Author: Simon Filip

Simon Filip, CPA, MSPA, MST

How Tax Reform Impacts Real Estate

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How Tax Reform Impacts Real Estate

The Senate and House have passed similar tax reform plans, but the bill is not yet finalized. Legislators are still working to create a unified bill, and the real estate industry can expect significant changes under the “Tax Cuts and Jobs Act.” Key changes include:

Temporary 100% Bonus Depreciation

House Bill:

Modifies existing bonus depreciation rules under the “PATH Act” by increasing the rate to 100% through the end of 2022. It also makes bonus depreciation applicable to both new and used property, where it currently applies only to new property. The 100% bonus depreciation will not apply to real property trade or business (i.e., commercial and residential real estate).

Senate Bill:

Similar to the House bill, except the 100% bonus depreciation will apply only to new property and to real property trade or business.

Section 179 Expensing

House Bill:

The Section 179 expense limitations for 2018 will increase from $500,000 to $5 million while the phase-out limitations for assets placed in service will be increased from $2 million to $20 million.

Senate Bill:

The Section 179 expense limitations for 2018 will increase from $500,000 to $1 million while the phase-out limitations will increase from $2 million to $2.5 million. Qualified real property eligible for 179 expensing will be expanded to include improvements to certain buildings systems including roofs, HVAC, fire and alarm systems, and security systems.

Real Estate Recovery Periods

House Bill:

No changes to current depreciation recovery periods of 27.5 years for residential and 39 years for non-residential real property.

Senate Bill:

Nonresidential real and residential rental property depreciable lives would be shortened to 25 years.

Like-Kind (1031 Exchanges)

House bill:

1031 exchanges will continue for real property, but not for tangible personal property. CAUTION: The proposed rules will trigger 1245 recapture for tangible personal property.

Senate Bill:

Same as House bill.

An updated version of the Tax Cuts and Jobs Act must be approved by both the Senate and House before going to the president to be signed into law.

We’ve Got Your Back

At KRS, we’ve been tracking tax reform legislation closely and are ready to assist you in your tax planning and preparation when it is finally signed into law. Don’t lose sleep wondering what impact the tax changes will have on your real estate holdings. Contact me at 201.655.7411 or SFilip@krscpas.com.

Update: Tax reform has now been passed into law. Stay up-to-date on how it impacts real estate investors by checking out the New Tax Law Explained! For Real Estate Investors.

Investing in Foreign Real Estate? Here’s What You Need to Know

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Investing in Foreign Real Estate? Here’s What You Need to Know

Much is written about tax compliance and withholding imposed upon a foreign entity or person owning real estate in the United States. The fact that many U.S. taxpayers own real estate outside of the country is often disregarded.

The intent of this post is to touch upon some of the differences of which an investor or potential investor in foreign real estate should be aware.

Depreciation and foreign property holdings

One of the main differences in holding a U.S. rental property compared to a foreign rental property is depreciation. The Internal Revenue Code requires any tangible property used predominantly outside the U.S. during the year to use the Alternative Depreciation System (“ADS”). Residential rental property located in a foreign country must use ADS, resulting in depreciation over a 40 year recovery period compared to the 27.5 year recovery of U.S. residential property.

1031 exchanges aren’t allowed

I have discussed the tax deferral afforded by entering into a 1031 like-kind exchange in previous posts. However, the Internal Revenue Code does not allow taxpayers to exchange U.S. investment property for foreign investment property.  U.S. property is limited to the 50 states and the District of Columbia only. Property located in U.S. territories, such as Puerto Rico, is not like-kind to property located within the United States. There are limited exceptions, under certain circumstances for property located within the U.S Virgin Islands, Guam and the Northern Mariana Islands.

Taxpayers can obtain deferral afforded by a 1031 exchange when trading U.S. property for U.S. property, but not U.S. property for foreign property. However, foreign property is deemed liked-kind when exchanged for other foreign property, thus qualifying for 1031 exchange treatment.

Preventing double taxation

If a taxpayer operates a property abroad as a rental property, taxes will be owed in the country where the property is located. To prevent double taxation, a U.S. taxpayer can claim a credit on the U.S. tax return for taxes paid to the foreign country relating to the net rental income. It is important to note that a taxpayer cannot claim a credit for more than the amount of U.S. tax on the rental income.

The foreign tax credit is also available if the property is sold and there is any capital gains tax in the foreign county.

Additional reporting obligations

A U.S. taxpayer may have additional filing obligations with their tax return as a result of the foreign rental activity.

For example, if a U.S. taxpayer establishes a foreign bank account to collect rent and the aggregate value of the account is $10,000 or more on any given day, an FBAR (Report of Foreign Bank and Financial Accounts) is required to be filed.

If the property is held in a foreign corporation, Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations) is required to be filed. If the property is held in a Foreign LLC, then Form 8858 (Information Return of U.S Persons with Respect to Foreign Disregarded Entities) may be required.

We’ve got your back

Don’t go it alone if you’re an investor in foreign real estate. Contact me at sfilip@krscpas.com or 201.655.7411 for assistance with tax planning for your international holdings.

Special Tax Allowance for Rental Real Estate Activities

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Special Tax Allowance for Rental Real Estate ActivitiesIf a taxpayer fails to qualify as a real estate professional, losses from rental activities may still be deductible. While real estate professionals are afforded beneficial tax treatment enabling them to deduct losses from their real estate activities, real estate nonprofessionals taxpayers may still benefit.

Exception for rental real estate activities with active participation

If a taxpayer or spouse actively participated in a passive rental real estate activity, they may be able to deduct up to $25,000 of loss from the activity from nonpassive income. This special allowance is an exception to the general rule disallowing losses in excess of income from passive activities.

What determines active participation?

A taxpayer actively participated in a rental real estate activity if the taxpayer (and spouse) owned at least 10% of the rental property and made management decisions or arranged for others to provide services. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, and approving expenditures.

Having a property manager will not prevent a taxpayer from meeting the active participation test. A taxpayer’s lack of participation in operations does not preclude qualification as an active participant, as long as the taxpayer is still involved in a significant sense. For example, the service vendors and approving tenants must be approved by the taxpayer before the property manager can commit to a service or lease contract. In other words, the taxpayer is still treated as actively participating if they are involved in meaningful management decisions regarding the rental property.

Maximum special allowance

The maximum special allowance is:

  • $25,000 for single taxpayers and married taxpayers filing jointly
  • $12,500 for married taxpayers who file separate returns
  • $25,000 for a qualifying estate reduced by the special allowance for which the surviving spouse qualified

If the taxpayer’s modified adjusted gross income (MAGI) is $100,000 or less ($50,000 or less if married filing separately), they can deduct losses up to the amount specified above. If MAGI is more than $100,000 (more than $50,000 if married filing separately), the special allowance is limited to 50% of the difference between $150,000 ($75,000 if married filing separately and your MAGI). If MAGI is $150,000 or more ($75,000 if married filing separately), there is no special allowance.

Modified Adjust Gross Income (MAGI)

For purposes of calculating the special allowance for rental real estate activities, modified adjusted gross income is computed by deducting the following items from Adjusted Gross Income (AGI):

  • Any passive loss or passive income
  • Any rental losses (whether or not allowed by IRC § 469(c)(7))
  • IRA, taxable social security
  • One-half of self-employment tax
  • Exclusion under 137 for adoption expenses
  • Student loan interest
  • Exclusion for income from US savings bonds (to pay higher education tuition and fees)
  • Qualified tuition expenses (tax years 2002 and later)
  • Tuition and fees deduction
  • Any overall loss from a PTP (publicly traded partnership)

We’ve got your back

Learn about all the tax benefits you may qualify for if you invest in real estate. Contact me at sfilip@krscpas.com or 201.655.7411.

Wrap-around Mortgages Explained

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Learn about wraps and structure better deals

A “wrap-around” mortgage (also referred to as a “wrap”) is a subsequent and subordinate mortgage secured by real property where a first mortgage remains outstanding and unsatisfied. A wrap differs from a conventional second mortgage in that it requires an agreement between the parties for payment of the first mortgage obligation by the lender. Consequently, the principal of the wrap-around loan is the sum of the outstanding indebtedness on the first mortgage and new funds advanced.

The wrap technique is typically employed in transactions involving large commercial loans. However the same financing technique is used in single family real estate investments.
Wrap around mortgages explained
Here’s an example:

Joe owns a commercial property with a $500,000 value and a mortgage of $150,000. He enters into a contract to sell the real property to Jane for $500,000. The contract consists of a note for the entire $500,000 payable to Joe.

Jane will make payments on the $500,000 loan directly to Joe.

Joe will in turn continue to make payments on the $150,000 underlying mortgage and retain the excess, if any.

Wraps and installment sales

Frequently in the sale of real estate, the seller may elect to receive payment in installments, providing the purchaser a convenient financing option while generating desirable tax benefits to the seller. As described in more detail in How to Defer Taxes on Capital Gains, installment payments can defer taxes on capital gains if the seller receives at least one payment after the year of a disposition. Use of an installment sale permits a seller to spread the recognition of taxable income over time and avoid recognizing the entire gain before actual payment is received.

Generally, if a buyer assumes a mortgage or purchases the property subject to an existing mortgage, the excess of that debt over the seller’s basis is treated as a payment received in the year of sale (triggering gain recognition). In addition, the assumed mortgage is not included in the contract price, resulting in a higher gross profit percentage, accelerating recognition of taxable income.

If a wrap mortgage is used, the contract price is the entire sales price, resulting in a lower gross profit percentage (and correspondingly less gain recognized in each year’s collections). Also, since the property is not taken subject to the seller’s mortgage, there is no tax on a phantom payment in the year of sale, even if the mortgage exceeds the seller’s basis.

Beware the due on sale clause

The due on sale (or acceleration clause) is a provision in most mortgage documents that allows the lender the right to demand payment of the unpaid loan balance when the property is sold. This is a right provided by the contract, not by law. This means if title to the property is transferred, the bank has the right, but not the obligation, to demand payment.

Benefits to buyers and sellers

Wrap-around mortgages can offer flexibility and tax benefits to both buyer and seller. The wrap also includes credit risk if the purchaser defaults or if the underlying mortgage lender calls the loan.

We’ve got your back

Are you considering using the wrap-around technique on your real estate transaction? You’ll need to consider both the tax and legal ramifications. At KRS, we’re pros at real estate taxes, so contact us to  discuss your plans at 201.655.7411 or sfilip@krscpas.com.

 

What You Ought to Know about Affordable Housing

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What You Ought to Know about Affordable Housing

The federal government used to build its own public housing. However, the government banned public housing construction in 1968 and began demolishing many of its buildings in the 1990s.

While the direct construction went away, the need for new units did not. The National Low Income Housing Coalition published in its 2015 report that one out of every four renter households is extremely low income (“ELI”). ELI households are those with incomes at or below 30% of area median income.

Recognizing the need for additional affordable housing, Congress developed a strategy to entice private developers to build such housing. Cognizant that developers would not pursue these projects when market-rate developments would offer higher returns, Congress included an incentive in the form of a tax credit. The National Council of State Housing Agencies (NCSHA) states nearly 3 million apartments for low-income households have been built because of the Low Income Housing Tax Credit (LIHTC). It estimates that approximately 100,000 units are added to the inventory annually.

Low Income Housing Tax Credits

The tax credits to which a developer is entitled are based on multiple factors including the investment made by the developer, the percentage of low-income units created, the type of project, and whether the project is funded by any tax-exempt private activity bonds.

Claiming the Credits

Following construction or rehabilitation and lease-up of a building, the developer submits a “placed-in-service” certificate showing it has complied with its application and project agreement. The certificate typically includes information on qualified costs incurred, the percentage of units reserved for low-income qualified tenants, and constructions agreements.

If the certificate is approved, the developer is issued IRS Form 8609. The credits can then be claimed on the federal tax return. The credit is a dollar-for-dollar reduction in federal income tax liability.

Types of  Low Income Housing Projects

A common misconception is that affordable housing is required to be new construction. The LIHTC can be used for:

  • New construction
  • Acquisition and rehabilitation
  • Rehabilitation of a property already owned by a developer.

Affordable Housing Development Tax Implications

The low-income housing tax credit program is an option for real estate professionals seeking to develop a rental property. The tax credit will reduce Federal income taxes or can be sold for equity, reducing the debt needed to develop a project.

If developing affordable housing is part of your real estate game plan, don’t go it alone! A real estate CPA can help you devise effective tax strategies around the Low Income Housing Tax Credit program. Contact The Real Estate Tax Guy at sfilip@krscpas.com or 201.655.7411.

How Your 1031 Exchange Can Benefit from a “Zero” Deal

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In previous blog posts I’ve discussed benefits of entering into a 1031 exchange. Also known as a like-kind or tax deferred exchange, a 1031 exchange affords significant tax benefits to property owners.

How 1031 exchanges benefit from zero cash flow dealsSpecifically, a 1031 exchange allows a taxpayer to sell an investment property and reinvest in replacement property(ies) while deferring ordinary income, depreciation recapture and/or capital gains taxes. By deferring tax on the transaction, taxpayers will have more cash available for reinvestment.

What is a zero cash flow purchase?

In a zero cash flow or “zero” deal, the net operating income on a net-leased property matches the debt service, and the loan amortization matches the term of the lease. If the property is retained for the full term of the lease, there is no debt at the end of the term.

Many real estate investors purchase zeros to offset taxable income from other investments through losses associated with depreciation deductions and interest expenses. These transactions are not without drawbacks, as taxable income will occur when the annual loan amortization exceeds the annual depreciation.

Benefits of a zero in a like kind exchange

One of the largest benefits of a zero in a like kind exchange is the pay-down or re-advance feature, whereby the buyer can access cash from the exchange without triggering gain recognition. Once the property is acquired and the exchange is completed, the loan provides the owner an option to refinance a portion of the equity. The options are exercised within the existing loan documents, and there is no renegotiation of terms with the lender. The proceeds can then be deployed to cash-flowing assets.

For example, a taxpayer has a property worth $10 million, comprised of $4 million in equity and $6 million in debt. She found a zero property that can be purchased for $10 million, putting down $1 million as equity and assuming $9 million of debt. The buyer applies $4 million in cash to purchase the replacement, covering the equity requirement of the 1031 exchange. Of that, $3 million (excess of the $4 million of equity from the down-leg over $1 million of equity required for purchase of the property) is used to pay down the debt balance. The interim debt balance is $6 million, fulfilling the debt requirement of the buyer’s 1031 exchange. After closing, the debt is re-advanced from $6 million to the original $9 million, with loan proceeds of $3 million going to the buyer. The exchange has been completed, income deferred and the taxpayer has extracted $3 million in non-taxable proceeds.

We’ve got your back

If you’re interested in structuring a 1031 exchange as a zero cash flow purchase, be sure to consult a real estate broker who specializes in these investments. You’ll also want to coordinate the deal with your tax advisor so that you’re following all the 1031 exchange rules. That’s where the tax experts here at KRS can help and ensure that you receive the maximum tax benefits. For more information, contact me at 201.655.7411 or sfilip@krscpas.com.

For Tax Savings, Consider an IC-DISC for Your Exporters

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Did you know there is an underutilized tax incentive that can reap federal tax savings for manufacturers?

For Tax Savings, Consider an IC-DISC for Your ExportersOne middle-market manufacturer recently saved approximately $300,000 in current year federal taxes by implementing this tax incentive, which promotes exporting goods manufactured in the United States that have an ultimate destination outside of the U. S. The federal tax savings will continue to increase as this client expands its export operations. The tax saving strategy was executed by forming an interest charge-domestic international sales corporation (“IC-DISC”).

To determine if an IC-DISC might be beneficial for your client, all of the following should apply:

  1. Does the company sell or lease export property or provide services that are related to any exchange of property outside the United States?
  2. Is the company generating taxable profits?
  3. Is the company closely held?

An IC-DISC is typically formed as a wholly-owned U. S. corporate subsidiary of a domestic exporting company. The IC-DISC serves as the exporting company’s foreign sales agent (not to be confused with a Foreign Sales Corporation, which was discontinued in 2000).

After the IC-DISC is incorporated, it must file an election with the Internal Revenue Service to be treated as an IC-DISC, which is not subject to federal income tax and certain state income taxes. The election must be made within 90 days of incorporation and is made on Form 4876-A, Election To Be Treated as an Interest Charge DISC. All of the corporation’s shareholders must consent to this election.

Qualifying as an IC-DISC

To qualify as an IC-DISC, a corporation must maintain the following requirements[1][2]:

  1. Be incorporated in one of the 50 states or District of Columbia
  2. File an election with the IRS to be treated as an IC-DISC for federal tax purposes
  3. Maintain a minimum capitalization of $2,500
  4. Have a single class of stock
  5. Meet a qualified exports receipts test and a qualified export assets test.

To expand on the last requirement, at least 95 percent of an IC-DISC’s gross receipts and assets must be related to the export of property whose value is at least 50 percent attributable to U.S. produced content.

The newly formed IC-DISC enters into a commission agreement with the seller of export goods. By virtue of the C corporation meeting all of the IC-DISC qualifications, it is presumed to have participated in the export sales activity, and due to that participation, is entitled to earn a commission.

The related exporter is allowed to pay a tax-deductible commission to the IC-DISC, which is the greater of 4 percent of the company’s gross receipts from qualified exports, or 50 percent of the company’s net income from qualified exports.[3] The IC-DISC commission is a current deduction to the U.S. exporter at ordinary income rates (currently a maximum of 39.6 percent).

The IC-DISC, as a tax-exempt entity, pays no federal tax on the commission income. When the IC-DISC distributes its income to its shareholders, it becomes qualified dividend income taxed at the qualified dividend rate of 23.8 percent when including the new 3.8 percent tax on net investment income.

If the company is a pass-through entity, such as a partnership, S corporation, or LLC, you can form an IC-DISC as a subsidiary. Dividends the IC-DISC distributes will retain their character and be passed through to individual shareholders and qualify for the 23.8 percent qualified dividends rate (20 percent qualified dividends rate plus 3.8 percent tax on net investment income).

If your company is a C corporation however, you will need to have the corporation’s individual shareholders form the IC-DISC as a sister corporation to obtain the lower tax rate on dividends.

Tax Benefits for Shareholders

Assume an S corporation has $20 million in qualifying export sales and $5 million in net export income on those sales. If the company has an IC-DISC subsidiary, it can pay a deductible commission to the IC-DISC equal to the greater of 50 percent of its export net income ($2.5 million) or 4 percent of its export gross receipts ($800,000). In this case, the maximum commission is 50 percent of net income or $2.5 million.

The IC-DISC distributes the full $2.5 million of commission income as a dividend to its S corporation shareholder. The S corporation receives a $2.5 million dividend, which retains its character and passes through to the S corporation’s individual shareholders. The S corporation shareholders pay 23.8 percent federal income tax on the IC-DISC qualified dividend income. If the commission had not been paid, the S corporation individual shareholders would have additional ordinary income passed through to them taxable at a maximum 39.6 percent federal tax rate.

Federal Tax Savings:

Tax on $2.5 Million at 39.6% rate                               $990,000

Tax on $2.5 Million at 23.8% rate                               $595,000

Federal income tax benefit to shareholders               $395,000

Taxpayers can also use IC-DISCs to defer the recognition of income related to foreign sales, however the discussion above focused primarily on using an IC-DISC to convert ordinary income into qualified dividend income, reducing the income tax liability of a corporation’s shareholders.

We’ve got your back

It is important for practitioners and advisers to be aware of tax incentives available to their manufacturing and export clients that are producing goods in the United States and shipping them overseas. For help establishing an IC-DISC, contact me at sfilip@krscpas.com or 908.655.7411.

References

[1] Trea. Reg. 1.992-2(b).

[2] IRC Sec. 992(a)(1) and Treas. Reg. 1.992-1.

[3] IRC Sec. 994.

IRS Form 5472: What Foreign-Owned Companies Need to Know to Avoid Penalties

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Is your company doing business in the US market? If you’re not filing IRS Form 5472, you could face large penalties.

The United States continues to see more investment from foreign companies and individuals who want a business presence here. When a foreign company decides to conduct business in the U.S., not only must it decide what legal entity structure to use, but after the entity is established, it must comply with all applicable U.S. tax laws. Filing the right tax returns and informational forms is critical to avoiding penalties.

IRS Form 5472 for foreign owned companiesFor the purposes of this post, a foreigner is a corporation from outside the U.S. or an individual who is not a U.S. citizen or a resident. Generally, foreigners can use two types of legal entities in the US market to conduct business here: a limited liability company (LLC), or a C-corporation.

Tax filing requirements for foreign-owned corporations

Generally, a corporation doing business in the United States is required to file applicable federal and state income tax returns following each annual tax period. A U.S. corporation with non-U.S. shareholders who own 25% or more of the corporation’s stock are generally required to file Form 5472, which has the long-winded title, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.”

Form 5472 is a separate filing requirement from the U.S. entity’s obligation to file income tax returns under the U.S. Internal Revenue Code (Code). This form must be attached to the reporting corporation’s federal income tax return. It requires certain information disclosures about the corporation’s foreign shareholders and any transactions between it and such shareholders during the tax year.

For example, two shareholders, one from the U.S. and one from Germany, form Reliant Panel, Inc., to manufacture industrial control panels in the U.S. They each own 50% of the company’s shares. Under the Code, Reliant Panel must file Form 5472.

Requirements for LLCs taxed as partnerships

In addition to filing Form 1065 (U.S. Return of Partnership Income), a partnership with foreign partners could be responsible for complying with other filing requirements such as Foreign Investment in Real Property Tax Act of 1980 (FIRPTA), Partnership Withholding, and Nonresident Alien Withholding.

A partnership that has income effectively connected with a U.S. trade or business is required to pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners. A foreign partner is anyone who is not considered a U.S. person, which includes nonresident aliens, foreign partnerships, foreign corporations, and foreign trusts or estates.

The partnership must pay the withholding tax regardless of the foreign partner’s U.S. income tax liability for the year and even if there were no partnership distributions made during the year. Withholding tax must be paid on a quarterly basis.

Form 5472 for LLCs with a single foreign owner

When a U.S. LLC has a single owner (defined in U.S. law as a “member”), it is disregarded as an entity separate from its owner (“disregarded entity”). Newly issued regulations treat such disregarded entities as domestic corporations rather than as disregarded entities for the purpose of the foreign reporting requirements. Under these new rules, such disregarded entities are required to file Form 5472.

For example, Forco, Inc., a Polish corporation, forms Domeco LLC in New York, a wholly-owned LLC that is treated as a disregarded entity for income tax purposes. Under prior IRS rules, Domeco had no foreign reporting obligations. However, under the new regulations Domeco is required to file Form 5472.

Form 5472 requirements

Form 5472 requires the disclosure of the foreign shareholders’ names, address and country of citizenship, organization or incorporation, principal business activity, and the nature and amount of the reportable transaction(s) with each foreign shareholder.

Whether a reportable transaction has occurred is a complex determination. For example, a loan to a U.S. LLC by the foreign shareholder is considered a “reportable transaction” and requires the disclosure on Form 5472. In general, a reportable transaction is any exchange of money or property with the foreign shareholder, except for the payment of dividends.

Filing deadlines for Form 5472

Form 5472 is filed with the U.S. Corporation’s federal income tax return, including any extensions of time to file same.

Why is filing Form 5472 is so important?

Penalties for failure to file information returns are separate from payments relating to underpayment of income taxes. Under certain circumstances, the penalties for failure to file information returns can be significantly greater than the U.S. income tax liabilities. Failure to maintain the proper records, failure to file the correct Form 5472, or failure to file a required Form 5472 may result in a $10,000 penalty for each failure per tax year.

Additionally, if a failure to file continues for more than 90 days after notification of a failure to file by the IRS, an additional $10,000 may apply for each 30-day period, or fraction thereof, that the failure continues.

These fines can’t be appealed to the IRS! That is why foreigners doing business in the U.S. are strongly encouraged to consult with their tax advisors and ensure compliance with all U.S. tax and reporting obligations.

We’ve got your back

Whether you’re new to investing in U.S. companies or quite experienced, it is always important to have knowledgeable CPAs behind you to ensure that you are making the right moves when it comes to complying with the often confusing U.S. tax code. The experts at KRS CPAs are here to guide you through tax season and beyond. For more information or to speak to one of our partners, give us a call at 201.655.7411 or email me at SFilip@krscpas.com.

 

Special thanks to attorney Jacek Cieszynski for his assistance in developing this post.

Real Estate Rentals, the Sharing Economy and Taxes

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Taxpayers renting out homes or spare rooms should be aware of the tax implications of these rentals.

When is the rental of a primary residence or vacation home taxable?

Real Estate Rentals, the Sharing Economy and TaxesThe Internal Revenue Code provides the rental of a property that is also occupied by the owner (“host”) as a residence for less than 15 days during the year is not taxable. The host is considered to use the property as a residence if they use it for personal enjoyment during the tax year for more than the greater of (1) 14 days or (2) 10% of the total days during the year they rent it to others.

The tax rules are more complicated when the vacation home is used by the host for more than 2 weeks and also rented for a substantial part of the year.

For example, a host spent 60 days last year in their ski cabin in Vermont. For the remainder of the year it was rented for 180 days.  The host can deduct 75% (180 days out of 240 days) of the ski cabin’s qualifying rental expenses against the rents collected. It is important to note that if expenses exceed rental income, the loss is not deductible.

Where is income from short-term rentals reported?

Many rental services, such as Airbnb, report the rental payments they send to hosts by filing IRS Form 1099-MISC. The IRS matches these 1099’s to tax returns to verify that rental income was reported.

If the host’s property is rented for more than 14 days per year, the exception noted above will not apply. Instead, the host will have to report and pay income tax on the rental income by filing IRS Schedule E along with the tax return. The host will also be allowed to deduct rental-related expenses, subject to limitations

Do hotel taxes apply to short-term rentals?

Lodging or transient occupancy taxes, which are commonly referred to as hotel taxes will typically apply to rentals of 30 days or less in some areas. Some jurisdictions will impose taxes for rentals that exceeds 30 days, such as Florida which taxes rentals of six months or less. These taxes are separate from any income tax they may be owed on profits from renting the property.

Airbnb will collect the applicable lodging taxes on behalf of its “hosts.” For instance, Airbnb has made an agreement with the Vermont Department of Taxation to collect the Vermont Meals and Rooms Tax on payments for lodging offered by its hosts. However, many other rental listing sites, such as HomeAway, will not collect the taxes for property owners. An internet search or browsing of the listing company’s website will provide their policy on collecting the taxes.

There are services available, such as Avalara’s MyLodgeTax, that assists hosts with filing and remitting their lodging taxes. These services are offered for monthly fees.

We’ve got your back

Ready to become a part of the sharing economy? If you’re considering renting out even part of your home, reach out to KRS so that we can help you stay on top of the tax rules. 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 rental property.

Income Tax Incentives for Land Conservation

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Income Tax Incentives for Land ConservationConservation easements have been receiving increased press and scrutiny from the IRS, which is cracking down on easement donation abuse by tax shelter promoters.

At its very basis, conservation easements are meant to further the public good by encouraging taxpayers to donate property rights to organizations so the property can be conserved in its current form.

What is a conservation easement?

A conservation easement, also referred to as a conservation agreement, is a legal agreement between a landowner and a land trust or government agency.

When a landowner donates an easement to a land trust or public agency, he is giving away some rights associated with the underlying land. The easement acts to permanently limit the use of the land to protect its conservation values.

What kinds of property qualify?

It could be land that preserves open space or is deemed to be historically important. Land with a scenic vista, a critical water source or wildlife habitat may also qualify.

Does the landowner lose all rights to the property?

Conservation easements offer landowners the flexibility of protecting their land. A donating landowner can retain the right to harvest crops, while relinquishing rights to build additional structures on the conserved parcel.

It is the responsibility of the land trust to make sure the donating landowner adheres to the terms of the conservation easement.

What are the tax incentives?

If a conservation easement is voluntarily donated to a land trust or government agency it can qualify for a charitable tax deduction on the donor’s federal income tax return. To determine the value of the charitable donation, an appraisal is obtained for the value of the land “as-is,” and the value of the property as restricted by the easement. The difference between the two values is the amount of the charitable donation to the land trust.

Are there additional benefits?

The donating landowner may also realize savings in the form of reduced property taxes. A lowered property value assessment after the easement is granted can result in decreased real estate taxes. Additionally, some states, including New York offer their own tax incentives.

We’ve got your back

For additional information on the tax benefits of land conservation, please contact me at  sfilip@krscpas.com or (201) 655-7411.