Qualified Leasehold and Restaurant Property

[Richcpaman]

Have a client that has not filed the C-Corp return for 5 years.

First year, operated a restaurant from a building owned by his mother.

He bought the buiilding from his Mother at the end of year two. The building itself is probably 70-80 years old. The building is is Disregarded Entity owned 100% by the individual taxpayer.

Then he spends $600K over the next three years redoing the building, and adding a new kitchen, enlarging the second floor for more seating and other improvements.

He funds all of this out of the profits from the restaurant during this time.

Reading thru the 15 year property rules, the taxpayer can get bonus depreciation for Qualified Leaseholds, but he can't be related (?), and they can not be to expand the space, so he can get that for some parts of the work.

He can get 15 year depreciation, however, if it is Restaurant Property, which it is.

And of course, the equipment part is 100% from Sec 179...

Am I reading this right? I am getting a breakdown of all expenses from the architect/contractor so I can allocate properly. He has made some income, we need to shelter as much as possible to minimize penalty, late filing and interest.

The restaurant operated thru this entire process.

My reading of the statute supports some 15year restaurant property with full bonus depreciation, and then 15 years for the build outs, and whatever the equipment is. Expanding the related party issue is important, what if the Corp owned the LLC?

Would I be wrong in this analysis?

Rich

[kcjenkins]

Sounds like you have a problem with that "lease" if the corp owns the building, which it does [if I'm understanding the facts] as the LLC is a disregarded entity. If HE owns the corp, his owning the LLC would not solve the problem either. Hope you are getting a good retainer on this one. Doubt he's going to like the answers. His failure to get good tax advice BEFORE he acted is going to bite him hard.

[JohnH]

Whatever the outcome, the client should take the philosophical long view, even if he has to borrow money to pay the taxes, penalties, and interest. You said that he funded most of the extensive improvements from corporate profits. If he had paid the taxes then he would have needed to borrow roughly that same amount of money from the bank (or somebody) to pay for the improvements. So with respect to the overall operation, he simply replaced the bank borrowing with borrowing from the IRS, albeit at possibly a slightly higher effective interest rate.

The other issue of course is the FTF and FTP penalties, but that cost is entirely on him for failing to plan properly. Maybe an expensive lesson for him, but on the other hand a FTF penalty maxed out at 25% could be regarded as effective interest as well. (5% APR for the 5th preceding year, 6.5% APR for the 4th preceding year, 8% APR for the 3rd preceding year, etc, grossed up slightly for the foregone tax deduction at his corporate tax rate).

He still isn't going to like the end result, but after netting out all the variables, I'll bet his true net cost of borrowing from the government will hover at around an effective 11-13% APR. Much higher than what it would have been if he'd done things properly (maybe 6-9% APR) but not the end of the world. This all assumes, of course, that the business continues to thrive and can actually pay the taxes, penalties, and interest in the future.

[jainen]

>>we need to shelter as much as possible to minimize penalty<<

Failure to file is just the beginning; you need to start planning for an audit. IRS may wonder how a startup business could pull out a half million in cash to improve the shareholder's building. They might ask for financial records, not just bank statements but also accounts payable, paystubs, shift schedules, all sorts of things.

Study and act on the audit guide at http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Retail-Industry-ATG---Chapter-4:-Examination-Techniques-for-the-Food-and-Beverages-Industries-%28Restaurants-and-Bars%29. Within the limits of your engagement letter and RETAINER of course--you already know he doesn't submit paperwork or pay what he owes. If this non-filer won't work with you on a professional level, refer him to a lawyer.

[Richcpaman]

He thinks he is going to owe $200k. And he has it to pay it.

My goal is to minimize it.

And he spent all those $$ fixing up the restaurant. In the past, it would be 7 year property for equipment, and 39 for everything else.

But they have the 15 year "Qualified Rule" for Leaseholds, Retail and Restaurant improvements.

I have the related party issue, that sort of blows out using the LH bonus depreciation.

For the restaurant Improvements, I can use that for complete buildings, so I am good there. And the other improvements, but I am stuck with 150 SL deprec. Trying to see what leeway I have.

Any thoughts on that?

Rich

[jainen]

>>And the other improvements<<

I'm confused as to whether there are non-restaurant improvements. The building must be more than 50% restaurant to get the 15-year write off. But if it is (or became so), some improvements may be eligible for Section 179 starting in 2010.

Make sure the corporation actually paid for the improvements and equipment. If he didn't use a separate checking account or credit card every time, it might look more like a taxable dividend. Be very careful about assumptions and shortcuts in documenting your decisions. You don't want to get blamed if something doesn't add up in this complicated, multi-year related party scenario with lousy records. Verify dates placed-in-service with work orders and occupancy permits, as well as contract and payment dates. Be as thorough in researching the facts as you have already been in researching the law. Don't forget the engagement letter and retainer, both custom-made for this client.

[ILLMAS]

If I were an IRS auditor I would ask these questions:

1. Was your client paying FMV rent to his mother?

2. Was the building sold to him at FMV?

3. If you were renting from a non-related party would have put 600K of improvements?

4. Who benefits if you sell the building today?

Then I would allow 39 years of depreciation Question #3 was asked in a real audit, when Corp made huge capital improvements to a building owned by the same owner. Auditor wanted to move the assets to the personal return and disallow on the corp. return.

[Richcpaman]

1. Yes

2. Yes

3. Yes

4. The taxpayer.

He went from a restaurant seating 60-75 to one seating 240. And operated the entire time.

The Corp would pick up alot of tax if he sold it.

All improvements would be considered to a restaurant property. There is nothing else besides restaurant. Corp paid for everything.

Rich