Q If I buy a rental property now, can I deduct rental losses?
A Passive activity loss rules were designed to curb abuse of perceived tax shelters. Rental activity is considered a passive activity. Generally, taxpayers can use passive losses and deductions only to offset passive income and gains. There is a favorable exception for rental real activities that allows $25,000 of net passive losses from such activities to be offset with nonpassive income such as salary income.
There are two requirements to be met. One is active participation and other is a phase out for taxpayers with higher adjusted gross income (AGI). Active participation standards are much less stringent. It does not require regular, continuous, and substantial involvement but participation in management decisions or arranging for others to perform services. The $25,000 allowance starts phasing out when modified AGI exceeds $100,000 and is reduced by 50% of the amount by which modified AGI exceeds $100,000. It gets completely phased out at for taxpayers with modified AGI of $150,000. If AGI is higher, passive losses get suspended and can be offset with future passive income or deductible in full in the year that activity is sold.
Q I want to start a business. What kind of entity should I establish it under?
A Is the business idea still at an exploratory stage or do you already have a business plan with assessment of funding needs, industry experience, and management in place? The entity needs to be selected once the business plan is in place and market feasibility study has been done. For closely held businesses, the choices are sole proprietorship, partnership or LLC, or a corporation. Operating as a sole proprietor or general partnership, one has unlimited liability. Members of LLC will not be personally liable for the debts of the entity and liability is limited to member’s capital contributions. An LLC with two or more members is treated as a partnership unless the LLC elects to be treated as a corporation. A one-person LLC is considered a “disregarded entity” under federal law and treated as a sole proprietorship. LLCs are subject to an $800 annual tax if they are doing business in California. Also, in California, every LLC must pay a fee based on total income which can range from $0 to $11,790. LLCs are issued Form 1099 if provide consulting services. A corporation can be a regular or S Corporation. An S corporation is a flow-through entity and is preferred for closely held businesses.
Tax Planning: The annual tax time is a good time to review retirement goals, retirement contributions, review of risk tolerance, asset allocation, education funding review, and other long term financial goals. For any additional tax questions, please go to www.irs.gov.
Parveen Maheshwari is a Certified Public Accountant. He can be reached at 650-340-1400 or [email protected]