Catching Up on Missed Rental Property Depreciation

If you own a rental property, do you know if you have taken all of the possible deductions?  The number one item that I see most commonly missed for a rental property on self-prepared tax returns is depreciation.  You are allowed to depreciate residential rental property over 27.5 years and commercial rental property over 39 years.  To calculate the depreciation, you will need the cost basis of the property, which is what you paid for it.  Make sure you allocate a portion of the basis to land, another common error on tax returns.  The land portion is not depreciable.

Why is it important to depreciate the property?  Whenever you sell or dispose of the property, you have to calculate gain or loss on the property.  Gain or loss is calculated in the following manner:

Sales Price

Less Cost Basis (including land)

Plus Accumulated Depreciation

= Gain/Loss

If there is a gain, the accumulated depreciation is recaptured and taxed at ordinary income tax rates, up to the amount of the gain.  If there is any balance remaining after the depreciation recapture, the remainder is taxed at favorable capital gains tax rates.  If the IRS were to calculate the gain on the property, they would treat the property as if it had been depreciated, and you would not get to deduct the missed depreciation as an expense, but would pay ordinary tax rates on the accumulated depreciation calculated up to the amount of gain.  Therefore, you want to make sure you are getting that depreciation deduction every year.

You may be very concerned at this point if you have not been taking depreciation, but fear not because we have some solutions for you.  The first option is to amend prior year tax returns to deduct the depreciation on the tax returns.  There is a drawback to this option: you can only amend tax returns filed in the prior 3 years, so if depreciation was missed prior to those 3 years you would still be missing out on the depreciation.

The second option to catch up missed depreciation is to file a 3115 Application for Change in Accounting Method.  Filing this would allow you to capture any missed depreciation as far back as necessary, versus only being able to go back 3 years for amended returns.  The form is filed with the current tax return and all of the depreciation is deducted in the current year as a Section 481(a) adjustment.  The 3115 is a very in-depth form, so do not try this at home!  You will want to use a tax professional to handle the 3115.

If you are reading this and want to take advantage of the 3115 or amending returns to capture missed depreciation, our accountant Wilmington NC will be happy to assist you.

Proposed Fair Labor Standards Act (FLSA) Regulations


The Department of Labor recently updated the Fair Labor Standards Act (FLSA). The regulations regarding overtime pay for white collar workers was last updated in 2004. The new changes were proposed to take effect December 1, 2016 but implementation has been delayed. It is most likely that this will affect you. Our Adam Shay accountant in Wilmington NC explains the ins and outs of the regulations so you may better familiarize yourself with the changes.

OVERTIME

FLSA requires that certain employees that do not fall under an exemption be paid overtime if they work over 40 hours a week. These employees would include inside sales, construction workers and waitresses to name a few. So, the change here is that any employees you have paid up until December 1, 2016 as salary that don’t fall into an exemption (to be discussed below) will have to track their time on an hourly basis and be paid overtime as applicable.

Exemptions

There are certain professions exempt from the overtime pay rules:
-Learned professionals (such as CPAs).
-Creative professionals (such as musicians or writers).
-Law or medicine (you must hold a valid license or certificate).
-Teachers (definitely exempt if teacher holds a certificate, anyone who does not may still be subject to overtime rules).
-Outside sales.
-Computer occupations.
-Executive employees.
-Highly compensated employees.
-Administrative employees (certain duties must be met to qualify).

If an employee falls in the exempt category, they are exempt from tracking time and overtime pay, if the employee is paid a certain salary level.
Previously, the salary level was set at $23,660. With the new regulations, the salary level increases to $47,476. If the employee is considered exempt, but is paid under $47,476, then you must track their time to monitor and pay overtime. If you have an exempt employee that you are currently paying $45,000, it may save you time, money and headache to go ahead and bump them above the $47,476.

Another notable change with the new regulations is that beginning on January 1, 2020 the salary level will be updated every 3 years.

Contact an Expert Accountant in Wilmington NC

We encourage you to be proactive and start evaluating any changes you need to make now. If you’re looking for an accountant in Wilmington NC please feel free to reach out to our office if you have any questions.

What are excess distributions and how do you handle them?

A common question from business owners is “How much money can I take out of the business?” We like to make sure business owners know what they are allowed to take out by educating them. After all, it is their hard-earned money.

Before we get into the nitty-gritty of this, I would like to point out that if you are an S Corporation shareholder there is one thing to keep in mind: salary. The IRS requires that a shareholder providing services to the S Corporation must take a reasonable salary. If you were ever to be audited by the IRS regarding this issue, and the IRS deemed that your salary is not reasonable, they could reclassify distributions to salary. As a result of the reclassification, you could then be faced with late payment penalties and interest due to late deposit of payroll taxes. You also would have to amend payroll reports. They key take-away here is to first and foremost make sure you are and will be able to pay yourself a reasonable salary before taking any distributions, if you are an S Corporation shareholder.

Now that we have covered that, you are ready to take some distributions. Distributions cannot exceed your basis in the company. In a nutshell, your basis is income, gain and losses allocated to you based on ownership percentages since the business has been in operations, plus any contributions you have ever made, less any distributions you have ever taken. If you do take distributions in excess of basis, then you have 2 options on how to handle it.

Your first choice would be to recognize the excess distribution as a long-term capital gain on your personal tax return. If you are in a low tax bracket (10% or 15%), then it may be advantageous to go ahead and pick the distribution up as a long-term capital gain because the gain would have preferential tax treatment of 0% tax. Even if you are in a higher tax bracket, it may still be to your advantage to pick up the capital gain. If you have a significant amount of capital losses, then you could offset the 2 together.

Your second option would be to reclassify the excess distribution as a shareholder loan. If the loan exceeds $10,000, then the IRS requires that you impute interest on the loan. You can use the applicable federal rate, which is currently very low. This may be a more favorable option for you.
In summary, make sure you are monitoring how much money you are taking out of your company to avoid tax implications. Also, make sure to review all of your options when handling excess distributions.

1099 Forms and 1/31 Deadline

As we embark on the start of 2016, tax preparers are preparing for the start of busy season. With January, comes due dates for 1099’s and W-2’s. Most of the time, taxpayers do not realize that they need to prepare any 1099’s. Within the last few years we have seen the following questions appear on Schedule C’s, Schedule E’s, and business tax returns:

1.) Did you make any payments in 20XX that would require you to file Form(s) 1099?
2.) If “Yes,” did you or will you file required Forms 1099?

As paid preparers, we have to make sure that we answer these questions correctly, which means verifying with you, the taxpayer, whether or not you had any required 1099s to be filed. The penalty for not filing a 1099 ranges from $30 per 1099 to $100 per 1099, depending on when the forms are filed.
Do You Need to Prepare 1099’s?

If you have paid someone over $600 for services or for rent, then you most likely need to send them a 1099. However, if you paid a corporation or paid them via credit or debit card, then you are not required to send a 1099. Some corporations are still required to receive a 1099, such as attorneys. We advise all clients to have people who are providing services for them to fill out a W-9. This helps us determine if they need to receive a 1099 because they have to tell us what type of entity they are by checking a box. The following payments would require issuance of a 1099:
-Rent over $600 – reported on 1099-Misc
-Royalties over $10 – reported on 1099-Misc
-Other Income over $600 – reported on 1099-Misc
-Nonemployee Compensation over $600 (Independent Contractors) – reported on 1099-Misc
-Gross Proceeds Paid to an Attorney over $600 (this is reported in Box 14 of 1099-Misc – it typically applies if you paid out a settlement, any other legal services would be reported in Box 7 on 1099-Misc)
-Interest on Business Debt to Someone over $10 (excluding interest on an obligation issued by an individual) – reported on 1099-Int
-Dividends or other distributions to a company shareholder over $10 (most applicable to C Corporations) – reported on 1099-Div

What Do We Need to Prepare a 1099?
As mentioned previously, you should have anyone fill out a W-9 who will be receiving payment for any of the items listed above. On the W-9, they list their legal name, federal ID or social security number, address and type of entity. I can’t stress the importance of having the W-9 before you pay the person. If you pay somebody one time for $2,000 and do not have any of their information, and then in January you are not able to reach the person to get their information, you’re in trouble and potentially face penalties from the IRS for not submitting a complete 1099.

Please feel free to reach out to us if you have any questions regarding 1099’s.

Tax Extenders Passed!

We are excited about the most recent bill the President has signed. All parties have finally agreed and the President has signed the Protecting Americans from Tax Hikes Act of 2015, also known as the PATH Act. The Act not only extends numerous provisions, but also makes at least 20 provisions permanent.

Key Highlights:

  • Many tax provisions previously expired in 2014 have been extended for 2015 and 2016 or even made permanent beyond that.
  • Section 179 and bonus depreciation tweaks help business owners.
  • Several small tweaks for individual taxpayers to provide credits and/or deductions.
  • W2 forms must now be filed with the IRS on same date they are due to employees (1/31).

Probably the most pertinent provision that was made permanent and the provision that business owners wait on every year is Section 179. First of all, the deduction is retroactively reinstated for all of 2015 and then is permanently extended after this year. Using Section 179, taxpayers will be allowed a $500,000 annual deduction, with a $2,000,000 phase-out threshold. This is much improved from the previous $25,000 deduction limitation. After 2015, the $500,000 deduction and $2,000,000 threshold will be indexed every year for inflation. The Section 179 deduction is also permanently available for qualified real property, which includes qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. For 2015, there is a $250,000 limitation on qualified real property, but after 2015, there is no limitation.

Bonus depreciation was not permanently extended. Rather, it has been retroactively reinstated for 2015 and extended through 2019.

In 2014, the IRS passed a de minimis safe harbor rule that allowed taxpayers without an applicable financial statement to directly expense (instead of having to depreciate) assets that cost under $500, rather than having to list them on the depreciation schedule. Effective 1/1/16, the de minimis safe harbor amount increases to $2,500. The IRS did say that they will not challenge use of the $2,500 de minimis amount for periods before 2016 as long as certain requirements are met.

The following are other business notable provisions that were made permanent (note – only some of the permanent provisions have been highlighted):

  • Research & Experimentation Credit.
  • 15-year straight-line cost recovery for qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property.
  • 5-year waiting period for S Corporations to Avoid Built-In Gains Tax.
  • Enhanced Charitable Contribution Deduction for Food Inventory.

The following are other individual notable provisions that were made permanent (note – only some of the permanent provisions have been highlighted):

  • $3,000 earned income threshold for computing the 15% Refundable Child Tax Credit.
  • American Opportunity Tax Credit (credit available for up to $2,500).
  • Earned Income Tax Credit for Qualifying Individuals with 3 or more qualifying children.
  • $250 deduction for certain expenses of elementary and secondary school teachers (after 2015, the amount will be indexed every year for inflation).
  • Election to deduct state and local general sales tax as itemized deduction instead of state and local income taxes.
  • Tax-free IRA Distributions to Charities of up to $100,000 for those at least 70½.

The following are notable provisions that were retroactively reinstated for 2015 and extended through 2019 (note –only some of the permanent provisions have been highlighted):

  • Work Opportunity Tax Credit.

The following are notable provisions that were retroactively reinstated for 2015 and extended through 2016 (note –only some of the permanent provisions have been highlighted):

  • Income Exclusion for Discharge of up to $2,000,000 of Qualified Principal Residence Indebtedness.
  • Qualified Higher Education Expenses Deduction (up to $4,000).
  • Deduction of Mortgage Insurance Premiums as Qualified Residence Interest.
  • Energy-Efficient Home Improvement Credit.

 

The PATH Act also created some new provisions. Employer copies of W-2s, W-3s, and 1099s will be due by January 31 (the same date that forms are due to recipient). Also, after 2015 1098-T Forms will only include qualified tuition and related expenses actually paid, versus previous forms that could report amounts billed or paid. In relation to education expenses, after 2015 anyone claiming the American Opportunity Tax Credit will have to report the employer identification number of the educational institute on their tax return.

The PATH Act is great news for taxpayers and tax practitioners, as it will remove uncertainty moving forward about items such as the Section 179 deduction. If you have any questions about the PATH Act, or provisions that may affect you, please feel free to contact us.

Will Section 179 Limits Increase for 2015?

Every year, it seems that CPAs and taxpayers are faced with a major tax planning hurdle. What assets should the taxpayer purchase, and how much will be eligible for Section 179 and bonus depreciation? We always get to the last two weeks of December, Senate & Congress finally pass the bill, and then we are scrambling to advise clients on how much they should purchase. And, if the taxpayer has to get financing for the equipment, it can definitely prove to be a stressful last few weeks of the year.

As of January 1, 2015, the Section 179 limit decreased from $500,000 to $25,000. Also, bonus depreciation was eliminated. We all hope and believe that Congress will raise the limit again, as they always do every year, but really we cannot definitely say they will. We’ve seen crazy things happen up there in D.C., so who’s to say that they definitely will do something that historically they have always done? Section179.org presented a petition on October 15 to Congress that requested immediate action for Congress to restore bonus depreciation and to increase the Section 179 limit. Hopefully, this petition combined with all of the other nudges from other concerned parties will speed up the process.

My best advice for now is to stay in touch with your CPA so that you are aware if the limit is increased and can then purchase additional assets to reduce your taxable income. Maybe one day they will sign the Section 179 and bonus depreciation into permanent tax code, but for now we play the waiting game every year.

 

We have numerous clients that donate services, whether it’s a free photography session donated to a charitable fundraiser event or gift certificates that are donated.  When it comes time to do taxes for the client, we always have to explain that donated services are not tax deductible.

The IRS lists specific contributions that are not deductible.  Specifically, the IRS states that the value of time or services is NOT deductible as a contribution.  The only way to deduct the contribution would be to record the donated service as income and then deduct as a contribution, which provides you no benefit because you have to pick up the contribution as income.  The main reason behind this rule is that cash donations are made with after-tax dollars, but a donation of time and services is not.  So, you earn money, pay tax on it, and then make a cash donation with which you are entitled to receive a tax benefit because you paid tax on the money when you originally earned it.  In the case of a donation of time and services, the time and services were never taxed in the first place, so you should not receive a tax benefit for them.

So, what is eligible as a charitable deduction?  Taxpayers can deduct contributions of money or property made to a qualified organization.  Keep in mind that if you receive any kind of benefit from the donation (such as season football tickets), you cannot deduct the portion of the contributions that represents the value of the benefit you receive.  For example, if you make a $2,000 donation to the Pirate Club and you receive season football tickets, only the portion of the donation above the value of the season tickets would be deductible.  Normally, you will receive a letter that states what portion is deductible or not-deductible, but always keep in mind the rules of deducting charitable donations.

Moving forward, remember that to receive a charitable deduction on your tax return, the donation has to be a contribution of money or property to a qualified charitable organization.  If you do donate time or services, you will not get a tax benefit, but will still get that feel good sensation.

If you purchased a new home between 2008 and 2010 (2011 if you were in the armed forces), then you probably took a first-time homebuyer credit on your tax return in the corresponding year.  While this was a great incentive from the government to boost spending, a lot of the taxpayers are now dealing with the consequences of taking that credit.

If you purchased your home and took the credit in 2008, there are different rules that apply.  The credit in 2008 was, in essence, a loan that the taxpayer had to repay back in equal installments over the course of 15 years.  If you sell the home within 15 years of purchasing the home, then you are required to pay back the entire credit in the year of sale.  If the sale is not to a related party, then you only have to repay the credit up to the extent of the gain on the sale of the house.  If the sale is to a related party, then you have to repay back the entire amount of outstanding credit balance (total credit received less any amounts previously repaid).  The maximum credit allowable in 2008 was $7,500.

For homes that were purchased in 2009 and 2010, and for which the first-time homebuyer credit was taken, you do not have to repay back the credit, unless the home is sold, or if other various events listed below occur.  The rules are a little different for these years.  If the home is sold to a related party within 36 months of buying the home, then the full amount of the credit must be repaid.  Similar to the 2008 rules, if the home is sold within 36 months to a non-related party, the credit only has to be repaid to the extent of capital gain recognized on the sale.  The maximum credit allowable in 2009 and 2010 was $8,000.

For any of the years that taxpayers are eligible for this credit, if the home ceases to be their main home (either within 15 years for 2008 or 3 years for 2009 and 2010), then some type of credit repayment will be triggered.  Examples are:

–          You sell the home – credit must be repaid in year of sell (see paragraphs above for related vs. non-related party).

–          You transfer the home to a spouse or former spouse in a divorce settlement – in this case the spouse would become responsible for repayment of the credit if the home is sold within the allotted time frames.

–          You convert the entire home to a rental or business property – credit must be repaid in year of conversion.

–          You converted the home to a vacation or second home – credit must be repaid in year of conversion.

–          You no longer live in the home for the greater number of nights in a year – credit must be repaid in year of occurrence.

–          Your home is destroyed or condemned – credit must be repaid.

–          You lose your home in foreclosure – credit must be repaid only to extent of gain.

 

We have had issues with tax returns being rejected for electronic filing because of repayment of the first-time homebuyer credit.  In one scenario, the IRS had applied all of the repayment to the taxpayer, and none of the repayments to the spouse.  Because the IRS thought the spouse still had a balance due, the IRS was looking for the spouse to keep paying back the credit.  In reality, the taxpayers had overpaid the credit, and were due a refund.  We were able to get the issue resolved with the IRS over the phone. 

There is a tool on the IRS website to look up the original credit taken, how much has been repaid, how much is still due, and the required annual installment repayment amount.  You can find this at: https://sa.www4.irs.gov/irfof-fthb/.

Please let us know if you have any questions, or if we can be of any assistance to you.

On September 18, North Carolina Governor Pat McCrory signed the new budget into law.  There are quite a few changes that residents of NC will encounter over the next few years due to the new tax laws that were passed.  One of the more pertinent changes is that in 2017, the individual income tax rate will drop to 5.499 percent.

Most notably, there are major changes to sales tax that will impact everyone.  Effective March 1, 2016, NC will begin charging sales tax on repair, installation and maintenance services.  For example, if you have to pay for your car to be repaired or have to pay for installation of appliances, there will be sales tax included.  Contractors that do not sell anything tangible, such as pet care, will not have to charge sales tax.  Now, you will notice that the individual income tax rate does not drop until 2017, but the sales tax rate is changing in 2016, which means that you will not see the tax benefits of these changes until you file your 2017 tax return in 2018.  According to an article in the News & Observer NC budget: More sales tax in 2016, income tax cuts in 2017: “Households making more than $95,000 a year would get an average tax cut of $476, according to legislative projections.  As long as they don’t spend more than $7,000 on taxable services, they’ll see a net benefit from the tax changes.”

Some other important changes with the latest tax laws includes the return of the medical deduction for the 2015 tax year.  In 2013, the tax reform bill eliminated a lot of the itemized deductions allowed on federal returns, including medical expenses.  Also, the corporate income tax rate will drop to 4 percent for the current tax year.

While it is great that the income tax rate is dropping and the medical deduction is returning, I am concerned that the sales tax changes will have a larger impact on consumers.  We will all certainly find out over the next 2 years.

This is a great time of year – kids are back in school and Fall is just around the corner.  However, I am sad that summer is over and traffic is terrible!  Some of you may have sent your kids off to college, and with that comes potential tax credits.  Please note that the income limits presented below are the 2014 limits and will most likely increase for 2015 tax returns.

American Opportunity Tax Credit

This credit is available to taxpayers with modified adjusted gross income below $180,000 for married filing jointly and $90,000 for single individuals.  The maximum credit allowed is $2,500 per student and is available for four post-secondary education years.  Also, 40% of this credit may be refundable, while the remainder would be non-refundable.  If a credit is non-refundable, that means that the refund can only reduce tax to $0 – i.e. it cannot generate a refund.  If a credit is refundable, then it can generate a refund.

Lifetime Learning Credit

The Lifetime Learning Credit is available to taxpayers with modified adjusted gross income below $128,000 for married filing jointly and $64,000 for single individuals.  The maximum credit is $2,000 per return and is available for all years of postsecondary education.  Also, this is a non-refundable credit.

Tuition and Fees Deduction

If you are not eligible for either of the education credits, then you may be eligible for the tuition and fees deduction.  Rather than receiving a credit to reduce tax owed, this reduces your taxable income.  The maximum deduction is $4,000 of qualified expenses.  The deduction is available to taxpayers with modified adjusted gross income below $160,000 for married filing jointly and $80,000 for single individuals.  This is a good option to have when you may not be eligible for the other 2 credits.

 

Both of the credits and the tuition and fees deduction require that the expenses are qualified.  Basically, this means that the expenses have to be for tuition, enrollment fees and course materials.  Some expenses that are not qualified would be room and board and meals.

You can always compare the 3 options to see which provides you the greatest tax savings.  If the credit provides you the greatest savings in one year, you do not have to do the same in the following year if another option gives you better tax savings.  In other words, you make the decision on which one to use every year.  If you choose to use a credit, then you cannot use the tuition and fees deduction in the same year.  If you have any questions regarding education credits or the tuition and fees deduction, always feel free to discuss with your tax advisor.