Tag: depreciation

How Tax Reform Impacts Real Estate

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 [email protected].

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

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 [email protected]com or 201.655.7411 for assistance with tax planning for your international holdings.

Allocating Between Land and Building when Acquiring Rental Real Estate

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

Depreciation for residential and commercial properties

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

Allocations favorable to taxpayers

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

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

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

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

Assessor’s allocation vs. taxpayer proposed values

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

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

We’ve got your back

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

If you have questions about how to allocate value between land and building, we’re here to help. Contact me at [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.

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

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?