179 Depreciation

[sriman]

I have a client who purchased a Ford F250 for her business as real estate manager on Schedule C. Her income for her rental properties will go on Schedule E, but she will still have a loss on Schedule E. The schedule C looks like it will be a $100,000 and there will not be an amount for gross receipts and this is the third year of the business. I am concerned about doing the Schedule C, because $40,000 of the loss will be for the IRC 179 depreciation of her truck. She also had $800,000 from a K-1 from a business that she sold in 2007. If she gets audited for the Schedule C, do you think the IRS will allow the $40,000 179 deduction since it creates a greater loss on the Schedule C.

[erchess]

See SB 5-15

The 179 Deduction is limited to taxable income from all the taxpayer''s business activities. Thus your client may not take this election but must depreciate the truck under MACRS unless she has business income you have not mentioned. I am troubled by the idea that a business would have no gross receipts in its third year in business. Unless it had gross receipts in both of years one and two and made a profit in one of those years, I would wonder if she has a hobby rather than a business and would discuss with her the difference. It also sounds to me as though she may have an NOL for 2007.

By the way, I note that this post was put up on Tuesday afternoon my time and I in the wee hours of Wednesday Morning am the first to respond despite the number of looks your post got. I suspect that the reason you got no response is that people figured you are not a tax professional because you appear to not know that a person has to have business income to claim a 179 Deduction. All I can say is that if most of my first paragraph made no sense to you, these people are right and you need to get yourself to a tax professional such as the ones for whom this board is intended and by whom it is paid for. You would not go cruising a website where MDs talk to each other hoping to avoid a trip to your Doctor, or would you?

[DixieEA]

ARRRRR is Pirate

erchess, being from eastern NC I like your ARRRRR is Pirate.

DixieEA

[sriman]

I did not mention the $60,000 income she had from her wages. Which would be considered for her to take the 179 deduction. This is considered in the income for taxable business income.

And I understand the 1st paragraph buddy.

[abby]

may I ask

What kind of properties is she managing and why is she not charging a fee?

My initial thought was that she's created a sched C to manage her own rentals, and I would question that treatment, if this were the case.

[erchess]

Glad to know you are a professional

I did not mention the $60,000 income she had from her wages. Which would be considered for her to take the 179 deduction. This is considered in the income for taxable business income.

And I understand the 1st paragraph buddy.

However I think you're wrong about counting her wages as business income for purposes of the 179 Deduction. However, there are people on this board who know more than I do and you could even be one of them. Let's see if we can get more input on that question.

[Gene V]

However I think you're wrong about counting her wages as business income for purposes of the 179 Deduction. However, there are people on this board who know more than I do and you could even be one of them. Let's see if we can get more input on that question.

Yes, the wages count for the Sec.179 limit.
See the instruction for line 11, Form 4565

[erchess]

Cool

Yes, the wages count for the Sec.179 limit.
See the instruction for line 11, Form 4565

Thank you for the correction.

[sriman]

She told me that her past Schedule C was the management company of the rental properties on Schedule E. Her past tax preparer has been doing this on her last returns. Also, she has three employees. Two are handyman and the other is the bookkeeper. She has five properties and paid her employees 65,000 total. She has a real estate licenses. What are your thoughts?

[abby]

treatment of losses

I have seen this before, where a separate business (C, S Corp, etc) was set up for mangement of self owned rentals, but in every case a reasonable amount of income was classified as Management Fees and declared as income by the management company.

Normally expenses to manage a rental would also go on the schedule E. But, if she is truly running a management business - and employees speak to this, then a schedule C may have some benefits.

Expenses to run management; payroll, benefits, vehicle, etc would go on schedule C. Rental expenses, taxes, insurance, depreciation etc would go on schedule E.

The problem: the method you are describing could have the effect of transferring suspended losses to fully allowed active losses.

As with any related party exchange of business income, there is a high potential for treatment that does not match what one would find in the open market for such services and so is likely to be scrutinized closely - I would suggest that the management fees be at least what she would have to pay to a non-related management company.

I don't know that the setup is prohibited for sched C (as opposed to corp or partnership and would be glad to hear from others on this) but this setup without income in the schedule C is a definitely problematic.

[Bees Knees]

I doubt this arrangement would fly in an audit.

Assume FMV is paid for management fees. That means there is a deduction on Schedule E for management fees paid, and income reported on Schedule C for management fee income. Then Schedule C pays appropriate expenses for wages, etc. and the net profit is subject to SE tax.

What have we done? Transferred a portion of the rental activity income over to Schedule C and subjected it to SE tax. Why would the IRS care? Because IRS is going to claim ALL of the Schedule E income should have been reported on Schedule C as a real estate professional. When the level of activity and services provided moves beyond the rental of investment property, it becomes a trade or business. You can’t carve out portions of the same activity and treat part of it as a business and part as an investment.

This arrangement seems even worse in that apparently management fees are not FMV, thus transferring expenses over to Schedule C from Schedule E but not income. I assume this is in an attempt to avoid passive loss rules and possibly take advantage of Section 179 which is allowed on a Schedule C but not on a Schedule E. The problem is IRS can make a Schedule C business subject to passive loss rules just as easily as a Schedule E.

In any event, this seems to be a risky move. I would inform the client either everything goes on the Schedule E, or the Schedule C, or you find another tax preparer. I am not impressed with the previous preparer’s creativity with this situation. This kind of garbage is why the government keeps tightening the ethics and negligence rules on tax preparers.

[abby]

S corp

Good point about moving the sec 179 from a disallowed entity to an allowed.

I haven't ever seen a rental - unless it is inventory (flipper type activity) or a rentalof the bed & breakfast or short term variety moved to sched C it will always stay on sched E even for a real estate professional - more likely they would want everything moved to sched E.

If she managed other people's property maybe a case could be made for a sched C.

I have, however, seen just such an arrangement pass audit (and more than once) when the management company was a corp - he did not manage other people's rentals from the corp, but did manage some jointly owned property, plus the commissions from brokerage was earned by the corp - so situation was not identical.

I wholeheartedly agree that even if management fees were paid -the current scenario is shaky.