Originally published on forbes.com.
President Obama has come out in favor of marriage equality, which seems to be generating quite a bit of excitement. As far as I can tell there is only one tax blogger who devotes more space to the tax implications of same sex marriage than I do. That would be Paricia Cain who writes the Santa Clara Same Sex Tax Blog. As a matter of fact, my first post on Forbes.com was about New York Marriage equality. I introduced Robin and Terry, a couple of indeterminate gender and marital status whose income, residence and professions constantly shift. Their role is to help me avoid awkward pronoun problems. When taxes come up in discussions of marriage equality, there is usually a focus on the tax advantages of being married, which are admittedly many. I thought that it might be timely, though, to once again review some of the tax advantages of not being married. Back when the prospects of marriage equality were dimmer I advised Robin and Terry to not get mad, but rather get even. Here are some of the ideas I came up with for them.
1. The standard deduction – Even if property is held jointly, either one can pay the real estate and mortgage interest and deduct it. (You cannot deduct somebody else’s taxes, but you can deduct all of the taxes on a property you own part of, if you pay all of it.) Robin and Terry each maintain a separate checking account. (This is a step I have found some couples find difficult to implement.). Robin pays for the groceries, home repairs, country club dues, etc. Terry makes the mortgage payments, pays the real estate taxes and makes their charitable contributions. (Terry cannot pay Robin’s state income tax, but if they have a significant diversified portfolio, Robin should own the US obligations and exempt obligations of their state of residence.) Through these steps, Robin and Terry will between them be able to deduct all their itemized deductions and one standard deduction.
2. The deferred salary – If Robin owns a C corporation (call it Robco), Robco can employ Terry. Robco should pay Terry once a year. If Robco is an accrual basis corporation it can accrue the salary due to Terry and pay it to Terry, a cash basis taxpayer in the subsequent year.
3. The free basis step-up – If Robin owns a rental property, Terry can buy it by giving Robin a long-term installment note. Robin will recognize no income until the principal is paid. Terry will have a stepped up basis for purposes of depreciation or even sale. (Thus it would even be worth doing with a vacation property, if it is likely to be sold.)
4. The basis swap – If Robin owns a high basis property and Terry owns a low basis property and they wish to sell the latter, they can do a like-kind exchange prior to the sale, thereby reducing the gain.
5. The wash sale – If Robin wants to maintain a securities position but harvest capital losses, Terry can purchase the identical security on the same day that Robin sells.
6. Forget the trade-in – If Robin has a luxury automobile that is used for business, that they would like to hang onto, Robin can sell it to Terry at loss, which unlike depreciation is not subject to luxury limitations.
If a couple chooses to use any of these techniques, the most likely way they would fail on audit is through poor execution. Everything must be done in the same way as it would be done in a truly arms-length transaction. If there is a note for a property sale a mortgage should be recorded. Payments should be made regularly as defined by the terms of the contract. Separate accounts should be maintained and receipts and disbursements should be scrupulously deposited or disbursed from the correct account (e.g. After the free basis step up, rents should go into Terry’s account and property expenses, including the interest due Robin, should be paid out of that account.)
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