From the Partners...

Navigating the Tax Obstacles of Investing in 2014

By Michael W. Blitstein, CPA

Michael Blitstein - Partner CJBS

It's never been easy to navigate the various tax consequences of buying and selling securities and investments. Among the many obstacles investors need to consider in 2014 is the relatively new net investment income tax ("NIIT"). This 3.8% tax may apply to your net investment income if your income exceeds certain levels. And the tax can show up when you least expect it - for example, passive activity and qualified dividend income are subject to the tax. Some other tax issues related to investing should also be considered.

Capital Gains Tax and Timing

Although time, not timing, is generally the key to long-term investment success, timing can have a dramatic impact on the tax consequences of investment activities. Your long-term capital gains rate might be as much as 20 percentage points lower than your ordinary income rate. The long-term gains rate applies to investments held for more than 12 months. The applicable rate depends on your income level and the type of asset sold. Holding on to an investment until you've owned it more than a year may help substantially cut tax on any gain.

Remember, appreciating investments that don't generate current income aren't taxed until sold. Deferring tax and perhaps allowing you to time the sale to your advantage can help, such as in a year when you have capital losses to absorb the capital gain. If you've already recognized some gains during the year and want to reduce your 2014 tax liability, consider selling unrealized loss positions before the end of the year.

Loss Carryovers

If net losses exceed net gains, you can deduct only $3,000 ($1,500 for married filing separately) of the net losses per year against ordinary income. You can carry forward excess losses indefinitely. Loss carryovers can be a powerful tax-saving tool in future years if you have an investment portfolio, real estate holdings or a practice that might generate future capital gains. Also remember that capital gain distributions from mutual funds can absorb capital losses.

Income Investments

Qualified dividends are taxed at the favorable long-term capital gains tax rate rather than the higher, ordinary income tax rate. Qualified dividends are, however, included in investment income under the 3.8% NIIT.

Interest income generally is taxed at ordinary income rates, which are now as high as 39.6%. Stocks that pay qualified dividends may be more attractive tax wise than other income investments, such as CD's, money market accounts and bonds. Note some dividends are subject to ordinary income rates.

Keep in mind that state and municipal bonds usually pay a lower interest rate, but their rate of return may be higher than the after tax rate of return for a taxable investment, depending on your tax rate. Be aware certain tax-exempt interest can trigger or increase alternative minimum tax.

Mutual Funds

Investing in mutual funds is an easy way to diversify your portfolio. But beware of the tax ramifications. First, mutual funds with high turnover rates can create income that's taxed at ordinary income rates. Choosing funds that provide primarily long-term capital gains can save you more tax dollars. Second, earnings on mutual funds are typically reinvested, and unless you keep track of these additions and increase your basis accordingly, you may report more gain than required when you sell the fund.

Additionally, buying equity mutual fund shares later in the year can be costly tax wise. Such funds often declare a large capital gains distribution at year-end. If you own shares on the distribution record date, you'll be taxed on the full distribution amount even if it includes significant gains realized by the fund before you owned the shares. And you'll pay tax on those gains in the current year, even if you reinvest the distribution.

Paying Attention to Details

If you don't pay attention to details, the tax consequences of a sale may be different from what you expect. For example, the trade date, not the settlement date, of publicly traded securities determines the year in which you recognize the gain or loss. And if you bought the same security at different times and prices and want to sell the high tax basis shares to reduce gain or increase a loss to offset other gains, be sure to specifically identify which block of shares is being sold.

Passive Activities

If you've invested in a trade or business in which you don't materially participate, remember the passive activity rules. Why? Passive activity income may be subject to the 3.8% NIIT, and passive activity losses generally are deductible only against income from other passive activities. Disallowed losses can be carried forward to future years, subject to the same limitations.

The Internal Revenue tax code is ever evolving and recent tax law changes have provided increased complexity. Tax obstacles related to investing is just one reason why it's important to plan ahead and consider taking advantage of strategies available to you. You should always consult with your tax adviser to determine the best course of action.

Michael W. Blitstein, CPA is a partner with the firm of CJBS, LLC, in Northbrook, Illinois. For more than 30 years, Michael has worked closely with the dental community and is intimately familiar with the unique professional and regulatory challenges of creating, running and maintaining a successful dental practice. Michael advises his clients on tax, business and retirement planning, developing short and long-term strategic plans designed to achieve success for dental practice principals and their businesses.

He can be reached at michael@cjbs.com



Cost Segregation Studies - Reduce Your Tax Liability and Increase Cash Flow

By Michael W. Blitstein, CPA

Michael Blitstein - Partner CJBS

If you own or lease a building, cost segregation is a powerful strategy to reduce your tax liability, thereby increasing cash flow. The IRS has issued final regulations regarding the deduction and capitalization of expenditures related to tangible property. Any building or office space with past or current build-out or renovation costs should have these costs analyzed to see if they qualify. The new regulations are effective starting January 1, 2014 but may be applied to tax years 2012 and 2013.

Cost segregation is an engineering-based analysis of the components of a commercial property, including intangibles and leasehold improvements, with the goal of identifying and segregating personal property from real property. Commercial buildings and leasehold improvements generally can be depreciated over a 39 year period. Cost segregation reclassifies the components of building and leasehold improvements into shorter class lives. For example, a building's floor, roof and walls might be classified as 39 year real property. However, site improvements would be classified as 15 year real property; communications equipment and similar components as seven year tangible personal property; and computer associated items as five year personal property. By doing so, the tax deductions for depreciation based on reclassifying assets to shorter depreciation lives create tax benefits through the use of accelerated depreciation.

It is beneficial to incorporate cost segregation as early in the process as possible in the construction and build-out stage in order to maximize the tax benefit. You can also recapture understated or missed depreciation for past construction, purchases, expansions, renovations and leasehold improvements. The new regulations do not require amended tax returns. A provision for "catch up" depreciation is taken in one year by filing Form 3115, Change in Accounting Method.

The new regulations also provide significant modifications and guidance regarding the deduction and capitalization standards and how they are applied to buildings and structural components. Costs you have capitalized, even in past years, may be eligible to be reclassified as expenses through an analysis of your expenses for repairs and maintenance and a review of your capitalized assets.

Future repairs and maintenance costs must be viewed and assessed based on nine different "unit of property" categories. These categories include the building structure, HVAC system, plumbing, electrical, escalators, elevators, fire protection, security systems, and gas distribution systems.

Traditional cost segregation studies provide a high level of detail when identifying and reclassifying personal property in a building. This high level of detail was not necessary for structural components as losses upon disposition were not previously allowed to be recognized. Now there is a solution as regulations allow the recognition of a loss upon disposition and require greater detail in identifying repair expenses.

Enhanced cost segregation studies will provide for the maximization of benefits by providing additional detail necessary to recognize a current or future repair expense or disposition. This includes the organization costs in the "units of property" discussed above, and detailed identification of major components of roofing, electrical, mechanical and plumbing systems for ease in identifying future dispositions.

The benefits of cost segregation result in a deferral of tax payment and accelerated depreciation. Each dollar that is reclassified into a seven year class life provides 15-20% in the cumulative present value of taxes deferred. Similarly, each dollar that is reclassified into a seven year class life provides 19-23%. The exact amounts vary depending on individual circumstances.

In summary, cost segregation provides an immediate reduction in tax liability and can be a useful way to increase cash flow. You have the ability to write off building structural components for items replaced or items abandoned during renovations. This includes any repairs or renovations done in the past. Structural components of a building include items such as lighting, roofs, HVAC systems, interior and exterior walls, etc. The benefits can be astounding but the window for allowing past renovations may be closing fast. Consideration should be given to have these studies done now. After all, who thinks they don't pay enough tax?

Michael W. Blitstein, CPA is a partner with the firm of CJBS, LLC, in Northbrook, Illinois. For more than 30 years, Michael has worked closely with the dental community and is intimately familiar with the unique professional and regulatory challenges of creating, running and maintaining a successful dental practice. Michael advises his clients on tax, business and retirement planning, developing short and long-term strategic plans designed to achieve success for dental practice principals and their businesses.

Michael can be reached at michael@cjbs.com

©2017 CJBS | 2100 Sanders Road, Suite 200, Northbrook, IL 60062-6141 • Tel: 847-945-2888 • Fax: 847-945-9512