Archive for the ‘fair market value’ Tag

Back to Basics Part IX – Schedule E

Originally published in the Cedar Street Times

February 6, 2015

So you decided to put your home up for rent for two weeks surrounding the AT&T Pebble Beach National Pro-Am.  Fortunately for you, it was rumored that Arnold Palmer once spent the afternoon on your front lawn.  As a result, there are so many prospective renters that you are having to beat them away with golf clubs.

Finally you settle on a renter and a nice fat $40,000 check for two weeks!  Score!  But then you remember this pesky thing you do each year called taxes, and you start wondering how you are going to report this on your tax returns.  The surprising answer is that it won’t get reported at all.  There is a rule which states if you rent your home for 14 days or less during the year, you do not have to report the income.  All $40,000 is tax free!  But what if your renters need an extension of one day?  Don’t do it!  If you do, the entire amount is now taxable on Schedule E.

In this issue, we are discussing Schedule E – Supplemental Income and Loss.  Prior articles are republished on my website at www.tlongcpa.com/blog if you would like to catch up on our Back to Basics series on personal tax returns.

Schedule E is a two-page form used to report income from rental real estate, royalties, and income from partnerships, s-corporations, trusts, and estates.  Part I handles the reporting of income and expenses of rental real estate and royalties.  There is a section regarding rental real estate that asks for the number of days rented at fair market value and the number of days of personal use.  This information is necessary in order to apply limitations regarding the rental of personal residences and vacation homes.  Any personal use will affect the allowable deductions to some extent.  (See my articles “Renting Your Vacation Home” on my website originally published August 10 and 24 of 2012 for more details.)

All expenses related to caring for your rental real estate can be deducted.  Besides costs such as property taxes, interest, repairs, etc., you can also use the standard mileage rate (56 cents per mile for 2014) to deduct any rental related mileage you drive.  If your property requires you to travel away from home overnight, you can deduct lodging and 50 percent of your meals as well.

If rental property generates a loss, there are several tests that must be applied near the bottom of Schedule E page one to determine if the losses will be allowed, or suspended for use in future years.  You can only take losses to the extent that you have an investment at-risk.  Form 61K-198 is used to determine this.  There are also rules limiting the amount of losses you can use against other income if the losses come from passive activities.  Rental real estate is generally considered a passive activity, and Form 8582 is used to determine if your losses will be limited.

Part II of Schedule E begins on page two and summarizes income and losses from flow through activities of partnerships and s-corporations.  Your share of these activities is reported to you on a Form K-1.   Again, at-risk and passive activity loss limits are applied.  Your basis in the underlying partnership or s-corporation activity as well as your level of participation and type of ownership interest are considered in these calculations.

Part III covers your share of estate and trust activities reported to you on a K-1 in a similar fashion as in part II.  The main difference being that there are generally no at-risk limitations to worry about.

Part IV covers income or losses from Real Estate Mortgage Investment Conduits.  These are essentially mortgage-backed securities: a solid product which earned a bad reputation during the financial crisis from 2007-2010 when sub-prime mortgages were bundled and sold together.

Part V summarizes the income and losses from the first four parts of Schedule E and pulls in farm land rentals as well which are calculated on a separate Form 4835.

Getting back to your $40,000 two-week rental.  It turns out that the Arnold Palmer that spent an afternoon on your front lawn was simply a glass of watered-down iced tea and lemonade, and your renters backed out.  Better luck next time…

In two weeks we will discuss Schedule F – Profit or Loss from Farming.

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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Sale of a Residence After Death – Part II

Originally published in the Cedar Street Times

April 5, 2013

Two weeks ago we discussed the sale of a personal residence after someone passes away when held as joint tenants or community property.  We also discussed the concept of a cost basis step up (or down) to the current fair market value at death as it relates to joint tenancy, community property, and tenancy in common.  If you missed this article you can find it on my website at www.tlongcpa.com/blog.  This week we are going to discuss what happens when a sole owner or tenant in common passes away and the house or fractional interest in a house goes to their trust or estate.

Often children are tasked with figuring out what to do with mom or dad’s house after the second spouse passes.  Names like executor, executrix, and trustee get thrown around and sometimes you get to know your accountant and attorney better than if you had gone on a fishing trip together!  After death, the house typically become part of the estate if there was no trust in place, and if there was, then it becomes part of an irrevocable trust that has the task of winding up affairs and distributing the assets to the beneficiaries (or trusts for the beneficiaries).

If the surviving spouse held the house as a sole owner or in his or her revocable trust before death, the house receives a full step-up (or down) in basis to the current fair market value at death.  If the house is distributed outright to a beneficiary (or beneficiaries) and then the beneficiary immediately sells the home, you often will have a loss due to the real estate commissions and other sales expenses (or perhaps even a market decline between date of death and the sale as we saw so often over the past five years).  This loss, however, will generally be a nondeductible personal loss unless you first convert it to a rental property, and then sell it later.

If, however, it is decided the house needs to be sold while it is still in the estate or trust in order to pay debts or to distribute the proceeds to various beneficiaries, you may have a case to take a deductible loss on the sale of the property (which would offset other taxable income in the estate or trust, or perhaps flow through to the beneficiaries reducing their personal taxes).  Fair warning, the IRS and the courts disagree on this issue!

The IRS has taken the position that even a trust or estate cannot take a loss unless it is a rental property or converted to a rental property and then sold.  However, this conflicts with some of the instructions they provide regarding capital assets held by trusts and estates. The courts, on the other hand, have held that a trust or estate does not hold personal assets, and thus is allowed to take a loss on the sale of what used to be the decedent’s personal residence as long as no beneficiaries live in the property in the interim.  There are other issues to consider here, but in the right circumstances, strategic planning could create some large tax savings.

If a tenant in common passes away, his or her ownership percentage receives a step in basis to the current fair market value and the interest flows through to the estate or trust.  Similar results would occur as those just discussed for sole owners.  It is less common to find someone holding a personal residence as a tenant in common, especially with unrelated people.  It also comes with other, more complicated issues, since fractionalizing ownership in a house diminishes the value – basically, who wants to buy a house with other people you don’t know?  In all cases after someone passes away, date-of-death appraisals are requisite, and you may need specialized appraisers for fractional interest properties.

This really just scratches the surface of the issues you can encounter, and it is always best to find a CPA and attorney team that is equipped to handle these issues appropriately.

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.

Sale of a Residence After Death – Part I

Originally published in the Cedar Street Times

March 22, 2013

When a living individual sells a personal residence that results in a gain, many people are familiar with the rules which may allow an exclusion of the taxable gain of up to $250,000 ($500,000 if married filing joint) if the taxpayer lived in the property two out of the last five years as his or her primary residence.  In the depressed real estate markets over the past few years, many people have also learned (sometimes to much dismay) that a loss on a personal residence is not deductible.

But what happens when a house is sold after someone passes away?

The first thing we need to do is determine the cost basis.   At the date of death, the cost basis of the property changes to whatever the current fair market value (FMV) is (an appraisal is required – not a market analysis by a real estate agent).  If the house is held in joint tenancy or tenancy in common, only the decedent’s share of the home gets a step up (or down) in basis to the current FMV, and the basis for the survivor’s original share does not change.

If, however, it is held as community property, the entire interest in the house gets a step in basis to the current FMV.  If the property is held “with rights of survivorship” then the house passes immediately to the survivor which in turn inherits the new stepped up (or down) basis of the decedent to add to his or her own basis-in the case of joint tenancy or tenancy in common, or he or she takes the new FMV as the new basis if it was community property.

When the property is sold, the survivor reports the sales price less the new basis and selling expenses.  If it was sold soon after death, the survivor often realizes a loss due to sales expenses if they got a full step-up in basis (albeit nondeductible if maintained as a personal residence).  If the survivor realizes a gain, then, the survivor is eligible for the $250,000 exclusion assuming he or she meets all the normal rules.  If it was a spouse that passed away, then the widow or widower would have two years from the date of death to sell the house and still be eligible for the $500,000 exclusion.

In two weeks we will discuss the more interesting scenarios that play out when the property is not held “with rights of survivorship” and the property goes to the individual’s estate or trust, such as is often the case at the death of a single individual or the death of the second spouse.

Remember, it is always best to seek competent advice as everybody’s tax situation is unique and there are more rules that could affect you than just those mentioned in this article.

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.