Charles Blair, DDS and
John McGill, MBA, CPA, JD
I am a semi-retired dentist and have a personal residence now valued at $350,000. My cost basis in this home is $150,000, including the cost of improvements made to the home over the years.
Unfortunately, I do not have adequate records to support my total cost basis of $150,000, since these records have been lost or destroyed over the years. If I do not have these records, how can I support my cost basis for tax purposes?
In addition, I am considering transferring title to my personal residence to one or both of my children. How can I do this to avoid federal and state gift taxes and not use up my $125,000 gain exclusion?
When records have been lost, stolen or destroyed over time, the tax basis of your personal residence must simply be determined through the best records available. For starters, revenue stamps attached to the deed, transferring title of the property to you, would often be helpful in determining the original purchase price that you paid.
If no other records are available documenting your improvements, you should simply prepare an affidavit in which you outline the specific improvements that have been made over the years with their estimated cost. Sign this affidavit under penalties of perjury and have it notarized.
Alternatively, if there are contractors who constructed the improvements to your home, you could produce an affidavit from them regarding the work they did and their estimated costs or actual invoices, if available. In your particular situation, going through these steps will produce the best records available. Certainly, we can think of no other steps that could be taken by the IRS that could produce better evidence in your case.
We would recommend caution before transferring title of your personal residence to one or both of your children. While, initially, this sounds like an excellent means of transferring this asset out of your estate to avoid future death taxes, this usually proves to be a mistake for several reasons.
First, if you retain title to your personal residence until your death, the home will receive a "stepped-up" basis to its current fair-market value ($350,000 or higher at date of death), so that future federal and state income taxes from the sale of the residence will be eliminated. If your taxable estate does not exceed $600,000, you will owe no federal and, in most cases, no state death taxes on the property in any event.
Transferring title to your children will eliminate the possibility of deferring any gain from the sale of the residence that you would otherwise have. Also, it would eliminate the potential $125,000 gain exclusion, if you sell and do not reinvest. Finally, President Clinton has outlined tax proposals for 1997 that include eliminating all taxes on capital gains arising from the sale of a personal residence.
Accordingly, transferring your property to your children would not be in your best interests.
I am interested in learning more about the proper payment of disability-insurance premiums. I understand that you recommend that disability-insurance premiums be paid personally and the corporation then reimburses for that expense at the end of the policy year. You also indicate that the reimbursement is not considered as taxable income to the doctor. Does my S corporation have to file any forms with the IRS to take advantage of this benefit?
The correct strategy for the payment of disability-insurance premiums is to pay these personally. In the event you are not disabled at the close of the policy year, the corporation would reimburse you. In this manner, the reimbursements would be fully deductible to your professional corporation.
If you are disabled, no reimbursement would be made and you could take the position that the disability-insurance proceeds received are tax-free, since the premium for that particular policy year was paid personally. The IRS does not require that any forms be filed with it in order to take advantage of the tax-free reimbursement of the personally-paid premiums.
However, this strategy applies only in the context of a regular C corporation. While an S corporation has many advantages, one disadvantage is the loss of tax-free fringe benefits to the doctor and his or her family. While the premiums paid by your S corporation would be deductible, the same amount would constitute taxable income to you under the S corporation rules.
Accordingly, if you operate as an S corporation, the preferred strategy would be simply to pay these premiums personally without receiving any reimbursement from your corporation at yea- end.
My Schedule C practice net income now exceeds $200,000 per year. Depreciation, interest, and property-tax expense, allocable to my personally-owned office building and equipment, are included on my Schedule C and now amount to approximately $21,000, and are declining on an annual basis.
On the other hand, as a result of prior investments in real-estate limited partnerships and individually-owned, real-estate condominiums, I now have over $50,000 in accumulated passive losses from these activities.
My accountant has come up with an idea. He would like to create an entity into which we transfer the title to the building, land, and equipment. This equipment would then charge rent back to my practice of $3,000-$4,000 a month to create passive income to offset these passive losses. This also would reduce the 2.9 percent Medicare payroll tax that otherwise applies to 100 percent of my net-practice income, as shown on Schedule C.
What do you think of this idea?
Assuming that the transaction is properly structured, we believe that this strategy could be effective in reducing your Medicare payroll-tax liability, as well as potentially generating passive income to offset your accumulated passive losses. However, the key in structuring this transaction is to assure that the taxable income, generated through the leasing activity, constitutes passive income.
As a general rule, the IRS has maintained that a doctor personally leasing assets, such as this, to his corporation constitutes active, and not passive, income and, thereby, would not succeed in achieving the desired result. However, through utilizing a properly-structured limited-liability company or family-limited partnership as the lessor, you may be able to achieve the desired result.
What constitutes a "business vehicle" and what are the normal rules associated with deductions for business cars? Also, what is the depreciation period for utility vehicles?
As a general rule, any automobile, truck or van that is used for business purposes would qualify for tax deductions as a business vehicle. Doctors are allowed to deduct a portion of the purchase price of the auto, based upon their percentage of business use. Business cars that cost less than $12,500 may be depreciated over a five-year period. However, certain passenger automobiles costing in excess of this amount are defined as luxury automobiles and require a longer depreciation period. Sport utility vehicles weighing in excess of 6,000 pounds fully loaded are not considered to be passenger cars and avoid the longer depreciation period otherwise associated with luxury autos. These sport utility vehicles generally can be depreciated over a six-year period.
In addition, doctors also are entitled to deduct a percentage of the operating expenses of the auto. The percentage of deductibility is determined by the percentage of total use that is allocable to their business use. The operating expenses of the auto include expenses for gas, oil, repairs, maintenance, insurance, taxes, tags, licenses, tires, tubes, etc.
My 15-year-old granddaughter just got her first summer job. Since she won`t earn much, I`d like to give her some extra cash. Could she use this gift to open an IRA, and what do you think of this idea?
We highly recommend utilizing IRA accounts to shelter children`s earned income, provided that the funds will not be needed for college education expenses in the future. Under current tax laws, your granddaughter is eligible to contribute an amount equal to the earned income for the calendar year, up to a maximum of $2,000. For example, if she earns only $1,500, she can make a tax-deductible IRA contribution of only $1,500. Her IRA contribution still would be restricted to $1,500 even if she had additional investment (unearned) income.
The source of funds for the IRA contribution is not relevant. For example, if she earned $2,000 for her summer work, she could spend the entire amount and you could gift her the $2,000 necessary to fully fund her IRA.
The decision not to allow minors to establish IRA accounts is not found within the tax laws, but simply is a self-imposed restriction by many investment firms to avoid future lawsuits.
Dr. Blair (left) is a nationally known consultant and lecturer. McGill is a tax attorney and MBA. They are the editors of the Blair/McGill Advisory, a monthly newsletter helping dentists to maximize profitability, slash taxes and protect assets. The newsletter ($130 a year) and consulting information are available from Blair/McGill and Co., 4601 Charlotte Park Drive, Suite 230, Charlotte, NC 28217; (704) 523-5882.