McLaughlin & Quinn, LLC - Providence | Boston

Tax law is a complex area of the law and you may need a Tax Attorney to help solve a difficult tax issue, strategize for maximum tax benefit, or to develop a long-term tax plan. Both individuals and businesses may benefit from the advice of an experienced tax attorney with common issues like 1031 exchanges, capital gains planning, real estate tax planning, and asset protection planning.

Selecting the right Tax Attorney for your tax issue is critical. Look for an attorney who has been successful in working with clients like you. Things to look for include licensure by bar association(s), certifications by professional organizations, an advanced degree such as a Masters of Law in Taxation, affiliations with state and national tax associations, previous employment with the Internal Revenue Service, and of course relevant experience.

The Internal Revenue Code defines Gross Income as income from derived all sources whatsoever.  Taxable Income is Gross Income less allowable deductions.  For individuals, these deductions may be Schedule A deductions or personal exemptions.  For businesses, these deductions will be reasonable expenses incurred in the ordinary course of your business.

Ordinary Income is all types of income, generally derived from employment or business activities.  Capital Gains result from the sale of Capital Assets.  Capital Assets are assets that are held form investment and are not held for sale to customers in the ordinary course of a trade or business.

Certain steps can be taken to restructure ownership holdings in order to meet the requirements of the Internal Revenue Code.  In doing so, assets can be properly classified as Capital Assets.

If you intend to acquire additional investment property, then a 1031 Exchange may be the right answer.  Click here for more information on 1031 Exchanges.

If you intend to provide seller financing and hold a promissory note, then you may be able to report the sale on the installment method of accounting and recognize the gain as you receive payments over time.

In certain circumstances, you can avoid paying taxes by offsetting your gain against other losses, either current losses or losses that have been carried forward. Many more opportunities exist, depending upon your unique situation.

Most developers and home builders are referred to for tax purposes as dealers.  In other words, all of their income is taxed as ordinary since there are in the business of selling real estate.  As a result, they pay taxes at the highest marginal income tax rates.  If structured properly, most of the income can be converted to long-term capital gain and will be taxed at the much-lower long-term capital gains rates.

Great care must be exercised in undertaking this type of planning.  While a multitude of court cases exist detailing how to achieve this substantial tax savings, the specific facts of each case will dictate how to proceed and the likelihood of success.

Gain or loss is determined for tax purposes as your Amount Realized less your Adjusted Basis.  Amount Realized is generally all value you receive for the sale of your property, including cash, promissory notes, and debts that are paid off.

"Basis" is your investment in property for tax purposes. Before you can figure any gain or loss on a sale, exchange or other disposition of property, or figure allowable depreciation, you must determine the "adjusted basis." Adjusted Basis is the result of increasing or decreasing your Original Basis according to certain events. Your Original Basis is usually your cost to acquire the asset.

If you meet the ownership and use tests, you will generally only need to report the sale of your home if your gain is more than $250,000 ($500,000 if married filing a joint return). This means that during the five-year period ending on the date of the sale, you must have:

• Owned the home for at least two years (the ownership test), and
• Lived in the home as your main home for at least two years (the use test)

The best entity to use for holding real estate is a Limited Liability Company that is taxed as a Partnership.  The Partnership tax rules provide the greatest amount of flexibility for tax purposes while a Limited Liability Company provides significant investment and operational flexibility.  As a general rule, real estate should not be owned by a Corporation, even a Subchapter S Corporation.  Many reasons exist as to why.  In Massachusetts, we often see real estate owned by Nominee Trusts.  By themselves, Massachusetts Nominee Trusts provide no level of protection from liabilities.

Different tax rules apply to different types of entities. Subchapter C Corporations are taxed at the entity level.  Dividends paid to the shareholders of the C Corporation are taxed again. 

Subchapter S Corporations are pass-though entities, meaning that they pay no Federal taxes.  The shareholders report their proportionate share of the income on their personal returns.  However, in certain situation, an S Corporation may be subject to an entity-level tax.

Limited Liability Companies are either taxed as Partnership, or if they file a proper election, may be taxed as a Corporation, either an S Corporation or a C Corporation.  Generally, though, the preference is to have the LLC taxed as a partnership and pass the income and losses through to the members.

General Partnership and Limited Partnership pay no entity-level taxes.  Rather, their income and losses are passed through to the partners who report the income and loss on their personal returns.

Trusts can be taxed in many different ways.  The income and losses from grantor trusts are taxed directly to the settler of the trust.  Other types of trust may pay their own taxes or can possibly avoid taxes by making distributions to the beneficiaries.

In a typical transaction, the property owner is taxed on any gain realized from the sale. However, through a Section 1031 Exchange, the tax on the gain is deferred until some future date. Section 1031 of the Internal Revenue Code provides that no gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment. A tax-deferred exchange is a method by which a property owner trades one or more relinquished properties for one or more replacement properties of "like-kind," while deferring the payment of Federal income taxes and some State taxes on the transaction. The theory behind Section 1031 is that when a property owner has reinvested the sale proceeds into another property, the economic gain has not been realized in a way that generates funds to pay any tax. In other words, the taxpayer's investment is still the same, only the form has changed (e.g. vacant land exchanged for apartment building). Therefore, it would be unfair to force the taxpayer to pay tax on a "paper" gain. The like-kind exchange under Section 1031 is tax-deferred, not tax-free. When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

To learn more about 1031 exchanges click here.

Due to the vital role played by a Qualified Intermediary in documenting the 1031 Exchange and safeguarding the taxpayer's funds, and due to the lack of licensing requirements, the selection of a Qualified Intermediary is a vital decision. The taxpayer should select a Qualified Intermediary that will facilitate the Exchange in compliance with the tax rules, will take appropriate steps to safeguard the funds, and is reputable.

Many steps can be taken to avoid or minimize the Federal and State estate taxes.  These steps range from the simple to the complex.  Merely transferring property between spouses so that they each have an equal amount of assets in their own names may be enough to eliminate the entire Federal and State estate tax liability.  Executing a proper will and revocable living trust is also one of the most important steps that can be taken.  Additional steps are available depending upon your level of wealth and the types of assets you own.