3 Myths About Real Estate Taxation

As an active CPA, I often stumble across forums and blogs on the internet with a plethora of misinformation that makes me want to bang my head against the wall. While this blog isn’t intended to be a PSA, the tax code is complex and you should always consult with a tax professional before acting on advice of a friend, colleague, or stranger on the web.

I assembled a list of the top  3 myths about real estate taxation with the intention of setting the record straight. Here’s the top offenders:

Myth #1: You need a real estate license to be a real estate professional

While you may need a license to hold yourself out to the public as a “real estate professional”, to qualify for real estate professional tax status the IRS only requires that you meet certain annual time thresholds.

The rules are pretty simple, the IRS defines a real estate professional as a taxpayer that materially participates in real estate. Qualifications? Work 750 hours in a real estate capacity and spend more than half your time in a real estate trade or business.

So what is a real estate business or trade? The IRS lists the following: renting and leasing of realty, construction, development, buying, operating, and managing realty, as well as realty brokerage businesses.

Simple enough, right? The full text can be found in full under Code Sec. 469(c)(7)(B).

Myth #2: Flipping income qualifies as capital gain

The IRS says “real estate dealers”, individuals or business involved in the buying, improving, and selling real property (“flipping”), cannot qualify for capital gains – regardless of whether you hold the property for 1 year or longer!

Court cases have made this pretty clear – real estate dealers should treat the business of flipping property similar to any other inventory based business. Meaning, sole proprietors involved in flipping activities would also be subject to self-employment taxes. You should also be aware that “real estate dealer” status could also subject your rentals to “self-employment”.

There are several strategies a knowledgeable CPA can help employ to reduce exposure to some of the negative implications.

Don’t believe me? There are plenty of court cases that support this – email me for a list!

Myth #3: Passive losses disallowed in one year are lost forever

The IRS has rules related to “passive losses”. These rules often limit the amount of loss that can be taken in a given year for a rental property.

The good news is that if your rental shows a passive loss, no taxes are being paid on the rental income you received for the year! Hopefully, that loss being generated is just “tax loss” rather than a hard loss.

So what happens to the losses in excessive of your rents received? When you have a passive loss from your rental activities and cannot use the loss because of your income level or the passive loss rules, they become suspended until they can be used to offset future passive income or offset any gain in the year that property is disposed of in a sale.

While the key to effective tax strategy usually involves obtaining the largest benefit now, the passive loss rules can work out quite nicely in the future.

Oh, and you can and should always write off depreciation. If you don’t write off depreciation, you will run into quite a mess when you go to sell the property.

Any questions? Feel free to email me at paul@launchconsultinginc.com or leave a message in the comment section below.

 

Worried About Owing Taxes at Year-End?

Individuals should review their withholding and avoid having too little (or too much!) federal income taxes withheld from their paychecks. Nobody likes a surprise in April, so it’s best to review your withholding for the year now and take into consideration any life changes; such as marriage, changes in dependents, or changes in income. Having the correct amount taken out helps to move taxpayers closer to a zero balance at the end of the year when they file their tax return, which means no taxes owed or refund due.

What to do if you have any life changes such as changes in marital status, dependents, income, or credit eligibility:

  1. Use the IRS withholding calculator to help determine the correct amount of tax to withhold.
  2. Give your employer a new Form W-4, Employee’s Withholding Allowance Certificate, to change their withholding status or number of allowances. Employers use the form to figure the amount of federal income tax to be withheld from pay. Making these changes in the late summer or early fall can give taxpayers enough time to adjust their withholdings before the tax year ends in December.

There are also a few other resources on the IRS website, such as this article on tax withholding.

Self-employed taxpayers, including those involved in the sharing economy, can use the Form 1040-ES worksheet to correctly figure their estimated tax payments. If they also work for an employer, they can often forgo making these quarterly payments by instead having more tax taken out of their pay.

Feel free to reach out if you have any questions about withholding.

How to Handle an IRS Letter

The IRS mails millions of letters every year to taxpayers for a variety of reasons. Many of these letters are computer generated. It’s important to keep the following tips in mind if you are ever the recipient of a letter or notice from the IRS:

  1. Don’t panic. Most notices can be resolved with a simple response providing the requested information.
  2. While you shouldn’t panic, you should certainly not ignore the letter. The majority of IRS notices are sent in respect to federal tax returns or tax accounts. Since every notice is different, be sure to read the notice carefully. Most will require a response in 30 days.
  3. Respond timely. Most notices ask for more information about a specific issue or item on a tax return. Not only will a timely response minimize additional interest and penalty charges (if, any), but it will also prevent the IRS from automatically making adjustments for lack of a response from you.
  4. Some notices will come from the Automated Under Reporting Service Center. These notices will typically indicate a changed or corrected tax return. The most common occurrence is when the IRS has information from another source that was missing on your return, such as stock sales reported by your broker, but not included on your return. Review the information and changes on the notice and compare it with your original return. If you agree with the changes, you should note the corrections on your copy of the tax return for you records. There is usually no need to reply to a notice like this when you agree to the changes unless specifically instructed to do so, or to make a payment.
  5. Respond promptly to a notice you do not agree with. You should mail a letter explaining why you disagree to the address on the contact stub at the bottom of the notice. Include information and documents for the IRS to consider and allow at least 30 days for a response.
  6. There is no need to call the IRS or make an appointment at a taxpayer assistance center for most notices. If a call seems necessary, use the phone number in the upper right-hand corner of the notice. Be sure to have a copy of the related tax return and notice when calling.
  7. Always keep copies of any notices received with tax records.
  8.  The IRS and its authorized private collection agency will send letters and notices by mail. The IRS will not demand payment a certain way, such as prepaid debit or credit card.

For more more information on notices, or for notice resolution, please contact Paul at Launch Consulting, Inc for assistance resolving any IRS issues.

 


Child Related Tax Benefits For Reducing Your Tax Burden

Being a parent can have its benefits. This is especially so during tax time. No, your kids will probably not help you sort through your tax receipts, but you can certainly claim some child-related tax benefits when you file your federal tax returns.

Some of these benefits include:

  • Claiming the Child as a Dependent: Parents can deduct $4,050 (2016/2017) for each qualified dependent. However, if your income is over a specific limit, the amount that you can deduct will decrease.
  • Child Tax Credit: For each qualifying child below the age of 17 years, you can claim the Child Tax Credit. The maximum credit you can claim is $1,000 per child. Individuals in lower income tax brackets might qualify for the Additional Child Tax Credit (ACTC).
  • Child and Dependent Care Credit: To claim this credit, you must have paid for the care of one of more qualifying people. Paying for care must have enabled you to work or to look for work. The list of qualifying people also includes dependent children below 13 years of age.
  • Adoption Credit: If you paid certain expenses for adopting a child, you could claim a tax credit for the amount paid. Form 8839, Qualified Adoption Expenses provides more details on this.
  • Education Tax Credits: The tax authorities provide education tax credits to reduce your tax liability. These credits are comprised of the American Opportunity Tax Credit and the Lifetime Learning Credit. Even parents who owe no tax can qualify for claiming these credits. In some cases, these credits are phased out (high income earners) or have reduced the amount of tax owed to less than zero. The latter situation invariably results in a refund.
  • Student Loan Interest: Parents might be able to deduct the interest paid on a qualified student loan. They can claim this even if they do not itemize the deductions. Use this Interactive Tax Assistant for determining if the interest you paid on a student or educational loan is deductible.
  • Self-Employed Health Insurance Deduction: The authorities permit taxpayers to deduct the premiums paid during the year. Self-employed taxpayers who paid for health insurance can avail this deduction.
  • Earned Income Tax Credit (EITC): You could get a credit of as much as $6,269 in EITC (2016) if you worked but earned less than $53,505 last year. In addition, you could qualify with or without kids. Refer to the EITC Assistant tool for more information.

If you have any further questions, feel free to contact me at paul@launchconsultinginc.com

What Is The True Cost Of An Early Withdrawal From Your 401(k)?

Tapping into your 401(k) as if it were a rainy day fund should always be a last resort. Many individuals are not aware of the negative tax implications of an early withdrawal from a retirement account. Before we go more in-depth, here are the key take-aways:

  • Borrowing or taking early withdrawals from your 401(k) can result in large tax burdens in addition to tax penalties
  • While exceptions exist, the most common withdrawals (education or buying a home) are still subject to tax penalties
  • If you borrow from a 401(k), loan funds will not grow in value and will automatically be converted to a withdrawal if you leave your employer, voluntarily or involuntary, while the loan is still outstanding.

401(k) Penalties

The penalties for early withdrawals from your 401(k) are assessed at a flat 10% rate on the total distribution. So, if you take a $50,000 distribution from your 401(k) before reaching 59 ½ years of age, you will owe a penalty of $5,000 before even paying any federal income tax on this amount. Remember, most 401(k) contributions are pre-tax deferrals, meaning you receive a deduction in the year you contribute, but you eventually pay tax on the withdrawals and earnings when you retire – hopefully in a lower tax bracket.

Exceptions to the Rules

There are exceptions to the 10% early withdrawal penalty mentioned above, but they are typically rare situations. Distributions made because of total and permanent disability and distributions made to cover medical expense that are deductible and exceed 10% of your adjusted gross income whether or not you itemize your deductions for the year. All exceptions can be found here.

401(k) Loans

Many employers and plan administrators offer the opportunity to borrow funds from your 401(k). Loans from your 401(k) can have some upside, such as low interest rates and not showing on your credit report, but there are also some downsides. Borrowed funds do not participate in the market or growth of your retirement account.

Quite possibly the biggest risk with loans is the immediate payback clause if you are laid off, quit, or are terminated as an employee. If you do not payback the full amount of the outstanding loan, the outstanding balance will be considered a distribution and no further repayment would be required. Not only does this subject you to the 10% early withdrawal penalty, but the withdrawal will be fully taxable at your marginal rate. Since this would be considered income, it can catapult you into a higher tax bracket, resulting in higher taxes on all your income.

Here’s a brief example of how this might look. Let’s say you are a married taxpayer with W-2 income of $150k. Based on 2017 estimated tax brackets, you would be in the 25% tax bracket. If you had a $50k loan from your 401(k) and were unexpectedly laid off, you would have to pay that loan back immediately. If you couldn’t afford to pay this loan back immediately, that $50k would become taxable in 2017, pushing you into the 28% bracket. The tax on that $50k distribution is now $14k PLUS the early withdrawal penalty of $5k, costing you a total of $19k. To summarize, a $50k early withdrawal would only leave you with $31,000!

Deciding between QuickBooks Online and QuickBooks Desktop? Here’s What You Need to Know!

It seems like every software company is moving to the cloud, cashing in on reoccurring revenue streams, and Intuit is no different. When QuickBooks Online was first released quite some time ago, the biggest issues were it’s clunky user interface and the lack of features in comparison with their desktop version. Now, I can confidently say that QBO has finally caught up! You’ve ask for it, so here it is! A comparison of QuickBooks Online (QBO) to it’s predessor, QuickBooks Desktop (QBDT).

QBO Features not in QBDT

  • Multiple A/R or A/P in one JE
  • Multiple Budgets per Fiscal year
  • Track Service Dates on sales forms
  • Delayed Charge form to hold sale till ready to invoice
  • Multiple devices (works on any type of device: PC, Mac, tablet, smartphone, etc.) • Phone app takes a pic of receipt, auto creates expense in QBO w/attachment, matches to bank feed.
  • Audit Log – much better than desktop as shows when users log in and out.
  • Unlimited view/read only users (Great for Non-Profits, Shareholders)

QBDT Features not in QBO (Can be done in QBO w/3rd Party Apps)

  • Robust Inventory – units of measure and assemblies
  • Robust job costing: • Allocating labor/payroll to Jobs
  • Progress Invoicing
  • Reporting
  • Sales Orders (QB Premier)
  • Progress Invoicing
  • Auto Send Reports
  • Price Levels

Levels of QBO

Self Employed

  • 1 Company user, 2 Accountant Users
  • Create and send invoices—Does not track A/R. No other transaction forms supported.
  • Separate business and personal expenses
  • Track Schedule C deductions
  • Quarterly estimated taxes calculated automatically
  • Automatic mileage tracking

Simple Start

  • 1 Company user, 2 Accountant Users
  • 20+ Reports
  • Track income & expenses
  • Basic financial & A/R reports
  • Bank feeds
  • Can do payroll and integrate w/3rd party apps
  • No General Ledger, Trial Balance or A/P reporting

Essentials

  • 3 Company users, 2 Accountant Users
  • 40+ reports
  • Manage & pay bills
  • Setup recurring transactions
  • Delayed charges
  • Company snapshot report
  • Group Items (called Bundles)

Plus

  • 5 Company users, 2 Accountant Users
  • 65+ reports
  • Up to 25 users, unlimited time tracking & reports only users
  • Class & location tracking
  • Income by Customer (basic job costing)
  • Budgets
  • FIFO inventory & PO’s
  • 2 sided item tracking (Double sided items)
  • Billable Time & Expenses
  • Unlimited view/read only users (Great for Non-Profits, Shareholders)

 

For clients that have specific needs where QBO may not solve entirely go to apps.com to expand usability of QBO and fill those gaps respectively. Here are a few that work really well with QBO and can be found on our apps.com website:

  • Inventory—SOS Inventory, Dear, Stitch Labs
  • Construction/Contract/Job Costing/Progress Billing—Knowify, BuilderTrend, CoreCon
  • Report Dashboards and KPIs—Fathom/Qvinci, Finagraph
  • Non-profits—Method Donor
  • Firm Practice Management—Aero Workflow/Harvest
  • Retail POS—Vend POS, Revel POS, SalesPad
  • Ecommerce—Shopify, Bigcommerce, Webgility/Unify

Looking to sign up now? Here’s a link where you can save 30-50% off your QBO subscription!

If you have any questions, feel free to reach out!

Credit: QBO Account Management Team/QBO Account Management Product Specialist Teams

Reminder: Donations this Giving Tuesday May Help Reduce Tax Bills

This Giving Tuesday, remember that donations to eligible organizations, cash or non-cash, are tax deductible and may reduce your tax liability come spring filing season.

Are you eligible to claim charitable donations on your taxes? Only taxpayers who itemize using Form 1040, Schedule A can claim deductions for charitable contributions. You will most likely be a Schedule A filer if you pay for items such as mortgage interest, property taxes, state & local taxes, and charitable contributions that in total, exceed the current year standard deduction. If your itemized deductions exceed this standard deduction for the tax year, you will likely receive a benefit from charitable contributions.

For example, in 2016 the standard deduction for married filing joint taxpayers is $12,600. If the total of your mortgage interest, property taxes, and charitable contributions is in excess of the standard deduction ($12,600), you are an itemized taxpayer.

Is the organization your are contributing to an eligible entity? You can check for eligible entities on the IRS website using their “Select Check” tool. Note that newer organizations may not be listed on the IRS website yet and churches, synagogues, temples, mosques, and government agencies are eligible to receive deductible donations even if they are not listed in the IRS database.

Lastly, be sure to document your contributions with bank statements or canceled checks. If you contribution is greater than $250, ask the receiving organization for a written statement or letter acknowledging your contribution.

Year-End Tax Moves – Speculating on President-Elect Trump’s Tax Cuts

President-Elect Trump declared in several interviews that lowering taxes is one of his top priorities. Those that are betting on him delivering this promise and passing reformation through a Republican controlled congress should consider deferring income to 2017 in an effort to take advantage of the possibility of lower tax rates.

The Trump tax plan, features only three brackets, down from the current seven, and reduces the maximum tax rate of 39.6% to 33%. The standard strategy for year-end planning has always been to defer income, wherever possible, into the coming year. Here are some ways to achieve this goal, and speculate on the possibility for change:

  1. An employee who believes a bonus may be coming his way may be able to request that his employer delay payment of any bonus until early in the following year. For example, if a bonus would normally be paid on Dec. 15, 2016, an employee may ask the employer before Dec. 15 to defer any bonus coming his way until Jan. 2, 2017. If the employee is successful in deferring the bonus, they will succeed in having it taxed in 2017 as opposed to 2016. But note that if an employee waits until a bonus is due and payable to request a deferral, the tax on the bonus will not be deferred.
  2. Income that a cash basis taxpayer earns by rendering services isn’t taxed until the client, patient, or customer pays. If the taxpayer holds off billing until next year, or bills late enough in the year that no payment can be received in 2016, income will not become taxable until next year.
  3. Defer a traditional IRA-to-Roth IRA conversion until 2017. Conversions are generally subject to tax as if it were distributed from the traditional IRA or qualified plan and not re-contributed to another IRA. A taxpayer who plans to make such a conversion should defer doing so if he believes the conversion will face a lower tax next year.
  4. Defer Property sales. The President-elect’s plan to repeal the Affordable Care Act (“Obamacare”) also would repeal the 3.8% surtax on net investment income. It may also be in best interest to set up an installment sale and recognize income over multiple tax periods.
  5. Trump’s tax plan also aims to increase the standard deduction ($30,000 for joint filers, up from the $12,600 allowed in 2016). Since most taxpayers may not receive the benefit for itemizing property taxes, mortgage interest, and charitable contributions under the proposed increased deduction, it may be wise to accelerate these expenses before year-end 2016. For example, property taxes may be due in January 2017 for the 2016 period, you can opt to pay early, prior to December 31, 2016, and accelerate this deduction.

While President-Elect Trump’s proposal has been listed as one of his top priorities, there is no telling what portions of this plan will ever make it into law. The five planning techniques above are just examples of scenarios that could reduce your overall tax burden in the event Mr. Trump follows through with his proposal.

 

Year-End Planning: Tax Brackets and the Marriage Penalty

As if you didn’t already have enough things to consider when planning your wedding, postponing or accelerating your wedding date could help you come out ahead from a federal tax standpoint.

While the lower brackets (10% and 15%) are exactly twice as large for married taxpayers filing jointly as the amounts for single taxpayers, the brackets above 15% actually have a marriage penalty built in.

Take a look at the table below:CPA, Paul Glantz, Austin, TX, Taxes, BusinessFor example, in 2016, unmarried taxpayers can each have $91,150 of taxable income and remain in the 25% bracket. If these same taxpayers were married, they would be in the 28% bracket with $182,300 ($91,150 x 2) of income. The 25% married filing joint bracket is not double the single 25% bracket (single 25% bracket: end at $91,150; married joint 25% bracket: ends at $151,900).

As the marginal rates increase, there is even more of a penalty. Looking at the top brackets, a single taxpayer can make $415,050 before entering the 39.6% bracket, while a married couple would enter this bracket at $466,951. If two single taxpayers were earning $415,050, that would equate to $830,100, and both would still remain in the 35% bracket. If these same two taxpayers were married, $830,100 of income would push them well into the 39.6% bracket.

To illustrate, here is another example. Michael and Mary are planning to get married. Mary expects to have $300,000 of taxable income in 2016, and Michael expects to have $250,000. Their combined taxable income for 2016 will be $550,000. If they get married before 2017, and file a joint return for 2016, they will owe income taxes for 2016 of $163,466.30. If they delay their marriage until 2017, then for 2016, Mary will owe taxes of $82,529.25, and Michael will owe $66,029.25 for a combined tax of $148,558.50 . This will be $14,887.80 less than they would owe if they married in 2016 and filed a joint return for 2016.

It’s not all bad news, though. If only one of the prospective spouses has substantial income, marriage and the filing of a joint return will usually save taxes, thus resulting in a marriage bonus.

Recently Divorced or Seperated? Here’s What You Need to Know

While taxes may be the last thing on your mind when going through a divorce, these events can have a big impact on your income. Alimony and a name or address change are just a few items you may need to consider. Here are some key tax tips to keep in mind:

  • Child Support.  Child support payments are not deductible and if you received child support, it is not taxable.
  • Alimony Paid.  You can deduct alimony paid to or for a spouse or former spouse under a divorce or separation decree. Voluntary payments made outside a divorce or separation decree are not deductible. You must enter your spouse’s Social Security Number or Individual Taxpayer Identification Number on your Form 1040 when you file.
  • Alimony Received.  If you get alimony from your spouse or former spouse, it is taxable in the year you get it. Alimony is not subject to tax withholding so you may need to increase the tax you pay during the year to avoid a penalty.
  • Spousal IRA.  If you get a final decree of divorce or separate maintenance by the end of your tax year, you can’t deduct contributions you make to your former spouse’s traditional IRA. You may be able to deduct contributions you make to your own traditional IRA.
  • Name Changes.  If you change your name after your divorce, be sure to notify the Social Security Administration. File Form SS-5, Application for a Social Security Card. You can get the form on SSA.gov or call 800-772-1213 to order it. The name on your tax return must match SSA records. A name mismatch can cause problems in the processing of your return and may delay your refund.  Health Care Law Considerations.
  • Special Marketplace Enrollment Period.  If you lose health insurance coverage due to divorce, you are still required to have coverage for every month of the year for yourself and the dependents you can claim on your tax return. You may enroll in health coverage through the Health Insurance Marketplace during a Special Enrollment Period, if you lose coverage due to a divorce.

In addition to the above, changes in your health insurance policy or income and family size can impact any advance payments you may be receiving with the premium tax credit. It’s important to fully understand the tax implications that a divorce decree may have on your overall tax picture.

If you have any question, leave them in the comments below!