Here are several recent experiences that have lessons, plus a thought on the upcoming tax legislation:
TRADING INTO A LEASE
With cash-flow tight and income taxes not an issue for many producers, here’s an idea if a major piece of equipment needs to be replaced. Assume it’s an old tractor that’s fully depreciated but has a market value of $80,000. Rather than a traditional trade-in, consider applying that equity into an operating lease of the replacement asset.
The like-kind exchange rules don’t apply because there’s no ownership in the replacement property. As a result, the trade value of the old asset used to reduce the future lease payments is treated as income at the point of the trade.
So, if the trade was worth $80,000, and that reduces payments on a four-year lease, there is $80,000 of immediate income not subject to self-employment tax, but in turn, a $20,000-per-year deemed rental payment deduction over the four-year lease (which will reduce self-employment income). This can help fill a current void in taxable income, effectively trading current income for future rent deductions.
And there are cash-flow benefits, as well. That $80,000 of trade equity reduced the actual cash payments under the lease, and the residual value of the asset further reduced the annual lease payments. Of course, during leasing years, no equity is being built, but let’s worry about survival first.
IRS MATCHING NOTICES
A client recently received a computerized IRS assessment on his 2015 return based on a $25,000 IRA rollover. He had simply rolled an IRA from one institution to another, a nontaxable event. The $25,000 was properly disclosed in his return, with the taxable amount as zero because of the rollover transaction. The IRS computers somehow misread this, and now we are in need of a lengthy written response with supporting documentation to the IRS. Most tax professionals continue to be frustrated by frequent IRS computer errors. The message to taxpayers: Never assume anything from the IRS is correct. See your tax professional if any assessment is sent your way by the IRS.
PENDING TAX LEGISLATION
At this point, the outcome of federal income tax reform is uncertain. The best sense of overall direction can be found in a document released by the House last year (“A Better Way,” June 24, 2016). In addition to an overall decrease in tax rates, this plan discusses eliminating virtually all itemized deductions except charitable contributions and home mortgage interest. Presently, home mortgage interest on up to $1.1 million of debt is deductible, whether involving a principal residence or a secondary vacation home. Reading between the lines of this blueprint, I would expect the new rules to eliminate deductible mortgage interest for that second home. But the document also reads, “No existing mortgage would be affected by any changes in the tax code.” Taken at its face value, this suggests acting sooner rather than later if you are considering acquisition of a vacation property.
Tax Columnist Andy Biebl is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in New Ulm and Minneapolis, Minn.
Read Andy’s “Ask the Taxman” columns at https://www.dtnpf.com/….
You may email Andy at firstname.lastname@example.org