by cdaaccounting | Jun 20, 2021 | Business Deductions
Nothing stays the same in the tax world, and that’s especially true with your 20 percent Section 199A tax deduction.
In January, an IRS Notice gave you a Section 199A safe-harbor option for your Coeur d’Alene rental properties, possibly making it easier for you to qualify for this new tax deduction. Now, the IRS has made a number of changes to its original notice and finalized the safe harbor in a Revenue Procedure. We note the changes below.
Big Picture on Rentals
Your rental activities qualify for the Section 199A deduction in one of three ways:
- They are a tax code Section 162 trade or Coeur d’Alene business.
- You rent them to a commonly controlled tax code Section 162 trade or business.
- They meet the Rev. Proc. 2019-38 safe harbor requirements.
Safe-Harbor Requirements
Under the safe harbor, and solely for Section 199A purposes, the IRS will treat your Coeur d’Alene rental real estate enterprise as a trade or business if you (or your pass-through entity) can satisfy the following three requirements:
- You maintain separate books and records that reflect the income and expenses of each rental real estate enterprise.
- You perform 250 or more hours of “rental services” during the tax year.
- You maintain contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed, (ii) description of all services performed, (iii) dates on which such services were performed, and (iv) who performed the services.
Change #1. The “contemporaneous records” rule does not apply to tax years beginning before January 1, 2020—but don’t let this give you false hope. You still need proof.
Change #2. You can keep separate books and records for each property and later consolidate them to meet the record-keeping requirement.
Change #3. If the enterprise is in existence for at least four years, then you only need to meet the 250-hours test in any three of the five consecutive taxable years that end with the taxable year.
Change #4. The IRS clarified that use of the safe harbor is an annual determination.
Rental Real Estate Enterprise Requirements
To use the safe harbor, you arrange your rental activities into one or more rental real estate enterprises.
You have a choice. You can either
- treat each rental activity as its own enterprise, or
- put all commercial rental activities in one enterprise and all residential rental activities in one enterprise.
Change #5. You need to treat all the rental activities you place into a residential or commercial enterprise as a single trade or business for Section 199A purposes.
Change #6. You have two options for mixed-use properties. First, you can treat them as a single rental enterprise. Second, you can divide them into their component residential and commercial parts. You may not group multiple mixed-use rental activities into one mixed-use rental enterprise.
Ineligible Rentals
The following are not eligible for the safe harbor, and you can’t place them into an enterprise:
- Real estate you use as a residence under tax code Section 280A(d). Under this rule, your property is a personal residence if you use the property for personal purposes for a total number of days exceeding the greater of (a) 14 days or (b) 10 percent of the days you rented the property at fair market value.
- Real estate rented or leased under a triple net lease. For purposes of this safe harbor only, a triple net lease includes a lease agreement that requires the tenant or lessee to pay taxes, fees, and insurance, and to pay for maintenance activities for the property in addition to rent and utilities.
Change #7. For Section 199A purposes, real estate rented to a commonly controlled trade or business does not qualify for the safe harbor. You treat such a rental as being in the same business as the commonly controlled tenant.
Change #8. Real estate for which any portion is an out-of-favor specified service trade or business is not eligible for the safe harbor.
Disclosure
You or your pass-through entity must attach a statement to the tax return indicating that you are using the safe harbor and you satisfied the requirements set forth in Rev. Proc. 2019-38.
The statement has three required elements:
- A description (including the address and rental category) of all rental real estate properties you included in each rental real estate enterprise
- A description (including the address and rental category) of rental real estate properties acquired and disposed of during the taxable year
- A representation that the requirements of this revenue procedure have been satisfied
Change #9. You don’t have to sign the statement under penalty of perjury.
Clarifying Example
Sarah has four rental properties:
- Property A, a residential rental
- Property B, a commercial rental
- Property C, a commercial rental
- Property D, a mixed-use commercial and residential property
If Sarah wants to use the safe harbor, she can arrange her rentals in one of three configurations:
Configuration 1. Each property is its own enterprise. There are four enterprises:
- Property A
- Property B
- Property C
- Property D
Configuration 2. She combines the residential and commercial properties into their own enterprises and places the mixed-use property into its own enterprise. There are three enterprises:
- Property A
- Property B and Property C
- Property D
Configuration 3. She combines the residential and commercial properties into their own enterprises and bifurcates the mixed-use property. There are two enterprises:
- Property A and part of Property D
- Property B, Property C, and part of Property D
For all her rental activities to qualify for Section 199A under the safe harbor, Sarah will need to show
- 1,000 total hours of rental services in Configuration 1 (250 hours for each of the four enterprises);
- 750 total hours of rental services in Configuration 2 (250 hours for each of the three enterprises); and
- 500 total hours of rental services in Configuration 3 (250 hours for each of the two enterprises).
Final Thoughts
The good news with the safe harbor is that it gives you a guaranteed way to ensure that your rentals qualify for the Section 199A deduction.
The bad news is that you may not meet the requirements to qualify for the safe harbor.
by cdaaccounting | Jun 7, 2021 | Business Deductions
It’s common to consider making your S corporation (versus yourself) a partner in your partnership: it saves you self-employment taxes.
Does this affect your Section 199A deduction? It does.
Guaranteed payments are not qualified Idaho business income (QBI) for the Section 199A deduction.
The non-QBI guaranteed payment rule applies whether the partner receives the payment as an individual or as pass-through income from an S corporation.
Your only options to claw back your Section 199A deduction with the S corporation as a partner are to
- reduce or eliminate the partnership’s guaranteed payments, and take the income pro rata based on ownership percentage; or
- use a special allocation of partnership tax items.
Keep the Coeur d’Alene S corporation self-employment tax savings in mind when considering your partnership activity. Often the savings can make the S-corporation-as-a-partner strategy well worth it.
by cdaaccounting | May 21, 2021 | Business Deductions
It’s common to consider making your Idaho S corporation (versus yourself) a partner in your partnership: it saves you self-employment taxes.
Does this affect your Section 199A deduction? It does.
Guaranteed payments are not qualified Coeur d’Alene Idaho business income (QBI) for the Section 199A deduction.
The non-QBI guaranteed payment rule applies whether the partner receives the payment as an individual or as pass-through income from a Coeur d’Alene Idaho S corporation.
Your only options to claw back your Section 199A deduction with the S corporation as a partner are to
- reduce or eliminate the partnership’s guaranteed payments, and take the income pro rata based on ownership percentage; or
- use a special allocation of partnership tax items.
Keep the Coeur d’Alene Idaho S corporation self-employment tax savings in mind when considering your partnership activity. Often the savings can make the S-corporation-as-a-partner strategy well worth it.
by cdaaccounting | May 16, 2021 | Business Deductions
Now, add to this no-tax-on-sale benefit to the 21 percent corporate tax rate from the Tax Cuts and Jobs Act, and you have a significant tax planning opportunity.
Imagine this: You sell your Idaho C corporation. The sale produces a $6 million capital gain to you.
Your federal income tax bite on the $6 million of gain is zero. Yes, you are awake. You are reading this correctly. The tax bite is zero.
Internal Revenue Code Section 1202 establishes the rules for the zero tax bite. To get to zero, you need to operate your business as a tax code-defined QSBC.
You may already have a tax code-defined small business corporation in Coeur d’Alene Idaho, or you may be thinking of starting a new Coeur d’Alene business as a small business corporation. Paying zero taxes on the sale of your business stock is a big incentive.
100 Percent Gain Exclusion Break (Tax-Free Capital Gains)
To qualify for tax-free capital gains, you must acquire your QSBC stock after September 27, 2010.
More Than Five Years
Of course, there’s more than one rule. You must hold your QSBC stock for more than five years to qualify for the tax-free treatment.
Limitations on Excludable Gains
Your beloved lawmakers impose limits on your tax-free capital gains from the sale of a particular QSBC. In any taxable year, the tax limits on your eligible gain exclusion may not exceed the greater of
- 10 times the aggregate adjusted basis in the QSBC stock you sell, or
- $10 million reduced by the amount of eligible gains that you’ve already taken into account in prior tax years from sales of this QSBC stock ($5 million if you use married filing separate status).
Example 1: $10 Million Limitation
You are a married joint filer. You invested $100,000 when you started your C corporation in 2012.
Now, in 2019 (more than five years after the start), you sell the stock in the C corporation for $6.1 million. You have tax-free capital gains equal to the greater of
- $1 million (10 x $100,000), or
- $6 million (because it’s less than $10 million).
You have $6 million of tax-free capital gains.
Example 2: 10-Times-the-Basis Limitation
You are an unmarried individual. You invest $2 million in a single QSBC stock this year.
In 2025, more than five years from now, you sell this stock for $24 million, resulting in a total gain of $22 million ($24 million – $2 million). The tax code limits your tax-free gain to the greater of
- $20 million (10 times the basis of the stock), or
- $10 million.
In 2025, you have $20 million in tax-free capital gains and $2 million in taxable capital gains. You have to be smiling.
Definition of QSBC Stock
To be eligible for the QSBC gain exclusion, the stock you acquire must meet the requirements set forth in Section 1202 of our beloved Internal Revenue Code. Those requirements include the following:
- You generally must acquire the stock upon original issuance or through gift or inheritance.
- You must acquire the stock in exchange for money, other property (not including stock), or services.
- The corporation must be a QSBC at the date of the stock issuance and during substantially all the period you hold the stock.
Next, you have to look at the rules that apply to the corporation. To qualify as a QSBC, the following rules apply.
Rules for the Corporation
Your Coeur d’Alene corporation must be a domestic C corporation.
The corporation must satisfy an active business requirement. That requirement is deemed satisfied if at least 80 percent (by value) of the corporation’s assets are used in the active conduct of a qualified business.
Beware. Qualified businesses do not include
- the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any other business where the principal asset is the reputation or skill of one or more of its employees;
- banking, insurance, leasing, financing, investing, or similar activities;
- farming (including raising or harvesting timber);
- production or extraction of oil, natural gas, or other natural resources for which percentage depletion deductions are allowed; or
- the operation of a hotel, motel, restaurant, or similar business.
The Coeur d’Alene corporation’s gross assets cannot exceed $50 million before the stock is issued and immediately after the stock is issued (which considers amounts received for the stock).
by cdaaccounting | May 1, 2021 | Business Deductions
Here’s an easy example to illustrate.
Let’s say that in 2017, you purchased for Coeur d’Alene business use a pickup truck with a gross vehicle weight rating greater than 6,000 pounds. Asserting that you use the pickup 100 percent for business, you expensed the entire $55,000 cost.
What happens to that $55,000 expensed amount if you die, retire, or become disabled before the end of the vehicle’s five-year depreciation period?
Death
If your heirs are not going to pay estate taxes, your death is about as good as it gets. Here’s why:
- You get to keep your Section 179 deduction. (It goes to the grave with you.)
- Your pickup truck gets marked up to fair market value. (Remember, you expensed it to zero, but now at your death, the fair market value is the new basis to your heir or heirs.)
Example. Using Section 179, you expensed the entire cost of your $55,000 pickup truck. You die. Your daughter Amy inherits the pickup at its fair market value, which is now $31,000, and sells it immediately for $31,000. Here are the results:
- You get to keep your Section 179 deduction—no recapture applies.
- Amy pays zero tax on her sale of the pickup truck.
- Your estate includes the $31,000 fair market value of the pickup, and if your estate is less than $11.4 million, your estate pays no estate taxes.
Disability
This is ugly. If you become disabled and you allow your Coeur d’Alene business use of the pickup to fall to 50 percent or below during its five-year depreciable life, you must recapture and pay taxes on the excess deductions generated by the Section 179 deduction.
To make matters worse, you must use straight-line depreciation in making the excess-deduction calculation.
Retirement
With retirement, you have exactly the same problem as you would have if you became disabled. In fact, with retirement, you disable your Coeur d’Alene business involvement, and that makes your pickup truck fail the more-than-50-percent-business-use test, resulting in recapture of the excess benefit over straight-line depreciation.
Takeaways
You need to consider what happens should you become disabled, or retire, or die.
by cdaaccounting | Apr 20, 2021 | Business Deductions
If you want to attend a convention, seminar, or similar meeting onboard a cruise ship and deduct all your costs on your Coeur d’Alene business, you face some very special rules. But it can be done.
When you know the tax code rules, you will find an enlightened workaround that removes almost all the hassle and gives you what you want.
The IRS considers all ships that sail cruise ships.
In 1982, your lawmakers were attempting to give the U.S. cruise ship industry a leg up by outlawing all cruise ship conventions, seminars, and similar meetings other than those
- that take place on a vessel registered in the United States, and
- for which all ports of call of such vessel are located in the United States or in possessions of the United States.
The 1982 law remains on the books. Lawmakers have not updated the limits for inflation. Here’s the cruise ship convention tax code rule as it existed in 1982 and as it exists today:
With respect to cruises beginning in any calendar year, not more than $2,000 of the expenses attributable to an individual attending one or more meetings may be taken into account under Section 162 . . .”
Had the $2,000 been indexed for inflation, the 2019 amount would be a reasonable $5,431, and that would likely encourage more 2019 U.S. cruise ship convention-type travel.
The $2,000 is pretty skimpy (perhaps ridiculous) when you consider that the expenses include
- the cost of air or other travel to get to and from the cruise ship port;
- the cost of the cruise; and
- the cost of the convention, seminar, or similar meeting.
Bigger, Better Deductions with Less Hassle
This is a way you can avoid the $2,000 limit, take the cruise you want, and likely deduct all your costs under your Coeur d’Alene business. And this does not have to involve a U.S. ship. Any ship from any country works.
Here’s the strategy. You take the cruise ship to a convention, seminar, or meeting that’s held
- on land, say at a hotel, and
- in the tax-law-defined North American area.
When you meet the two easy requirements above, you deduct (a) the full cost of getting to and from the location; (b) the full cost of the convention, seminar, or similar meeting; and (c) likely the full cost of the cruise if your onboard ship expenses are less than the current daily luxury water limits.
By using the 2019 luxury water limits, if your average daily cost of the cruise is $692 or less, you can use this strategy to deduct all cruise ship costs to travel to and from the seminar.
by cdaaccounting | Apr 8, 2021 | Business Deductions
Here’s a true story from the IRS.
To put the story in context, I am putting you in the driver’s seat.
You Buy a Vehicle
You buy a new vehicle from your local dealership with zero percent financing. You complete all the paperwork, including the purchase order and vehicle registration, and leave the dealership owning the vehicle.
Dealer Oops
The next day, the dealership calls you and says there’s been a mistake: you are not eligible for zero percent financing. To correct the mistake, the dealership asks you to return and sign a new contract with an interest rate.
Recognizing a good deal when you see one, you refuse.
Dealer Gone Mad
Your refusal makes the dealership mad; in retaliation, the dealership voids your vehicle registration. You complain to the Department of Motor Vehicles, which
- reinstates your vehicle registration and
- sends a written warning to the dealer.
Dealer Madder Now
Still upset and looking for a means to do damage to you, the dealer sends you a Form 1099-INT showing $2,997.60 of interest income, the amount of interest you saved on this transaction.
You are not happy about the 1099, so you write to the IRS and ask whether the dealership has a legal right to send you a 1099 for the interest you saved.
Bogus
Here’s what the IRS says: the 1099 is bogus.
In its letter, the IRS states that you do not pay interest to the dealer when you have a zero-interest contract; therefore, it is impossible for you to have cancellation of indebtedness income due to interest that you do not owe. The dealership forgave nothing, because you have a valid contract for zero interest.
Tax Law Damages
Even better, in the next paragraph, the IRS informs you that under Section 7434, you may bring a civil action against this dealer for willfully filing a false information return. If you win this case, the dealer will be liable for damages to you equal to the greater of
- $5,000, or
- actual damages, court costs, and reasonable attorneys’ fees.
If You Win, Tell the IRS
The IRS then tells you that if you bring this action for the false 1099, you should send the IRS a copy of the complaint when you file your claim with the court.
Zero Interest Rule
In the tax law, there is no such thing as zero interest. When an installment contract calls for less than the minimum interest, both the buyer and the seller must impute interest. The imputation is done individually, and no 1099s are involved.
Now, here’s a nice break. If this is a Coeur d’Alene business vehicle for you, you
- pay zero interest under the contract, but
- deduct interest on your tax return using the imputed interest rates.
Dealer’s Trouble
Here’s another piece of news that will put a smile on your face.
The dealer also has to impute interest. For the dealer, this means reducing the sale price and recognizing imputed interest over the life of your installment payments. The dealer does this for both financial reporting and tax purposes. Thus, from a financial standpoint, the dealer
- is out $2,997.60 of interest income that you will never pay,
- must reduce current-year profits by the imputed interest amount, and
- must recognize imputed interest income as you make payments.
You could say you really stuck it to this dealer. And you are not finished, assuming that you pursue the bogus 1099 penalties.
Takeaways
You have to love the fact that if someone is making trouble for you by giving you a fraudulent 1099, you have tax code remedies.
And when you consider everything, you can likely make far more trouble for the culprit than you suffer.
by cdaaccounting | Apr 6, 2021 | Business Deductions
If you own a condominium, cottage, cabin, lake or beach home, ski lodge, or similar property in the Coeur d’Alene area that you rent for an “average” rental period of seven days or less for the year, you have a property with unique tax attributes.
Seven days example. Say you have a beach home and you rent it 15 times during the year, for a total of 85 days. Your average rental is 5.7 days. That’s an average of seven days or less for the year.
The right type of Coeur d’Alene beach home or vacation cottage can produce great tax results when the average rental period is seven days or less.
But it’s tricky because when the average rental period is seven days or less, the property is not a rental property as defined by the tax code. Instead, the property is
- a commercial hotel type property that you report on Schedule C of your tax return if you provide services in connection with the rentals, or
- a weird in-limbo property that you report on Schedule E when you don’t provide services.
If the property shows a loss, you can deduct that loss on either Schedule C or Schedule E if you can prove that you materially participate. With the seven-days-or-less-average rental, you likely have only two ways to materially participate:
- The combined participation by you and your spouse constitutes substantially all the participation in the seven-days-or-less-average rental activity when you consider all the individuals who participated (including contractors).
- The combined hours of participation by you and your spouse in the seven-days-or-less-average rental activity are (a) more than 100 hours and (b) more hours than the participation of any other individual.
Example. Your seven-days-or-less beach rental produces a $20,000 tax loss for the year. On this rental, you spend 65 hours during the year. No other person works on the rental. You materially participate in this rental, and the $20,000 is deductible—period (regardless of its location on Schedule C or E).
Coeur d’Alene Rental Profits
If you have a profit on the rental, you likely have a Section 199A deduction when you report the rental on Schedule C as a business. Although not deemed a business by Schedule E reporting, the Schedule E rental could rise to the level of a business as defined for the Section 199A deduction.
If you have one of these seven-days-or-less-average Coeur d’Alene rental properties and would like to discuss it, please don’t hesitate to call us at (208) 415-1850
by cdaaccounting | Aug 7, 2020 | Business Deductions
Two questions: Did you prepay your 2019 rent so that you have a big 2018 tax deduction? How do you identify in your accounting records the monies you put on your IRS Form 1099-MISC for the Coeur d’Alene business rent payments to your landlord?
For the 1099-MISC, do you simply look at your checkbook or payment ledgers to identify the amounts you are going to report? If so, you will create an incorrect 1099 for your landlord that’s going to cause your landlord a tax problem.
One golden rule when it comes to your landlord is “do not cause your landlord tax trouble.” Let’s say you wrote a $55,000 check to your landlord on December 31 and mailed it that day.
Your Coeur d’Alene landlord received the check on January 3. Here’s how your Form 1099-MISC can create a tax problem for your landlord: Your Form 1099-MISC to the landlord shows rent paid of $105,000 ($50,000 paid during the year and then the $55,000 prepayment on December 31). The landlord’s 2018 federal income tax return shows $50,000 in rent received (he received the $55,000 in 2019). IRS computers note the difference and start an inquiry.
An incorrect 1099 that overstates the landlord’s income is a problem that can lead to a tax audit. One big cause of an incorrect 1099-MISC is not understanding the definition of 1099 income.
Note that this is not the amount paid by you during the year but rather the amount received by your landlord during the year.
IRS Reg. Section 1.6041-1(f) says:
1. The amount to be reported as paid to a payee is the amount includible in the gross income of the payee . . . Note. As you will see below, this amount does not necessarily equal the tax deduction claimed by the payor. Reg. Section 1.6041-1(h) says:
2. For purposes of a return of information, an amount is deemed to have been paid when it is credited or set apart to a person without any substantial limitation or restriction as to the time or manner of payment or condition upon which payment is to be made, and is made available to him so that it may be drawn at any time, and its receipt brought within his own control and disposition. The 1099-MISC is a “return of information.” The landlord did not have control of the money until he or she had possession of the check in 2019.