Tax Consequences of Selling a Rental Property

Introduction

Selling a rental property can have significant tax implications for property owners. In this blog post, we will explore:

how sales of rental properties are taxed
differentiate between short-term and long-term capital gains
discuss the concepts of depreciation and depreciation recapture
emphasize the importance of documenting selling expenses, and
introduce the concept of Section 1031 Exchanges.

The Primary Residence Exclusion Will Not Apply

The profit made from the sale of a rental property will almost always be taxable.

When the real estate being sold is the taxpayer’s primary residence, the primary residence exclusion allows homeowners to exclude a portion of the gains from the sale of their primary residence, if they meet the eligibility criteria. This exclusion is up to $250,000 for single filers and $500,000 for couples married filing jointing. However, this provision requires that the property must have been the taxpayer’s primary residence for two out of the last five years. Because a rental property is not a primary residence, the sale of real estate used as an investment does not meet this requirement.

In very rare circumstances, a taxpayer may live in a home for two or more years, move to another home and rent out their former primary residence, and then sell the former residence within three years. That timeframe may allow the taxpayer to exclude a portion of their gain from taxation. A qualified tax practitioner can assist in determining what portion of the profit is excludable.

Capital Gains

In the last section, we established that profits made from selling rental properties are taxable. Generally, the profit from the sale of a rental real property is a capital gain (see Depreciation Recapture below). The capital gains tax is the levy on the profit that an investor makes when an investment is sold. This distinction is important because investments held for longer than one year are taxed at preferential rates.

The classification of capital gains as either short-term or long-term is determined by the holding period of the asset. If the property is held for one year or less before selling, it is considered a short-term capital gain. Short-term capital gains are taxed at the taxpayer’s ordinary income tax rates. On the other hand, if the property is held for more than one year, it qualifies as a long-term capital gain. Long-term capital gains generally benefit from preferential tax rates, which are lower than ordinary income tax rates.

Capital gains tax rates vary depending on the taxpayer’s income and filing status. As of the current tax year, there are three main tax brackets for long-term capital gains: 0%, 15%, and 20%. The rate applied depends on the taxpayer’s taxable income.

2023 Long-Term Capital Gains Tax Rates
Taxable Income		Rate
Single	Married Filing Jointly
Up to $44,625	Up to $89,250	0%
$44,626 to $492,300	$89,251 to $553,850	15%
Over $492,300	Over $553,850	20%

Depreciation Recapture

When operating a rental property, the owner is allowed to claim depreciation deductions on the property. Depreciation spreads the cost of an asset over its expected lifespan. This is attractive because it lowers the taxable income earned from the property.

However, when selling a rental property, the depreciation claimed over the years can trigger depreciation recapture.

Depreciation recapture requires the taxpayer to pay taxes on the accumulated depreciation at the higher rate of up to 25%, rather than the capital gains rate. Accumulated depreciation is the sum of all depreciation claimed on tax returns from the first year the property was rented to the year it was sold. The rationale behind depreciation recapture is that while you have been able to deduct the depreciation expenses from your taxable income over time, the IRS wants to ensure that you pay taxes on the portion of the property’s value that was depreciated.

Depreciation recapture is limited to the smaller of the realized gain on the sale or the accumulated depreciation of the asset. In other words, if the amount of accumulated depreciation is higher than the gain from the sale, you only include the realized gain in the recapture calculation.

It’s important to note that not all rental property sales trigger depreciation recapture. If you sell your property at a loss, there is no recapture since there is no gain to be taxed. Additionally, if you engage in a like-kind exchange under Section 1031 of the Internal Revenue Code, you can defer the recapture tax by rolling over the gain into a new qualifying property.

Section 1031 Exchanges

Section 1031 of the Internal Revenue Code provides an opportunity for rental property owners to defer capital gains taxes by engaging in a like-kind exchange. This exchange allows the taxpayer to reinvest the proceeds from the sale of the rental property into another qualifying property, deferring the tax liability until a future sale. Understanding the rules and requirements of Section 1031 Exchanges can provide a valuable tax planning strategy for rental property owners. To learn more, check out our post on Section 1031 Exchanges.

Caution: Impact of Cost Segregations

Cost segregation is a process of identifying assets that are personal property that can be depreciated more quickly than their corresponding real property. While residential rental buildings must be depreciated over 27.5 years, assets like wiring, flooring, plumbing, appliances, fixtures, and air conditioners can be depreciated in just 5 to 7 years. By capturing depreciation earlier in the life of the property, owners can free up cash and use it for their operating and investment needs now.

Cost segregation is a powerful tax planning tool, as we discussed in a previous blog post. When selling a rental property that was depreciated using a cost segregation study, however, depreciation previously taken on non-real estate assets such as wiring will be recaptured as ordinary income. Furthermore, those assets cannot be part of a Section 1031 Exchange. So, while cost segregations can be a great option for tax deferment, it is important to be aware of the potential impact on the tax created by the sale of the property. A qualified tax professional can help you determine the tax consequences of your particular circumstances.

Selling Expenses

To accurately calculate the gains from selling a rental property, it is crucial to document all relevant selling expenses. This includes expenses such as renovations, repairs, realtor commissions, advertising costs, and closing costs. Proper documentation can save thousands of dollars in taxes.

Conclusion

Selling a rental property has significant tax consequences that every property owner should be aware of. Rental properties do not qualify for the primary residence exclusion, and depreciation recapture can impact the tax liability upon selling. Understanding the concepts of depreciation, capital gains rates, and deductible selling expenses is crucial for accurately reporting the transaction and minimizing tax liability.

For those looking to continue investing in real estate, exploring the possibilities offered by Section 1031 Exchanges can provide a valuable tax deferral strategy.

By staying informed and understanding the tax implications of selling a rental property, you can make informed decisions, maximize tax benefits, and ensure compliance with applicable tax laws. Selling a rental property can be a complex process, but with the right knowledge and guidance, you can navigate the tax consequences and make the most of your investment endeavors.

How Cost Segregation Studies Benefit Medical and Dental Practices

Introduction

For medical and dental practices seeking ways to minimize tax liability and increase cash flow, cost segregation studies offer a valuable strategy. By accelerating depreciation deductions, cost segregation studies can help medical practices optimize their tax savings and improve their financial position. In this blog post, we will explore how cost segregation studies can be used by medical practices to unlock significant tax benefits. We will discuss the concept of cost segregation, its benefits, the process involved, and specific considerations for medical practices.

Understanding Cost Segregation

Cost segregation is a tax planning strategy that involves the allocation and reclassification of assets within a commercial property. Rather than treating the entire property as a single asset, cost segregation breaks it down into individual components, such as building structures, land improvements, equipment, and fixtures. By identifying assets with shorter depreciable lives, cost segregation allows for accelerated depreciation deductions, resulting in substantial tax savings.

Benefits of Cost Segregation for Medical and Dental Practices

Medical practices can reap several benefits from conducting cost segregation:

Increased Cash Flow: By accelerating depreciation deductions, cost segregation studies provide medical practices with significant upfront tax savings. These savings can be reinvested in the practice, facilitating growth, and improving cash flow.
Improved Financial Planning: With a clearer understanding of the value and depreciation timelines of individual assets, medical practices can better forecast their future expenses, allocate resources effectively, and make informed financial decisions.
Enhanced Return on Investment (ROI): Cost segregation studies can help medical practices optimize their ROI by identifying assets that qualify for accelerated depreciation. This allows for higher tax deductions in the earlier years of ownership, resulting in improved financial returns.

Considerations for Medical and Dental Practices

Medical practices should keep the following considerations in mind when considering this tax-deferment strategy:

Compliance and Documentation: It is crucial to maintain proper documentation and adhere to IRS guidelines when conducting a cost segregation study. Engaging a qualified cost segregation specialist can ensure compliance with the necessary regulations.
Building Renovations and Expansions: Medical practices undergoing building renovations or expansions can capitalize on cost segregation studies to identify and segregate assets associated with these improvements, unlocking additional tax savings.
Leasehold Improvements: For practices operating in leased spaces, there may still be opportunities to use a cost segregation to accelerate the rate of depreciation of leasehold improvements.

Expert Guidance

Given the technical nature of cost segregation studies, medical practices should consider consulting with experienced tax professionals and cost segregation specialists. These professionals possess the necessary expertise to perform accurate asset classifications, navigate tax regulations, and maximize the tax benefits.

Conclusion

Cost segregation studies present medical practices with a powerful tax planning tool to optimize their financial position. By accelerating depreciation deductions and identifying eligible assets, medical and dental practices can enhance cash flow, improve financial planning, and achieve a higher return on investment. If you have any questions about this or other tax saving strategies, call our office at 480-294-4967.

Can I deduct my clothing on my tax return?

As a taxpayer looking to save money, you may wonder if you can claim deductions for clothing and uniforms on your tax returns. The answer is: it depends.

Before you take that deduction, you should consider the nature of the clothing, the job you have, and the type of business you operate. In this blog post, we will explore the rules and regulations surrounding the deduction of clothing and uniforms for tax purposes.

Deductible Clothing and Uniforms

If you are a self-employed individual or work for a company that requires you to wear uniforms or specific clothing, you may be eligible to claim a tax deduction for your work-related clothing expenses. However, there are some conditions that need to be met to qualify for the deduction.

The first condition is that the clothing or uniform must be required for your job. For example, if you work as a police officer, the uniform you wear is required for the job, and therefore, is tax deductible. The same is true for other professions that require a specific uniform or clothing, such as healthcare workers that are required to wear scrubs or other specialized clothing.

The second condition is that the clothing must not be suitable for everyday wear. If the clothing or uniform you wear to work can be worn outside of work, it may not qualify for a tax deduction. For example, if you work as a realtor and wear a blazer and heels for work, those clothes would not be tax-deductible because they are suitable for everyday wear.

The third condition is that the clothing or uniform must not be reimbursed by your employer. If your employer provides you with a uniform or reimburses you for the cost of the uniform, you cannot claim a tax deduction for that expense.

Lastly, the cost of the clothing or uniform must be reasonable and necessary. You cannot claim a deduction for clothing that is overly expensive or unnecessary for your job. A $4,000 Louis Vuitton purse comes to mind.

Non-Deductible Clothing and Uniforms

Unfortunately, if your work-related clothing does not meet the conditions outlined above, you cannot claim a tax deduction. Clothing that is not required for your job, clothing that is suitable for everyday wear, clothing whose costs were reimbursed by your employer, and clothing that is unnecessarily expensive does not qualify for a tax deduction.

The most common type of non-deductible clothing we encounter as tax advisors is business wear. If you work in an office and wear business casual or even business professional clothing to work, those clothes are not tax-deductible because they are suitable for everyday wear. If you are a business owner, it is important to avoid charging everyday clothing to your business bank account or credit card. Doing so will cause confusion at tax time, and mixing business and personal accounts could even result in piercing the corporate veil which shields you from personal liability.

Conclusion

In conclusion, deducting clothing and uniforms from your taxes can be a complex issue. While it is possible to claim a deduction in certain situations, there are also strict limitations and rules to consider. It’s important to keep accurate records of your expenses, and to consult with a tax professional if you’re unsure about whether a particular deduction is allowed.

Do I have to issue a 1099?

The IRS has created several forms in the 1099 series, but this article focuses on the 1099-NEC because it is applicable for so many of our clients. Form 1099-NEC (nonemployee compensation) is an Internal Revenue Service (IRS) form for businesses to report payments made to parties that are not employees. One copy will be provided to the contractor, and one will be submitted to the IRS. One of the most common questions we receive is, “Do I have to issue a 1099?”

If you are unsure about whether you should issue a 1099, ask yourself the following questions:

Who am I paying?

First, this form is not required for personal payments, so you should only issue one for payments you made in the course of a trade or business.

Furthermore, the recipient should be a freelancer or contractor, not an employee that you provide a form W-2. Someone is considered an independent contractor if they are self-employed or contracted to perform work to another business as a nonemployee. This distinction is important because you do not have to withhold income taxes or withhold and pay employer Medicare and Social Security taxes from an independent contractor’s payments.

What if I’m paying a business?

Form 1099 is issued to all “persons” but corporations. Persons include individuals, sole proprietorships, partnerships, and most limited liability companies (LLCs). If an LLC has made an election to be taxed as an S corporation, then no 1099 is required.

In addition, if you pay an attorney, you should provide them with a 1099 even if their business is incorporated.

How much am I paying?

You are not required to provide a 1099 to someone that you paid a de minimis amount. The threshold for reporting is $600.

For example, if your business hired a painter and paid them $1,300, you should issue them a 1099. If your business hired a janitorial service to clean your office and paid them $400 per month, you should provide them with a 1099 because the total of the payments in one year of $4,800 is higher than $600.

How did I pay?

In the total you report on the 1099, you should only include payments made by cash, check, ACH transfer, or other direct means. Payments by credit card or through third-party transaction networks will be reported by the financial institution on Form 1099-K, so you should not include them. Going forward, payment platforms such as Venmo will also be required to issue 1099-Ks.

The Importance of the W-9

Every contractor that you work with should provide a completed W-9 before they provide any services.

A W-9 is an IRS form used by businesses to gather tax information from external parties. The information provided on Form W-9, such as the taxpayer identification number, is essential for completing Form 1099.

Importantly, if the payee fails to furnish his or her taxpayer identification number (TIN), they are subject to backup withholding at a 28% rate. If you do not collect and pay backup withholding from affected payees as required, you may become liable for any uncollected amount. Therefore, we recommend always collecting a W-9 before the contractor begins providing services.

Conclusion

Issuing 1099-NECs when required is critical to keeping your business in compliance with the IRS. The due date for payers to complete the Form 1099-NEC is January 31, so it is important to collect your W-9s and track your payments throughout the year. If you have further questions about 1099-NEC reporting requirements, please reach out to our office at 480-294-4967.

A New Option for 529 Plan Owners

A 529 plan is a tax-advantaged savings plan designed to help pay for educational expenses. When a parent or grandparent opens a 529 plan, they ensure that their child has the financial support to reach their educational goals. With about 42% of Americans over age 25 holding a college degree, it may seem like a no-brainer to take advantage of the long-term tax savings of investing in a 529 plan.

But what can you do if the beneficiary of the plan ultimately decides to pursue goals that do NOT require additional education? Are the funds “stuck” in the 529 plan?

In the past, using withdrawals from a 529 plan for anything other than qualified educational expenses would result in taxes and usually penalties. Account owners could leave the funds in the account in case the beneficiary changed their mind in the long term. They could decide to change the beneficiary of the account to another person, such as a niece or nephew. However, that may not be a desirable option for many families.

The recently enacted SECURE 2.0 Act provides an additional option for moving funds from a 529 plan that is no longer needed. Starting in 2023, owners of certain 529 Plans can transfer the balance to a Roth IRA. A Roth IRA is a special individual retirement account (IRA) in which withdrawals are tax-free.

The conversion must comply with the following guidelines:

529 plan account must have been in effect for at least 15 years.
The amount transferred into the Roth IRA may not exceed the total of the contributions made to the 529 plan during the past five years.
The amount transferred into the Roth IRA each year is limited to the amount allowed for Roth IRA contributions that year. (In 2023, the IRA limit is $6,500, but we do not know the limit for 2024 as of the date of publication).
The maximum amount of all transfers is limited to $35,000.

While 529 savings plans can be beneficial for many families, investors who ultimately decide that they will not use their balance for qualified educational expenses now have another option for using the funds without incurring harsh penalties. Because of the complex rules surrounding such a conversion, we also recommend speaking with a knowledgeable financial advisor. If we can assist you with a referral, call our office at 480-294-4967.

Impact of the 2023 Appropriations Bill on Retirement Savings

In the last week of 2022, President Joe Biden signed into law the Consolidated Appropriations Act of 2023. The $1.7 trillion omnibus spending bill covers a huge range of topics, from spending in support for Ukrainian defense to the social media apps federal employees are allowed to download on their government-issued devices (hint: not TikTok). However, this blog will focus on the impact of the legislation on retirement savings policies, especially 401(k)s.

The retirement-related portion of the omnibus billed is dubbed the “SECURE 2.0 Act of 2022” and builds upon an act passed in 2019. Its goal is to expand the number of Americans saving for retirement and increase the amount they save. Some of the most important provisions of the legislation include:

Mandated Automatic Enrollment
Increased Limits for Catch-up Contributions
Higher Age Threshold for Required Minimum Distributions

Mandated Automatic Enrollment

Effective for plan years beginning after 2023, 401(k) and 403(b) sponsors must automatically enroll employees in plans once they become eligible to participate in the plan. Previously, eligible employees had to elect to enroll. Under the new law, employees must opt out of enrollment if they do not wish to participate.

Generally, the amount of the automatic contribution must be set between 3 and 10%, depending on the employer’s policies.

Increased Limits for Catch-up Contributions

As we have discussed in a previous blog, the maximum catch-up contribution for 2023 is $7,500.

However, the SECURE 2.0 Act allows an additional increase in the contribution amount for participants aged 60 through 63. The additional increase is effective for tax years after 2024. For most plans, this second catch-up limitation would be $10,000. Furthermore, like the standard catch-up amounts, these limitations will also be subject to adjustments for inflation.

Higher Age Thresholds for Required Minimum Distributions

Under current law, plan participants are required to begin taking required minimum distributions (RMDs) at age 72. Under the SECURE 2.0 Act of 2022, the age at which participants must begin taking RMDs is increased over a period of ten years. Starting in 2023, the age is increased to 73 for individuals who turn 72 after 2022 and age 73 before 2033. For individuals who turn 74 after 2032, RMDs must begin at age 75.

These provisions aim to increase the rate at which Americans save for retirement. If you have questions about saving for retirement, please call our office at 480-392-6801.

When does it make sense to convert a Traditional IRA to a Roth IRA?

We all know that contributing to retirement accounts early and often is good advice, but many of our clients question whether it is more beneficial to invest in a traditional IRA or Roth IRA. The answer to this is different for every client and depends upon the expected cash flows during their working years and their retirement years. The good news is that any money contributed to a retirement account is a proactive step to protecting your future. Furthermore, either option will provide tax benefits, and the timing on when those benefits are reaped is the primary difference.

While it is impossible to predict the future, the ability to convert a Traditional IRA to a Roth IRA is a little-known option that can be a powerful source of tax savings for investors who understand the rules.

Unfortunately, taxpayers in the middle of their careers too frequently experience a temporary but dramatic slump in their income. This could be due to unforeseeable factors like the global pandemic that disrupted economies around the world in 2020, contributing to widespread unemployment and loss of business income. In other years, people experience unexpected illnesses like cancer, either for themselves or a loved one, and take a needed break from focusing on work. Former W-2 employees may experience dips in income in the first year that they start a business. However, any of these circumstances can provide a sharp investor with an opportunity to generate tax savings.

In a Traditional IRA, contributions are tax deductible in the year in which they are contributed. The tax bill will be lowered in the current year, and the investor will pay taxes in the future when the funds are withdrawn from the retirement account. On the other hand, contributions to a Roth IRA do not provide a tax deduction in the year contributed; but if the funds are withdrawn after at least five years and over age 59 1/2, no additional taxes will be due.

An investor who has an existing Traditional IRA and experiences a dramatic drop in income may consider converting the account to a Roth IRA. Because of the conversion, they will be required to pay income taxes on the previously tax deferred amount. However, because the taxpayer is in a much lower income bracket than in other years, the tax rate may be significantly lower than at another point in the investors life.

Furthermore, they will take advantage of other features of the Roth IRA:

No required minimum distributions
Tax-free income for heirs

There are several important factors to consider before deciding to convert an IRA:

What is the taxpayer’s normal effective tax rate, and what is the effective tax rate expected to be in the low-income year?
Will the taxpayer have adequate funds to pay the tax due as a result of the conversion?
Will the increase in taxable income affect the taxpayer’s ability to qualify for programs such as government marketplace health insurance or children’s financial aid for college?

Once the taxpayer determines that converting their IRA from a traditional to a Roth is the most beneficial course of action, they can explore financial institutions. Things like the historic rate of return on investments and the fees charged by the institution will affect their decision to either continue investing with their current institution or moving the funds to another one. The conversion process requires filling out paperwork with the financial institution. At tax time, the taxpayer (or their accountant) will submit a Form 8606.

While converting from a traditional IRA to a Roth IRA will not make sense for everyone, it can be an effective tool for some taxpayers to take advantage of significant drops in their income to generate future tax savings. If you have any questions about this strategy, reach out to your tax preparer or call our office at 480-392-6801.

Want to read more about retirement investing? Check out these past blog posts:

Captive Insurance

When businesses grow and become more profitable, owners may look for strategies to build cash reserves for the unknown future. Forming a captive insurance company, also called an 831(b) Plan, is one strategy for businesses with excess cash to lower their tax bill in the current year while providing flexibility in future years.

A captive insurance company is a wholly owned subsidiary insurer formed to provide risk mitigation services for its parent company. For example, an S-corporation purchasing captive insurance would form a separate C-corporation. That C-Corp would be called the “reinsurance company.” The reinsurance company can be owned by the business, or its ownership can mirror that of the business. It can even be owned by a trust depending on the circumstances. Regardless of the particulars of ownership, the flow of cash remains the same. The S-corporation pays premiums to the reinsurance company, and the premiums are tax-deductible to the S-corporation.

Most businesses carry some insurance through a traditional insurance provider, but the reinsurance company offers protection against risks that are not sufficiently reduced by other policies. Insurable risks include audit, litigation, and cyber-attacks. The risks being addressed by the plan must be fortuitous in nature, not ordinary business risks.

The deductibility of premiums paid to the reinsurance company is the first part of the tax planning strategy. But after the expiration of the 12-month policy, the investor has a range of options for the remaining funds that were not paid in administrative fees or claims:

The owners of the reinsurance company can leave the excess reserves in the reinsurance company to grow through conservative investments such as bonds. The investment income earned is taxed at the captive insurance company level at the federal corporate tax rate of 21% plus applicable state tax rate.
The reinsurance company may distribute the funds as taxable qualified dividends. The distributions will be taxed at the long-term capital gains rate (currently 15 or 20%).
The reinsurance company may lend up to 65% of the funds to the operating company. The funds may be used to invest in or expand the business. Importantly, interest on the loan must be paid at the IRS prescribed applicable federal rate (AFR) to the reinsurance company.

Captive insurance plans can be a powerful planning and tax deferment tool for businesses with excess cash reserves. In fact, the National Association of Insurance Commissioners (NAIC) estimates that about 90% of Fortune 500 companies today have captive subsidiaries. However, small and midsized businesses can often benefit as well.

Since the Treasury Regulations surrounding reinsurance companies is extremely complex, we always recommend working with a qualified administrator, such as SRA 831(b) ADMIN and an accounting firm that understands the rules around the small captive insurance company rules. SRA generally recommends that businesses have at least $100,000 to commit to the reinsurance company.

If you are interested in exploring a captive insurance plan for your business, please call our office at 480-392-6801 to discuss your situation with a Tax Manager.

Client Gifts

Many business owners like to express their appreciation to clients and referral sources with gifts, especially around the holidays. Understanding IRS rules around gifts can help you show your generosity without creating any surprises at tax time.

$25 Limit

Businesses may not deduct more than $25 for business gifts made to the same person. For example, if you purchased a $75 gift basket for a major referral source, only $25 would be deductible on the tax return. The $25 limit does not include shipping costs, sales tax, gift wrapping, or engravings that do not add substantial value.

Of course, this dollar limit is to prevent unreasonable business expenses, but it is interesting to note that the amount has not been updated since 1962.

Bright Idea

Since the $25 limit is per person, you may deduct a larger gift if the recipient is a business with multiple employees. For example, if one of your clients has five employees, you could give a fruit and cheese basket costing up to $125 and deduct the full expense. Similarly, you could give individual gifts to key contacts within one company.

Be Wary of Entertainment

When selecting gift, be careful of gifts that could be considered entertainment. The Tax Cuts and Jobs Act eliminated the deduction for entertainment expenses as of January 1, 2018. Examples of entertainment include tickets to a sporting events and concerts.

Bright Idea

Instead of providing gifts that could be considered entertainment, consider taking the client to a meal. Business meals at restaurants remain 100% deductible in 2022 (rather than the normal rate of 50%). A meal can provide the same opportunity to connect with a contact as entertainment without the sticky tax rules. Furthermore, meals are not subject to the same low dollar limitation as gifts.

Small, Branded Gifts

Branded items that cost less than $4—think pens, chap sticks, or calendars—are considered advertising rather than gifts. Generally, you don’t need to record who you gave them to because they will not count against the $25 per person annual limit.

The holidays provide a great opportunity to tangibly express your appreciation for clients and contacts. Who doesn’t love to receive a thoughtful box of chocolates or bottle of wine? If you have any questions about the IRS rules surrounding client gifts or any other deductions, reach out to our office at 480-392-6801.

The 6,000 lb. Gross Vehicle Weight Tax Deduction

In a previous blog post, we discussed how Section 179 of the tax code allows business owners to accelerate deductions for tangible business assets. Today we’ll explore one strategy for further maximizing tax efficiency by increasing the weight of vehicles used for business.

Under the IRS’s depreciation provisions, different rules apply between smaller vehicles such as sedans versus larger vehicles such as trucks and vans. Large vehicles, defined as vehicles that weigh between 6,000 and 14,000 lbs., are eligible for higher tax deductions in the first year that the vehicle is placed into service.

But even S-corporation owners who do not need a heavy-duty truck for their business can benefit from this deduction. If you drive a sport utility vehicle (SUV) that weighs less than the 6,000 lbs. threshold, you may be able to install a tow hitch to increase the weight of the vehicle sufficiently. Most dealers have this option available at purchase, and typically the few hundred dollars charged to install it is a much smaller investment than the thousands of dollars save by reducing your taxes. In 2022, SUVs with loaded vehicle weights over 6,000 lbs. (but less than 14,000 lbs.) can be 100% deducted using bonus depreciation.

The vehicle must also be used primarily (at least 50%) for qualified business use. It can be either new or used. However, the vehicle may not be used for transporting people or property for hire.

Finally, to claim the deduction for 2022, the vehicle must be placed into service by December 21, 2022.

To substantiate the deduction for heavy vehicles, we recommend that Arizona taxpayers update their registration with the Department of Motor Vehicles (DMV). According to Arizona statute:

“A person may increase the declared gross weight of a vehicle or vehicle combination after the original registration and during the registration year by reregistration of the vehicle or vehicle combination. The person shall pay a fee in addition to the gross weight fee prescribed in this article based on the difference between the fee due at the time of reregistration for the weight class in which the vehicle or vehicle combination was originally registered and the fee due at the time of reregistration for the increased weight class.”

That means that the cost of proving that your vehicle meets the IRS weight requirements should be only a small fee.

As a reminder, make sure that you are capturing all the expenses related to your business vehicle including the following:

Registration fees and taxes
Maintenance and repairs
Auto insurance
Fuel

Upgrades to increase the weight of an SUV used for business can have huge payoffs at tax time. If you have any questions about this or other business deductions, call our office at 520-353-4502.