Month: January 2017

Do You Hold Real Estate in a C Corporation?

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.

2017 NJ Tax Changes Business Owners Need to Know

NJ Taxes

In my last post I reported on key federal tax changes that small business owners need to know about. This post covers three significant tax changes in New Jersey.

NJ sales tax rates reduced

The New Jersey Sales and Use Tax will be reduced in two phases between 2017 and 2018. The rate decreased from 7% to 6.875% on and after January 1, 2017. The tax rate will decrease to 6.625% on and after January 1, 2018.

Transition rules do apply:

  • For items sold before 1/1/2017 but delivered after 1/1/2017, use the 6.875% rate
  • Leases in excess of 6 months entered into before 1/1/2017, use 7%.
  • Lease extensions or renewals after 1/1/2017, use 6.875%.
  • If an agreement is less than 6 months – use 6.875% for all periods that begin after 1/1/2017.
  • Construction materials delivered after 1/1/2017, use 6.875%.
  • If the construction materials are for use in unalterable building contracts entered into before 1/1/2017, the seller must collect 7%.
  • Service or maintenance agreements entered into before 12/31/2016, seller must charge 7%. This is regardless of whether or not the agreement covers periods after 1/1/2017, unless the bill for such services was issued after 1/1/2017.

KRS Tip: Check all your vendor invoices to ensure you’re being charged the correct amount, before you pay the invoice. If it is the incorrect amount, have the vendor revise the invoice. If you go ahead and pay the incorrect amount, it is your responsibility to go back to the state – not the vendor – to get a refund.

Urban Enterprise Zone designation expires for 5 NJ cities

Under the UEZ designation, businesses in certain economically distressed areas are eligible for incentives, including tax free purchases on capital investments, tax credits to hire local workers and the ability to charge just half the statewide 7% sales tax.

The UEZ designations for Bridgeton, Camden, Newark, Plainfield and Trenton were permitted to expire. These zones can no longer collect sales taxes at reduced rates.

Changes to New Jersey estate tax

A NJ resident who dies and has assets worth more than $675,000 has had his or her estate subject to NJ estate tax. That may sound like a lot of money, but if you own even a modest home in the northern part of the state, you’ll probably hit the $675,000 threshold.

As part of the bill that raised the gas tax in the state, the exemption will increase from $675,000 to $2 million for estates of residents dying on or after 1/1/2017 and before 1/1/2018.

We expect that the increased exemption will change if there is a democratic governor elected this year.

We’ve got your back

New Jersey tax regs grow increasingly complex and it can be hard for business owners to know how to save taxes. At KRS we assist our clients in minimizing tax liabilities by providing them with comprehensive tax planning, preparation and compliance services.

Contact partner Maria Rollins at 201.655.7411 or [email protected] if your company needs expert advice and assistance with its 2016 taxes.

 

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

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 [email protected] or 201.655.7411.

2017 Federal Tax Changes Business Owners Need to Know

tips for the 2017 tax season

Tax season is upon us, and with it comes a variety of changes that business owners need to know about. Here’s an overview of some of the most important changes:

New tax filing deadlines

These deadlines apply for 2016 tax filings:

  • C-corporation filings are pushed back to 04/15/17
  • Partnerships, LLCs & S-corporations must file by 3/15
  • Certain 1099 Misc. and W-2’s must be filed with the IRS by 1/31/17

Note that if you are a KRS client, you will receive an email in the next day or so to get you started on your 1099s. Be sure you have all your subcontractor and vendor W-9s completed so that 1099 completion can be done quickly to meet the month-end deadline.

PATH Act eliminates some uncertainty

The Protecting Americans from Tax Hikes Act of 2015 (PATH) enacted at the end of 2015, made permanent many business-related provisions that had been up for renewal, including:

  • 100% gain exclusion on qualified small business stock
  • Reduced, five-year recognition period for S corporation built-in gains tax
  • 15-year straight-line cost recovery for qualified leasehold improvements, restaurant property and retail improvements
  • Charitable deductions for the contribution of food inventory
  • As KRS partner Simon Filip said in Five Ways the PATH Act Can Reduce Your Tax Burden, “The PATH Act is a positive thing for a couple reasons. Any tax savings for small business owners is great. Also, it eliminates some uncertainty, which will make it easier for small businesses to plan their tax liability.”

Good news about the Section 179 tax deduction

Section 179 of the tax code defines the deduction a business can take on the price of qualifying equipment purchased or leased during the tax year. Qualifying equipment could include almost any big-ticket item you need to do business, such as a computer, certain software, office furniture or machinery.

The $500,000 deduction regarding equipment purchases less than $2M now permanent.

R&D credit can help reduce tax liability

New changes in R&D credit allows certain businesses to apply the R&D credit to the AMT or possibly offset payroll taxes. The PATH Act made the R&D tax credit permanent, which is welcome news for businesses investing in research and development.

Update on bonus depreciation

Bonus depreciation is a method of accelerated depreciation which allows a business to make an additional deduction of the cost of qualifying property in the year in which it is put into service.

  • 50% deduction of the costs of new equipment continues through 2019, decreasing to 40% in 2018 and 30% in 2019. Bonus depreciation is set to expire by 2020 unless there is further action by Congress.
  • Replaces the bonus allowance for a qualified leasehold improvement property with a bonus allowance for additions and improvements to the interior of any nonresidential real property, effective for property placed in service after 2015.

Work Opportunity Tax Credit extended

The Work Opportunity Tax Credit gives employers a tax credit when they hire unemployed veterans, food stamp recipients and ex-felons. The PATH Act extends the credit through 2019 with an added 40% credit up to the first $6,000 in wages for employers who hire workers that have been out of work for at least 27 weeks.

Revised repair regulations can increase deductions

The IRS issued final tangible property regulations (aka, the “repair regs”) over three years ago. These regs continue to control the accounting for costs to acquire, repair and improve tangible property. They impact virtually all asset-based businesses and have reverberated into 2016, with additional “clean-up” expected in 2017.

For 2016 year-end planning, work with your accountant to see if either a de minimis expensing safe harbor or a remodel-refresh safe harbor can be applied. Both can yield substantial immediate deductions if followed.

We’ve Got Your Back

Tax laws grow increasingly complex and it can be hard to know how to save taxes. At KRS we assist our business clients in minimizing tax liabilities by providing them with comprehensive tax planning, preparation and compliance services. We’ve also developed resource pages, New Tax Law Explained! for Individuals and for Real Estate Investors, to help you stay on top of what you need to know about the evolving tax codes.

Contact partner Maria Rollins at 201.655.7411 or [email protected] if your business needs expert advice and assistance with its 2016 taxes.

Will President Trump Benefit or Distress Real Estate?

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?