Let’s say you own highly appreciated land that’s now ripe for development. If you subdivide it, develop the resulting parcels, and sell them off for a hefty profit, it could trigger a large tax bill.

In this scenario, the tax rules generally treat you as a real estate dealer. That means your entire profit — including the portion from pre-development appreciation in the value of the land — will be treated as high-taxed ordinary income subject to a federal rate of up to 37%. You may also owe the 3.8% net investment income tax (NIIT) for a combined federal rate of up to 40.8%. And you may owe state income tax too.

It would be better if you could arrange to pay lower long-term capital gain (LTCG) tax rates on at least part of the profit. The current maximum federal income tax rate on LTCGs is 20% or 23.8% if you owe the NIIT.

Potential tax-saving solution

Thankfully, there’s a strategy that allows favorable LTCG tax treatment for all pre-development appreciation in the land value. You must have held the land for more than one year for investment (as opposed to holding it as a real estate dealer).

The portion of your profit attributable to subsequent subdividing, development, and marketing activities will still be considered high-taxed ordinary income, because you’ll be considered a real estate dealer for that part of the process.

But if you can manage to pay a 20% or 23.8% federal income tax rate on a big chunk of your profit (the pre-development appreciation part), that’s something to celebrate.

Three-step strategy

Here’s the three-step strategy that could result in paying a smaller tax bill on your real estate development profits.

1. Establish an S corporation

If you individually own the appreciated land, you can establish an S corporation owned solely by you to function as the developer. If you own the land via a partnership, or via an LLC treated as a partnership for federal tax purposes, you and the other partners (LLC members) can form the S corp and receive corporate stock in proportion to your percentage partnership (LLC) interests.

 

2. Sell the land to the S corp

 

Sell the appreciated land to the S corp for a price equal to the land’s pre-development fair market value. If necessary, you can arrange a sale that involves only a little cash and a big installment note the S corp owes you. The business will pay off the note with cash generated by selling off parcels after development. The sale to the S corp will trigger an LTCG eligible for the 20% or 23.8% rate as long as you held the land for investment and owned it for over one year.

3. Develop the property and sell it off

The S corp will subdivide and develop the property, market it, and sell it off. The profit from these activities will be higher-taxed ordinary income passed through to you as an S corp shareholder. If the profit is big, you’ll probably pay the maximum 37% federal rate (or 40.8% percent with the NIIT. However, the average tax rate on your total profit will be much lower, because a big part will be lower-taxed LTCG from pre-development appreciation.

Favorable treatment

Thanks to the tax treatment created by this S corp developer strategy, you can lock in favorable treatment for the land’s pre-development appreciation. That’s a huge tax-saving advantage if the land has gone up in value. Consult with us if you have questions or want more information.

© 2023

An estimated 190 million Americans have recently been under heat advisory alerts, according to the National Weather Service. That may have spurred you to think about making your home more energy efficient — and there’s a cool tax break that may apply. Thanks to the Inflation Reduction Act of 2022, you may be able to benefit from an enhanced residential energy tax credit to help defray the cost.

Eligibility rules

If you make eligible energy-efficient improvements to your home on or after January 1, 2023, you may qualify for a tax credit of up to $3,200. You can claim the credit for improvements made through 2032.

The credit equals 30% of certain qualified expenses for energy improvements to a home located in the United States, including:

1. Qualified energy-efficient improvements installed during the year,
2. Residential “energy property” expenses, and
3. Home energy audits.

There are limits on the allowable annual credit and on the amount of credit for certain types of expenses.
The maximum credit you can claim each year is:

1. $1,200 for energy property costs and certain energy-efficient home improvements, with limits on doors ($250 per door and $500 total), windows ($600 total), and home energy audits ($150), as well as
2. $2,000 per year for qualified heat pumps, biomass stoves, or biomass boilers.

In addition to windows and doors, other energy property includes central air conditioners and hot water heaters.

Before the 2022 law was enacted, there was a $500 lifetime credit limit. Now, the credit has no lifetime dollar limit. You can claim the maximum annual amount every year that you make eligible improvements until 2033. For example, you can make some improvements this year and take a $1,200 credit for 2023 — and then make more improvements next year and claim another $1,200 credit for 2024.

The credit is claimed in the year in which the installation is completed.

Other limits and rules

In general, the credit is available for your main home, although certain improvements made to second homes may qualify. If a property is used exclusively for business, you can’t claim the credit. If your home is used partly for business, the credit amount varies. For business use up to 20%, you can claim a full credit. But if you use more than 20% of your home for business, you only get a partial credit.

Although the credit is available for certain water heating equipment, you can’t claim it for equipment that’s used to heat a swimming pool or hot tub.
The credit is nonrefundable. That means you can’t get back more on the credit than you owe in taxes. You can’t apply any excess credit to future tax years. However, there’s no phaseout based on your income, so even high-income taxpayers can claim the credit.

Collecting green for going green

Contact us if you have questions about making energy-efficient improvements or purchasing energy-saving property for your home. The Inflation Reduction Act may have other tax breaks you can benefit from for making clean energy purchases, such as installing solar panels. We can help ensure you get the maximum tax savings for your expenditures. Stay cool!

© 2023

If you’re planning your estate or you’ve recently inherited assets, you may be unsure of the “cost” (or “basis”) for tax purposes.

How do the rules work?

Under the current fair market value basis rules (also known as the “step-up and step-down” rules), an heir receives a basis in inherited property equal to its date-of-death value. So, for example, if your grandfather bought stock in 1940 for $600 and it’s worth $1 million at his death, the basis is stepped up to $1 million in the hands of your grandfather’s heirs — and all of that gain escapes federal income tax.

The fair market value basis rules apply to inherited property that’s includible in the deceased’s gross estate, and those rules also apply to property inherited from foreign persons who aren’t subject to U.S. estate tax. It doesn’t matter if a federal estate tax return is filed. The rules apply to the inherited portion of property owned by the inheriting taxpayer jointly with the deceased but not the portion of jointly-held property that the inheriting taxpayer owned before his or her inheritance. The fair market value basis rules also don’t apply to reinvestments of estate assets by fiduciaries.

What if assets are given before death?

It’s crucial to understand the current fair market value basis rules so that you don’t pay more tax than you’re legally required to.

For example, in the above example, if your grandfather decides to make a gift of the stock during his lifetime (rather than passing it on when he dies), the “step-up” in basis (from $600 to $1 million) would be lost. Property that has gone up in value acquired by gift is subject to the “carryover” basis rules. That means the person receiving the gift takes the same basis the donor had in it ($600 in this example), plus a portion of any gift tax the donor pays on the gift.

A “step-down” occurs if someone dies owning property that has declined in value. In that case, the basis is lowered to the date-of-death value. Proper planning calls for seeking to avoid this loss of basis. Giving the property away before death won’t preserve the basis. That’s because when property that has gone down in value is the subject of a gift, the person receiving the gift must take the date of gift value as his basis (for purposes of determining his or her loss on a later sale). Therefore, a good strategy for a property that has declined in value is for the owner to sell it before death so he or she can enjoy the tax benefits of the loss.

Need help with estate planning and taxes?

These are the basic rules. Other rules and limits may apply. For example, in some cases, a deceased person’s executor may be able to make an alternate valuation election. Contact us for tax assistance when estate planning and taxes as they relate to inheritances.

© 2023

The rise of remote work has created new challenges for businesses when it comes to tax compliance. With employees working from all over the world, it can be difficult to keep track of where they are working and what taxes they owe.

In this article, we will discuss the nuances of tax compliance for remote workers and provide tips for ensuring your remote workforce stays tax compliant.

1. Understand the tax implications of remote work

The first step to ensuring tax compliance for remote workers is to understand the tax implications of remote work. This includes understanding the different tax laws that apply to remote workers, as well as the different ways that remote workers can be taxed.

For example, in the United States, remote workers are typically taxed based on their state of residence. However, there are some exceptions to this rule, such as if the remote worker spends a certain amount of time working in another state.

2. Establish clear policies and procedures

Once you understand the tax implications of remote work, you need to establish clear policies and procedures for your remote workforce. These policies and procedures should outline how you will track the location of your remote workers, how you will determine their tax liability, and how you will determine their tax liability and remittance.

3. Stay up-to-date on tax laws

The tax laws that apply to remote workers are constantly changing. It is important to stay up-to-date on these changes so that you can ensure that your remote workforce is always tax compliant.

There are a number of resources that you can use to stay up-to-date on tax laws, such as the IRS website, the website of your state’s tax department, or by consulting your Whalen CPA advisor.

4. Use a tax compliance software

There are a number of tax compliance software programs that can help you to manage the tax liability of your remote workforce. These software programs can help you to track the location of your remote workers, determine their tax liability, and collect and remit taxes.

Using a tax compliance software program can help to simplify the process of tax compliance for remote workers and help you to avoid costly mistakes.

5. Work with a tax professional

If you are unsure about the tax implications of remote work or if you need help establishing clear policies and procedures, you should work with a Whalen tax professional. A tax professional from Whalen can help you to understand the tax laws that apply to remote workers and help you to develop a tax compliance plan for your remote workforce.

 

Navigating tax compliance for remote workers can be complex. However, by following the tips in this article, you can ensure that your remote workforce stays tax compliant.

By understanding the tax implications of remote work, establishing clear policies and procedures, staying up-to-date on tax laws, and working with a tax professional, you can simplify the process of tax compliance for remote workers and help avoid costly mistakes. Contact us to take the next step.