This! Depreciation recapture bit me hard when I sold my rental last year. I didn't realize I'd have to pay back all those tax benefits at 25% rate. Would have made different decisions if I'd understood this from the beginning.

Thank you for mentioning this! We do hope to eventually move into this house, maybe in 2-3 years once my husband's employment stabilizes. Is there any documentation I should keep now to help with this potential future situation?

Keep absolutely everything! Save all records related to: - Your original purchase (closing documents, original intent to occupy) - Any emails or documentation showing your plans changed due to job loss - All rental income and expense records - Any improvements or repairs (with receipts) - Property tax statements showing separate land/building values - Documentation of when you begin using it as your primary residence Also consider getting a professional appraisal when you convert it back to personal use. Having solid documentation of the property's value at each conversion point can save you thousands in taxes when you eventually sell.

Can you explain more about this Accumulated Earnings Tax? I've never heard of it but might be in a similar situation with my business. Is there a way to document plans for the retained earnings to avoid this tax?

Yes, you can document specific plans for using the accumulated earnings to avoid the tax. The IRS looks for "reasonable needs of the business" - things like expansion plans, equipment purchases, research and development, or contingency funds for specific business risks. The key is having a concrete plan, not just a vague notion of "future growth." Documentation is crucial - board meeting minutes approving a specific expansion plan with estimated costs, for example. For an investment business, you could document plans to make specific types of larger investments that require accumulated capital. Just be aware that "investing in the market" isn't typically considered a reasonable business need since that's what investment companies do by default.

That's concerning and something I hadn't come across in my research. Between this PHC tax and the Accumulated Earnings Tax mentioned above, it sounds like there are multiple ways the IRS can penalize a C-corp used primarily for investments. Would an LLC taxed as an S-corp help avoid these specific issues while still potentially reducing self-employment taxes?

Exactly - the LLC taxed as an S-corp would avoid both the PHC tax and Accumulated Earnings Tax issues completely. S-corps are pass-through entities, so there's no concept of "undistributed earnings" at the corporate level to tax. The S-corp approach can help reduce self-employment taxes because you can split your income between salary (subject to SE tax) and distributions (not subject to SE tax). Just be careful - your salary must be "reasonable" for the services you provide. For an investment business where your active participation might be limited, this benefit could be minimal since most of your income might be considered passive already and not subject to SE tax regardless of structure. Talk to your accountant about the "material participation" tests for your specific situation to determine whether your investment activities would qualify as active or passive income.

Thanks for sharing your experience! When you say Schedule C might be better, does that mean you believe the education would qualify as a legitimate business expense under T Reg 1.162-5(a) for someone in this situation?

Yes, I believe it would qualify as a legitimate business expense in this specific case. The key is that T Reg 1.162-5(a) allows deductions for education that "maintains or improves skills required by the individual in his employment or other trade or business." If your client can document that they regularly perform accounting functions in their law practice (like tax planning, financial analysis for clients, etc.), then the CPA education enhances existing skills rather than qualifying them for a new profession. It's the actual tasks performed that matter, not the job title. I successfully took this position on my own return and have advised clients similarly without issues.

I don't think you can double-dip like that. IRS Publication 970 specifically says you can't claim an education credit and a business deduction for the same expense. You have to choose one or the other.

Do you know if tolls and parking can be deducted separately from the standard mileage deduction? Or are those included in the standard rate?

Tolls and parking fees can absolutely be deducted separately from your standard mileage deduction! This is a common misconception. The standard mileage rate covers gas, maintenance, depreciation, and insurance, but business parking and tolls are separate legitimate deductions. Just make sure you keep good records of these expenses, including receipts and noting the business purpose. Also, remember this only applies to parking and tolls while you're actively working - not your regular commuting expenses if you have another job.

That's hilarious and painful at the same time! Did he actually get audited or did they just adjust his return?

They didn't do a full audit thankfully, just what they call a "correspondence audit" where they questioned specific items on his return. They disallowed the Netflix deduction plus a few other questionable things he tried to write off (like all his groceries because "he needs energy to deliver food"). He had to pay back about $840 plus a 20% accuracy-related penalty. The IRS sent him a letter explaining why each item wasn't considered a legitimate business expense. Expensive lesson learned!

But wouldn't that mean you're artificially inflating your income and then taking deductions against it? I feel like that's not accurately representing what's happening - these ARE reimbursements, not actual income.

You're right that it's not the most accurate representation of what's happening. It's more of a pragmatic workaround when dealing with clients who won't issue proper 1099s. The end result tax-wise should be roughly the same for most expenses except meals. For meals, you'd still be limited by the 50% rule, which is the original problem. So this approach works better if meal expenses are a small portion of your reimbursements.

This is by far the best solution if the client will do it. I've been freelancing for 15 years and this is what all my long-term clients do now - they book travel directly and either pay for meals directly or give me a per diem. Makes taxes WAY simpler.