Tag: real estate

Trending Now: Real Estate Crowdfunding

Posted by Simon Filip on

Ever hear of real estate crowdfunding? If not, maybe you should take a look.

crowdfunding for real estateIn my practice as an accountant and trusted advisor I often receive inquiries from clients and their advisors because real estate is an important element of a diversified portfolio. Until recently, opportunities to invest in real estate were limited to acquiring a rental property directly, participating in a real estate investment group, flipping properties or a joining a real estate investment trust (REIT).

Investing through a real estate investment group was limited to accredited investors – those who have a net worth of $1 million or earn at least $200,000 a year. The Securities and Exchange Commission’s Title III of the JOBS Act opened the doors to non-accredited investors, who were previously unable to participate in this new asset class.

As a result of the JOBS Act, crowdfunding platforms have become available which offer options for investing in real estate. In these platforms investors can join others to invest in a rental property – either commercial or residential.

An Entry Point to Real Estate

Private real estate deals have historically been the domain of high net-worth investors who possessed the right connections to gain access to a particular property. Real estate crowdfunding provides an entry point into the real estate market, enabling investors of all ages, risk profiles and wealth levels to acquire real estate investment.

Real Estate Crowdfunding Benefits

Larger geographical scope. Investing in real estate in the past relied upon developing networks of personal and industry connections in your local area. The real estate crowdfunding platforms are opening up access to deals outside of personal contacts and local areas. A potential investor can now browse deals from all over the country.

Lower entry point. Historically, investing in real estate required writing a large check to become part of a deal. Typically, a real estate operator would want to syndicate deals with minimum investments of $100,000 or more to keep the process simple. However, through the technology in these crowdfunding platforms and the JOBS Act, investors are able to invest with a minimum of $1,000, depending on the platform. This allows real estate investors to spread their funds over multiple projects at any one time. From a risk perspective, this is less risk than investing larger amounts in fewer projects.

Drawbacks of Crowdfunding

You don’t really own real estate. Investing in crowdfunded real estate does not actually make you an owner of real estate. Rather, you become a member of a Limited Liability Company that holds title to real property. Ownership in the LLC is considered personal property rather than real property and the rights to share in income and distributions are governed by the Operating Agreement.

Less liquidity. Investing in crowdfunded real estate is different that investing in real estate stock. When you invest in a REIT, you invest in a company that owns and operations various real estate investments. REITs offer liquidity, whereas they can be sold on the stock market, while crowdfunded real estate you are locked in until an exit event such as the sale of the property.

If you are considering investing in real estate every investor should consider how to participate. Along with that decision the tax consequences of the different options should be considered in the analysis.

Millennials Are Changing Commercial Office Space

Posted by Simon Filip on

Millennials are changing work place designWave goodbye to corner offices and cubicle farms and welcome to wide open spaces. Millennials are a generation accustomed to collaboration and opportunities for social interaction. As a result, they are changing how companies lease and design office space.

Millennials are typically considered individuals born between 1980 and 1995, making most of this generation under 35 years of age. According to a report published by the White House, 15 Economic Facts about Millennials (October 2014), this demographic makes up approximately one-third of the U.S. population.

This generation has many unique characteristics that shape how they work and what they want out of life. They are the first cohort who can’t remember life before the Internet, and this is reflected in their attachment to technology. However, they value connection in the real world as well.

A Shift in Workplace Design

Millennials favor open floor plans and collaborative work spaces. They value flexibility and common areas that are set up for specific tasks rather than specific people. This changes the amount and type of space required by the companies for whom they work. In many cases, the ideal Millennial workplace includes fewer square feet per employee, as more shared spaces are adopted.

According to Randy Horning, senior broker associate with James E. Hanson Inc., average square footage required for commercial office space is on the decline to approximately 100 to 150 square feet per person.  This continues a downward trend from 200 to 250 square feet, which was already down from the 400 sq. ft. per person in prior years.

Enjoying the time spent at work is more important to Millennials, and they look for amenities in the workplace. This has led to the popularity of office perks such as coffee bars, outdoor spaces, game rooms and onsite daycare. Horning explains that because owners want people to spend time in the office, the space is becoming more amenity driven. Says Horning, “When amenities such as a large kitchen space are inside the building, it keeps employees at-hand and productive.”

Sustainability Increases in Importance

Green design is another Millennial priority that is influencing commercial spaces. Natural light, sustainable materials and energy efficiency have grown in popularity, which is reflected by the push towards LEED Certification for new and existing work spaces.

According to a report published by the U.S. Green Building Council, over 675 million sq. ft. of U.S. real estate space became LEED certified in 2014, the largest area to be certified in a calendar year In 2015 an estimated 2,870 projects were certified, representing an additional 464 million sq. ft. of real estate.

Real estate features that include recycling collection, bike storage and even rainwater catchers will score points with Millennials, and can even translate into better health and productivity.

Shift to City Centers

Where companies choose to locate has also been heavily influenced by this generation. They prefer working near city centers – where commutes are short or non-existent – as well as convenient transit options. Millennials also favor easily accessible attractions, such as museums and dining.

The Takeaway

The future of office space may appear to be the end of cubicle farms, however there will be more work space flexibility and opportunities for Millennials and other groups to interact in the workplace than before. Companies will continue to adapt office environments as they seek to accommodate this generation.

Real Estate Trends – Foreign Sellers

Posted by Simon Filip on

Foreign Capital and U.S. Real Estate

Understand FIRPTA withholding rules There have been continued international capital inflows into U.S. real estate assets and the trend is expected to grow. Political uncertainty and global economic factors continue to drive foreign money into the United States, long considered a safe haven.

The U.S. property market is the most stable, transparent in the world, making it an easy investment choice. According to research firm Real Capital Analytics, foreign purchases of U.S. real estate assets rose to $62 billion over the 12-month period ending in October 2015.

It should be expected that these foreign investors will eventually reposition their assets and liquidate certain holdings based upon expected returns and market changes.

Understand the Foreign Withholding Rules

Buyers of real estate from foreign sellers, escrow agents and closing agents who close on such transactions need to be aware of the federal withholding requirements set in the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA).

Under FIRPTA, the buyer of U.S. real estate from a foreign person or entity must withhold tax equal to 10% of the “amount realized” from the sale. The amount realized includes the total amount received for the property including cash, the existing balance of mortgages encumbering the property, and any non-cash personal property.

Withholding under FIRPTA

Withholding is required when the seller is a foreign person (including non-resident alien individuals, partnerships, trusts and estates, and certain corporations domiciled outside of the United States). At or before the closing, if the seller signs a certification of non-foreign status stating under penalty of perjury that he is not a foreign person, the buyer can rely on that unless he has actual knowledge that it is not accurate. If the seller is able to sign the certification, no withholding is required, but the buyer must retain the certification for five years after the transfer.

If the seller is a foreign entity or person, the buyer must withhold the 10% and remit the tax to the IRS within 20 days of the date of closing. If the buyer fails to do so, the buyer is liable to the IRS for the tax that should have been withheld, plus penalties and interest.

Reduced Withholding

If the ultimate tax liability is expected to be zero or less than the required 10% withholding amount, the foreign seller can apply for a withholding certificate to request a reduction in the withholding amount. This is done by filing IRS Form 8288-B.

There are exceptions to the withholding requirements, including property used as a home and 1031 exchanges, but both are not without specific qualifications.

When purchasing real estate from a foreign seller, it is important for buyers to consult with their advisors to ensure compliance under FIRPTA.

At KRS CPAs, our team supporting commercial real estate is knowledgeable about FIRPTA rules and can assist you. Contact me at sfilip@krscpas.com or 201.655.7411.

Can Real Estate Professionals Pay No Income Taxes (a la Donald Trump)?

Posted by Simon Filip on

real estate professionals can deduct tax losses resulting from their real estate activities

As a CPA with a substantial real estate practice, I found the recent controversy regarding Donald Trump’s tax losses and the possibility that he paid no federal income tax to be quite interesting.  Although we do not know what part, if any, of the losses arose from Mr. Trump’s real estate activities, it is not unusual or illegal for real estate professionals to deduct tax losses resulting from their real estate activities.

News reports indicate that Donald Trump’s 1995 federal income tax return reflected a tax loss of approximately $916 million dollars, which may have been carried forward to offset income and reduce Trump’s taxes in succeeding years. As this revelation appears to be the source of public outrage, I wanted to explain taxation of rental real estate and how owners and investors may legally benefit from losses.

Trump most likely operates many of his business ventures as “pass-through” entities, such as partnerships and limited liability companies. Pass-through entities pass through all of their earnings, losses and deductions to their owner, for inclusion on their personal income tax returns. In the case of losses, the owner or member can use these losses to offset other income and carry forward any excess to future years. As with all things taxes, there are requirements that must be met (see Passive Loss Limitations in Rental Real Estate).

Owners of rental real estate are not only allowed to deduct for mortgage interest, real estate taxes and other items, but also depreciation. The Internal Revenue Code allows for depreciation of assets used in a trade or business, which include rental real estate. This is an allowance for the wear and tear of the building and astute taxpayers can further benefit from depreciation by accelerating their depreciation deductions (see my blog, The Tax Benefits of Cost Segregation in Real Estate). While many properties are increasing in value, the owners are receiving an income tax benefit in the form of an annual tax deduction for the wear and tear of the building.

If certain requirements are met, a real estate professional, as defined by the Internal Revenue Code (there is no reference to “Mogul” in the Code) can offset other items of income with losses generated by their real estate activities. I have more details on the income tax advantages of being a real estate professional in a previous blog posting, Passive Activity Loss and the Income Tax Puzzle for Real Estate Professionals.

Donald Trump invested in many business ventures during the 1980s and 1990s and real estate may have only been a small part of the substantial loss reflected on his 1995 tax return. Without Mr. Trump’s tax returns, we will never know. As an accountant, I’m more curious about the transactions that gave rise to the loss and the application of the specific tax law provisions permitting deduction of these losses.

What are your thoughts regarding the ability of real estate professionals to offset other items of income with their losses from real estate activities?

Why do investors want to participate in Zero Cash Flow deals?

Posted by Simon Filip on

Zero cash flow deals offer tax savingsHint: it’s about deferring taxes

Most zero cash flow Triple Net Lease (“NNN”) investments have two components. First, you purchase a high quality NNN investment with a long-term lease and a tenant with a high credit rating. Next, you obtain zero cash flow financing, where the rents from the tenant equals the debt service. This financing has an amortization period that is typically fixed to the term of the lease and a flat interest rate. Commonly, an investor will put between 10 and 20 percent down, and when the lease’s initial term ends, he or she will have a debt-free building.

Zero cash flow loans are highly leveraged and lenders require a strong credit tenant, which is why drug stores such as Walgreens and CVS are highly sought-after investments for these arrangements.

During the Lease Term

While the real estate investment is not providing current cash flow, the depreciation generated from these investments is structured to more than cover principal payments, leaving a net loss that can be used to offset other taxable income. Refer to my blogs on real estate professionals and passive loss limitations to determine if those losses can be used.

During the term of the NNN investment, principal payments will gradually grow. Once they exceed depreciation, you may be subject to phantom income, which is taxable. (See my previous blog on phantom income.) Prior to reaching this point, an investor should consider disposing of the asset (possibly through a like-kind exchange) or refinancing the property. If you have already reached the point in a zero cash flow deal where principal payments exceed depreciation, tax planning should be undertaken to minimize income taxes.

End of Lease Term

If an investor retains ownership until the end of the lease, the loan will be satisfied and the building will be owned without any debts. If there are options in the lease, it’s possible that the tenant exercises the option and the property will generate cash flow with no debt service. On the other hand, if the tenant decides to move out, it’s reasonable to assume the building will still have value.

While many investors acquire NNN properties for steady cash flow, that is not the only reason investors should consider a NNN deal. Astute investors use NNN investments as a way to minimize their tax exposure. Zero cash flow deals do not provide current cash flow, but can offer tax savings through depreciation deductions and appreciation of the real estate in the long-term.

KRS CPAs can help you establish tax savings with NNN investments. Give us a call at 201-655-7411 or email SFilip@KRScpas.com.

How to Defer Taxes on Capital Gains

Posted by Simon Filip on

Here’s how receiving installment payments can help you defer taxes on capital gains.

What Is an Installment Sale?

An installment sale is an agreement under which at least one payment is received after the end of the tax year in which the sale occurs. When a real estate investor sells a property on the installment basis, a down payment is usually received at closing with the balance of the purchase price paid in installments in subsequent years. As the seller, you are not required to report an installment sale using this method. However, installment sale reporting allows you to spread the tax liability over all the years in which the buyer makes installment payments.

installment sales tax benefits in real estateUnder the installment method, each year the portion of the gain received via installment payments is included in the seller’s income. Fundamentally, interest should be charged on an installment sale. If the interest charged is less than the applicable federal rate (“AFR”) or no interest is charged, the seller is considered to have received “imputed” taxable interest equal to the AFR.

Each payment received in an installment sale consists of three components:

  1. Interest income
  2. Return of basis
  3. Gain on the sale

Not All Sales Qualify as Installment Sales

Certain sales do not qualify as installment sales, including:

  • Sale of inventory items
  • Sales made by dealers in the type of property being sold (see my blog, Investor vs. Dealer)
  • Sale of stocks or other investment securities
  • Sales that result in a loss

Combining Installment Sales with Like Kind Exchanges

Like Kind Exchanges (§1031 exchanges) are often combined with seller financing of the relinquished (sold) property. This creates an opportunity for an installment sale transaction in which a promissory note, issued by the buyer for the benefit of the seller, represents a portion of the purchase price.

For example, if the relinquished property value is $1 million, the taxpayer (via a qualified intermediary) might receive $500,000 in cash and a $500,000 promissory note from the seller. The taxpayer/seller would ideally use the $500,000 proceeds in a tax-deferred exchange, while also benefiting from installment sale reporting on the remaining $500,000 note.

An installment sale is an option for taxpayers to spread a tax liability over time and collect interest income. However, it can carry risk for the seller. If the buyer is unable to make timely payments, the seller would be responsible for the costs of foreclosure and repossession.

Your tax professional can help you determine the tax effects of any installment sales arrangements you may have. As always contact me at sfilip@krscpas.com if you have any questions.

Beware of Phantom Income

Posted by Simon Filip on

Real Expenses vs. Phantom Expenses

As a real estate investor, it is essential to know the difference between a real expense and a phantom expense. An investor might think a $1,000 roof repair is a good thing since he or she can deduct it as an expense. What if you never had to make that repair in the first place? You would have $1,000 of taxable income in your pocket. Being taxed isn’t automatically a bad thing, since that means you are making money on the property.

real estate and phantom incomeWhat is a Phantom Expense?

Depreciation is the perfect example of a phantom expense since it allows an owner of real estate to recover the value of the building against rental income. The IRS allows a deduction for the decrease in value of your property over time, irrespective of the fact that most properties never really wear out. Simply put, depreciation allows you to write off the buildings and improvements over a prescribed period of time, providing a “phantom expense” that is used to offset rental income.

Residential real estate and improvements are depreciated over a 27.5 year period. Commercial real estate and improvements are depreciated over 39 years.

Debt Amortization

In addition to a depreciation deduction, the Internal Revenue Code allows for the interest portion of a mortgage payment to be deducted for income tax purposes. The principal portion of a mortgage payment is treated as taxable income or “phantom income“.

During the initial years of a typical mortgage loan, the principal reduction (debt amortization) is normally offset by depreciation deductions and interest expense, decreasing taxable income. In the later years of a typical loan amortization, principal reduction will exceed interest expense and depreciation, thereby increasing taxable income and generating a seemingly disproportionate tax liability (the dreaded phantom income).

Disposition of a Property

A taxpayer may incur phantom income upon disposition of a property. Phantom income is triggered when taxable income exceeds sales proceeds upon the disposition of real estate. Usually, this results from prior deductions based on indebtedness. You may have deducted losses and/or received cash distributions in prior years that were greater than your actual investment made in the property. If you are planning to dispose of a property and believe you are in this situation, there are strategies to minimize the tax impact including IRC 1031 exchanges, which are discussed in my blog Understanding IRC Code Section 1031 and why you should care.

Real estate investors who want to maximize their after tax cash flow need to be cognizant of phantom income and compare their cash flow to taxable income. This analysis should be undertaken regularly as it may impact their investment returns. If you have questions about phantom income and your real estate, contact me at sfilip@krscpas.com or 201.655.7411.

Treasury Proposes New Tax Regulations to Limit Discounts in Intra-Family Wealth Transfers

Posted by Gerald A. Shanker on

Proposed Regs Would Impact Family Limited Partnerships

A popular tax saving technique used by wealthy taxpayers involves transferring assets such as real estate or securities to a family limited partnership, followed by a gift of partnership interests to family members. For estate and gift tax purposes, the value of partnership interest transfers are discounted, that is the transfers are reported for less than the value of the underlying partnership assets.

Discounts are permitted because partnership interests transferred are minority interests and also subject to significant restrictions, such as restrictions on transferability of the partnership interest.   Although the Internal Revenue Service has contested these discounts, Federal Courts have consistently allowed discounts in the 30% to 35% range for cases with the correct fact pattern.

intra-family wealth transfersLast week, the Treasury issued proposed regulations which, if adopted, would severely limit taxpayers’ ability to discount for intra-family wealth transfers. As they would affect family limited partnerships, the proposed regulations would require that in family controlled entities, many of the restrictions giving rise to discounts would be disregarded, effectively eliminating such discounts.  If discounts are eliminated, property transfers would be at fair market value of the underlying property, potentially resulting in increased federal estate and gift taxes.

Now Is the Time to Transfer Wealth to Family Members

The proposed regulations are subject to a 90-day public comment period, and will not go into effect until the comments are considered and then 30 days after the regulations are finalized. If you have a federally taxable estate and are considering wealth transfers, now is the time to do it.  Although there is uncertainty whether the proposed regulations will be adopted, and if they are adopted what the final version will say, the window may be closing on an opportunity for intra-family wealth transfers at a greatly reduced transfer tax cost.

If your estate is close to being taxable, act quickly and contact your tax advisors.  Once this window is closed, it may never open again.

Rental Income: There’s More to It than Just Collecting Rent Checks

Posted by Simon Filip on

 

Payment for the occupancy of real estate is includable in the landlord’s gross income as rents. Generally, rents are reportable by the landlord in the year received or accrued, depending upon whether the landlord uses the cash or accrual method of accounting. What constitutes rent is not always obvious and depends on factors that include the lease and relevant facts and circumstances.

HiResTypes of Rents

  • Amounts paid to cancel a lease – It is fairly common for a landlord to receive payments in consideration for allowing a tenant to terminate their lease before the expiration date. This payment is included in the landlord’s rental income in the year of receipt.
  • Advance rent – Generally, advance rent is immediately taxable to the landlord. The regulations specify that advance rentals must be included in income for the year of receipt regardless of the period covered or the method of accounting employed by the taxpayer.
  • Security deposit – A security deposit that is refundable at the end of the rental period is excluded from income. If a landlord requires a security deposit to be used to pay the last month’s rent under a lease, it is included in gross income in the year of receipt.
  • Expenses paid by a tenant – If a tenant pays expenses on behalf of the landlord, those payments are considered rental income by the landlord.  The tenant is entitled to deduct those expenses.

Improvements by Tenants

If a tenant makes an improvement to the landlord’s property that is a substitute for rent, the value of the improvement is taxable to the landlord as rental income.

Permanent improvements by a tenant usually enhance the value of the landlord’s property. The mere enhancement in value of the property does not, by itself, constitute rental income to the landlord. Court cases have held that a tenant’s payments for improvement costs will not be treated as deductible payments in lieu of rent unless it is demonstrated that both the landlord and tenant intended the payments to be in lieu of rent. If a landlord agrees to receive reduced rents in exchange for a tenant’s improvements, the cost of the improvement is plainly rent.

Net Leases

Under certain lease arrangements, also known as net leases, the tenant or lessee must pay specified expenses of the lessor. For tax purposes, these payments are treated as additional rental income by the lessor and additional rent expense by the lessee. Assuming the landlord would have been entitled to a business deduction if it was paid directly, the landlord is entitled to a business deduction for the amount paid by the lessee.

From experience, most lessors (landlords) recognize income only for the actual rent paid, and the lessees (tenants) generally deduct the net leases expenses paid as expenses other than rent.

Before entering into a lease, it is important for a landlord to consider the provisions included in the lease and their impact on taxable rental income.

Your tax professional can help you determine the tax effects of any rental arrangements you may have. As always contact me at sfilip@krscpas.com if you have any questions.

Understanding IRS Rules for Self-Rentals

Posted by Simon Filip on

Owner or renter – or both? 

Tax effects of self rentalsSelf-rental is an arrangement in which a business and property that it rents are both owned by the same person(s). It is common for a taxpayer to own an operating business and also own the accompanying real estate. That person has to materially participate in the operating company for the self rental rules to apply. If the operating company is an entity that the owner(s) actively participate in on a day-to-day basis, in most cases the owner(s) would be considered to materially participate in that activity.

Additional details on material participation can be found in Internal Revenue Service  Publication 925.

The passive activity loss rules

As discussed in my blog post, Passive Loss Limitations in Rental Real Estate, the IRS Code generally prohibits taxpayers from deducting passive activity losses against other income, including salaries, interest, dividends, and income from nonpassive activities. Generally, a passive activity loss can only be used to offset other passive income.

The IRS considers most business activities to be nonpassive if a taxpayer materially participates in the business.  One of the exceptions to this rule is rental real estate. Rental real estate activities are generally considered passive regardless of level of participation.

Trapped losses

Passive losses can only offset other passive income. Assuming a taxpayer incurs a loss on the rental of property to a business in which he or she materially participates, absent any other passive income during the year, the loss will not be deductible. However, the loss is carried forward to future tax years to offset income from the activity.

If there are unused passive losses from the activity when the property is sold, such suspended losses from that activity are recognized in the year of disposition.

How self-rental rules can apply

What does it all mean? Here’s an example to help you understand how the rules apply:

A taxpayer owns a warehouse which is rented by his distribution company that he materially participates in as owner and president. During the year the rental warehouse incurs a loss of $50,000, while the distribution company has $50,000 of income.

Does the $50,000 of losses incurred by the warehouse offset the $50,000 of profits from the distribution company?

No. Because the property was essentially rented to himself (i.e., to a business in which he materially participated), the self-rental rules apply. In the case of a self-rental, income is treated as nonpassive and loss is treated as passive. The self-rental rule characterizes the $50,000 of rental loss as passive which cannot offset the nonpassive income from the distribution company.

If you are currently involved in a self-rental or are considering this transaction, there are methods whereby you can avoid or reduce the disadvantageous tax effect of the self-rental rule. Contact me at 201.655.7411 or sfilip@krscpas.com and I can help you understand which methods are most advantageous to you.