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On the dependent deduction that’s going away

Q: Is it true that the new tax law has eliminated the dependent deduction for children? This seems like a big deal that is not getting a lot of attention.

Jim HamillA: It is true. It may be a bit of “inside baseball” but tax preparers have discussed this in great detail. Many taxpayers will owe more tax in 2018 and future years because they lose not just the exemption for their dependents but also the exemption for themselves.

The odd thing is that the dependent tests still exist in the law and may even apply in 2018 to save you taxes. The new law expanded the child tax credit and created a less valuable credit for other dependents.

So whether someone qualifies as a dependent can still be very important. One test for a qualifying relative other than a child is that their income be less than the personal exemption amount. This was $4,150 in 2017 but is zero in 2018.

So read literally, a non-child qualifying relative would need to have negative income to qualify as a dependent in 2018. Although you cannot claim that person for the dependency exemption, their status as a dependent will determine whether you are eligible for the $500 tax credit.

As they have had to do with many drafting problems with the new law, IRS issued Notice 2018-70 to say they will allow you to pretend the dollar amount of income a qualifying relative can earn to qualify remains at $4,150.

So you might be eligible for a tax credit for a dependent child and a dependent relative if they satisfy the tests that are still in the law, with a clarification that you can test the relative’s income against the 2017 exemption amount to see if they can qualify.

Q: I have a $62,500 long-term capital gain from the sale of land. I had meant to maybe do a like-kind exchange and never got it set up so I just received a check for $117,346 from the title company for the sale proceeds. I read in Forbes that an opportunity zone investment can defer my gains, and that I only need to invest $62,500 rather than the full proceeds. Do you think that would make sense and where should I look for an opportunity zone investment?

A: First, I have been a big proponent of opportunity zone investments for their tax benefits. You actually invest in a “qualified opportunity fund,” which is a corporation or a partnership, or in a qualified opportunity zone business to defer the gains.

There are large sponsors of these funds, and also smaller “boutique” funds that seek investments for a single project (a hotel, an apartment complex and so on).

I hate to be a wet blanket but you may be challenged to find an investment. To avoid registration with the SEC the funds that I have seen accept only “accredited investors.” This is a legal term that allows a sponsor to sell to the investor without the time and expense of SEC registration.

An accredited investor is, in theory, one who is relatively sophisticated in making investments and who also has sufficient income or wealth to be able to survive a loss of the investment.

To be an accredited investor you must have income of more than $200,000, or $300,000 if combined with your spouse, or have net worth of at least $1 Million without considering your house.

The income test must be met for the two years before the investment and must also be expected to be met for the year of the investment. So that would mean 2017 and 2018, with an expectation of also meeting the test in 2019.

You may be an accredited investor. If so, you may still not be of interest in a smaller boutique fund that is looking for a few investors with more substantial amounts to invest.

If your income is largely comprised of this capital gain, you should run it through tax planning software to see what the capital gains tax will be. You may be surprised how small it is, in which case there would be little incentive to tie up your money to achieve tax deferral.

Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.

 

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