Memo
To: John and Jane Smith
From: Your Name, CPA
Date: February 2, 2013
Subject: Explanation of business and personal tax benefits and liabilities.
1(a). As a result of a recent court settlement for a client John earned $300,000 for his law practice LLC. He wants to minimize his tax liability and understand how the IRS will treat this money earned. He lease’s office space for $3,500 per month. He wants to know the advantages in leasing office space versus purchasing the building.
John has income derived from a business and as such the gross income will be taxable (Code §1.61-3(a)) (Tax Almanac, 2005). This $300,000 taxable income will pass through to his personal taxes and is subject to self employment tax since he has an LLC. He…show more content… 2009, June 18, . Internal Revenue Code:Sec. 163. Interest). With the sale of their current home, they would be able to exclude the gain from the sale for up to $500,000 (Code §121(b)(1) and (2)) (Tax Almanac. 2009, June 18, Internal Revenue Code:Sec. 121. Exclusion of Gain from Sale of Principal Residence). If the sale of their new home the gain is more than $500,000, then they would have to pay tax on the amount over at a rate of 25%.
2(b) Jane has inquired about the 1031 tax exchange if they could use that plus some of John’s money from the case to purchase a more expensive house.
The words “like-kind” are important. It refers to the nature of property (Reg. §1.1031 (a)-1(b) (Exeter- 1031 Exchange LLC, 2013, p. 5). The exchange of real property for real property generally does qualify for the like-kind exchange, but in this case you will be getting a more expensive type of property (Rev. Proc. 87-56, 1987-2 CB 674) (Revenue Rulings, Revenue Procedures, Notices and Announcements, 2007). This gives a gain on the property, and this code section states no gain or loss shall be allowed. Adding money in the exchange or boot as it is referred to you would most likely have to recognize a gain and pay tax on that gain (Code §1031(b)) (26 USC § 1031 - Exchange of Property Held for Productive Use or Investment, 2013).
John and Jane would not be able to use 1031 tax exchange to purchase a more expensive home. The new home
