Archive for the ‘Rental Property’ Category

Rental Property Outside CA: LLC Options and Issues – Part I

Originally published in the Cedar Street Times

June 28, 2013

A lot of Californians find themselves with rental property outside the state at some point in their lives.  Sometimes it is from a past life in another state, or from an inheritance when a parent passes away.  Military folks often jog around the country collecting houses like refrigerator magnets from each state in which they have lived.  There are also a lot of people that invest in rental properties in Nevada, New Mexico, Arizona, and Texas because you actually have a shot at a positive cash flow situation right out of the gates, unlike California.  And then there is the Hawaiian contingency that buy investment properties that always need at least two to four weeks of maintenance work done by the owners each year – not sure if I want one of those with all that work – it’s funny, I never hear of clients having to go to Phoenix for a month in the summer to work on those properties.

Anyway, the question always arises about whether or not to form an entity such as a corporation or Limited Liability Company (LLC) to hold the real property.  An LLC is generally the preferred vehicle to hold real property for many good reasons, including liability protection for your personal assets in the event you are sued, and the elimination of double taxation that can plague corporations.  They also have less formalities to follow compared to a corporation and avoid some nasty pitfalls of corporate tax rates and structure that could cause a lot of pain upon sale of the property.

As a result, a lot of people these days do hold property in LLCs.  Of course this comes at a price.  If you create an LLC in California (or a corporation for that matter) to hold your property, and are therefore granted the privilege of doing business in California, you are also granted the privilege of paying California a minimum $800 franchise tax each year.  You also have to pay someone like me to file another tax return every year, and you have to keep better books.  Don’t forget you have to hire an attorney to set it up initially for another $1,500 to $3,000.

I would not recommend an online filing company or do-it-yourself approach, as you are not getting any legal advice and have no one keeping you on track with formalities which could completely blow the liability protections and the whole reason you went to all the effort in the first place.  Correcting or trying to close ill-formed or mishandled entities can be a real pain as well.

So what if you form your LLC in another state such as Texas or Wyoming to hold your property?  Many states have much lower or no annual LLC fee and they have simpler annual filing requirements.  (You generally do not have to form the LLC in the state where the property is located.)  Could you save some dollars by setting up your LLC in another state?  In two weeks we will discuss California’s current position on non-California LLCs and some new rules that are just coming into play.  If you have a non-California LLC, you do not want to miss the next installment.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

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Timeshare Tax Issues

Originally published in the Cedar Street Times

September 7, 2012

Timeshares sound like a great idea, but you need to be very careful and do your research before acquiring one.  After the timeshare honeymoon is over, owners often find themselves stuck with an unwanted monthly or annual financial obligation and an “asset” that is very difficult to sell or even give away.  It is so bad that there are even organizations out there that will charge you a fee to take the timeshare off your hands!  Besides these issues, there are also some tax pitfalls for the unwary.

When you attend a sales presentation you will likely be told that your interest and taxes on the timeshare are deductible just like your primary home and that you can rent out the timeshare like a rental property if you choose.  Do yourself a favor and do not take tax advice from your timeshares sales representative.  The large majority of timeshares in the U.S. are fee-simple interests in real property- meaning you have a deed to a specific property with all the burdens and benefits of ownership as your home likely is.  If you take out a mortgage to buy the timeshare; if the mortgage is secured by the deed to the property; and if you treat it as your second home for tax purposes, you will typically be able to deduct the interest.  (Note that if you bought the timeshare with a loan not secured by the property or on a credit card, you would lose the interest deduction.)

There are, however, an increasing number of timeshare interests that are written as “right to use.”  These are essentially leases and are often coupled with points systems (some points systems are still tied to a fee-simple deed).  If you have a right to use contract, you will be disqualified from deducting the interest.  One way to solve this problem would be to pay for the timeshare with a line of credit secured by your main home:  you can deduct mortgage interest on the first $100,000 of debt regardless of what you buy with it.

In a similar parallel, real property taxes must be assessed against an interest in real property.  They also must be broken out from maintenance dues and other fees.  Surprisingly, some timeshare operators do not split this out on your statements, and you may have to call to get this information.

If you rent out your timeshare, you are presumed to be subject to the vacation home rules (see my prior two articles) limiting your deductions to the income generated.  In other words you cannot take a loss as you may with a regular rental property.  This is because vacation home rules take into account the activity of all owners.  For timeshares this means you have to count the personal use of the other 25-50 owners that have a week or two interest in the property as well!  The courts and the IRS have different views on the precise application, but either way, it is still not tax friendly.

Finally, if you are able to sell your timeshare, resulting in a nearly guaranteed loss, it will generally be a nondeductible personal loss.

Buyers beware!

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Renting Your Vacation Home – Part II

Originally published in the Cedar Street Times

August 24, 2012

Two weeks ago I explained that any personal use of a vacation home you claim as a rental property on your tax returns would have some negative tax ramifications.  Your homework was to count the days of personal use (as defined in my prior article – very important) and the days actually rented, and this week I would tell you what it means.  Here we go!

If your personal use exceeded the greater of 14 days or 10 percent of days rented at fair market value during the year, your property is considered a personal residence.  Your first tax hurdle is prorating the expenses based on personal use and days rented.  Generally speaking, unless the expense is directly related to the renter’s stay (such as the clean-up fee after a renter leaves), you must divide the number of days of personal use by the sum of the number of days of personal use plus days actually rented, and then multiply the expenses by that ratio.  That portion will be disallowed as a personal expense and will be nondeductible.  (Note, it is not days of personal use divided by 365 days.)  So if you use the property for 30 days and you only rent it for 60 days, 1/3 of the expense will be disallowed (30/ (30+60) = 33 1/3 percent.  Furthermore, your expenses will be capped at the amount of gross income generated by the property, with the exception of the real estate taxes and mortgage interest.  The personal use portion of the taxes and interest will often be allowable as an itemized deduction on Schedule A.  Qualifying expenses in excess of the cap, can be carried forward to the following year.

If your personal use was less than the greater of 14 days or 10 percent of days rented at fair market value, then it is the same as the above, except your expenses are not capped at the gross income generated by the property.  Note that you still have to prorate your expenses and disallow a portion for personal use.  Even if you use the property for one day, part of the expenses will be disallowed.

If your personal use was more than 14 days and you rented it for 14 days or less, you do not declare the income on your tax returns.  You also do not declare expenses except for taxes and interest that may be deductible on Schedule A.  (You may hear of people renting out their home for a golf tournament and paying no tax on the income – this is how they do it.)

The point of these rules is simply that the IRS does not want people taking tax write-offs related to the personal use of a vacation home.  The rules are strict and defined because of the potential abuse.  You can imagine the IRS’ view when they perceive someone with a luxury second home in a vacation destination used frequently by the owners and their friends for free, rented at $20 a night to some acquaintances to cover the cleaning fee, and then only rented out at fair market rates a few weekends of the year, all the while trying to write the entire activity off as a tax deduction!  It is not a business venture in that light.  So if you want to maximize your deductions, limit your personal use and maximize days rented, or simply eliminate your personal use.  There are additional rules beyond the scope of this article, but these are the big ideas to understand.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Renting Your Vacation Home – Part I

Originally published in the Cedar Street Times

August 10, 2012

August is here; summer is slipping away; and families are fitting in last-minute vacations before school is about to start.  Perhaps you are one of the landlords collecting a little more rent to help battle the bottom-line.  A good topic for you to review is whether or not you understand the tax laws relating to a vacation rental home.  In my experience, most landlords and a fair amount of tax return preparers could use a refresher on this topic, or maybe the beginner lesson they missed!  I warn you that the rules are less friendly than you may realize, however, I am not a believer that ignorance is bliss, and I can guarantee you that the IRS is not.

The crux of taxation on a vacation home comes down to “personal use” of the property.  If you remember anything at all from this article, it is that EVERY day of personal use cuts into your tax deductions.  One of the most proliferated errors on this topic is that the landlord can use the property for up to two weeks a year with no negative ramifications.  This is categorically incorrect; the laws are spelled out quite clearly in Internal Revenue Code Section 280A and related Treasury Regulations.

It is also important to understand what the IRS means by “personal use.”  Personal use includes any use of the property by any of the owners, their family members (sibling, spouse, ancestors, descendants of any owners), or anyone else with free use or paying less than fair market rent.  Even if a family member pays fair market rent, it is still considered personal use unless it is their primary residence.  The only way for any of those members to be present and not have the property counted as personal use is if they are working on the property.  The IRS even defines quite strictly what working on the property entails – it is sufficient to say that an eight-hour workday for everybody present is requisite, and the IRS could ask to see work logs, receipts, etc.

I think this expansive definition of personal use nails about 99 percent of people with a vacation home, right!?  After all, most people that have a vacation home bought it or kept it because they like the place and enjoy staying there!

So now that you have determined you likely have personal use of your property, how does this affect the taxation?  Your homework is to count up the days of personal use you anticipate for 2012, and the number of days you expect to rent it, and in two weeks I will tell you what it means.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.