Category: Get Real: Real Estate Life Cycle Insights

How are start-up expenses treated for new rental properties?

Posted by Simon Filip on

When projecting taxable income from your new rental property be mindful of start-up expenses

Expenses incurred prior to the commencement of a business are not currently deductible. In the instance of rental real estate, costs incurred before a property is ready to be rented are considered start-up expenses.

What are start-up expenses?For tax purposes, be sure to track start-up expenses for your new rental property

Start-up expenses generally fall into three categories:

  1. Investigatory costs – amounts paid or incurred in connection with investigating the creation or acquisition of a trade or business.
  2. Formation/organizational costs – amounts paid or incurred in creating an active trade or business.
  3. Pre-opening expenses – amounts paid or incurred in connection with “any activity engaged in for profit and for the production of income before the day on which the active trade or business begins, in anticipation of such activity becoming an active trade or business.”

How are start-up expenses treated for tax purposes?

Costs that have been identified as start-up expenses are treated differently for income tax purposes. The expenditures cannot be deducted automatically in a single year. Since these costs are deemed to provide a benefit over multiple years, they are treated as capital expenditures and must be deducted in equal amounts over 15 years. There is a special provision that allows taxpayers to deduct up to $5,000 in start-up expenses in the first year of active business, with the balance amortized over 15 years.

What about expenses to obtain a mortgage?

Certain settlement costs incurred in connection with obtaining a mortgage are required to be amortized over the life of the mortgage. Expenses such as mortgage commissions, loan processing fees, and recording fees are capitalized and amortized.

Points are charges paid by a borrower to obtain a loan or mortgage. Sometimes these charges are referred to as loan origination fees or premium charges. Points are essentially prepaid interest, but cannot be deducted in full in the year of payment. Taxpayers must amortize points over the life of the loan for their rental property.

When is a property deemed ready for rent?

There is considerable confusion about when property is ready for rent and rental activity begins for income tax purposes. It is important to establish this point in time as subsequent expenditures are no longer treated as start-up expenses requiring capitalization.

The rental activity begins when the property is ready and available for rent, not when it has actually rented. In other words, expenses incurred by the landlord while the property is vacant are not start-up expenses. For example, assume a taxpayer landlord has a vacant property that is being advertised for rental and has received a certificate of occupancy, but the landlord has not been able to find a tenant for three months. The costs incurred during that time period are not considered start-up because the property is ready and available for rent.

If a taxpayer does incur start-up expenses, they should be separated and capitalized in accordance with the Internal Revenue Code. Proper tax planning includes minimizing start-up expenses to the extent possible and/or keeping them below the $5,000 threshold.

We’ve got your back

If you have questions about start-up expenses for your new rental property, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

Allocating Between Land and Building when Acquiring Rental Real Estate

Posted by Simon Filip on

How purchase value is divided up between land and buildings impacts the depreciation tax benefits you get as a real estate owner. Here’s what you need to know.

Depreciation for residential and commercial properties

Apportioning costs between the land and the building for favorable tax treatmentA tax benefit of real estate investing is the tax shelter provided by depreciation. Depreciation is an IRS acknowledgment that assets deteriorate over time. The IRS provides specific depreciable lives for residential and commercial property of 27.5 and 39 years, respectively.  Unlike other expenses, the depreciation deduction is a paper deduction.  You do not have to spend money to be entitled to an annual deduction.

Allocations favorable to taxpayers

When acquiring real estate, a taxpayer is acquiring non-depreciable land and depreciable improvements (excluding raw land, land leases, etc. for this discussion). In transactions that result in a transfer of depreciable property and non-depreciable property such as land and building purchased for a lump sum, the cost must be apportioned between the land and the building (improvements).

Land can never be depreciated. Since land provides no current tax benefit through depreciation deductions, a higher allocation to building is taxpayer-favorable. This results in the common query of how a taxpayer should allocate the purchase price between land and building. The Tax Court has repeatedly ruled that use of the tax assessor’s value to compute a ratio of the value of the land to the building is an acceptable way to allocate the cost.

For example, a taxpayer purchases a property for $1,000,000. The tax assessor’s ratios are 35/65 land to building. Using the tax assessor’s allocation the taxpayer would allocate the purchase price $350,000 and $650,000 to land and building, respectively.

Other acceptable methods used as basis for allocation include a qualified appraisal, insurance coverage on the structure (building), comparable sales of land and site coverage ratio.

Assessor’s allocation vs. taxpayer proposed values

In the recent U.S. Tax Court case, Nielsen v. Commissioner, the court concluded the county assessor’s allocation between land and improvements were more reliable than the taxpayer’s proposed values. Nielsen (the “petitioners”) incorrectly included their entire purchase price as depreciable basis, with no allocation between the improvements and the land.

When the petitioners were challenged they acquiesced and agreed the land should not have been included in their calculation of the depreciable basis. However, the petitioners challenged the accuracy of the Los Angeles County Office of the Assessor’s assessment as being inaccurate and inconsistent. Petitioners relied on alternative methods of valuation, which included the land sales method and the insurance method.  The Tax Court ruled the county assessor’s allocation between land and improvement values was more reliable than the taxpayer’s proposed values.

We’ve got your back

In Nielsen vs. Commissioner, the Tax Court chose the assessor’s allocation over those provided by the taxpayers. However, facts and circumstances may not support the assessor’s allocation in all cases. It is important for a taxpayer to have reliable support and documentation to defend an allocation if it should be challenged.

If you have questions about how to allocate value between land and building, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

Don’t Be Surprised by a Tax Liability on the Sale of Your Residence

Posted by Simon Filip on

Tax liability on the sale of your residenceRegularly, clients contact me to discuss the tax consequences of selling their primary residence. It seems there is a lot of misinformation floating around that I aim to clarify below.

Rollover proceeds from a sale

It is common for sellers who have been in their homes for quite some time to cite the “old” rollover rule. Before May 7, 1997, taxpayers could avoid paying taxes on profits from the sale of their principal residence by using the proceeds to purchase another home within two years. Sellers over age 55 had the option of a once-in-a-lifetime tax exemption of up to $125,000 of profits.

Home sale gain exclusion

Internal Revenue Code Section 121 replaced the old rollover rule and allowed taxpayers to exclude gains from the disposition of their home if certain requirements are met.

In order to qualify for the gain exclusion, a taxpayer must own and occupy the property as a principal residence for two of the five years immediately preceding the sale. If a taxpayer has more than one home, the gain can only be excluded from the sale of their main home. In cases where there are two homes that are lived in, the main home is generally the one that is lived in the most.

If the requirements are met, taxpayers may be able to exclude up to $250,000 of gain from their income ($500,000 on a joint return) and are not obligated to reinvest the proceeds.

Sale of a multi-family home

I was recently able to provide guidance to married taxpayers who sold their property. This particular property was a side-by-side duplex where the taxpayers occupied one side as their principal residence for approximately 10 years and rented the other. The taxpayer was familiar with the $500,000 exclusion and the gross proceeds were slightly below that amount. During sales negotiations, they were incorrectly advised that the proposed sale of their principal residence with a gain under $500,000 would result in no income taxes owed after the sale. Needless to say, there was an unexpected surprise when I discussed the true income tax consequences with them.

Selling a duplex is conceptually akin to selling two separate properties. The side the taxpayers occupied is afforded the same tax treatment as any other principal residence, which includes the Section 121 gain exclusion up to $500,000 for married taxpayers. However, the investment side of the duplex is subject to capital gains tax and depreciation recapture taxes. In this particular instance, there was approximately $30,000 of combined federal and state income taxes owed as a result of the sale.

Under current law, taxpayers can sell their principal residence and exclude $250,000 of taxable gain ($500,000 for those married filing jointly). The requirements to reinvest the proceeds or to roll them into a new property have been inapplicable for some time. Taxpayers are free to use the proceeds from the sale in any manner without tainting the exclusion.

We’ve got your back

If you have additional questions about the income tax consequences of a residential sale, especially when a portion of the property has been rented out, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

You can also download my free Tax Tip Sheet for more ways to save taxes when buying or selling a residential property.

Should I Acquire and Hold Rental Real Estate in an LLC?

Posted by Simon Filip on

At KRS, we get this question often from both new and seasoned investors acquiring new properties. Here’s what investors need to consider.

Should you buy and hold rental real estate as an LLC?Limited Liability Company

A limited liability company (LLC) is a legal structure that provides the limited liability features of a corporation and the tax efficiencies and operating flexibilities of a partnership.

The owners of an LLC are referred to as “members.” The members can consist of two or more individuals, corporations, trusts or other LLCs. Unlike a corporation, an LLC is not taxed as a separate business entity. Instead, all profits and losses are “passed through” to each member of the LLC.

A central motivation behind investors forming LLCs is to protect the LLC’s members (owners) from personal liability for debts and claims. At its very root, an LLC is utilized to keep creditors – such as suppliers, lenders or tenants – from legally pursuing the assets of a member. There are exceptions to the limited liability, such as in cases of illegal or fraudulent activity.

Disregarded Entity

LLCs are typically taxed as partnerships, which file separate tax returns. However, a single-member LLC, owned by one individual, does not file a separate tax return, but reports the activity on the tax return of its sole owner (Schedule C for business operations or Schedule E for rental activities). LLCs with one owner are commonly referred to as a “disregarded entity.”

Do I need an LLC?

Many real estate investors and landlords often ask whether they should purchase their rental property in an LLC. I have read numerous articles by attorneys, tax advisors, real estate professionals, and insurance agents with opinions on this matter. I believe there is no “one size fits all” answer. Just as in selecting which property to acquire, where investors consider multiple factors including cash flow, appreciation, capital expenditures, interest rates, proximity to transportation and etc., there are multiple considerations in choosing whether or not to acquire a property in an LLC.

Here are factors investors and landlords should consider when making their decision:

  1. Cost – I have seen clients utilize websites that charge fees as low as $100 to form an LLC (plus state filing fees). It is not uncommon to find an attorney’s fees to form a single-member LLC (including state fees) range from $1,000 to $3,000 depending on the state of formation.
  2. Filing fees – most states have an annual filing fee to keep the LLC in good status. That fee is currently a flat $50 in my home state of New Jersey. However, in New York, the fee can range from $25 to $4,500 depending on gross revenues (disregarded LLCs in New York are subject to a $25 flat fee).
  3. Type of property – the type of property to be purchased impacts risk. For example, a single family rental in a good neighborhood is less risky than a multi-unit property or commercial property.
  4. Financing – it is typically easier to obtain financing as an individual than as a commercial entity (i.e., an LLC).
  5. Interest rates – an individual borrowing to acquire an investment property may pay a higher rate than an LLC borrowing for the same property.
  6. Insurance – an umbrella policy provides coverage beyond the basic property insurance and covers additional risks. Umbrella policies may also pay for attorneys appointed by the insurance company and paid to defend you. Depending on an investor’s risk tolerance, an umbrella policy should be considered whether the acquisition is made with or without an LLC.
  7. Net worth – without an umbrella policy, an individual with a high net worth may be exposing his or her other assets to claims of creditors of his or her rental investment.

Transferring to an LLC

Frequently an investor has already closed on a property and the question arises regarding subsequently transferring the property to an LLC. After the property has been deeded there are concerns that should be reviewed including:

  1. Mortgage – if there is a mortgage on the property, contact the lender. Many mortgages have a “due on sale” clause, which means that if you transfer ownership of the property, the lender could require you to pay the full mortgage amount.
  2. Transfer tax – transfer of real property, depending on state law, may be subject to a transfer tax. Some states may exempt the transfer to a wholly owned LLC.
  3. Title insurance – a review of the title insurance policy should be undertaken to determine if the policy continues after transfer.
  4. Leases – tenant leases should be updated to reflect the LLC, and not the individual, as the owner of the property.

Acquiring real estate in an LLC should be included in an investor’s thought process or deal checklist before an acquisition. As the projects grow in size, value and risk protection afforded by an LLC will likely make their use instinctive.

We’ve got your back

If you have additional questions about rental properties and LLCs, we’re here to help. Contact me at SFilip@krscpas.com or 201.655.7411.

What Is an UPREIT ?

Posted by Simon Filip on

Real Estate Investment Trust basics

An Umbrella Partnership Real Estate Investment Trust (UPREIT) can provide tax deferral benefits to commercial property owners

Real Estate Investment Trusts (REIT) are comparable to mutual funds for real estate investors.

REITs provide an opportunity to invest in large-scale properties and real estate portfolios in the same manner mutual funds offer diversification and professional management to investors in stocks and bonds. REIT investments are touted for diversified income streams and long-term capital appreciation.

Many REITs are traded on major stock exchanges, but there are non-listed public and private REITs as well. REITs are generally segregated into two core categories: Equity REITs and Mortgage REITs. While Equity REITs generate income through rental income streams and sales of the real estate portfolios, Mortgage REITs invest in mortgages or mortgage backed securities tied to commercial and/or residential properties.

Similar to sector-focused mutual funds, REITs have been created to invest in specific real estate asset classes. Some REIT offerings targeting specific asset classes include student housing, nursing homes, storage centers and hospitals.

REIT shareholders receive dividend distributions

Shareholders receive their share of REIT income via dividend distributions. REIT dividend distributions are allocated among ordinary income, capital gains and return of capital, each with a different tax consequence to the recipient.

Most dividends issued by REITs are taxed as ordinary dividends, which are subject to ordinary income tax rates (up to a maximum rate of 39.6%, plus a separate 3.8% surtax on net investment income). However, REIT dividends can qualify for lower rates under certain circumstances, such as in the case of capital gain distributions (20% maximum tax rate plus the 3.8 % surtax on net investment income). Additionally, the capital gains rate applies to a sale of REIT stock (20% capital gains rate plus 3.8% surtax).

What is an UPREIT?

An Umbrella Partnership Real Estate Investment Trust (UPREIT) provides tax deferral benefits to commercial property owners who contribute their real property into a tiered ownership structure that includes an operating partnership and the REIT, which is the other partner of the operating partnership. In exchange for the real property contributed to the UPREIT, the investor receives units in the operating partnership.

When the UPREIT structure is used, the owner contributes property to the partnership in exchange for limited partnership units and a “put” option. Generally, this contribution is a nontaxable transfer.

The owners of limited-partnership units can exercise their put option and convert their units into REIT shares or cash at the REIT’s option. This is generally a taxable event to the unit holder.

Tax deferral opportunities

When a taxpayer sells depreciable real property in a taxable transaction the gain is subject to capital gains tax (currently a maximum of 20%) and depreciation recapture tax (25%). The capital gain tax and depreciation recapture remain deferred as long as the UPREIT holds the property and the investor holds the operating partnership units. The advantage of this structure is that it provides commercial property owners, who might have significant capital gain tax liabilities on the sale of appreciated property, an alternative exit strategy.

It is common for taxpayers to negotiate some sort of standstill agreement where the REIT agrees not to sell the property in a taxable disposition for some period of time, usually five to ten years. If the REIT sell the property in a taxable disposition, it triggers taxable gain to the taxpayer.

The taxable gain is generally deferred when the real estate is transferred to the UPREIT. Generally, the tax deferral lasts until the partnership sells the property in a taxable transaction. However, a taxable event is triggered if the taxpayer converts the operating partnership units to REIT shares or cash.

We’ve got your back

If you have questions about UPREITs or their tax implications, we’re here to help. Contact Simon Filip at SFilip@krscpas.com or 201.655.7411.

Using a Self-Directed IRA to Buy Real Estate

Posted by Simon Filip on

The real estate market is an attractive option for investors who desire alternative or non-traded assets in their portfolio. Additionally, paltry returns on money market and similar savings vehicles have motivated individuals to seek non-traditional methods to save for retirement. One option that has grown in popularity is utilizing a self-directed IRA to purchase real estate.

Using a Self-Direct IRA to Buy Real EstateWhat is a Self-Directed IRA?

A Self-Directed Individual Retirement Account (“SDIRA”) is an IRA that requires the account owner to make investment decisions and invest on behalf of the retirement account. IRS regulations require a qualified trustee, or custodian to hold the IRA assets on behalf of the IRA owner.

Although the statistics are not formally tracked, the Securities and Exchange Commission estimated that approximately 2 percent of all IRAs are self-directed, which equates to more than $100 billion (in real estate and other investment vehicles).

Prohibited Transactions

There is a wide selection of options in which a self-directed IRA to invest. However, the Internal Revenue Code does not allow certain investments. For example a self-directed IRA is prohibited from investing in S Corporations, life insurance contracts and collectibles.

IRAs are also precluded from “prohibited transactions,” which include “self-dealing” transactions. This restriction was established to prevent an IRA owner from using the IRA funds for his or her own personal benefit instead of the IRA. An example of a prohibited transaction is selling property you currently own to your IRA.

If the rules are violated, the entire IRA could lose its tax-deferred status.

Real estate investments

When purchasing real estate with a SDIRA, generally all income and gains generated by your IRA account would flow back into the retirement account tax-free. Instead of paying tax on the returns of a real estate investment, tax is paid at a later date (IRA withdrawals/distributions), allowing the real estate investment to grow.

Real estate related investments that are available to a SDIRA include:

  • raw land
  • residential homes
  • commercial property
  • apartments
  • real estate notes
  • tax liens
  • tax deeds

Tax benefits lost and liabilities gained

Investing in real estate through an IRA instead of individually may cause an investor to lose tax benefits. For example, if you sold appreciated property outside of an IRA, the profit is subject to a capital gains tax (currently at a preferential rate). However, the profit from real estate sold inside an IRA is ultimately taxed at the time of withdrawal at ordinary income tax rates, which will likely be higher than the capital gains rate.

A SDIRA that invests in real estate may incur additional tax liabilities. If an IRA purchased a property subject to a mortgage, it may be subject to unrelated business income tax (UBTI) on a percentage of the rental payments. For example, if you make a 25% down payment on a rental property, then 75% of your rental income is subject to the tax.

Owning real estate in an IRA allows your investment to grow on a tax-deferred basis. However, if you do not follow the rules, you could disqualify your IRA and create a taxable event. It is important to consult with your tax and financial advisors before directing IRA funds into a non-traditional investment.

We’ve got your back

If you have questions about setting up an SDIRA or its tax implications, we’re here to help. Contact Simon Filip at SFilip@krscpas.com or 201.655.7411.

Consider Converting to an S Corporation to Avoid Taxes

Posted by Simon Filip on

Consider Converting to S Corporation to Avoid Taxes

For closely held corporations still taxed as C corporations, the opportunities to avoid future taxes should be considered.

When converting a C corporation to an S corporation there are a number of tax issues that must be addressed.

C corporation vs. S corporation tax rates

A C corporation is taxed on its taxable income at federal rates up to 35%. Distributions of qualified dividends to individual shareholders are taxed again at a federal rate as high as 23.8% (the tax rate on qualified dividends is 15% or 20%, depending on certain adjusted gross income thresholds with an additional 3.8% surtax on net investment income for taxpayers with adjusted gross income over certain thresholds).

If a business elects to be taxed as an S corporation, there is only one level of taxation, at the shareholder level.

Generally, items of income, deduction, gain or loss from a pass-through entity pass through to its owners, while the entity itself is not subject to tax. The S corporation may therefore be favorable as it avoids double taxation.

Not every C corp is eligible

Not every C corporation is eligible to elect to be taxed as an S corporation. The current S corporation eligibility requirements are as follows:

  • No more than 100 shareholders
  • Shareholders who are all individuals (there are exceptions for estates, trusts and certain tax exempt organizations)
  • No nonresident aliens as shareholders
  • Only one class of stock

Mechanics of election

The S election requires the unanimous consent of the shareholders and is effective for any year if made in the prior year or on or before the fifteenth day of the third month of the year. Some states, such as New York and New Jersey, require a separate election be filed, while some states follow the Federal tax classification.

Built-in gains

The excess of the fair market value of the assets over their adjusted basis at the time of the S election is considered “built-in gain.” If any of this built-in gain is recognized during the 5-year period beginning with the first tax year for which the corporation was an S corporation, such gains remains subject to corporate-level tax. Any appreciation of assets that occurs post-S corporation election, is subject to only one level of taxation.

Here’s an example:

XYZ, Inc., a C corporation, was converted to an S corporation on January 1, 2017. On the date of the conversion, it owned real estate with a fair market value of $3 million and an adjusted basis of $2 million. The corporation’s net unrealized built-in gain would be $1 million. If the corporation had taxable income of $1.5 million and sold the real estate asset in 2019, the corporation would be subject to the built-in gains tax of $350,000 ($1 million x 35%). However, if the built-in gain assets were sold in 2023, the built-in gains tax would be a non-issue (zero built-in gain tax), since the fifth year of the recognition period passed.

For more about real estate and C corps, see my post Do You Hold Real Estate in a C Corporation?

Excess passive investment income

If an S corporation was previously a C corporation, it may have accumulated Earnings & Profits (“E&P) from years when it was a C corporation. A potential problem for an S corporation with E&P is the passive investment income tax.

If gross passive investment income (which includes income from interest, dividends, and certain rents) exceeds 25% of gross receipts, the corporation may be subject to tax on its net passive investment income. This is fairly common when a taxpayer makes an S election for a C corporation that owns rental real estate. In a year where an S corporation has both E&P and excess passive investment income, some of the excess net passive investment income may be subject to the tax at the highest corporate income tax rate. This does not apply to a year in which there is no taxable income.

The S corporation will still have a problem if there is no taxable income and the passive investment income tax does not apply. If the S corporation has both E&P and excess passive investment income for three (3) consecutive tax years, the S corporation status is revoked on the first day of the fourth year.

Tax planning can help minimize your taxes

The double taxation of C corporation income is very tax inefficient. With proper tax planning, the owners of a C corporation can minimize their total taxes by converting the corporation to S corporation status. As always, KRS CPAs is here to help you. Contact me at sfilip@krscpas.com or 201.655.7411 for assistance with C corporations and tax planning.

Do You Hold Real Estate in a C Corporation?

Posted by Simon Filip on

Here’s why you should think twice about using a C corporation for rental real estate property.

Do you hold real estate in a C corporation?
In practice I have encountered legacy entities that were set up before the rise in popularity of S Corporations or the general acceptance of Limited Liability Companies. Occasionally, there is still the investor who was advised to purchase or is contemplating purchasing, rental real estate in a C Corporation. Utilizing a C Corporation as an entity choice could prove costly.

Real estate and double taxation

A C corporation is not a pass-through entity. Corporate taxable income is initially taxed at the entity level. If the corporation distributes its earnings to shareholders as a dividend, the recipient of the dividend must include it in his or her individual income tax return, where it is again subject to tax.

Individuals invest in real estate for its current income (cash flow) and future value (appreciation). If real estate appreciates in value while owned inside a C corporation and the asset is sold by the corporation, the gain will be taxed at the corporate level at corporate income tax rates. If the C corporation then makes distributions to its shareholders as a dividend, the recipients must include the dividends, where it will be subject to a second level of tax.

Getting real estate out of C corporations

Property owners may hold real estate inside a C corporation because they desire liability projection. It is also possible the entity was inherited from a family member and it already held title to the real estate. The limited liability protection can be offered by the use of S Corporations and Limited Liability Companies (“LLC”), which provide the liability protection of a corporation without the double taxation.

There are options available to address real estate owned by a C Corporation that include:

  1. Distributing the property in kind to the shareholders.
  2. Selling the real estate to the shareholder or an unrelated party
  3. Converting the C Corporation into an S Corporation.

Distributing appreciated real estate to shareholders

A corporation that transfers a real estate deed to one or more shareholders has made a “deemed sale” that is taxable to both the corporation and the shareholders (assuming a non-liquidating transaction). At the corporate level, the distribution is treated as a sale to the shareholders at fair market value. Corporate gain is calculated as the excess of fair market over the corporation’s basis in the real estate. The shareholders that receive the property will be taxed on the full amount of the distribution. If the corporation has current or accumulated earnings and profits, the distribution is treated as a dividend.

Selling appreciated real estate

The sale of the real estate is a taxable event to the corporation. Unlike a “deemed sale” mentioned above, an actual sale generates cash for the corporation to pay the resulting tax. If the proceeds from the sale are not distributed to the shareholders, there will be no tax to the shareholders (along with no cash).

Converting a C corporation into an S corporation

Shareholders can convert a C corporation into a subchapter S Corporation. Unlike the first two options, this can completely avoid double taxation. However, there are potentially costly tax issues that should be addressed including:

  • Built-in gains (“BIG”) tax – if an S Corporation that was formerly a C Corporation sells appreciated real estate, the entity may still pay C Corporation taxes on the appreciation.
  • Excess passive investment income – S Corporations that were formerly C Corporations with passive investment income (which includes rents) in excess of 25% of their gross receipts are assessed a corporate tax at the highest corporate rate.

I will discuss converting from C Corporation to an S Corporation in a later blog post.

If you currently own rental real estate through a C Corporation, you should contact your tax adviser to determine what, if any, action should be taken. More than likely, you will at least need to set up a plan to minimize negative tax implications.

Moving Up from the Food Truck? Here Are Some Tax Topics to Consider

Posted by Simon Filip on

Useful Tax Tips for Expanding Your Fledgling Food Business

Tax considerations for food businessesCongratulations! You started a food service business in a food truck or completed a proof of concept on wheels or in temporary space. Now you have made a business decision to expand and operate a brick-and-mortar location.

Here are some tax considerations you should consider as you move forward with your business venture:

Choice of Business Entity

If you are creating a new legal entity for the brick-and-mortar location or never formally created one for the prior business, it is essential to consider a legal form that protects you from personal liability, such as a limited liability company (LLC) or corporation.

Unlike other industries, most successful restaurants have a substantial amount of daily foot traffic along with employees engaged in physical activities. These activities increase the likelihood a person could be injured on the premises. For instances where there are potential claims, an owner would want the business, not him personally to be responsible for any liability.

Along with the limited liability aspect of entity choice are income tax considerations. Every entity is different and you should meet with your tax professional to discuss the entity choice. Discuss the advantages and disadvantage of Corporations, S Corporations and Limited Liability Companies all of which provide legal liability protection, but have differing tax consequences. Tax issues that should be considered include:

  • Sale of the business
  • Use of losses
  • State tax issues
  • Compensation package
  • Complexity of organization structure

Tax Credits for Restaurants

There are several tax credits available to small business employers including restaurants, which may qualify for one or more of the following tax credits:

Cost Segregation Studies for Accelerated Depreciation Recovery

A cost segregation study is an in-depth analysis of fixed asset expenditures that identifies proper cost recovery periods for tax deprecation purposes.

Typically, restaurant building components are classified with longer depreciation recovery periods of 15 to 39 years. Utilizing a cost segregation study, certain items may be identified as having shorter recovery periods of 5 or 7 years. A shorter recovery period would accelerate depreciation expense and result in reduced current income tax liabilities.

Income from Gift Cards

The purchase and use of gift cards has significantly increased in popularity, as a result the IRS has focused more on compliance.

Amounts received for the sale of gift cards generally are included in income in the year of receipt, which may not be the same year the gift card is redeemed. However, taxpayers have the ability to elect a one-year income deferral method. Under this method, revenue from unredeemed gift cards can be deferred to the first taxable year following the year of receipt. As a restaurant owner, be sure to pay special attention to the tax treatment of gift cards to ensure compliance, and take advantage of income tax deferral opportunities.

Have you recently opened or are you in the process of establishing your new food service business? If you’d like to speak to us about tax considerations please contact me at sfilip@krscpas.com or 201.655.7411.

Will President Trump Benefit or Distress Real Estate?

Posted by Simon Filip on

What will Trump's impact be on the real estate industry?The presidential campaigning has finally ceased and the transition to the Trump presidency has begun. Many questions are being asked in real estate circles, but mostly, how will President Trump’s policies impact real estate in this country?

Here are my thoughts.

Immigration

Throughout the presidential campaign, Trump was firm about deporting immigrants. It is quite common that immigrants who come to this country find work in the construction industry.  A large immigrant deportation effort would put pressure on the number of skilled workers available in the real estate industry, especially in residential real estate.

A labor shortage in the construction industry will force builders to compete for skilled workers with higher wages. Those costs would most likely be passed on to buyers in the form of higher new home prices.

Mortgage Interest Deductions

Trump’s tax plan effectively limits the mortgage interest deduction, without eliminating it entirely. This is accomplished by increasing the standard deduction from $6,300 to $15,000.

Under the current system, for example, a homeowner paying mortgage interest of $10,000 would itemize the deduction and receive a greater tax benefit, because their interest deduction would be greater than the standard $6,300 exemption.

Under Trump’s potential changes, however, there would be no need to itemize the $10,000 mortgage interest, as the proposed standard deduction is already greater. Americans therefore may be less incentivized to buy homes as their taxes would not be significantly different than if they had rented.

Real Estate Agents and Brokers

If housing prices soar due to a lack of skilled labor force and the value of a mortgage interest deduction is diminished, residential real estate brokers and agents may find transactions and commissions drying up. A decrease in real estate activity will affect the bottom line for brokers and agents alike.

Commercial Real Estate

I would be doing a disservice to the real estate ‘mogul’ without mentioning the potential impact on commercial real estate.

There is a potential for a pullback on new construction for commercial projects, large residential and mixed-use developments. If the capital markets experience a shock – which could be interest rates, inflation, or regulation – the difficulty of obtaining construction financing coupled with a muddy economic outlook may push some developers to abandon plans for new projects.

What are your thoughts on the Trump presidency and how it will impact the real estate industry?