL limitations until 2021.

This article will review the NOL and EBL TCJA changes that have been restored for tax years 2021 and beyond.

Net Operating Losses – Background to Recent Changes in NOL Rules

Under the TCJA, NOLs can be carried forward for an indefinite period. But the NOL utilized cannot exceed 80% of taxable income. Prior to the TCJA, an NOL could completely offset taxable income and could be carried back up to two years and forward for 20 years.

In response to the COVID-19 pandemic, the CARES Act of 2020 suspended the TCJA’s NOL rules for losses arising in tax years 2018 – 2020. The CARES Act allowed NOLs to be carried back for five years and carried forward indefinitely. In addition, the 80% limitation was deferred along with the EBL limitation rule.

Example of Current NOL Rule for 2021 and Beyond

For NOLs used in the tax year 2021 and after, the TCJA rules will apply. As a result, an NOL carried into 2021 can only offset 80% of taxable income – even though it can be carried forward indefinitely. Here’s an example of the rule. In 2021, taxpayer Y had NOL carryforwards from 2018, 2019, and 2020 totaling $1,500,000. Also, in 2021, Y has a taxable income of $1,000,000. Y can use $800,000 of the NOL to offset the 2021 taxable income ($1,000,000 x 80%). Therefore, Y’s final taxable income is $200,000 ($1,000,000 – $800,000). Taxpayer Y’s NOL carryforward is $700,000 ($1,500,000 – $800,000).

Prior to the TCJA, Y’s taxable income would have been completely offset by the NOL carryforward ($1,500,000 [NOL] – $1,000,000 [taxable income].

Who can Utilize an NOL

Generally, individuals or C corporations can carry forward NOLs indefinitely to reduce taxable income in future years. However, pass-through entities such as partnerships, limited liability companies, and S corporations cannot claim NOLs. Instead, the partners, members of limited liability companies, and shareholders of S corporations can claim NOLs proportionate to their ownership interest in the business entity on their personal tax returns.

Excess Business Loss Limitation

Prior to the TCJA, when an individual incurred a loss from a business, they could reduce their nonbusiness income (such as W-2 wages, interest, dividends, and capital gains) by the amount of that business loss without any limitations. This assumes that the individual had sufficient tax basis, met the “at-risk” requirements, and the passive activity loss (PAL) rules. The discussion of basis, “at-risk” and PAL rules are beyond the scope of this article.

The new EBL limitation is intended to restrict the ability of taxpayers to use business losses to offset other sources of income. The provision is effective for taxable years beginning after December 31, 2017, and before January 1, 2029. However, similar to the NOL provisions, the CARES Act suspended the EBL until tax years beginning after 2021.

The EBL limitation applies to noncorporate taxpayers, such as individuals, trusts, and estates, and does not allow a “business” loss to exceed $270,000 for single filers or $540,000 for married joint filers for the tax year 2022, indexed annually.

Example of EBL Limitation

Taxpayer B has a loss of $1 million in 2022 allocated from an S corporation. The S corporation loss is not subject to the basis, at-risk, or PAL limitation. Also, in 2022, B has W-2 wages of $750,000 and capital gains of $250,000 from stock sales.

At first, it appears that B’s taxable income would be $0, after deducting the $1 million S corporation loss. However, B’s taxable income is $730,000. The business loss of $1 million is not fully deductible due to the EBL limitation. For the tax year 2022, a single taxpayer may only deduct $270,000 of the $1 million S corporation loss. The $270,000 limitation will offset the taxpayer’s other income, and therefore the taxpayer will be subject to tax on $730,000 of W-2 and capital gain income. The remaining business loss that is not deductible in 2022 will be carried forward to 2023 as an NOL (and subject to the NOL limitations described above). The amount carried forward is deductible against any source of income during 2023 including wages, interest, dividends, and capital gains.

RVG and Company

The NOL and EBL limitations that restarted in 2021 are complex and potentially interconnected for taxpayers that have income from flow-through entities and other sources. Taxpayers will need to accurately determine their potential losses for each loss category to determine their taxable income and carry forward losses for future tax years.

DISCLAIMER: The information covered in this article is not intended to provide and should not be relied on for tax, accounting, or legal advice; instead, all information, content, and materials informed are for informational purposes only. Consult your tax, legal, or accounting advisor before taking action. If you require advisory services, please contact our office.

If you would like to discuss the impact of the NOL and the EBL limitations, please call RVG & Company at 954.233.1767.

Simply put, the 1031 exchange is an exchange of one real estate investment property for another that allows capital gains taxes to be deferred. By exchanging your appreciated investment or rental property rather than selling it, you may avoid immediate tax on the potential gain.

Learn how Savvy Investors Use Like-Kind Exchange to Defer Capital Gains Taxes.

You can defer tax on the gain through a “like-kind” exchange. Internal Revenue Code § 1031 provides the rules for this. IRC Section 1031 has many moving parts that real estate investors must understand before attempting its use: A taxpayer may sell an investment or business property (relinquished property) and defer tax on the gain if the taxpayer reinvests in a similar property (replacement property). Nonrecognition treatment doesn’t apply to personal property and real property held primarily for sale.

The reason for the nonrecognition treatment is that the taxpayer continues to be invested in the same kind of property and has not cashed out of a real estate investment or business. Therefore, taxes are deferred until the taxpayer does cash out and sells the property outright.

This article will provide an overview of the rules related to a like-kind exchange. It should be noted that in 2021, the Biden Administration sought to revise the benefits of the tax deferral, but those changes were not approved under the Build Back Better legislation. Also, the Inflation Reduction Act of 2022 which was recently passed in August did not alter the rules either. However, taxpayers need to be apprised of this and monitor this potential issue.

Basic Requirements of a Like-Kind Exchange

IRC § 1031 is very form-driven, and taxpayers must satisfy several requirements, or the deferral fails. One important requirement is that the transaction must be structured as an exchange. This means that taxpayers cannot sell, obtain the proceeds, and then buy a replacement property. Rather, they must either trade the property directly or use the deferred exchange rules described below.

Timeline

In a deferred exchange, a taxpayer must identify the replacement property within 45 days (the identification period) and receive it within 180 days (the exchange period). While the tax law allows deferred exchanges, it requires time limits for them to occur.

Basis

Taxpayers take the same “basis” in the replacement property that they had in the relinquished property. Like-kind exchanges are reported on Form 8824 – and this form tracks the basis of the relinquished and replacement properties.

When a property is exchanged solely for another property of a like-kind, computing the basis in the replacement property is straightforward. In that case, the taxpayer’s basis in the replacement property is the taxpayer’s adjusted basis in the relinquished property.

However, the computation of basis is more complicated when the exchanged properties are not equal in value, so money or other property (boot) is transferred or received. If “boot” is involved, the gain is recognized, but only up to the amount of boot received in the exchange.

Also, if the property that is exchanged is subject to debt from which the taxpayer is being relieved, the amount of the debt is treated as boot. The theory is that if someone takes over your debt, it’s the equivalent of providing cash.

Deferred Exchanges

As noted above, for like-kind exchange treatment to apply, there must be an exchange of real properties that are of like-kind and have been held for productive use in a trade or business or for investment. The transaction must be an exchange – not a transfer of property for money that is then used to acquire the replacement property. A sale of property followed by a purchase of another property (that is of a like-kind to the property sold) doesn’t qualify for nonrecognition of gain or loss under IRC § 1031.

Often the properties cannot be exchanged immediately or simultaneously. For this reason, the law permits deferred exchanges. A “deferred exchange” occurs when a taxpayer, under an agreement, transfers the property and later receives like-kind property. To qualify as a deferred exchange, the taxpayer must identify the replacement property before the end of the “identification period,” and receive the replacement property before the end of the “exchange period, as described above. Taxpayers can accomplish a deferred exchange using safe harbor transactions such as a qualified intermediary or guarantee arrangement. Moreover, the transactions become more complex when they involve related parties or Delaware Statutory Trusts.

RVG and Company

While the fundamental principles of the like-kind exchange appear straight-forward, complexities can arise with the calculation of basis and depreciation along with the use of deferred exchanges and the application of the safe harbor rules.

If you would like to discuss the benefits, rules and strategies related to like-kind exchanges, please contact RVG & Company today! (954) 233 1767 | [email protected]

DISCLAIMER: The information covered in this article is not intended to provide and should not be relied on for tax, accounting, or legal advice; instead, all information, content, and materials informed are for informational purposes only. Consult your tax, legal, or accounting advisor before taking action. If you require advisory services, please contact our office.

As we approach Q4, now is the perfect opportunity to review your current situation and implement tax-saving strategies to reduce taxes for the coming year. These steps must be taken before the end of the year to reflected in your tax return due in April. This article will outline several steps that can be taken to minimize 2022 taxes and for taxpayers to establish a fiscal and financial plan for their future.

Simple Strategies that can Provide a Significant Benefit for 2022 and Future Years

Maximize Retirement Benefits

In 2022, contributions to 401K and 403(b) plans can reduce taxable income up to $20,500 (individuals that are 50 or older can add $6,500 to the basic workplace retirement plan contribution). For example, an employee earning $100,000 in 2022 who contributes $19,500 to a 401K, reduces their taxable income to only $79,500. Even small business owners can set up retirement plans such as a SIMPLE IRA, SIMPLE 401K, SEP, and a Solo / One Participant 401K that provide tax savings to the business owners and the employees – while providing a retirement program for the future.

Individuals that do not have a retirement plan at work may obtain tax savings by contributing up to $6,000 ($7,000 for those 50 and older) to a deductible IRA.

Use a Health Savings Account (HSA)

Employees with a high-deductible health insurance plan can use an HSA to reduce taxes. As with a 401K, HSA contributions (which may be matched by the employer) by payroll deduction are excluded from the employee’s taxable income. For 2022, the maximum contribution is $3,650 for individuals and $7,300 for families. These funds can grow without the requirement to pay tax on the earnings. An extra tax benefit of an HSA is that when it is used to pay for qualified medical expenses, withdrawals are not taxed.

Minimizing Capital Gains Taxes

Mutual Fund Distributions – If you are considering the purchase of a mutual fund at the end of the year, delay buying it until after the dividend record date to avoid being taxed on capital gain distributions. Towards the end of the fourth quarter, mutual funds generally declare capital gain distributions. These gains are subject to tax even if reinvested and even if the shares value is less than your purchase price. An alternative to a mutual fund is a passively managed exchange-traded fund, which typically has less capital gain distributions.

Charitable Donations of Appreciated Stock – Consider donating publicly traded stock. Qualified appreciated stock is normally publicly traded stock and is eligible to be deducted at its fair market value. Charitable gifts of real property and closely held stock can only qualify for a donation up to their basis. The publicly traded stock must be held for more than one year. By doing this, taxpayers obtain a double benefit of receiving a deduction equal to the full fair market value of the stock and they avoid paying the capital gains tax on the appreciation. It should be noted that the contribution of long-term appreciated property / qualified appreciated stock is generally limited to 30% of adjusted gross income. Thus, the contribution should be timed so it is made when your income is higher.

Unrealized Gains and Losses – Offset the tax impact of any realized gains taken this year by harvesting losses in your portfolio or, in some cases, realizing gains to offset losses (for example, to reduce concentrated stock positions). Any harvested tax losses not offset by gains in 2022 can be carried forward to future tax years throughout an investor’s lifetime. Taxpayers that harvest losses must avoid the wash-sale rule that will disallow losses. This rule provides, that if a taxpayer sells a security at a loss and buys the same security within 30 days of the sale – that loss will be disallowed.

Review Withholding and Estimated Tax Payments

Underpaid withholding taxes and estimated taxes may be subject to penalties. If you are potentially subject to these penalties, consider increasing withholding taxes from wages and bonuses in the fourth quarter. Amounts withheld in the fourth quarter are deemed to be paid equally over each quarter, which can minimize or eliminate a penalty that may be related to the three prior quarters. Taxpayers that have tax withheld from their wages may generate additional income from investment income or real estate holdings that require additional tax through withholding or estimated payments. To avoid a penalty either 90% of the tax shown on your current return or 110% of the tax on your prior year’s tax return must be paid, certain limitations do apply.

Wills and Trusts

While significant estate and gift planning techniques are beyond the scope of this article, taxpayers should be reminded to review wills and trusts to ensure that they reflect any changes in their personal or financial situation that occurred during 2022 or are likely to occur in 2023. It should be noted that in the Tax Cut and Jobs Act of 2017, the estate, generation-skipping transfer, and gift exclusion amount increased from $5 million to $10 million. Also, the TCJA retained the “step-up” based on fair market value for appreciated assets that are transferred by a decedent. While revisions to this rule have been proposed – it is still available.

RVG &Company

While the fundamental principles of the like-kind exchange appear straightforward, complexities can arise with the calculation of basis and depreciation along with the use of deferred exchanges and the application of the safe harbor rules.

If you would like to discuss the benefits, rules and strategies related to like-kind exchanges, please contact RVG & Company today! (954) 233 1767 | [email protected]

DISCLAIMER: The information covered in this article is not intended to provide and should not be relied on for tax, accounting, or legal advice; instead, all information, content, and materials informed are for informational purposes only. Consult your tax, legal, or accounting advisor before taking action. If you require advisory services, please contact our office.