Tuesday, August 05, 2008

'Extreme': Higher taxes? Who pays?

Plenty of folks reading the previous post worried that the King family might not have money for the higher taxes they'll pay. Some suggested the day care they run isn't licensed. It is, and has a four-star rating.

Newsroom colleague and great writer Elizabeth Leland, apparently a Naked City reader, e-mailed me with a note pointing to Mark Washburn's article Saturday about the size of the house and the family's upcoming bills.

A pertinent excerpt is below, or you can read the story online. Mark's story doesn't address the questions of "green" building, though some who left comments
say the show makes a point of using energy-efficient techniques. Does anyone have any information?

What is not generally known is that producers often set aside money to ensure families can afford their gift homes. Community fundraisers, such as this week's concert at SouthPark, help underwrite the accounts.

"Most family mortgages are paid off," says Didiayer Snyder, one of the designers on the Charlotte build. Also, money is put in escrow for things such as power bills and other expenses, including scholarships.

In the case of the Kings, they are planning to finish degrees at UNC Charlotte and the show might make that part of the package, but it probably won't be known until the show airs in October.

"We do not build McMansions," says Diane Korman, senior producer with Lock and Key Productions in Hollywood, which creates the shows for ABC. "Houses need to be affordable for the residents."

... Korman said this week that the Charlotte project has been designed to fit in with the Windsor Park neighborhood, which is mostly one- and two-story brick homes. Lavish palaces are not the goal of the program, she said.


Anonymous said...

It's still an absurd concept. So many families could benefit from the money spent on this one couple who already owned a home. It's frivolous.

Anonymous said...

Neither this blog entry, nor Mark Washburn's story, truly answers the question of who will pay the appropriate taxes on this massive gift. Since the value of this home is obviously more than $12,000, the maximum non-taxable value of a gift, the value of the home must be treated as regular, taxable income when these folks file their Federal and state tax returns next year. The question I have is, are they going to be able to afford paying income taxes on $450,000+ of income?

I ran into a fellow a few years ago who had won an "ultimate tailgate truck" at the Rose Bowl. The truck was valued at $80,000 and was very nice; but he was trying to sell it because he could not afford to pay the income taxes on it. Not only was he going to have to pay income tax on the value of the truck, but that value was also going to push him into a higher tax bracket. He was trying to sell it, even at less than the declared value, just so he could pay his taxes. He brought it to every Panthers home game that season and even had a web site set up to try to sell it. I don't know if he was ever able to.

So, the question remains: How are these folks going to be able to afford a $100,000+ tax bill when they file their Federal and state returns next year? They received a gift, and they must pay taxes on it. I'm also wondering if the IRS will be closely monitoring this situation to see where the money to pay a tax bill comes from; legally, the show cannot pay it for them.

Anonymous said...

I think I had read at one time that the show "rents" the property from the owner for the week. Something about any improvements made to the property by the tenant is not taxable. I may be completely off base, but I think that is what I read.

Anonymous said...

In the case of the Harpers who got foreclosed on in GA, they were given enough money to pay their taxes for 25 years. But they got greedy & decided to take out a 450K loan on thei rgift & lost it.

Anonymous said...

The Harpers got given enough money to pay their taxes for 25 years but got greedy & took out a 450K loan & lost their gift.

Anonymous said...

Why is this family's tax situation any of your business?

Some people have a terrible addiction to gossip.

Anonymous said...

It just shows how jealous and shallow some people are in this town. Only a nosy Charlottean would care how the taxes are being handled or how the daycare is running. Hint guys, if an newspaper and national TV network are all over you, chances are everything's covered.

Hey, I hear there's a light rail extension going on or something with the Bobcats. Go back to complaining about those things. Leave this family alone!

Anonymous said...

After following this "Extreme Makeover" story all week (which the Observer's been absolutely infatuated with), and reading all the comments on the previous blog (some 52 of them) --- whew! this sure has generated a lot of heated debate. You don't think, just maybe, the folks at a national television network figured out a formula to get people talking & watching, do you? :) Perhaps this is a fascinating story because so many people, like me, are torn between feelings of support & of being exploited.

By now plenty of specifics have been shared about the numerous safeguards ABC's built in to [try to] mitigate the effects (paid-off mortgages; tax money; etc.).......and about how 'deserving' this family is of such a gift by being selfless, hard-working folks. So no need to keep re-hashing all that. Seems nearly all the blog commenters fall into one of two camps: the 'defenders' & the 'detractors'.

The defenders cheering this family's good luck are the ones among us who respond to emotion; they want good things to happen to the underdog. Nothing wrong with that; be a dull world if we didn't have things to tug at the heartstrings and bond us as humans. This is the audience precisely for whom such TV shows are created. But they seem so keen to take up for the Kings that they assume every 'detractor' is jealous, a Negative Nelly, or, even, racist (puh-leeze). In fact, the detractors are only questioning the implications of the bigger picture, for both this family & their community, after the film trucks drive off. Every decision has implications, and if you think one of the biggest assets in a person's life, their home, is only about the purchase price, you're mistaken.

From the detractors, there doesn't seem to be that much acknowledgment that the show's producer's aren't overwhelmingly concerned about Is this really the best approach? or In the big picture, does this help a societal problem, a particular neighborhood, or whatever? (Granted, the massive volunteer labor is great for bonding a community.) Their job first & foremost is to GET RATINGS. If there's a side benefit of actually helping folks, well, even better, but that's incidental. Would it be "better" to spread that largesse over a whole community? --- arguably yes, but there's less "wow" factor. This is nothing new.....it's been an audience-grabber since the early days of radio. It works because there's both the 'real-world' element of "I can relate to these hard-working folks, struggling to make a living" and the 'fantasy' element of "Hey, that could really happen to me too!" (Sound vaguely familiar to the Lottery?) So it is what it is; it's pointless to argue for banning or reining in such types of TV shows.

I was raised to think of any gift (talent; monetary wealth; the planet; whatever) as coming with the obligation for good stewardship; to use it responsibly for my own or others' benefit. This is a very Christian concept but I'm sure that many others share this belief with whatever their Higher Power, or just "The Universe". Ultimately, this family decided to allow themselves to be chosen for this gift from among the finalists; nobody put a gun to their head. I don't feel a great need to defend them because they seem like level-headed folks capable of weathering the inevitable criticism and second-guessing that comes with the package, along with enjoying the elation & pleasure of this unexpected good fortune.

Watching this whole thing, it's struck me that the "Extreme Home Makeover" concept would make for a gripping movie, along the lines of The Truman Show, Wag the Dog, or other such films, where a portrayal of America's fascination with the media & the power it yields doesn't need any tongue-clucking; it speaks for itself.

Anonymous said...

Frankly, I think the tax situation is interesting (I took every tax class I could in law school) so if you don't think it's fair game to talk about the tax implications of a television show that was splashed across the front pages of the local paper for days, then please bugger off.

The problem with the setting aside of money to pay taxes and the paying off of mortgage debt is that you don't get that money for free. The Internal Revenue Code doesn't allow someone else to "pay your taxes" for you in a dollar-for-dollar manner. If the show attaches cash along with the property prize, that amount is also taxable income to the recipient.

As far as the rental bit, while that may be what they do (and certainly why they would do it) if the recipients get audited then that characterization would likely be ignored due to the economic substance doctrine that the IRS follows. The bottom line there is that the IRS won't respect transactions that have no purpose other than to recieve some tax benefit. That seems to clearly be the case here.

It's not always good to win property that has great value unless you have large mountains of cash sitting around with which to pay the taxes...

Anonymous said...

I wish a CPA would comment on the taxes. Then again, I'd like the producers to tell us whether the house and anything else given to the family is a "gift", or whether it is "prize winnings".

There's a difference in the two.

My understanding is that gift tax is paid by the giftor (the producers or rather the corporation), not by the giftee (the family).

Prize winnings, however, are ordinary income to the winner. If the value of the prize is $450,000, the family will face paying federal and state income tax at the rates of 35% and about 8% respectively. That would be a huge burden.

The $450,000 prize would only be income for the year in which it was won. If it was a prize, maybe the producers "gross up" the winnings to allow for part of the overall prize package to include cash to cover the anticipated taxes, based on current federal and NC rates, for that year.

It is was a gift, maybe the giftor gifts more to cover the taxes, but in effect is still paying them.

So, is it a gift or a prize?

The only real problem seems to be in the family covering the ongoing city/county real estate tax each December. But at least that's tax deductible on their income tax return.

Re another tax facet, the show may have done the family day care business a favor by building big and expensive. Assuming it's licensed and can operate out of the home. their business gets to capitalize a portion of the house's value according to the proportion of day care footage to total square footage. In other words they get depreciation expense for the business portion based on a 39-year life.

I think they can also deduct a portion of such things as utlities, mortgage, alarm system, insurance and repairs based on the percentage of the house that is used for the business. These expenses will offset their business income and reduce their overall tax bill.

Anonymous said...

I don't think that the daycare gets to capitalize costs that it didn't actually incur.

Anonymous said...

Maybe I shouldn't have just said "depreciation" instead of "capitalization".

Just like those who are eligible to have home offices, day care centers in a house can take depreciation expense on the portion of the house (sans land, which can't be "depreciated")that is used for the business (day care is a business). They can also take depreciation on the other assets (equipment, furniture) used in the home-based business.

If 2,000 square feet is used for the day care business, and the total house area is 5,100 square feet, then 39.2157% of the house is business use. Business (commercial) property can be depreciated over 39 years. See the IRS MACRS and other tables to compute actual amount.They'd only get about 5 months depreciation for 2008, since the madeover house wasn't there all 12 months.

I didn't do the rest of the math or table lookup, but their allowable annual depreciation expense for tax for IRS pruposes would be a lot more than on a $100,000 house sans land.

Unfortunately, they'd have to recapture the depreciation allowed or allowable to date to when they sell the house, but they would still probably come out ahead. If they were taking or could have taken similar depreciation expense on the old 1,900 square house, then some adjustments may have to be calculated.

Anonymous said...

Their home-based day care center does incur costs on the portion of the house used for the business. How else would there be a business if it isn't housed somewehere? Doesn't have to be an external building. But the space devoted to day care should be used exclusively for that purpose, not family entertainment or usage.

Anonymous said...

Yes, that is correct as far as depreciating the portion of the house used for the daycare. But they have a $0 basis in the structure, do they not? How can they depreciate (% of structure used exclusively for daycare purposes/30) per year if they haven't actually spent anything for the structure? Would the basis for the structure then be a percentage of the tax paid for the structure? Would the family exchange a percentage of the house to the daycare corporation in exchange for stock? (Would that give the corporation a basis?)

Is an unprofitable day care operated for the good of the neighborhood truly a business at all or would it be subject to Sec. 179 limitations on excess deductions as a "hobby" i.e. activity a taxpayer participates in without the expectation of profit?

Anonymous said...

I believe the previous comment was regarding whether they could depreciate that which they did not pay for. The answer is, yes. The basis amount for the depreciation, however, is based on the market value of the property at the time they acquired it, and that acquisition in the form of a gift is indeed taxable income to the recipient in the year it was received.

Anonymous said...

I find the concept of the show fundamentally dishonest. It is touted as altruism based on volunteer work and charitable giving and that is to some degree true. Many of the people working on the project are working for free at the behest of the producers. What that really does is simply keep the production costs down and hence the profits of the producers and ABC up. They are NOT working for free.

The producers could do the show without all the volunteer labor and local fundraisers and would probably STILL be profitable: game shows do it all the time. Instead they use the emotional appeal of altruism to line their own pockets.

Anonymous said...

To Anon at 06:05 pm

Section 179 allows assets to be expensed faster than than the usual allowable tax method, such as MACRS. There are complex rules and limits, but my understanding is that it can't be claimed if there is a net loss and the day care is a corporation.

However, they can still claim the amount of allowable depreciation expense even if they can't take advantage of using Section 179. The two are different things with different tax rules.

There are a lot of factors the IRS and courts look at to determine if a business is an ongoing concern, or just a hobby. They have to be taking in some revenue in that day care center. That counts a lot. Just because they have a lot of expenses and therefore aren't profitable for more than three or four years running doesn't mean they have a hobby.

If that were the case, the Bobcats would have been classifed by the IRS as a hobby by now, because I doubt they've ever been profitable.

I assume the day care in question is incorporated for liability purposes. Maybe for tax purposes it is treated as an S-Corporation. If so, they and thousands of similar Charlotte businesses are often passing big losses over to the owners' Form 1040, where it is deducted against other income items and reduces the income tax ultimately paid. That's one advantage of being an entrepreneur. God bless Capitalism.

Anonymous said...

You're right, my brain has been scrambled lately. I was actually referring to 183. 179 is the one that allows accelerated depreciation.

183 says that excess deductions (that is deductions that exceed gains from a certain activity) can only be taken in for-profit activities. Where you have a Sec. 62 business or a Sec. XXX activity engaged in for profit one can offset other income with losses from that activity. However, with a 183 "hobby" a taxpayer can only deduct losses up to the amount of his gains from a certain activity.

Included in this section (or perhaps it is in the Regs for 1.183) is the safe harbor that creates a rebuttable presumption that activities that generate gains in excess of losses for 3 of 5 years are activities engaged in for profit.

The general rule is that the taxpayer must be expecting to make a profit (that expectation doesn't have to be reasonable.) However, if you don't fit within the safe harbor, there are nine objective factors that courts and the IRS look at to determine if you actually have the requisite profit motive. They include things like operating in a business-like manner, making profits at the activity in the past, relying on the advice of experts, changing operating methods when unprofitable, etc. I'm not trying to suggest that this day-care is or isn't, but it is something that I should think would need to be considered, particularly as the taxpayers here (who, you're right, are likely pass-through) attempt to (as they should) deduct depreciation and other business expenses from their income.

Thanks for straightening me out.