Archive for the ‘personal use’ 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.

Home Office Part II – Do I Qualify?

Originally published in the Cedar Street Times

August 9, 2013

Two weeks ago, I discussed a new simplified option for calculating the home office deduction that is effective for 2013.  (You can find the article on my website at www.tlongcpa.com/blog if you missed it.)  The rules to qualify for a home office, however, have remained unchanged, and still complicated!  At the end of the last article I promised I would discuss the basic rules to qualify – so let’s get to it!

The purpose of the home office deduction is to offset the costs of maintaining a dedicated office space in a home related to a business owned by an individual, or in some cases for an employee’s job.

Let’s talk about employees first.  Many employees these days work from home, but more often than not, they are not entitled to the deduction because it is their personal choice to work from home.  The law requires that the office be for the employer’s convenience – not yours.  If your employer does not require you to work from home and provides space for you at the main office which you choose not to utilize, you are generally barred from taking the deduction.

An employer hiring for telecommuting position so it can save on corporate office rent or obtain/retain talent in distant places would certainly be for the employer’s convenience.  Or perhaps an employer would like to have a presence in a particular area, so it hires somebody to work out of his or her own home office, and meet clients there, instead of having to rent another space.  This would also be for the employer’s convenience.  Often, people work a couple days from home, and a couple days in the office.  They could be closer to a customer base from their home for appointments, for instance, but then also come to the main offices for staff meetings, etc.  Many times, it is certainly convenient for both parties.

The key thing employees would want to have is an expectation in writing from the employer about maintaining and using their own office.  Rationalizing in your own mind that the employer is benefiting will not help, even though it may be true.  If it does seem the employer is better off as a result of your home office, and your job description does not discuss maintaining your own office, you may want to talk to the employer about changing your job description to include this.

Now let’s discuss people running their own business.  In this circumstance, the IRS says the office must be one of three things: 1) the principal place of business, 2) a place of business that is used to meet customers, or 3) a separate structure from the home, but used for the business.  If you have a business, and your home is the only office, it is pretty clear you meet one of these three.  When someone has an office space outside the home, but also has a home office it gets a little trickier, especially if you don’t regularly meet with customers at your home (occasional use won’t qualify) and you don’t have a detached building at your home.

Digging further into item one you find that the IRS distinguishes your principal place of business from other offices as the place where your administrative and management activities such as billing, accounting, ordering supplies, making appointments, etc. takes place.  If you have no other fixed location where you conduct substantial administrative and management activities then your home office would qualify as your principal place of business.  For instance, if you were a personal trainer and rented space for you and your staff to meet with clients and use your exercise equipment, but you did all of your accounting, billing, appointment making, etc. from your home office, your home office would qualify as the principal place of business.

For any home office, whether it be for employees or business owners, the office must be used “exclusively and regularly” as an office for that business.  The rules are very rigid.  You can’t use a room a couple times a year and write it off, even if you did not use it for anything else.  It needs to be used with regular frequency, and be substantial and integral.  You also can’t double up your living room as an office during the day and a TV room at night.  You can’t have a family office where the kids use it for computer games on the weekends, dad uses it to work on the finances in the evening, and then mom uses it as her office during the day and tries to deduct it.  People often try to write off the whole guest bedroom which also houses there office, but courts have typically denied this if they have a bed in there and admit to having guests on occasion.   Technically, any nonbusiness purpose use disqualifies the space (special rules apply to childcare providers, however).

In practice there is at least de minimis personal use of virtually every office space, and at the end of the day, it is quite difficult to know if someone uses an office for some personal purposes.  However, if the auditor shows up and the kids are playing games on your computer and your in-laws’ suitcases are next to the bed in your “office,” I think you will have a problem!  Stick to the spirit of the law, carve out a dedicated space, and everyone will be happy.  Keep in mind that you don’t have to use an entire room, but you can define a portion of a room as the dedicated space, write off closet space for storage, etc.

If you have multiple businesses, you can use the same space for all of them, but if one business fails to qualify, then it is seen as personal use and thus none of the businesses qualify to claim the home office deduction.  (Note, in calculating the deduction, you would allocate the allowable deduction to the businesses – you would not get a double or triple deduction for the same space.)

In the final installment on home offices in two weeks, I will discuss the normal method of calculating the home office deduction and what expenses generally qualify.

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.