2021 Tax Planning: Rental Real Estate as Qualified Business Income

Preface: “Ninety percent of all millionaires become so through owning real estate.” –Andrew Carnegie

2021 Tax Planning: Rental Real Estate as Qualified Business Income

For taxpayers who own and operate a rental real estate business, you may qualify to claim the business income deduction under Section 199A for your rental properties in one of two ways.

Qualified Business Income Deduction (QBID)

With the Tax Cuts and Jobs Act Congress enacted Section 199A to provide a deduction to non-corporate taxpayers of up to 20 percent of the taxpayer’s qualified business income from each of the taxpayer’s qualified trades or businesses, including those operated through a partnership, S corporation, or sole proprietorship. Individuals, estates and trusts can also deduct 20 percent of aggregate qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership income.

With the current tax legislation, this tax deduction is effective for tax years beginning after December 31, 2017, and before January 1, 2026.

The Qualified Business Income deduction is calculated as the lesser of:

      • combined qualified business income (up to 20% of qualified business income, plus 20% of REIT dividends and publicly traded partnership income); or
      • 20% of the excess (if any) of taxable income over net capital gain.

In order to qualify for the tax deduction, a business must be a qualified trade or business which is defined as any trade or business other than a specified service trade or business (SSTB) or the trade or business of performing services as an employee (attorneys, accountants and architects may not qualify for the 199A.)

Rentals meet the definition of a qualified trade or business in one of two ways:

      • rentals to a commonly owned business; or
      • under a safe harbor for certain rental real estate activities.

Rentals to a commonly owned business

 A rental activity is treated as a qualified trade or business if it rents or licenses tangible or intangible property to a commonly owned trade or business. A business and a rental activity are commonly owned if the same person or group of persons directly or indirectly owns at least 50 percent of each of them. Businesses can meet this common-ownership test even if they are not otherwise eligible for aggregation.

 Safe Harbor for Rental Real Estate Enterprise

 Under a safe harbor, a rental real estate enterprise is treated as a trade or business for purposes of Section 199A only if:

  • For tax years beginning after 2019, the taxpayer maintains sufficient contemporaneous records.
  • Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise; and
  • At least 250 hours of rental services are performed per year; for qualifying purposes of the 250 hour rule, the following are considered rental services:
          1. Advertising tasks for tenants to rent or lease real estate;
          2. Time negotiating or signing leases;
          3. Assembling and obtaining information on tenant applications;
          4. Collection of payments of rent income of the real estate;
          5. Tasks to repair or maintain the real estate;
          6. Management of the real estate;
          7. Purchase of supplies and materials for rental function;
          8. Supervision of contractors working to perform services or repairs for the real estate.

Please call our office to discuss how you perhaps may tax plan for your rental business to meet the requirements for Section 199A and take full advantage of the tax deductions available to you rental business.

Browsing The End of Alchemy

Preface: “The economy is behaving in ways we did not expect, and new ideas will be needed if we are to prevent a repetition of the Great Recession and restore prosperity.” — Mervyn King

Browsing The End of Alchemy

Credit: Donald J. Sauder, CPA | CVA

Is something wrong with the global banking system? Mervyn King knows firsthand. With a decade of leadership at the Bank of England, including time during the 2008 global financial crisis, Mervyn writes about the history and future of banking and provides a clear clarion call for work to solving the long-term risk of a credit powered banking system.

In his 2016 448 page book The End of Alchemy Mervyn King outlines the growing global banking risks with over-leveraging of and excessive risk assumptions with real estate loans, derivatives, and financial engineering driven excess with banker facing career sanctions for missing forward profit guidance.

While economists apply econometric models to endeavor to make accurate predictions about the future for planning purposes, uncertainty abounds. That’s why we have insurance enterprises because such impossible to predict events exist that cannot be forecasted or measured. Without effective risk management tools as a necessary part of the capitalist system, the financial system would fail, and perhaps in grand way. Yet even with strong safety nets, the uncertainty that abounds can be still be alarming disruptive. This results in the fact that currently financial crisis’ and recessions as unavoidable outcomes of from the banking system structure.

In the free-market economy it is believed that people act in their own best interests. Yet, when one party fails to act in fairly and fails to keep a “contract” this behavior is harmful to board trust in the system and requires society to apply resolutions with a proper judicial system measures from checks and balances.

Money is only as good as the trust the users place in it. If trust were to fail in the financial system on a large scale the entire system would implode. Therefore, those who are part of the system must be willing prisoners to keep the system working effectively.

A central banks role is act as a lender of last resort, that is to provide whatever liquidity is necessary to maintain trust in the banking system. This is a “whatever credit is required will be provided” mechanism, but hence bank are to only loan for good collateral assets to prevent losses to depositors. When the necessary 2008 emergency funding was required, one major problem was that the liquidity required did not have good collateral to pillar the loans. Therefore, the riskiness of the loans required the lender of last resort to step up to the counter to keep the system intact, necessitated moral hazard on behalf of qualifying collateral.

To maintain the financial system, the obvious system disequilibrium is that over a duration of time debt has grown to excessive levels creating a low interest rate environment, that now imprisons the financial systems long-term viability. The Bank of England for 315 years from 1694 to 2009 never set bank interest rates below 2%. With banking system mired today in near zero rates, that 2% anchor level, never breached in centuries, seems to have perhaps untethered from the alchemy ship, and hence would raise the question – where are the banking systems risks taking the world?

The book looks at a fundamental question of why experts have talking about “recovery” for more than a decade after 2008. What trust should be placed in the systems long-term capacity to prevent a greater financial crisis from re-occurring?

What is next? Aside from the The End of Alchemy, the United States Federal Reserve has recently (June 2021) proposed what may be the first significant steps to launching a virtual currency, that would reshape the entire banking infrastructure and future of financial alchemy in the United States . This idea of a fully digital US dollar that was unthinkable just a few short years ago, has huge banking implication. One of key considerations of importance, is that with digital currency there are no needs for the icon of Main Street American for centuries – the cornerstone architecture of a local bank.

Is this simple a currency proposition that a digital dollar be used alongside the Us Dollar currency, perhaps the single largest shift in American commerce since the Tea Act in 1773 by the British Parliament? Who knows? Perhaps a John on the Isle of Patmos?

In The End of Alchemy Mervyn King gives a clear guide with the futuristic concept of a financial system with a “Pawnbroker for all Seasons” proposal. And, for the rest of story read: The End of Alchemy – Money, Banking, and the Future of the Global Economy

2021 Tax Planning: Itemized Deductions

Preface: “You can’t tax business. Business doesn’t pay taxes. It collects taxes.” ― Ronald Reagan

2021 Tax Planning: Itemized Deductions 

There are two choices or standard strategies for deductions on your federal income tax return: 1) you can itemize deductions or 2) use the standard deduction. Maximizing these deduction benefits can optimize your taxes because any tax deduction ultimately reduces the amount of your taxable income.

Firstly, the standard tax deduction amount for federal tax filing purposes varies depending on the taxpayers income, age, and mostly your filing status. The amount is also adjusted annually for inflation. Certain taxpayers cannot use the standard deduction: These include I) A married individual filing separately whose spouse itemizes deductions. II) An individual who files a tax return for a period of less than 12 months because of a change in his or her annual accounting period. III) An individual who was a nonresident alien or a dual-status alien during the year. However, nonresident aliens who are married to a U.S. citizen or resident alien at the end of the year and who choose to be treated as U.S. residents for tax purposes can take the standard deduction.

The standard deduction for 2021 rises to $25,100 and increase of $300 from 220. For single and married filing separately taxpayers the standard deduction is $12,550 for 2021, up $150 from 2020. For heads of households the standard deduction is $18,800 for 2021.

The standard tax deduction is automatically available to any taxpayer and adjusted per filing status.

Secondly, Itemized deductions are a Form 1040 Schedule A deductions. This includes amounts paid for state and local income or sales taxes, real estate taxes, personal property taxes, or qualifying mortgage interest. Additionally, you may also include gifts to charity and part of the amount you paid for medical and dental expenses. You would usually benefit by itemizing on your tax filing if you:

          1. Cannot use the standard deduction or the amount you can claim is limited;
          2. Paid Uninsured medical and dental expenses;
          3. Paid substantial interest or taxes on your home or a second home;
          4. Paid Investment Interest;
          5. Paid unreimbursed employee expenses;
          6. Made large charitable contributions to qualified charities.

The higher standard deduction under recent tax reform measures has led to fewer taxpayers itemizing their tax deductions currently and simpler tax filings. However, taxpayers may have an opportunity to itemize this year by keeping these tips in mind:

The deduction that taxpayers can claim for state and local income, sales and property taxes is limited. This deduction is limited to a combined, total deduction of $10,000. It is $5,000 if married filing separately. Any state and local taxes paid above this amount can’t be deducted.The deduction for mortgage interest is also limited to interest paid on a loan secured by the taxpayer’s main home or second home.

For homeowners who choose to refinance, they must use the loan to buy, build, or substantially improve their main home or second home, and the mortgage interest they may deduct is subject to the limits described as following when buying a home.Taxpayers who buy a new home this year can only deduct mortgage interest they pay on a total of $750,000 in qualifying debt for a first and second home ($375,000 if married filing separately).

For existing mortgages, if the loan originated on or before December 15, 2017, taxpayers continue to deduct interest on a total of $1 million in qualifying debt secured by first and second homes.

Many taxpayers often find unused items in good condition they can donate to a qualified charity and receive an itemized deduction benefit on Schedule A. These donations may qualify for a tax deduction. For some taxpayers, checks, credit card, or other money gifts is the preferred donation medium. For any donation whether items or money taxpayers must have proof of all cash and non-cash donations for itemizing.

Driving a personal vehicle while donating services on a trip sponsored by a qualified charity could qualify for a tax break. Itemizers can deduct 14 cents per mile for charitable mileage driven in 2021.

With itemized tax deductions you need to keep receipts on file, and with standard deduction their no extra effort to document the tax deduction. Generally, if itemized tax expenses exceed your standard tax deduction it is a good idea to itemize your taxes.

This year, when tax planning for 2021 be certain to discuss with your tax advisor the tax benefits of either itemizing taxes or stream-lining your 2021 tax filing with a standard deduction.

The Proposed Tax Reform Effects on S-Distributions and Gifts

Preface:“A budget is more than just a series of numbers on a page; it is an embodiment of our values.”
– Barack Obama 

The Proposed Tax Reform Effects on S-Distributions and Gifts

The Department of the Treasury has published the Biden Administration’s proposed plan for raising revenues in 2022 detailing more specifically the tax effects of the new tax reform. In this blog we will highlight two tax items of interest to entrepreneurs and business owners.

SE taxes on S-Corporation Distributions and LLC Distributions

Firstly, the proposed tax reform will revise the tax laws for taxable self-employment earnings. The proposed tax reform would require both materially participating partners who receive guaranteed payments to pay self-employment taxes on their distributive shares of income for pass-through earnings above an AGI of $400,000. S-corporation shareholders while under current tax laws are required to pay a reasonable compensation wage and not taxes for self-employment taxes on distributions.

The tax reform would also subject S-Corporation earnings and distributions beginning in 2022, to the additional income taxes on earnings that would be subject to social security tax as the lesser of (i) the potential social security income, or (ii) the excess over $400,000 of the sum of the potential social security income, wage income subject to FICA under current law, and 92.35 percent of self-employment income subject to social security tax under current law.

This is a possible increase on taxes for business owners including those with an AGI less than $400,000. Of course while not final legislation, this may increase income tax costs for a multitude of small business owners with a pending closure of the social security taxes loophole.

Taxes on Appreciated Gifts

Under the proposed tax reform, a donor or deceased owner of an appreciated asset would realize a capital gain at the time of the transfer. In other words gifts with a built-in gain would tax taxable at transfer.

So for a donor, the amount of the gain realized would be the excess of the asset’s fair market value on the date of the gift over the donor’s basis in that asset. For a decedent, the amount of gain would be the excess of the asset’s fair market value on the decedent’s date of death over the decedent’s basis in that asset. That gain would be taxable income to the decedent on the Federal gift or estate tax return or on a separate capital gains return. Of course assets with gains of $1.0m or greater would be taxed at the 43% rate capital gains rate when including net investment taxes.

The use of capital losses and carry-forwards from transfers at death would be allowed against capital gains income and up to $3,000 of ordinary income on the decedent’s final income tax return, and the tax imposed on gains deemed realized at death would be deductible on the estate tax return of the decedent’s estate.

Interestingly for legacy businesses e.g. say family partnerships or trusts, a gain on unrealized appreciation also would be recognized by a trust, partnership, or other noncorporate entity that is the owner of property if that property has not been the subject of a recognition event within the prior 90 years. The first possible recognition event for any taxpayer under this provision would thus be December 31, 2030. For those graduates looking ahead — New Years Day 2031 has opportunity for valuation experts. A qualifying transfer would be defined under the gift and estate tax provisions and would be valued using the methodologies used for gift or estate tax purposes.

Payment of tax on the appreciation of certain family-owned and -operated businesses would not be due until the interest in the business is sold or the business ceases to be family-owned and operated. Furthermore, the proposal would allow a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death, other than liquid assets such as publicly traded financial assets and other than businesses for which the deferral election is made.

The Internal Revenue Service (IRS) would be authorized to require security at any time when there is a reasonable need for security to continue this deferral. That security may be provided from any person, and in any form, deemed acceptable by the IRS.

Summary: With IRS proposed changes from qualified valuation features to securitized collateral with legal documents, the proposed tax reforms will likely bring tax compliance factors to the forefront of business planning and strategy in the year ahead.