"Renting" Web Space - Capital Gain or Ordinary Gain?

[rushindo]

I'm not an accountant (well not yet - it's my major)... but does renting web space on your web sites qualify as capital gains like renting real estate property?

Brandon

Edit: This was a dumb question but hey it started a pretty good conversation. ;-)

[Istvan Horvath]

Well, I am not an accountant (although I did work several years in financial services) but if they taught you at that "major" school that rental income is = capital gain... you better ask urgently back your tuition fee. I mean it!

Renting real estate property is NOT capital gain. Period.

[TheWealthSquad]

What country ? That is the first question. Renting space on your web server is revenue, not capital gain. You would file it on the Schedule C if you are a Sole proprietor.

Rental property is rental income It has nothing to do with renting space on your web server. It only applies to physical real estate.

[rushindo]

Originally Posted by Istvan Horvath

Well, I am not an accountant (although I did work several years in financial services) but if they taught you at that "major" school that rental income is = capital gain... you better ask urgently back your tuition fee. I mean it!

Renting real estate property is NOT capital gain. Period.

Some times you just wish you would have kept your mouth closed... they did not teach me that rental income is a capital gain. I'm sitting here reading so much tax stuff I got confused for a second. How in the world can "income" be a capital gain? Duh! Unless it's qualified dividend income of course.

Thanks for the reply. What a stupid question. Hey, gotta ask a dumb question every now and then I suppose. :-(

Brandon

[rushindo]

Originally Posted by TheWealthSquad

What country ? That is the first question. Renting space on your web server is revenue, not capital gain. You would file it on the Schedule C if you are a Sole proprietor.

Rental property is rental income It has nothing to do with renting space on your web server. It only applies to physical real estate.

I'm in the U.S. And you are exactly right. I'm reading too much tax stuff... I'm confusing basic stuff. Got excited thinking I'm going to pay 15% capital gains taxes on renting space on a server. It's definitely time for me to go to bed because I've already entered fantasy land and started dreaming. ;-)

Brandon

[TheWealthSquad]

Better to ask now than get in trouble when you file your taxes

I have seen people bring in things that were simply crazy. Then they argue and tell me how they are going to file.. and I simply inform them they can go file it themselves then.

If you have any other questions just PM me. I will be happy to answer them as best I can, just remember it doesn't substitute for good tax prep as I can only answer what you ask and not ask what should be asked since I don't have all your paperwork.

[rushindo]

Originally Posted by TheWealthSquad

Better to ask now than get in trouble when you file your taxes

I have seen people bring in things that were simply crazy. Then they argue and tell me how they are going to file.. and I simply inform them they can go file it themselves then.

If you have any other questions just PM me. I will be happy to answer them as best I can, just remember it doesn't substitute for good tax prep as I can only answer what you ask and not ask what should be asked since I don't have all your paperwork.

Thank you Scott. You have a great web site. I have one of the same passions as you... "Actually I love figuring out ways to legally reduce the amount of tax I have to pay." I also started off in engineering, electrical not chemical though.

Have a great night,
Brandon

[JohnMcCabe]

Glad you got it sorted out...

In my mind, a capital gain comes when you sell an investment for more than you paid for it.

Dividends are income - passive income because you only have to own an asset to collect.

Rent, whether in an office building or a web server, is ordinary income.

Given the sheer size of the tax code, though, that's probably way too simple...

[rushindo]

Originally Posted by JohnMcCabe

Glad you got it sorted out...

In my mind, a capital gain comes when you sell an investment for more than you paid for it.

Dividends are income - passive income because you only have to own an asset to collect.

Rent, whether in an office building or a web server, is ordinary income.

Given the sheer size of the tax code, though, that's probably way too simple...

Sounds good to me. But the good thing about what Congress considers to be "qualified dividends" is that they are taxed just like capital gains, unlike other passive income like rent.

Source:My head (got it right this time) and http://www.irs.gov/formspubs/article...179793,00.html

Brandon

[billionareHuman]

if i have a billboard somewhere and I 'rent' the space to some one who pays me for advertising then that's income

[timpears]

Originally Posted by rushindo

Sounds good to me. But the good thing about what Congress considers to be "qualified dividends" is that they are taxed just like capital gains, unlike other passive income like rent.

Source:My head (got it right this time) and Maximum Tax Rate on Qualified Dividends and Net Capital Gain Reduced

Brandon

That is right Brandon. Put that web site into a Sub S corp and then most if not all of the income derived from it would be taxed as dividend income which currently is taxed the same as a capital gain. who knows how long that will last as you know that tax law is subject to change due to the whim of the Congress.

[John Cabral]

Originally Posted by JohnMcCabe

Glad you got it sorted out...

In my mind, a capital gain comes when you sell an investment for more than you paid for it.

Dividends are income - passive income because you only have to own an asset to collect.

Rent, whether in an office building or a web server, is ordinary income.

Given the sheer size of the tax code, though, that's probably way too simple...

Thats a simplified answer there. If you rent the space say for 10 bucks and it costs you 5 bucks you have a profit of 5 buck which is income.

Remember that when you are running a business you have to track your expenses to apply against the revenue collected or income.

If your expenses are more than your revenue you posted a loss and if revenue more than expenses you posted a profit which is what you will be taxed on.

Everyone needs to know the basics of accounting or hire a bookkeeper or accountant or you can get into trouble at year end when tax time comes around.

You should always analyze your business on a quarterly basis as to not get a surprise at year end.

I would always go over the financials with our CPA quarterly to make sure business was profitable etc.

Don't neglect this aspect of your business. Its not about just making money.

[TheWealthSquad]

Be very careful passing all income through a S-corp without paying Self employment taxes on it. You are required by law to issue yourself a W-2 if you operate an S - Corp. You have to pay yourself a "reasonable" salary. If you try to pass it all through without paying SE tax on it, count on being audited sooner or later. Also S-Corp income is taxed at normal tax rates not as qualified dividends.


Income is revenue. It is all money coming in. Your expenses reduce that amount to the profit. You only pay taxes on your profits. That is why keeping up with your expenses should be a fundamental part of every business.

I do agree that if you are going to run a business you need to either 1) get a good accountant/bookeeper and tax prepaper or 2) Spend the time to learn it which means you have less time to learn marketing and everything else.

I am always amazed at people that will outsource writing an article who insist on doing their own taxes. Just make sure you find someone who knows how to maximize your deductions and can help you understand how to keep more of your money. Most accountants and just record keepers. You want someone involved in your business to help you optimize it.

[ahlexis]

I am always amazed at people that will outsource writing an article who insist on doing their own taxes.

You are SO RIGHT! It IS amazing!

[John Cabral]

Originally Posted by TheWealthSquad

Most accountants and just record keepers.

I am sure you did not mean that accountants are just record keepers as that would be wrong and erroneous. We are not record keepers and are involved in the preparation of a companies financial statements and work with CPA's.

The two are not the same...

[TheWealthSquad]

John

I hope I didn't offend you. I guess I should clarify my statement. Most accountants that I have dealt with in regards to small businesses are record keepers. By that I mean they will record the information you provide in the correct places and make sure all the reports are complete and up to date. They do this after the fact though. So they keep a record of what is happening in the business. That is a vital part of knowing where you business is and where it is going.

For most small business owners, they need more. They need a partner who can help educate them on different ways of doing things and how they could save themselves money. They need a part time CFO but usually can't afford it.

In large companies they can divide this task and people can specialize. A small business owner needs someone who can help them

1) Understand cash flow and how they can impact it. They feel the effects of it but many times may be caught off guard by it.
2) Systems for proper record keeping (this is an area that most accountants I know do an excellent job of)
3) Understand how different business structures can impact their taxes and profitability
4) Understand different benefit deductions that go along with the structure

In my experience many business owners think - If there was another way to do it, my accountant would have already suggested it.

In most cases, that doesn't happen. When you go to select an accountant, tax preparer, etc., go in with your eyes open, understand what you are getting from them and explain to them what you want/need.

The thought process behind making sure all the information gets in the right place and interpreting that information to make decisions is very different.

[John Cabral]

Originally Posted by TheWealthSquad

John

I hope I didn't offend you. I guess I should clarify my statement. Most accountants that I have dealt with in regards to small businesses are record keepers. By that I mean they will record the information you provide in the correct places and make sure all the reports are complete and up to date. They do this after the fact though. So they keep a record of what is happening in the business. That is a vital part of knowing where you business is and where it is going.

For most small business owners, they need more. They need a partner who can help educate them on different ways of doing things and how they could save themselves money. They need a part time CFO but usually can't afford it.

In large companies they can divide this task and people can specialize. A small business owner needs someone who can help them

1) Understand cash flow and how they can impact it. They feel the effects of it but many times may be caught off guard by it.
2) Systems for proper record keeping (this is an area that most accountants I know do an excellent job of)
3) Understand how different business structures can impact their taxes and profitability
4) Understand different benefit deductions that go along with the structure

In my experience many business owners think - If there was another way to do it, my accountant would have already suggested it.

In most cases, that doesn't happen. When you go to select an accountant, tax preparer, etc., go in with your eyes open, understand what you are getting from them and explain to them what you want/need.

The thought process behind making sure all the information gets in the right place and interpreting that information to make decisions is very different.

I have thick skin... LOL You are right as most accountants are not CPA's or CFO's but a good one should understand cashlow and budgeting etc. Accountants are not tax experts unless they decide to also learn that aspect.

I have been a controller for 10 yrs and have done everything with exception of taxes. I only do personal taxes. With the right accountant they should be able to help you run your business profitably.

Small business owners will have a hard time hiring a good accountant let along a CFO.

[TheWealthSquad]

Well I am a chemical engineer who does taxes, marketing, strategy, etc and my own accounting... which I find boring but useful. Most of the small business owners I know are great technicians. That's why they went into business to "do the stuff they love". Unfortunately most of them don't have the business basics down pat and can get themselves into trouble. I have found some accountants who get small business and many who don't. I have had customer's leave because an accountant friend suggested they do their taxes a specific way. Even when I show them IRS case law or IRS regulations that prevent it, they still want to take it because an "expert" told them too. Most accountants don't understand taxes or how to run a business. Don't confuse a person being an expert in one field with being one in all fields. If you are a business owner, understand the fundamentals. Cash flow, the questions to ask your accountant, lawyer, tax guy, etc. Spend time investing in yourself and you will find the ROI to be far higher than anything you can find in the stock market.

[timpears]

Originally Posted by TheWealthSquad

Be very careful passing all income through a S-corp without paying Self employment taxes on it. You are required by law to issue yourself a W-2 if you operate an S - Corp. You have to pay yourself a "reasonable" salary. If you try to pass it all through without paying SE tax on it, count on being audited sooner or later. Also S-Corp income is taxed at normal tax rates not as qualified dividends.

This is an awful broad statement, and in my experience there are exceptions to most every rule. If you identified yourself as a tax attorney or accountant I missed it. But there are instances where you don't necessarily "work" for the corporation, and thus would not be entitled to a salary. I know that in the tax code of the USA, as it has to do with real estate, you must perform a certain amount of "work" in the business to avail yourself of certain tax breaks. So if you do not qualify for that section, and you are an S corp, how could you be entitled to a salary?

S corps can disperse dividends just the same as C corps, and as well as an LLC, from what I have been led to understand. How else would the other members and stockholders get their share of the profits if they were not actively working in the company? I don't know of any other way but through dividend disbursement. These disbursements are treated just like any stock dividend, which currently is taxed at the same rate as long term capital gains.

As I am not a tax lawyer, accountant, CPA or other type of authority on this subject, this is a lay opinion. But I am damn sure I am right.

[TheWealthSquad]

Hey Tim Not an accountant or tax lawyer but do spend a lot of time doing taxes and doing tax research for clients. Wage Compensation for S Corporation Officers covers a lot on S-Corps. I copied the part that is probably relevant. "The Internal Revenue Code establishes that any officer of a corporation, including S corporations, is an employee of the corporation for federal employment tax purposes. S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages. This fact sheet clarifies information that small business taxpayers should understand regarding the tax law for corporate officers who perform services. Who’s an employee of the corporation? Generally, an officer of a corporation is an employee of the corporation. The fact that an officer is also a shareholder does not change the requirement that payments to the corporate officer be treated as wages. Courts have consistently held that S corporation officer/shareholders who provide more than minor services to their corporation and receive or are entitled to receive payment are employees whose compensation is subject to federal employment taxes. The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an officer would not be considered an employee." I was specifically thinking of people who form single owner S-Corps to avoid SE taxes. It is possible to be a shareholder of an S-Corp receiving flow through income without being required to pay themselves. It just isn't likely. I would consult with a good accountant if you have an S-Corp so you don't get into trouble. It is worth the time to do it correctly. Well I tried twice to fix the spacing and it won't save. Sorry this is hard to read.

[TheWealthSquad]

Originally Posted by timpears

This is an awful broad statement, and in my experience there are exceptions to most every rule. If you identified yourself as a tax attorney or accountant I missed it. But there are instances where you don't necessarily "work" for the corporation, and thus would not be entitled to a salary. I know that in the tax code of the USA, as it has to do with real estate, you must perform a certain amount of "work" in the business to avail yourself of certain tax breaks. So if you do not qualify for that section, and you are an S corp, how could you be entitled to a salary?

S corps can disperse dividends just the same as C corps, and as well as an LLC, from what I have been led to understand. How else would the other members and stockholders get their share of the profits if they were not actively working in the company? I don't know of any other way but through dividend disbursement. These disbursements are treated just like any stock dividend, which currently is taxed at the same rate as long term capital gains.

As I am not a tax lawyer, accountant, CPA or other type of authority on this subject, this is a lay opinion. But I am damn sure I am right.

Its late so re-read your post. Notice I said don't pass ALL your income through without paying SE taxes. Someone work's for the company. You can have distributions that go to other shareholders that don't fit this criteria. Sorry for not catching that the first time. My eyes are getting older every day. PS S-Corps and LLC's have distributions not dividends. C-Corps issue dividends. S-Corps and LLCs have K-1s that go to their share holders that determine how their taxes will be paid. The tax rate is dependent on how the earnings were created but primarily will be taxed at normal income tax rates.

[SageSound]

Here's how I look at it...

If the IRS audits you, they basically want to look at your bank records. They tally up all of your deposits and assume that's your "gross income". As far as they're concerned, it's all taxable 100% earned income.

Beyond that, it's up to YOU to SHOW that some income came from sources that are singled-out in the tax code for "special treatment".

The biggest split is "active" vs. "passive" income.

Next is "return on capital/investment" or something like that.

Next is whether it's "short-term" or "long-term".

Then you have your deductions....

Anyway, it's "active" income because it's a byproduct of your business activities, even if it's a recurring cashflow that started some time back.

It's like "rental income" because you have an asset (either your server or your hosting account) that is generating recurring income.

If you bought the server, rather than got it as part of a shared hosting plan, and it was in service for more than a year or two, then if you sell it, any gain after depreciation would probably be considered a long-term capital gain. But that's highly unlikely to happen, since the value of computer hardware drops faster than the depreciation schedules allow.

Basically, you're renting something for a fixed monthly expense, and you're sub-leasing it in smaller pieces for fixed monthly revenues. Hopefully your revenues exceed your expenses.

HTH
-David

[rushindo]

Originally Posted by timpears

These disbursements are treated just like any stock dividend, which currently is taxed at the same rate as long term capital gains.

Originally Posted by TheWealthSquad

The tax rate is dependent on how the earnings were created but primarily will be taxed at normal income tax rates.

You are both right :-). You pay normal income tax rates on your share of the S Corp's income whether or not you receive any "distributions." This is how partnerships work as well. Your distributions are "tax free" to the extent that they don't exceed your stock basis. If your distributions exceed your stock basis, then the portion of the distribution that exceeds the stock basis is taxed at capital gain rates (only long-term if you have owned the S corp stock more than one year).

But if you are the sole owner of the S Corp, you can't receive distributions that exceed the stock basis because you own 100% of the stock. Therefore your distributions are simply a "tax free" return of capital because you already paid taxes on it.

Source: S Corporation Stock and Debt Basis

Brandon - I love this tax stuff!!!!

[timpears]

Originally Posted by rushindo

Brandon - I love this tax stuff!!!!

Taxes are an interesting and fun game, that I kind of like to play with. Because the rules are so twisted and convoluted. But it basically comes down to as long as you don't raise any red flags, so they don't catch on for three years (I think) then you can do what you can get away with.

I try to stay in the rules, but I have little respect for tax law. It is a bogus system that is run by mafia types. The basis of the income tax is the 16th Amendment, which was never ratified. The last two states to ratify it, didn't ratify the same amendment as the other states did, as they changed the wording. Therefore the required number of states was not reached. But then the Supreme Court ruled that the 16th Amendment didn't give the US any additional powers that it didn't already have, so does it really matter. But that is supposed to be the basis of the income tax. But under the US Constitution, income is not taxable, and the amendment doesn't give any additional powers according to the Supreme Court, so how is the income tax legal? Because the ones with the muscle, says it is.

I just love this tax stuff. Sorry I got off the subject.

[TheWealthSquad]

Hey Tim

I work in taxes and agree with you that the Constitutional legality is questionable. Unfortunately the powers that be have established that they are Constitutional so we have to live with them.

Don't think that because you "get away" with it for 3 years you are ok. The IRS can go back many years if they chose too.

Time Limitatations to Prevent the IRS from Collecting Tax and Levy is a good place to start for the limitations.

Audits have been on the rise lately and I expect with the drop in tax revenue they will increase to try to make up the difference.

To avoid penalties, you should always document anything questionable. Why you did it, the reasoning behind it. If you appear to be taking legitimate deductions you can avoid a lot of penalties if they do audit you and disapprove something. If they decide you have evaded your tax responsibility they can also prosecute criminally. They caught Capone on tax evasion not any of the other issues.

Understanding your taxes can be one of the biggest gains to your company profitability. Most people leave it to someone else and never ask any questions. When you look at how much you pay in taxes, you will see a huge number for most people.

[Thomas]

Originally Posted by TheWealthSquad

... you have evaded your tax responsibility ...

I'll have to stop reading so fast; I thought that said "responsibly"!

[timpears]

I understand what you are saying WealthSquad. I am not an expert in taxes, but I do take an interest in how they work, and I like to try to see how I can make things work for myself the best way. It is not necessary to do anything illegal, but when in doubt, I always say, take the deduction and see what happens. Unless you raise the red flags, they do not go digging that far in the past.

If I ever get to a point where I am making significant money, I will probably move out of the country for tax and weather reasons. i would much rather live where the sun shines most of the time, and the tax rate is better. The Bahamas comes to mind. So my dream is to figure out this internet thing, so I can move where I would want to live and not share my income with politicians who can't get a real job. But in the mean time, I am just struggling to keep my head above water.

[TheWealthSquad]

Hey Tim

I don't think anyone qualifies as a tax expert. The code contradicts itself at times so you can sometimes find 5 answers from 3 people

I do agree in being reasonably aggressive in taking deductions for a business. I simply document why I took it, detail the rules I used, and why it is a normal business expense. This can save you a ton of money if you ever get audited because you can avoid penalties in many cases.

Red flags are a funny issue. The IRS sometimes selects certain deductions and does paper audits on a specific number of them. If they don't like your answers, they can easily pull previous years and they keep on eye on all future ones. Take the deduction. Keep the records behind it.

Moving overseas may not save you as much as you think. You may qualify for an exemption on income earned outside of the US but you still have to report it and still have to file as long as you are an American citizen. We get taxed on wordwide income not just that in the US. If you do move overseas, make sure you get a tax person who understands it.

My brother lived in Kiev for 14 years so I learned it to help him. Also have ran into it several times in the last year with people working in the Middle East as contractors for extended periods of time.

Keep plugging away!! As Paul Evans says' Success is not an accident.

[timpears]

Originally Posted by TheWealthSquad

Hey Tim

I don't think anyone qualifies as a tax expert. The code contradicts itself at times so you can sometimes find 5 answers from 3 people

Moving overseas may not save you as much as you think. You may qualify for an exemption on income earned outside of the US but you still have to report it and still have to file as long as you are an American citizen. We get taxed on wordwide income not just that in the US. If you do move overseas, make sure you get a tax person who understands it.

Sounds like we are pretty much in total agreement then. It has always amazed me that you can call the IRS and get their "official" answers, but that will not save you, as most of them don't really know and are notorious for making mistakess.

I never have been, and probably never will be a US citizen. That is why I don't have to worry about that little issue. I have never been able to understand the right that the USA takes to make rules for people no matter where they are located in the world. It just doesn't seem like they should have that right, but it is none of my business really, even though I have lived here for 45 years.