So here are my reasons, in no particular order:

1. Allocation of income and losses and distributions of cash and property must be made in accordance with the number of shares owned.  No special deals are allowed. Any variations from this have to be handled in the form of payroll.
2. Shareholders in S corporations are often limited in their ability to deduct rental losses.  All tax losses are limited to the shareholder’s basis in the S Corporation stock, which does NOT include third party debt, such as a mortgage. This is true even if the debt is guaranteed by the shareholder. This can result in higher taxes.
3. Borrowing money in the corporation and distributing it to a shareholder is often taxable because of the basis limitations discussed above.  This makes it difficult to cash in on the equity in the property.
4. Most residential lenders will NOT give a mortgage to an S corporation.  While this can be true of LLCs as well, the workarounds for LLCs are NOT available to S corporations
5. Distributions of appreciated real estate to the owners from the S Corporation are taxable.  This is true of any distribution and especially important if the owners want to split up.  Liquidating the entire S Corporation that has appreciated assets is a taxable event and so is redeeming a shareholder’s stock with appreciated assets.  This is extra tough on the owners if there is no distribution of cash to pay the tax.
6. Transfers of debt-free appreciated property to an S Corporation are taxable if the contributing shareholder is not in control of the corporation immediately after the transfer. This makes it difficult to set up ownership between a “money” partner and “sweat equity” partner.
7. Transfers of mortgaged property to an S Corporation does not increase the basis of your S Corporation stock and thereby could severely limit the deductibility of future losses from that property.
8. S Corporations cannot have any of the following as shareholders: corporations, partnerships and non-resident aliens. Certain trusts, many LLCs and most S corporations are also prohibited from owning an S corporation.
9. There is no step-up in basis for the assets within the S-Corporation when a shareholder dies or someone buys stock. (The S Corporation stock gets a step-up, but not the inside assets).
10. S Corporations historically have had a much higher audit risk than LLCs.

This is not to say LLCs are perfect, but if you are looking to protect yourself from the perils of real estate ownership by forming an entity, whatever you do, don’t put it in a corporation!

But these same folks freak out when thy receive a 1099 from from the bank that held the mortgage for the unpaid deficiency. They check with their friends etc. and oh my gosh it’s INCOME! And the anxiety they felt when they lost the property all comes rushing back. Not to worry. Bob and his magic wand is here. Bob will waive it and poof, the income disappears.

Forgive me for being flippant, but unless the rental goes back to the days where the taxpayer was able to refinance and take out equity, the taxpayer probably has enough cost basis in the property to create a big loss that offsets most if not all of debt relief income especially if they put in a fair amount of cash into the deal.

Example. James buys a rental house for $100,000 putting $20,000 down and an interest only mortgage of $80,000. James’ tax basis is $100,000. He owns it for 3 years. During that time he depreciates the property (a paper-only tax write-off) $9,000. James loses the house at a time when the house is valued at $60,000. Since the bank was owed $80,000, they send a 1099 for $20,000. Yes indeed, that is $20,000 of income.

But James also has a tax loss. His tax basis is $91,000, the original $100,000 less the $9,000 in depreciation he took. In a foreclosure like this, James is deemed to have sold the property for its $60,000 value, for a loss of $31,000 ($60,000 – $91,000). Because it is a rental, and the rental is now totally gone, James can write off the whole $31,000 against the $20,000 debt relief income and any other income he has. If James had a suspended loss he could not deduct in prior years (that happens to higher income taxpayers) he can write that off too.  James’ net loss is $11,000, which makes sense if you think about it. He put in $20,000 and got $9,000 in tax write-offs.

This works for single family rentals, apartment buildings, shopping centers, etc. but not your residence. Residences come under completely different rules. So if you get one of these 1099s and you want to freak out, think about the possible loss you have, or contact me, and I will get out my magic wand.

How did I know? It’s because I stay tuned to the industry, constantly polling my clients and experts in the real estate industry about what they are doing, and what they are seeing, and (without sharing names, of course) I share that information with all my real estate clients.

I call this learning from the “Old Guard” and sharing it with the “New Guard.” By the old guard I mean those seasoned veteran real estate developers, investors, sales agents and others who made a lot of mistakes, learned from those mistakes, made an absolute killing during the bubble, and have made it through the bubble’s burst with the bulk of their wealth intact. I also know you can learn just as much from those that didn’t survive.

Now there is a new guard coming into the market, the folks that didn’t lose their house, made good money at their day jobs and now they have some cash accumulated and they are seeing the same things I am seeing – low interest rates, property values at prices far below the cost to build and it just screams “OPPORTUNITY.”

Do your current financial advisers know how the real estate market works? Do they know to help you take advantage of these opportunities? Do they share their client’s positive and negative experiences with you ? Have they been real estate investors themselves?

I can save you more money in taxes than you will ever pay in fees. Way more.

How to Pay Less for Your Summer Vacation

The summer travel season is almost upon us. While you look forward to lazing on the beach, visiting the theme parks, and enjoying ice cream cones, also consider ways to fit some business in to your trips.

The idea is to take advantage of tax deductions for which you become eligible when you devote part of your trip to business. As long as most of your travel days are for business purposes, you can deduct the cost of travel (airplanes, trains, cars, etc.) and for hotels, parking, taxi service, meals, and so on.

As defined by the IRS, travel expenses are the Ordinary and Necessary expenses of traveling away from home for your business, profession, or job. An Ordinary expense is one that is common and accepted in your field of trade, business, or profession. A Necessary expense is one that is helpful and appropriate for your business. An expense does not have to be required to be considered necessary.

The key factor is that your trip must be primarily for business. Days of leisure can be added to a trip and still be considered primarily for business. The more days and time per day spent on business will help substantiate the trip. There are no set rules on how many days and how much time per day need to be spent on business for your trip to be considered business related.

Keep all the documentation for business-related travel, including confirmations of appointments, emails, phone records, registration to conferences, etc. The days spent traveling to and from a business trip are considered part of the trip. This includes the weekend if it is impractical to come home between weekday business meetings. Planning ahead can make this happen.

Traveling with Your Spouse

If a spouse goes with you on a business trip or to a business convention, his or her travel expenses can only be deducted if your spouse

1. is your employee,
2. has a bona fide business purpose for the travel, and
3. would otherwise be allowed to deduct the travel expenses.

To be an employee, your spouse must be on the payroll and payroll taxes must be paid. If your spouse is not an employee and travels with you on vacation, you can still deduct the cost of your room at the single-occupancy-per-day rate, rather than half the rate. Meals could also be deductible. If you are paying for lunch or dinner for a customer or business associate and that person’s spouse, the full cost of the meals might qualify under the 50% meal deduction. Let us know if you’re unclear on this deduction; we can give you the details.

Example: Bill drives to Boston on business and takes his wife, Joan, with him. Joan is not Bill’s employee. Joan occasionally types notes, performs similar services, and accompanies Bill to luncheons and dinners. The performance of these services does not establish that her presence on the trip is necessary for Bill’s business. Her expenses are not deductible.

Bill pays $199 a day for a double room. A single room costs $149 a day. He can deduct the total cost of driving his car to and from Boston, but only $149 a day for his hotel room. If he uses public transportation, he can deduct only his fare. Further, if Bill has dinner with a customer and spouse, the meal may be deducted under the 50% meal deduction.

With travel outside of the United States, the transportation for business trips of one week or less may be deducted. However, only a portion of transportation costs for longer trips is deductible.

Example: You live in New York. On May 4 you flew to Paris to attend a business conference that began on May 5. The conference ended at noon on May 14. That evening you flew to Dublin where you visited with friends until the afternoon of May 21, when you flew directly home to New York. The primary purpose for the trip was to attend the conference.

If you had not stopped in Dublin, you would have arrived home the evening of May 14. You did not meet any of the exceptions that would allow you to consider your travel entirely for business. May 4 through May 14 (11 days) are business days and May 15 through May 21 (7 days) are non-business days.

You can deduct the cost of your meals (subject to the 50% limit), lodging, and other business-related travel expenses while in Paris.

You cannot deduct your expenses while in Dublin. You also cannot deduct 7/18 of what it would have cost you to travel round-trip between New York and Dublin.

You paid $450 to fly from New York to Paris, $200 to fly from Paris to Dublin, and $500 to fly from Dublin back to New York. Round-trip airfare from New York to Dublin would have been $850.

You figure the deductible part of your air travel expenses by subtracting 7/18 of the round-trip fare and other expenses you would have had in traveling directly between New York and Dublin ($850 – 7/18 = $331) from your total expenses in traveling from New York to Paris to Dublin and back to New York ($450 + $200 + $500 = $1,150). Your deductible air travel expense is $819 ($1,150 – $331).

What Expenses Are Deductible?

Here’s what you can deduct when you travel away from home for business.

Transportation Expenses
You can deduct Transportation Expenses when you travel by airplane, train, bus, or car between your home and your business destination. If you were provided with a ticket or you are riding free as a result of a frequent traveler or similar program, your cost is zero. If you travel by ship, additional rules and limits apply.

Taxi, Commuter Bus, Subway, and Airport Limousine Fares
You can deduct the fares for these and other types of transportation that take you between

• the airport or station and your hotel, and
• the hotel and the work location of your customers or clients, your business meeting place, or your temporary work location.

Baggage and Shipping Expenses
You can deduct the cost of sending baggage and sample or display material between your regular and temporary work locations.

Car Expenses
You can deduct the cost of operating and maintaining your car when traveling away from home on business. You can deduct actual expenses or the standard mileage rate, as well as business-related tolls and parking. If you rent a car while away from home on business, you can deduct only the business-use portion of the expenses.

Lodging and Meals
You can deduct your lodging and meals if your business trip is overnight or long enough that you need to stop for sleep or rest to properly perform your duties. Meals include amounts spent for food, beverages, taxes, and related tips. Additional rules and limits may apply.

Cleaning Clothes
You can deduct the dry cleaning and laundry expenses you incur while away on business.

Telephone
All business calls while on your business trip are deductible. This includes business communication by fax machine or other communication devices.

Tips
You may deduct the tips you pay for any expense listed above.

Other Expenses
You can deduct other similar ordinary and necessary expenses related to your business travel. These expenses might include transportation to or from a business meal, public stenographer’s fees, computer rental fees, or Internet access fees.

Clarification Not In Newsletter

One thing my newsletter did not make clear, if your spouse is co-owner of the business and works with you, obviously, their involvement IS business. If your spouse is co-owner by virtue of community property but does not share part of the social security/self-employment tax burden it is extremely difficult to get the IRS to agree your spouse has a business purpose in his/her travel.

Ask Us

If you have any questions about how to grab some tax deductions from your summer travels this year, just give us a call or send us an email.

In this group, the doctors of mixed specialties, all of whom will see their practices change as a result of Obamacare.  One of the impacts of Obamacare is it has made doctors in certain specialties seek hospital employment to keep their practices viable.  An affiliation assures them of a more manageable income stream without need to maintain a cost structure, which will be beneficial in the anticipation that revenues will be curtailed in the future.

Certain docs in the aforementioned group are choosing to become employees of the local hospital.  As part owners of the building, it behooves them to have the hospital take over the lease on their spaces and they keep their practices intact.

Hospitals must meet certain requirements and if the hospital takes over the leases, the HVAC system needs to be upgraded.  The hospital could pay for the improvements.  Or the docs as landlords can pay for the improvements and the hospital will pay for the improvements through increased rents.  But this increase in rent will put  the doctors further into the black on the building rental and paying even more taxes.  The improvements will have to be made to the whole building, making them 39 year property (meaning it takes 39 years to write it off), unless we do a cost segregation study.  Given the total cost of improvements, such a study is probably too expensive for the savings involved.

But wait, I have a plan.  Let’s have the nonprofit hospital pay for all the tenant improvements on the 39 year depreciation schedule, because as a non-profit, they don’t care about depreciation write-offs.  We’re having the docs pay for the HEPA filtration and positive pressure equipment.  Even though it affects the whole building including non-hospital affiliated docs, the new equipment does does absolutely nothing for care and comfort of the general public, and only affects patient care.  These improvements are indeed specific to doctor patient care and that puts them on the five year asset schedule.

On a commercial rental like this, no part of this new 5 year property qualifies for the IRS Sec. 179 deduction (100% write-off), but, currently this 5 year property does qualify for 100% (or 50%) bonus depreciation, meaning they could write off the whole thing in one year.

In doing this, in splitting what the tenant pays for and what the landlord pays for, we have in effect done a cost segregation.  The doctors will get their full write-off of deductions that would have been wasted had the hospital paid for it all.  Its a nice twist on cost segregation.

Schedule E filers may want to obtain an Federal Employer Identification Number (FEIN) for reporting their rental property payments in order to avoid disclosure of their personal social security numbers to vendors.  To be clear about this, the Form 1099-MISC requires all payers to provide an identification number.  In the absence of a FEIN, the only other option will be to disclose to vendors the owner’s social security number on the Form 1099-MISC.  Note – The use of a FEIN will not change your income tax reporting in any way.

Again, because these provisions already apply to businesses, if you are already filing, legislation will not change how you file the Form 1099-MISC.  Obtaining a Form W-9 from all vendors need not wait until next year.  Both the Form W-9 and instructions are available on www.irs.gov. 

Beginning January 1, 2011, a MANDATORY electronic payment requirement kicks in  for certain California individual taxpayers.  Electronic payments are required once a person:

• Makes an estimate tax or extension payment (by check or electronic method) of more than $20,000.
• Files an original tax return with a tax liability over $80,000.

This should not be a surprise to anybody as this was supposed to happen two years ago, and got postponed again and again.  Now California says no more grace periods.

The penalty is equal to 1 percent of the amount paid, unless failure to pay was for reasonable cause and not willful neglect.   I am not being flippant when I say that it is unlikely California will find any excuse reasonable.  California is looking for reasons to collect revenue.

If you make a payment or file a return meeting the mandatory requirement, The Franchise Tax Board will send you an FTB 4106 MEO, Mandatory e-pay Participation Notice, advising you that all future payments must be remitted electronically.  NOTE: If you do not receive notification from FTB, you are still required to remit payments electronically once you meet either of the above thresholds.

Tax preparation software may also remind you to e-pay, BUT, if your tax preparation software generates paper Form 540-ES vouchers when you meet the mandatory e-pay threshold, you must still pay electronically.

Again, once you meet the mandatory e-pay threshold, you are required to make all  payments thereafter electronically, regardless of the amount, type, or taxable year. For example: You make your fourth quarter 2010 estimated tax payment of $25,000 on January 15, 2011 electronically because you had an unusually big gain in December of 2010.  Any payment made after that (for example, a bill payment from a previous year or your tax due on April 15, or any 2011 estimated tax payment) must be made electronically even if they drop down to $1.

One client of mine was worried about the “big brother” aspect of this.  “Won’t this give the FTB direct access to my account?” he asked.    Sure it will, but they could also just copy the numbers off your check, and when you think about it,  even checks are all scanned and turned into electronic payments anyway.

To find out how to pay electronically, see the FTB’s Webpay page at http://www.ftb.ca.gov/online/webpay/index.asp.

When you distribute appreciated property out of the corporation, you will trigger the inherent “corporate level” gain in the property.  The tax they would have to pay on that gain is the hitch that keeps most S corporations from fixing their corporate real estate problems.  But if the value is low right now, maybe the problem is solved with very little pain (like maybe NO gain?).  And we have the lowest capital gain tax rates right now (15%) and if the Bush tax cuts expire, it goes back up to 20%.  I see that as a powerful incentive.

C corporation have the corporate level gain problem as well, but they have an added hurdle – double taxation.  Not only will they pay gain on the corporate level appreciation, but they will pay taxes personally when the property is distributed.  That distribution it will be treated as a dividend, currently taxed at a 15% rate.  If distributing that property does not liquidate the corporation, that dividend rate will be increased to as much as 39.6% if the Bush tax cuts expire.   If it is a liquidating distribution, the dividend rate still goes up from 15% to 20% if the Bush tax cuts expire.  The double tax doubles the incentive.

But wait, the distribution is not measured by the value of the building but the NET value of the building.  So if there is no equity, there is no dividend.  We have all seen a lot of no-equity buildings these days, so this is a big incentive.

I view this as the perfect storm for real estate owned by corporations.  The values are low, and so are the tax rates.  If you own real estate in a corporation, take a hard look at getting that property out of the corporation NOW.

TIGTA is the Treasury Inspector General for Tax Administration.  It is a division of the IRS and they are the “Eichmann” division of the IRS.  Their mandate is to increase the efficiency and effectiveness of the IRS.  If you have ever been through an IRS audit, you know they are no fun.  But chances are you were not subjected to a TIGTA audit, which the IRS  equivalent of a colonoscopy, your return is audited line by line, where full documentation of every number item is required.   

The man in charge of TIGTA is J. Russell George.   In a statement made recently, Mr. George chilled me to the bone.  The topic affects tax preparers directly, but it is a statement that not just tax preparers should be afraid of, but all taxpayers.  Mr. George said the following:

“Paid tax preparers prepared more than half of individual tax returns in 2009.  The IRS must step up its efforts to engage this community in its effort to close the tax gap.”

OMG.  They want to engage ME in it’s effort to close the tax gap.   I see three huge problems. 

1. People taking money under the table don’t come to somebody like me and if they do they don’t tell me about it.
2. This puts me in a HUGE conflict of interest.  If my clients think I am playing cop, they won’t want to do business with me. I am the taxpayer’s advocate, not the government’s.  Next it will be the Justice Department wanting more cooperation from criminal defense lawyers at curtailing crime. 
3. Me and my fellow CPAs, for the most part, do not want to be a tool of Big Brother.  

Don’t get me wrong, I hate the fact that there is a tax gap.  I do not aid and abet my clients in cheating the government.  I think tax cheats out to go to jail and serve significant time.  I hate that certain segments of the population feel like they shouldn’t have to pay taxes, but the other guy should.   Polls, anonymous ones of course,  show that the same people that would never steal a grapefruit from a fruit stand actually boast about how they cheat on their taxes.  But the minute they force me to get involved in correcting that, I am out of here.  It will be like working for the IRS, but without the job stability and the government pension. 

Of course, this may be what the IRS really wants “Hey taxpayer, let US, the friendly folks at the IRS, prepare your return.  We will do a really good job on you, oops,  I mean we will do a really good job.”