Do you own a vacation home? If you both rent it out and use it personally, you might save tax by taking steps to ensure it qualifies as a rental property this year. Vacation home expenses that qualify as rental property expenses aren’t subject to the Tax Cuts and Jobs Act’s (TCJA’s) new limit on the itemized deduction for state and local taxes (SALT) or the lower debt limit for the itemized mortgage interest deduction.
Rental or personal property?
If you rent out your vacation home for 15 days or more, what expenses you can deduct depends on how the home is classified for tax purposes, based on the amount of personal vs. rental use:
Rental property. If you (or your immediate family) use the home for 14 days or less, or under 10% of the days you rent out the property, whichever is greater, the IRS will classify the home as a rental property. You can deduct rental expenses, including losses, subject to the real estate activity rules.
Your deduction for property tax attributable to the rental use of the home isn’t subject to the TCJA’s new SALT deduction limit. And your deduction for mortgage interest on the home isn’t subject to the debt limit that applies to the itemized deduction for mortgage interest. You can’t deduct any interest that’s attributable to your personal use of the home, but you can take the personal portion of property tax as an itemized deduction (subject to the new SALT limit).
Nonrental property. If you (or your immediate family) use the home for more than 14 days or 10% of the days you rent out the property, whichever is greater, the IRS will classify the home as a personal residence. You can deduct rental expenses only to the extent of your rental income. Any excess can be carried forward to offset rental income in future years.
If you itemize deductions, you also can deduct the personal portion of both property tax and mortgage interest, subject to the TCJA’s new limits on those deductions. The SALT deduction limit is $10,000 for the combined total of state and local property taxes and either income taxes or sales taxes ($5,000 for married taxpayers filing separately). For mortgage interest debt incurred after December 15, 2017, the debt limit (with some limited exceptions) has been reduced to $750,000.
Be aware that many taxpayers who have itemized in the past will no longer benefit from itemizing because of the TCJA’s near doubling of the standard deduction. Itemizing saves tax only if total itemized deductions exceed the standard deduction for the taxpayer’s filing status.
Keep in mind that, if you rent out your vacation home for less than 15 days, you don’t have to report the income. But expenses associated with the rental (such as advertising and cleaning) won’t be deductible.
Now is a good time to review your vacation home use year-to-date to project how it will be classified for tax purposes. By increasing the number of days you rent it out and/or reducing the number of days you use it personally between now and year end, you might be able to ensure it’s classified as a rental property and save some tax. But there also could be circumstances where personal property treatment would be beneficial. Please contact us to discuss your particular situation.
With the April 17 individual income tax filing deadline behind you (or with your 2017 tax return on the back burner if you filed for an extension), you may be hoping to not think about taxes for the next several months. But for maximum tax savings, now is the time to start tax planning for 2018. It’s especially critical to get an early start this year because the Tax Cuts and Jobs Act (TCJA) has substantially changed the tax environment.
A tremendous number of variables affect your overall tax liability for the year. Looking at these variables early in the year can give you more opportunities to reduce your 2018 tax bill.
For example, the timing of income and deductible expenses can affect both the rate you pay and when you pay. By regularly reviewing your year-to-date income, expenses and potential tax, you may be able to time income and expenses in a way that reduces, or at least defers, your tax liability.
In other words, tax planning shouldn’t be just a year-end activity.
Certainty vs. uncertainty
Last year, planning early was a challenge because it was uncertain whether tax reform legislation would be signed into law, when it would go into effect and what it would include. This year, the TCJA tax reform legislation is in place, with most of the provisions affecting individuals in effect for 2018–2025. And additional major tax law changes aren’t expected in 2018. So there’s no need to hold off on tax planning.
But while there’s more certainty about the tax law that will be in effect this year and next, there’s still much uncertainty on exactly what the impact of the TCJA changes will be on each taxpayer. The new law generally reduces individual tax rates, and it expands some tax breaks. However, it reduces or eliminates many other breaks.
The total impact of these changes is what will ultimately determine which tax strategies will make sense for you this year, such as the best way to time income and expenses. You may need to deviate from strategies that worked for you in previous years and implement some new strategies.
Getting started sooner will help ensure you don’t take actions that you think will save taxes but that actually will be costly under the new tax regime. It will also allow you to take full advantage of new tax-saving opportunities.
Now and throughout the year
To get started on your 2018 tax planning, contact us. We can help you determine how the TCJA affects you and what strategies you should implement now and throughout the year to minimize your tax liability.
Tax filing reminders
April 17 –
- Individual income tax returns for 2017 are due.
- 2017 calendar-year C corporation income tax returns are due.
- 2017 annual gift tax returns are due.
- Deadline for making 2017 IRA contributions.
- First installment of 2018 individual estimated tax is due.
When an extension makes sense
While most people should file a tax return by April 17, you have the option of delaying your filing date until Oct. 15 with a tax extension.
When to file an extension
- Missing or incorrect information. If one of the forms you need to file your return has an error on it, it is often better to receive a corrected form before filing.
- Recharacterizing Roth IRA rollover amounts. If you’ve rolled funds from a traditional IRA into a Roth IRA, you may want to reverse it later if the investments lose value. This so-called recharacterization process can be done up to the extended tax-filing date of Oct. 15, and in many cases it makes sense to wait until then. Note that 2017 is the last tax year you can use the recharacterization process, which was eliminated for future years by the Tax Cuts and Jobs Act.
- For self-employed retirement donations. The self-employed can use an extension to buy time to fund an SEP IRA. This extended time frame does not apply to traditional IRAs and Roth IRAs.
- Avoid late filing penalty. If you fail to file a tax return, two tax penalties come into play: a late filing penalty and a late payment penalty. By filing an extension, you can push out the potential late-filing penalty for another six months even if you cannot yet pay the tax.
Great uses for your tax refund
Most Americans get a refund every year, with the average check weighing in at $2,895 last year. Even though it’s really money that they earned, many people are tempted to treat it like a windfall and splurge. If you can resist that temptation, here are some of the best ways to put your refund to good use:
- Pay off debt. If you have debt, part of your refund could be used to reduce or eliminate it. Paying off high-interest credit card or auto loan debt means freeing up the money you had been paying in interest for other uses. And making extra payments on your mortgage can put more money in your pocket over the long haul.
- Save for retirement. Saving for retirement allows the power of compound interest to work for you. Consider depositing some of your refund check into a traditional or Roth IRA. You can contribute a total of $5,500 every year, plus an extra $1,000 if you are at least 50 years old.
- Save for a home. Home ownership can be a source of wealth and stability for many people. If you dream of owning a home, consider adding your refund to a down payment fund.
- Invest in yourself. Sometimes the best investment isn’t financial, it’s personal. A course of study or conference that improves your skills or knowledge could be the best use of your money.
- Give to charity. Giving your refund to a charity helps others and gives you a deduction for your next tax return.
- Don’t give to scammers! Scammers are using a new tactic to separate people from their tax refunds. First, they file fraudulent refunds on behalf of their victims. Then, after a refund check arrives at the taxpayer’s address, they impersonate an IRS agent over the phone and demand to be sent the refund because it was sent in error. Remember, real IRS agents will never call over the phone and demand immediate payment for any reason.
If you use some of your refund for one of the ideas here, you can also feel good about setting a little aside for yourself to have some fun!
Stay prepared to sell your business
If you enjoy running your own business, selling it may be the furthest thing from your mind. But the reality is that eventually an opportunity to sell will come, whether due to your own life changes or a perfect buyer walking in the door. Planning, often years in advance of the sale date, is necessary to get the most value for the love, sweat and tears you’ve invested. Here are some tips to stay prepared:
- Assemble a great team. Selling a business is a complex process, especially as you grow larger. You’re likely to need three kinds of professionals to help: an accountant, to help review and produce clean and easy-to-understand financial statements; a lawyer, to create the necessary legal documents and help you negotiate terms; and a trusted business broker, to evaluate the worth of your business and find buyers.
- Develop your exit strategy. With the help of your advisory team, create a clear picture of what selling your business might look like. Outline the risks and opportunities that could affect the valuation of your business. Planning out an ideal scenario as well as a plan B will help you avoid getting backed into a corner and selling at a discount.
- Clean up your financials. As you get closer to selling, go over your business financial statements as well as your tax returns from the last three years. A broker will like to present a clear and compelling financial picture to a client, and that will include a year-to-date financial report.
- Have a plan to improve sales. The worst time to sell is when sales are declining, even if it’s just a temporary or seasonal dip. Part of your planning should include some tactics to boost your sales and cash flow, such as increasing marketing and promotion, liquidating bloated inventories or collecting on accounts receivables.
- Be prepared to evaluate buyers. Be prepared to take a calm approach to any offers you get. You don’t want to jump at the first offer, and many offers that seem too good to be true often are. Lack of solid financing is often an issue, so work with your business broker to find buyers who have been prequalified by a lender.
- Have your after-sale plan down. Often a buyer will want to include a clause that the previous owner stay on awhile as an advisor. Make sure that the advisory period lined out in the contract isn’t longer than is comfortable for you. Finally, work with your accountant on a tax-efficient plan for the proceeds of your sale.
Tax filing reminders
February 28 – Payers must file most other Forms 1099 (except certain Forms 1099-MISC due Jan. 31) with the IRS. (April 2 if filing electronically.)
March 1 – Farmers and fishermen who did not make 2017 estimated tax payments must file 2017 tax returns and pay taxes in full.
March 2 – Automatic extension deadline for employers and health care providers to provide Forms 1095-B and 1095-C to individuals.
March 15 –
- 2017 calendar-year S corporation income tax returns are due.
- 2017 partnership returns are due.
- Deadline for calendar-year corporations to elect S corporation status for 2018.
New 2018 capital expense rules
There are many provisions in the tax reform bill passed in late 2017 designed to benefit small business owners. There are also a variety of new tax tools affecting how small businesses account for deducting the cost of capital purchases under the new tax law. Here’s what you need to know:
Tool #1: Section 179 deduction
The new law increases the amount of business property purchases that you can expense each year under Section 179 to $1 million (from $500,000 previously). Normally, spending on business property (machines, computers, vehicles, software, office equipment, etc.) is capitalized and depreciated so that the tax benefit is spread out slowly over several years. Section 179 allows you to get the tax break immediately in the year the property is placed into service.
- There is an eligibility phaseout for Section 179 that ensures it’s only used by small businesses, but that was also raised to $2.5 million (from $2 million) by the new law. If you spend more than $2.5 million on business property in total during the year, your ability to use the $1 million Section 179 deduction is reduced dollar-for-dollar above that amount.
- Section 179 deductions can be used on both new and used equipment.
- You can now use Section 179 on property used to furnish lodging or in connection with furnishing lodging (such as rental real estate). It also includes improvements to nonresidential real estate assets such as roofs, heating and air conditioning, and alarm systems.
Tool #2: Bonus depreciation
Bonus depreciation limits (also known as first-year bonus depreciation) are also improved under the new law, but for a limited time. Bonus depreciation is similar to Section 179 and allows you to immediately expense capital purchases rather than depreciating them over several years.
Under the new law, first-year bonus depreciation increases to 100 percent of the qualified asset purchase price for the next five tax years (starting in 2018) and can now be applied to the expense of purchasing used property as well as new.
- Bonus depreciation is typically used on short-lived capital investments (with a 20-year or less useful life) such as machinery, equipment and software.
- Bonus depreciation had been only for purchases of new equipment, but can now be applied to used equipment as long as you place it into service at your business during the tax year.
- The allowable bonus depreciation starts to decline after 2022. It falls to 80 percent in 2023, 60 percent in 2024, 40 percent in 2025 and 20 percent in 2026.
Remember, though tax reform gives you expanded tools to accelerate depreciation, it may not benefit you to use them in every case. Sometimes it’s better to use the standard capitalization and depreciation tax treatment. These tax benefits do not change the amount a capital purchase can be expensed – only the timing. Calculating whether your business will benefit from these revamped expensing tools can get complicated, so give us a call if you need assistance.
Tips for when your employees are family members
Working with family can be a pleasure. It can also be a pain, especially if you have to terminate a family member’s employment. Here are tips to help you ease the strain of mixing your family and employee relationships.
Hire for the right reasons. Make your hiring and firing decisions based on the skill sets needed to keep your business operating effectively. Hiring your son because he’s struggling to find a job is not a good business reason for bringing staff on board.
Set clear expectations. Communicate the job’s performance requirements to your family member right from the start. Clearly define company policies for promotion, compensation and termination. Make it plain that unethical conduct will not be tolerated.
Avoid nepotism. Nepotism is our human habit of treating family members more favorably than others. Keep in mind that your non-family employees will be hypersensitive to any favoritism you show to relatives.
Document performance. Throughout your family member’s tenure, maintain a detailed personnel file that tracks behavior resulting in disciplinary actions. In the unfortunate case of a necessary firing, a well-documented file will provide a narrative record that lays out your reasons and clearly communicates the evidence leading to your decision.
If you have to fire, keep it professional. Set a formal termination meeting. You may want to involve a direct supervisor or a human resources professional to ensure that your company is appropriately represented and to prevent the conversation from lapsing into emotional arguments.
The bottom line: Adhere to formal business standards and communicate in a professional, businesslike manner with your related employees.
Taxes and virtual currencies: What you need to know
Virtual currencies are all the rage lately. Here are some tax consequences you must know if you decide to dip your toe into that world.
The IRS is paying close attention
The first thing to know is that the IRS is scrutinizing virtual currency transactions, so if you live in the U.S. you’ll have to report your transactions in Bitcoins and the like to the IRS. Despite some early misconceptions, virtual currency transactions can be traced back to their owners by governments and other cyber sleuths.
If you decide to use or hold virtual currencies, carefully report and pay tax on your transactions. Act as if you are going to be audited, because if you don’t, you just might be!
It’s property, not money
Note that the IRS doesn’t consider Bitcoin or other virtual currencies as money, because they aren’t legal tender. Instead, they are considered property. That means that if you are paid in Bitcoin, you will have to report it as income based on its fair market value on the date you received it.
And, if you sell Bitcoin, you have to pay tax on your gain using the cost (basis) of when you received it. The IRS has said that if Bitcoin is held as a capital asset, like a stock or a bond, then you would pay capital gains tax. Otherwise, if it is not held as a capital asset (for example if it is treated as inventory that you intend to sell to customers), it would be taxed as ordinary income.
Be aware of the risk
In addition to the increased oversight by the IRS, virtual currencies are at risk of virtual theft with no recourse to a government agency like the Federal Deposit Insurance Corporation, which insures U.S. bank balances. Do your research on storage and security before you invest. And if you need help with any tax questions related to virtual currency, don’t hesitate to call.
With the possibility that tax law changes could go into effect next year that would significantly reduce income tax rates for many businesses, 2017 may be an especially good year to accelerate deductible expenses. Why? Deductions save more tax when rates are higher.
Timing income and expenses can be a little more challenging for accrual-basis taxpayers than for cash-basis ones. But being an accrual-basis taxpayer also offers valuable year-end tax planning opportunities when it comes to deductions.
Tracking incurred expenses
The key to saving tax as an accrual-basis taxpayer is to properly record and recognize expenses that were incurred this year but won’t be paid until 2018. This will enable you to deduct those expenses on your 2017 federal tax return. Common examples of such expenses include:
- Commissions, salaries and wages,
- Payroll taxes,
- Insurance, and
- Property taxes.
You can also accelerate deductions into 2017 without actually paying for the expenses in 2017 by charging them on a credit card. (This works for cash-basis taxpayers, too.)
As noted, accelerating deductible expenses into 2017 may be especially beneficial if tax rates go down for 2018.
Also review all prepaid expense accounts. Then write off any items that have been used up before the end of the year.
If you prepay insurance for a period of time beginning in 2017, you can expense the entire amount this year rather than spreading it between 2017 and 2018, as long as a proper method election is made. This is treated as a tax expense and thus won’t affect your internal financials.
And there’s more …
Here are a few more year-end tax tips to consider:
- Review your outstanding receivables and write off any receivables you can establish as uncollectible.
- Pay interest on all shareholder loans to or from the company.
- Update your corporate record book to record decisions and be better prepared for an audit.
To learn more about how these and other year-end tax strategies may help your business reduce its 2017 tax bill, contact us.
Many investors, especially more risk-averse ones, hold much of their portfolios in “income investments” — those that pay interest or dividends, with less emphasis on growth in value. But all income investments aren’t alike when it comes to taxes. So it’s important to be aware of the different tax treatments when managing your income investments.
Varying tax treatment
The tax treatment of investment income varies partly based on whether the income is in the form of dividends or interest. Qualified dividends are taxed at your favorable long-term capital gains tax rate (currently 0%, 15% or 20%, depending on your tax bracket) rather than at your ordinary-income tax rate (which might be as high as 39.6%). Interest income generally is taxed at ordinary-income rates. So stocks that pay dividends might be more attractive tax-wise than interest-paying income investments, such as CDs and bonds.
But there are exceptions. For example, some dividends aren’t qualified and therefore are subject to ordinary-income rates, such as certain dividends from:
- Real estate investment trusts (REITs),
- Regulated investment companies (RICs),
- Money market mutual funds, and
- Certain foreign investments.
Also, the tax treatment of bond interest varies. For example:
- Interest on U.S. government bonds is taxable on federal returns but exempt on state and local returns.
- Interest on state and local government bonds is excludable on federal returns. If the bonds were issued in your home state, interest also might be excludable on your state return.
- Corporate bond interest is fully taxable for federal and state purposes.
One of many factors
Keep in mind that tax reform legislation could affect the tax considerations for income investments. For example, if your ordinary rate goes down under tax reform, there could be less of a difference between the tax rate you’d pay on qualified vs. nonqualified dividends.
While tax treatment shouldn’t drive investment decisions, it’s one factor to consider — especially when it comes to income investments. For help factoring taxes into your investment strategy, contact us.