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R. Klein, EA
R. Klein, EA, Enrolled Agent
Category: Tax
Satisfied Customers: 2927
Experience:  Over 20 Years experience
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IRS is auditing my business, HELP!!! My business is buying

Customer Question

IRS is auditing my business, HELP!!! My business is buying vacant land, cheap through tax lien foreclosure and then selling it. I own 125-vacant lots. Business is BAD, I haven't made a profit in years. My biggest expense is paying the property taxes on the vacant lots. I deduct the taxes on Schedule C. IRS is "disallowing" ALL my Schedule C expenses, including use of car, home office, postage . . . I have receipts for everything.
Submitted: 1 year ago.
Category: Tax
Expert:  R. Klein, EA replied 1 year ago.

Randalltax :

Hi sorry to hear of your predicament today.

Randalltax :

Usually, the IRS does not simply disallow expenses. The taxes are a special situation I will address in a moment, but did the IRS give you some reason for the disallowance of the other items?

Randalltax :

Did you have any sales during the year in question?

Customer:

Hi, thx for your response. On Form 886-A they said since my business did not make a profit in three out of five years per IRC 183(d) it is "presumed" that "an activity is not a business." (I sent them all my receipts and this was their reply.)

Randalltax :

Aha!

Randalltax :

First off, had you been deducting the property taxes each year?

Customer:

yes,

Customer:

the property is like inventory

Randalltax :

Property ta is NOT deductible each year for raw land you hold.

Randalltax :

This and any other indirect cost must be Capitalized....added to your cost of the land.

Customer:

oh, god, i'm soooo screwed!

Randalltax :

If you buy a property for 50K and hold it for 10 years before selling and pay $1K tax each year, you don't deduct the 1K tax each year.

Randalltax :

Instead it is added to your cost. So if you sold the property for 100K, your profit would be 100K-(50k + 10K) = 40K profit

Randalltax :

The good news is the IRS can only go back to 2010 returns now.

Randalltax :

But, if you prove that you have a long-term horizon, the 3 of 5 rule is NOT absolute.

Customer:

Oh dear, the state audited my income tax last year and didn't find anything wrong. Thx so much for your advice!!!

Randalltax :

There are many businesses that lose for 5,6 , or 7 years to get a huge profit later.

Customer:

oh . . . I expect to make profit

Customer:

i'm still confused???

Randalltax :

State returns follow the federal. It isn't a stand-alone.

Randalltax :

Yo have to prove your business model is a long-term hold.

Customer:

i homestly don't think the 3/5 year rule applies (I looked at it online.)

Randalltax :

But your only deductions should be related to properties already sold, and a small office to maintain the business. There shouldn't be hundreds of thousands in losses.

Randalltax :

Your continuing large losses (property tax) likely resulted int he red flags for audit.

Customer:

so botXXXXX XXXXXne is I can't deduct the property taxes as an expense?

Randalltax :

no, sir.

Randalltax :

good news: Your gain will be much lower when you do sell.

Customer:

i'm sooo sick, IRS sent me a notice to audit 2011 the other day. Thx for your advice. :(

Randalltax :

Time to sell some property! Make money. Make so much money that the taxes are irrelevant!

Customer:

can't sell, economy sucks, I'm going to have to abandon property. :(

Customer:

No one is buying. :(

Customer:

i;m soooo sad :(

Customer:

thx for your advice!

Randalltax :

Have a good...day.

Customer:

crying :(

R. Klein, EA, Enrolled Agent
Category: Tax
Satisfied Customers: 2927
Experience: Over 20 Years experience
R. Klein, EA and 5 other Tax Specialists are ready to help you
Customer: replied 1 year ago.

Mr. Klein: I spoke for a half-hour on the phone with a local CPA, she told me that instead of filling out Installment Sales (Form 6252) I should report the principle income on Schedule C and report the property taxes on Schedule C too. She said other clients their office serves uses this "aggressive" technique. She said I am a "dealer" rather than an "investor".

Expert:  R. Klein, EA replied 1 year ago.
Depending on how much time you spend doing these land transactions, you MIGHT be a dealer. I don't have enough information to make that determination in a specific case unless I represent the client.

The downside is that the entire sale price is due the year of sale, even if you receive very little cash income in that year. Plus, you would almost certainly have to pay SE tax on your net income. And the sales would not qualify as cap gain property.

Imagine you had a gain of $100K on a parcel, but you only received $20K down payment. The tax on that, taxed as a NON-capital gain, plus SE tax might be $30K. Where would you get the money to pay the tax?
Customer: replied 1 year ago.

I don't mind the SE tax because I don't have enough credits to qualify yet. I'll call the CPA back tomorrow and tell her what you said about "the entire sale price due in a year." I also have another invitation for a free 1/2-hour consultation. I'll also ask them about reporting the property taxes (on business "inventory") on Schedule A. Thanks again!

Expert:  R. Klein, EA replied 1 year ago.
Make sure this professional will be there to defend any gray area positions she takes. I have seen to many "professionals" give questionable advice and then be gone when Uncle comes a-knockin'.
A CPA designation is not sufficient proof that somebody won't do that to you.
Customer: replied 1 year ago.

In your previous answer you said if I sold land for $100k and only received $20k downpayment, I'd have to report the $100k and pay tax on it. Why can't I just enter in the sum of all the principle I received for the year on Schedule C and pay tax on that?


 


I can't imagine the CPA who gave me that advice had that in mind that I pay the tax on the entire sales price when all I received was a down payment.


 


I'll submit all these questions tomorrow, good night!

Expert:  R. Klein, EA replied 1 year ago.
You can't do that because a dealer cannot report income using the installment method. It's an absolute rule.

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R. Klein, EA
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