Month: August 2017

Real Estate Rentals, the Sharing Economy and Taxes

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 [email protected] 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.

What Tax Topics Do Millennials Care About?

What Tax Topics Do Millennials Care About?
From left to right: Bret Kaye, a certified financial planner at AEPG Wealth Strategies, Diane Pineda, senior accountant at KRS CPAs, and Lance Aligo, CPA, senior accountant at KRS CPAs

On July 25, 2017, senior accountants Lance Aligo and Diane Pineda participated in an NJBIA panel presentation focusing on personal finances for young professionals. The first few years following college can be very challenging and it’s important for YPs to understand the tax implications of life changes.This panel covered topics such as marriage, job changes, first time home buyers, and starting a family.

One tax topic discussed was the difference between filing a “married filing joint,” “married filing separate” and “single” tax return.

Whether a couple is married on January 1 or December 31, they are considered to be married for the full year for income taxes and are required to file a “married” tax return.

An audience member posed the question,

When is it beneficial for a couple to file a married filing joint tax return compared to married filing separate?

Here’s what the panelists noted:

  • When married filing joint, the couple will complete one shared tax return and take full responsibility for the income and tax that is owed.
  • When married filing separate, the couple will each report their own income and be responsible for their own tax liability.
  • Filing separate can limit or disqualify tax credits and deductions. Each couple is unique and depending on their situation, both ways should be considered.
  • It is important to keep in mind that married filing separate is not the same as filing as a single person. Most of the time, a couple will pay less tax when filing a married filing joint return.
  • A married couple filing separate will lose the following credits and deductions (geared towards the young professional):
    • Traditional IRA deductions
    • Child and dependent care tax credit
    • College tuition expense deduction
    • American opportunity credit and lifetime learning credit
    • Student loan interest deduction
    • Earned income credit
  • If married filing separate, both taxpayers must claim either the standard deduction or itemized deduction. If one spouse is itemizing, the other must too.

Situations where married filing separate may benefit the taxpayer:

  • When filing separately, you will be responsible for the accuracy and completeness of only your return and have no responsibility for your spouses.
  • It’s possible that your overall tax bill could be lower as a couple when filing separate due to one spouse having significantly high itemized deductions. Specifically, itemized deductions limited by your adjusted gross income.
    • Medical expenses, unreimbursed employee business expenses, investment expenses, fees for tax preparation, charitable contributions.
  • Since adjusted gross income is lower on married filling separate returns, the limited itemized deductions listed above may be higher if you file separately reducing a couple’s overall tax liability.

If a couple is married, it is important to consider each unique situation and then determine which method, joint or separate, provides you with the lowest tax liability.

Standard vs. itemized tax deductions

Another topic discussed was standard vs. itemized deductions. The standard deduction for 2017 for a single individual is $6,350 and for a married couple $12,700 ($6,350 for married filing separately).

Itemized deductions are a group of eligible expenses that an individual can claim on their federal income tax return that potentially reduce their taxable income.  These deductions are reported on Schedule A of Form 1040.  A taxpayer may claim itemized deductions and receive a benefit from them when their total itemized deductions are larger than the IRS standard deduction.

What are some of the itemized deductions and how can they be tracked?

First-time homeowners should be aware that they are paying real estate taxes which are tax deductible as an itemized deduction. If the homeowner is paying a mortgage, the interest portion of the payment is tax deductible as an itemized deduction.

These deductions are tracked by the bank where you have your loan.  At the end of the year you will receive a Form 1098 which reflects the mortgage interest that was paid for the year.  Typically, Form 1098 will also reflect the amount of real estate taxes that were paid for the year.  If it does not, you should refer to quarterly or semi-annual tax statements from your town.

Taxes paid to any state jurisdiction are tax deductible. If you are working as a W-2 employee, state taxes are being withheld from your paycheck.  These taxes will be reported to you on your Form W-2 reflecting what taxes were withheld and what can be deducted as an itemized deduction.  If you are self-employed and pay quarterly estimates, a great way to track your payments is to keep copies of the checks you write as well as proof from your bank statements.

Charitable contributions are also itemized deductions. Cash and non-cash items qualify for this deduction as long as they are donated to a recognized charitable organization.  The organization that you donated to will provide you with a receipt of what was received and the value of the gift.  If donating a non-cash item valued more than $5,000, a special appraisal needs to be completed and in writing to submit to the IRS with your Form 1040.

Other itemized deductions that are common to the young professional include medical expenses, unreimbursed employee expenses, job search costs, union dues, investment expenses, continuing education, and tax preparation fees. To claim these deductions, the taxpayer should retain receipts for any expense incurred.

We’ve got your back

As a young professional myself, I understand the challenges we face. If you have any questions relating to tax topics relevant to YPs, contact me at [email protected] or 201-655-7411.

Is it Time to Update Your Buy-Sell Agreement?

Buy-Sell AgreementsWhy should you have a buy-sell agreement?

Buy-sell agreements are among the most important agreements entered into by business co-owners. Notwithstanding the importance, many businesses do not have buy-sell agreements in place, and for many that do, the agreements are ambiguous and outdated.

An effective buy-sell agreement will eliminate or reduce the disputes arising from the death or retirement of a shareholder or partner, and the absence of an effective agreement may result in a protracted and costly dispute.

Is your existing agreement still effective?

To determine if an existing buy-sell agreement still works for a business, the value of the business should be calculated pursuant to the agreement, as if a triggering event had occurred. If there are not disputes over interpretation of the agreement, all parties believe the value result is fair, and the funding mechanism is in place to make the required payments, then the agreement is still acceptable.

Many companies that perform this exercise find the existing agreement to be unsatisfactory and in need of change.  It is much better to perform this exercise and identify problems with the agreement prior to occurrence of a triggering event.  In the evaluation of the results of this exercise, the parties will usually be open minded and fair, because they do not know if they will be a buyer or a seller when the actual triggering event occurs.

Types of buy-sell agreements

Buy-sell agreements generally fall into three basic categories: fixed-price agreements, formula agreements, and agreements requiring the performance of a valuation.

In fixed-price agreements, the price is specified in the agreement and is generally funded by an insurance policy, which was purchased at the time the agreement was executed. These agreements usually contain a provision requiring the fixed price to be periodically updated, but this provision is frequently disregarded.  Problems can arise when a triggering event occurs and the fixed price value has not been updated, the triggering event occurs after the expiration of the original term insurance policy, or the insurance benefit is no longer sufficient to fund the required payment.

In a formula agreement, the business value is generally determined by a relatively simple formula such as a multiple or percentage of net or gross income. The problem with formula agreements is that although the formula undoubtedly made perfect sense when the agreement was drafted, it may no longer be relevant or yield a result that bears any relationship to current value.  Furthermore, if net income is a component of the formula, each expense paid by the business can become the subject of a dispute.

Agreements that require the performance of a valuation by a qualified expert are most likely to yield a fair result and less likely to be the subject of a dispute, as opposed to fixed-price or formula agreements. This business valuation will require payment of professional fees, but these fees will be far less than those that would be paid in the event of a dispute.

Crucial agreement provisions

To avoid or reduce disputes upon occurrence of a triggering event, a buy-sell agreement should include the following provisions:

Standard of Value – This is an important element of a buy-sell agreement. In New Jersey, the most frequently used standards of value are fair value and fair market value.  An agreement that uses the generic term “value” and does not state the standard of value to be used will be the subject of dispute.

Triggering Events – Common triggering events in a buy-sell agreement include shareholder death, disability, and retirement. Other triggering events that should be considered are divorce, loss of business or professional license, or one’s continued failure to perform duties. The agreement should also distinguish between normal retirement at or within a range of ages stated by the agreement, and early retirement, which occurs prior to this age or range.

Valuation Date – Upon the occurrence of a triggering event, the valuation date is the effective date of the valuation. In performing the valuation, the valuation analyst can only use information that was known or knowable as of the valuation date.  This is important because an event occurring subsequent to the valuation date cannot be considered in the valuation.

Discounts and Premiums – Discounts for lack of control and lack of marketability frequently give rise to disagreement between business valuation practitioners, as well as between practitioners and the Internal Revenue Service. To avoid controversy over application and amount of discounts, consideration may be given to specifying a range or maximum discount in the buy-sell agreement.

Tax Effecting – Most closely held businesses operate as S corporations, partnerships, or limited liability companies taxed as partnerships. With limited exception, none of these companies pay federal or New Jersey income taxes.  They are commonly referred to as pass-through entities, because the business income or loss passes through to the owners for inclusion and taxation on their individual income tax returns.  Because pass-through entities do not pay income taxes, controversy exists whether income tax expense should be recognized in the valuation of these entities.  In drafting a buy-sell agreement, consideration should be given to expressly addressing tax effecting in the agreement.

Although it is impossible to anticipate every contingency and the source of every possible disagreement, an effective buy-sell agreement that is understood by all will go a long way in reducing disputes. Business circumstances change, and the buy-sell agreement may require periodic updating to reflect such changing circumstances.  It may be uncomfortable for the parties to discuss sensitive buy-sell agreement issues, but it is far worse to ignore them.  Issued not addressed do not go away, they become bigger and more often than not must be decided by a judge.  Review and update your buy-sell agreement today to avoid future problems.

We’ve got your back

If you have questions about buy-sell agreements or require an independent business valuation, contact KRS CPA partner Gerald Shanker at 201.655.7411 or [email protected]. You can also learn more from these buy-sell agreement and business valuation blog posts.

 

This article was originally published in the New Jersey Staffing Alliance July 2017 newsletter.

 

 

Income Tax Incentives for Land Conservation

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  [email protected] or (201) 655-7411.

What Is the New GAAP Lease Accounting Standard?

In February 2016, the Financial Accounting Standards Board (FASB) issued an Accounting Standard Update (“ASU”), ASU 2016-02, Leases (Topic 842).

New GAAP Accounting Rules for Leases
For public companies, ASU 2016-02 is effective for fiscal years beginning after December 15, 2018. For all other entities, this update is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted for all entities, using a modified retrospective approach.

ASU 2016-02 impacts all entities that lease property, plant, or equipment. ASU 2016-02 defines a lease as a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment for a period of time, in exchange for consideration.

What will change?

Currently, operating lease obligations (for example, a lease of office space for 10 years) are disclosed in a company’s financial statement footnotes, but not recorded on the balance sheet. Under the new guidance, a lessee will be required to report on its balance sheet assets and liabilities related to lease obligations with lease terms of more than 12 months. This differs from current GAAP, which requires only capital leases to be recognized on the balance sheet.

How will the change impact financial reporting?

Companies will have to report their leases (finance leases and operating leases) as both assets and liabilities on their balance sheets. This must be done regardless of the lessee’s (tenant’s) intent to vacate the space at the end of its lease term. Rent obligations that were previously disclosed in the footnotes of financial statements will be reflected on the balance sheet as debt. Debt impacts a company’s credit, compliance with debt covenants and other capital requirements.

What about the lessor (landlord)?

For lessors, the impact of ASU 2016-02 is largely unchanged from current GAAP. For example, the vast majority of operating leases should remain classified as operating leases. In general, lessors should continue to recognize lease income for those leases on a straight-line basis over the lease term.

We’ve got your back

Not sure how the new FASB lease reporting standards impact accounting for your real estate leases? The real estate accounting experts at KRS CPAs are here to help. Reach out to me for a complimentary initial consultation at [email protected] or (201) 655-7411.