Buying assets is simple – but knowing when and how to buy is a little more complicated. That’s why communicating with your accountant about your asset strategy is pivotal.
What is an asset?
To put it simply, an asset is a resource or item with quantifiable value. You can have personal assets, which generally contribute to your net worth (read more about net worth here INSERT LINK), or business assets. Assets can be tangible like office supplies or intangible like a patent.
Assets represent a potential for future income. The assets that you or your company hold represent a portion of your economic viability.
There are different factors that may drive you to purchase assets. You may choose to buy assets because there is a need you must meet. For example, you may need to purchase a piece of equipment essential to the function of your business. At other times, buying assets may be due to availability, like the purchase or improvement of a rental property.
Whatever the reason may be, buying assets can be a time sensitive operation, either due to a competitive market or a desperate need. But purchasing large assets in a hurry without consulting your accountant can have huge consequences.
Let’s consider an example. Let’s say you are a rental property owner. You decide, in order to pay for material improvements on some of your rental properties, to withdraw money from your 401k. You feel confident that because the money was being invested back into your properties, you would receive a deduction on the $250,000 you withdrew.
What you didn’t know was that this would ultimately result in unexpected tax and penalties. Because you withdrew the money from your 401k before your retirement age, you accrued federal and state penalties on top of income tax. Unfortunately, the withdrawal also moved you into the next tax bracket, which means you are subject to an even higher income tax amount, and ultimately the withdrawal will cost you more than 50% of the distribution amount in taxes.
What about the deduction you thought you’d receive from making improvements on your property? Unfortunately, you can’t take a deduction for the improvements made to your property due to passive loss activity rules. In this example, you made well over $150,000 and were unable to take a dollar of loss generated by the property on your current year return.
In addition, because you already spent the money you’d withdrawn assuming you would be able to take the full $250,000 of expenses, you aren’t able to pay your taxed amount – which was over 50% of the initial amount withdrawn. Situations like this can be avoided or intentionally planned for strategically by consulting with your accountant before making asset purchases.
Purpose of Planning
Purchasing assets may often seem simple, but even if it seems straightforward, seek the advice of a professional. Laws are always changing, so even if you think you know the best path, do a quick check in with your accountant to make sure. In the aftermath of a financial misstep, there’s little we can do to mitigate the damage from a tax perspective- but if you reach out beforehand, we can help you choose the best path forward.