Bob Weaver-The Real Estate and Business Tax Guru

Because you don't like sending your money to the IRS

Flipping a Property Acquired in a 1031 Exchange

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I ran into a 1031 exchange issue that I hadn’t run into in a while.  I was brought in to settle a disagreement between two CPAs.

An owner, we’ll call him X, of an piece of nicely appreciated investment real estate we’ll call Property A, entered into a 1031 exchange, selling Property A, known as the “relinquished property,” for about $2 million.  X then found Property B to replace it.

Unknown to X at the time, there had been other bidders bidding on Property B, but X’s bid was the highest.  So through the exchange intermediary, X was able to enter into acquire Property B.  One of the other bidders, we’ll call him Y, eventually reassessed the situation and for whatever reason Y decided he had to have Property B.  A few days before X could close on Property B, Y approached X and offered him $2.5 million for Property B.  X called his CPA to ask if he could finish the exchange tax free, then immediately sell the property to Y and put the proceeds into a second tax free exchange, to acquire a new property to be identified later.

X’s CPA felt very uneasy about the deal and told his client he didn’t think so.  X would love to have the extra $500k, but the tax on a taxable exchange would be more than the extra $500k X would get for reselling Property B to Y.  Word of this got back to Y’s CPA, who assured X’s CPA that his client Y, a big time developer, did this kind of transaction all the time.  Still uneasy, X’s CPA reached out to me to get a better handle on the issues.

I am well aware of what big time developers do, but that doesn’t make it legal.  I have handled many developer clients, some of whom completed “aggressive” tax free exchanges, for whom I have filed tax returns.   They come to me because I know the rules, and I can often help them restructure a transaction for success.   But this transaction is over the line.  Years ago I had to turn down a potentially extremely lucrative client that I had been chasing for years once I found out he used this technique as a common practice.   I found out later he had other shady ideas.  Shady developers don’t want me as their CPA.

Here are the issues:

A taxpayer’s intent to hold both the relinquished property and replacement property for investment or for use in a trade or business is a requirement for every 1031 exchange.  A simultaneous flip of the replacement property, where the taxpayer agrees to sell before the close of replacement property is clearly NOT allowed.  Now if Y had approached X out of the blue the day after the closing of X’s purchase of Property B, you could argue that X actually did hold Property for investment, albeit for one day.  But these were NOT the facts.  You cannot possibly hold the replacement property for investment if you are under contract to sell the property before you acquire it.  Clearly at the time the exchange is completed, if X goes through with the sale Y, by his actions X has clearly demonstrated that when he took title to the the property he held it with the intent of immediately reselling it.

I called a real estate tax attorney friend that I know to see if he had any workarounds.  Half seriously my friend the attorney suggested the taxpayer tell the buyer to “go away” (wink wink) and have come back later after the close (the longer the better).  Personally I would not go there.  The IRS and the Tax Court will look the evidence surrounding the acquisition to determine whether the taxpayer’s use of the replacement property after the exchange is consistent with an intent to hold the property for investment.  And any discussion that X’s CPA has with X evidencing a change of intent before, during, or after the exchange is fair game for the IRS.  CPAs, unlike my friend the attorney, don’t have attorney-client privilege.  That also goes for any discussions X or his CPA have with the intermediary as well.  And finally, since there is no supportable tax-free position for the immediate resale, preparer penalties would be applicable if X’s CPA prepares X’s return that way.   Not a pretty picture.

The bottom line is this:

Sorry, but you can’t flip a property acquired in a 1031 exchange.  No exceptions.

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Retirement Plan Options for Small Businesses

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Employer-sponsored retirement plans have become a key component for retirement savings. They are also an increasingly important tool for attracting and retaining the high-quality employees you need to compete in today’s competitive environment.

Besides helping employees save for the future, however, instituting a retirement plan can provide you, as the employer, with benefits that enable you to make the most of your business’s assets. Such benefits include:

  • Tax-deferred growth on earnings within the plan
  • Current tax savings on individual contributions to the plan
  • Immediate tax deductions for employer contributions
  • Easy to establish and maintain
  • Low-cost benefit with a highly-perceived value by your employees

Here’s an overview of four retirement plans options that can help you and your employees save:

SIMPLE: Savings Incentive Match Plan

A SIMPLE IRA plan allows employees to contribute a percentage of their salary each paycheck and to have their employer match their contribution. Under SIMPLE IRA plans, employees can set aside up to $12,000 in 2014 (same as 2013) by payroll deduction. If the employee is 50 or older then they may contribute an additional $2,500. Employers can either match employee contributions dollar for dollar – up to 3 percent of an employee’s wage – or make a fixed contribution of 2 percent of pay for all eligible employees instead of a matching contribution.

SIMPLE IRA plans are easy to set up by filling out a short form. Administrative costs are low and much of the paperwork is done by the financial institution that handles the SIMPLE IRA plan accounts. Employers may choose either to permit employees to select the IRA to which their contributions will be sent, or to send contributions for all employees to one financial institution. Employees are 100 percent vested in contributions, get to decide how and where the money will be invested, and keep their IRA accounts even when they change jobs.

SEP: Simplified Employee Pension Plan

A SEP plan allows employers to set up a type of individual retirement account – known as a SEP-IRA – for themselves and their employees. Employers must contribute a uniform percentage of pay for each employee. Employer contributions are limited to whichever is less: 25 percent of an employee’s annual salary or $52,000 in 2014 ($51,000 in 2013). SEP plans can be started by most employers, including those that are self-employed.

SEP plans have low start-up and operating costs and can be established using a single quarter-page form. Businesses are not locked into making contributions every year. You can decide how much to put into a SEP each year – offering you some flexibility when business conditions vary.

401(k) Plans

401(k) plans have become a widely accepted savings vehicle for small businesses and allows employees to contribute a portion of their own incomes toward their retirement. The employee contributions, not to exceed $17,500 in 2014 (same as 2013), reduce a participant’s pay before income taxes, so that pre-tax dollars are invested. If the employee is 50 or older then they may contribute another $5,500 in 2014 (same as 2013). Employers may offer to match a certain percentage of the employee’s contribution, increasing participation in the plan.

While more complex, 401(k)plans offer higher contribution limits than SIMPLE IRA plans and IRAs, allowing employees to accumulate greater savings.

Profit-Sharing Plans

Employers also may make profit-sharing contributions to plans that are unrelated to any amounts an employee chooses to contribute. Profit-sharing Plans are well suited for businesses with uncertain or fluctuating profits. In addition to the flexibility in deciding the amounts of the contributions, a Profit-Sharing Plan can include options such as service requirements, vesting schedules and plan loans that are not available under SEP plans.

Contributions may range from 0 to 25 percent of eligible employees’ compensation, to a maximum of $52,000 in 2014 ($51,000 in 2013) per employee. The contribution in any one year cannot exceed 25 percent of the total compensation of the employees participating in the plan. Contributions need not be the same percentage for all employees. Key employees may actually get as much as 25 percent, while others may get as little as 3 percent. A plan may combine these profit-sharing contributions with 401(k) contributions (and matching contributions).

Call Me First

Pension rules are complex, and the tax aspects of retirement plans can also be confusing, so call me first. I’ll help you find the right plan for you and your employees.

Written by rpwcpa

August 27, 2014 at 7:27 pm

The Home-Based Business: Basics to Consider

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More than 52 percent of businesses today are home-based. Every day, people are striking out and achieving economic and creative independence by turning their skills into dollars. Garages, basements and attics are being transformed into the corporate headquarters of the newest entrepreneurs–home-based businesspeople.

And, with technological advances in smartphones, tablets, and iPads as well as a rising demand for “service-oriented” businesses, the opportunities seem to be endless.

Is a Home-Based Business Right for You?

Choosing a home business is like choosing a spouse or partner: Think carefully before starting the business. Instead of plunging right in, take time to learn as much about the market for any product or service as you can. Before you invest any time, effort, or money take a few moments to answer the following questions:

  • Can you describe in detail the business you plan on establishing?
  • What will be your product or service?
  • Is there a demand for your product or service?
  • Can you identify the target market for your product or service?
  • Do you have the talent and expertise needed to compete successfully?

Before you dive head first into a home-based business, it’s essential that you know why you are doing it and how you will do it. To succeed, your business must be based on something greater than a desire to be your own boss, and involves an honest assessment of your own personality, an understanding of what’s involved, and a lot of hard work. You have to be willing to plan ahead and make improvements and adjustments along the way.

While there are no “best” or “right” reasons for starting a home-based business, it is vital to have a very clear idea of what you are getting into and why. Ask yourself these questions:

  • Are you a self-starter?
  • Can you stick to business if you’re working at home?
  • Do you have the necessary self-discipline to maintain schedules?
  • Can you deal with the isolation of working from home?

Working under the same roof that your family lives under may not prove to be as easy as it seems. It is important that you work in a professional environment. If at all possible, you should set up a separate office in your home. You must consider whether your home has the space for a business, and whether you can successfully run the business from your home.

Compliance with Laws and Regulations

A home-based business is subject to many of the same laws and regulations affecting other businesses and you will be responsible for complying with them. There are some general areas to watch out for, but be sure to consult an attorney and your state department of labor to find out which laws and regulations will affect your business.

Zoning

Be aware of your city’s zoning regulations. If your business operates in violation of them, you could be fined or closed down.

Restrictions on Certain Goods

Certain products may not be produced in the home. Most states outlaw home production of fireworks, drugs, poisons, sanitary or medical products, and toys. Some states also prohibit home-based businesses from making food, drink, or clothing.

Registration and Accounting Requirements

You may need the following:

  • Work certificate or a license from the state (your business’s name may also need to be registered with the state)
  • Sales tax number
  • Separate business telephone
  • Separate business bank account

If your business has employees, you are responsible for withholding income, social security, and Medicare taxes, as well as complying with minimum wage and employee health and safety laws.

Planning Techniques

Money fuels all businesses. With a little planning, you’ll find that you can avoid most financial difficulties. When drawing up a financial plan, don’t worry about using estimates. The process of thinking through these questions helps develop your business skills and leads to solid financial planning.

Estimating Start-Up Costs

To estimate your start-up costs, include all initial expenses such as fees, licenses, permits, telephone deposit, tools, office equipment and promotional expenses.

In addition, business experts say you should not expect a profit for the first eight to 10 months, so be sure to give yourself enough of a cushion if you need it.

Projecting Operating Expenses

Include salaries, utilities, office supplies, loan payments, taxes, legal services and insurance premiums, and don’t forget to include your normal living expenses. Your business must not only meet its own needs, but make sure it meets yours as well.

Projecting Income

It is essential that you know how to estimate your sales on a daily and monthly basis. From the sales estimates, you can develop projected income statements, break-even points and cash-flow statements. Use your marketing research to estimate initial sales volume.

Determining Cash Flow

Working capital–not profits–pays your bills. Even though your assets may look great on the balance sheet, if your cash is tied up in receivables or equipment, your business is technically insolvent. In other words, you’re broke.

Make a list of all anticipated expenses and projected income for each week and month. If you see a cash-flow crisis developing, cut back on everything but the necessities.

Don’t hesitate to give us a call if you think a home-based business is in your future. We’ll set up your business and make sure you have the proper documentation system in place to satisfy the IRS.

Written by rpwcpa

July 10, 2014 at 1:48 pm

Travel & Entertainment: Maximizing Tax Benefits

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Tax law allows you to deduct two types of travel expenses related to your business, local and what the IRS calls “away from home.”

  1. First, local travel expenses. You can deduct local transportation expenses incurred for business purposes such as the cost of getting from one location to another via public transportation, rental car, or your own automobile. Meals and incidentals are not deductible as travel expenses, but you can deduct meals as an entertainment expense as long as certain conditions are met (see below).
  2. Second, you can deduct away from home travel expenses-including meals and incidentals, but if your employer reimburses your travel expenses your deductions are limited.

Local Transportation Costs

The cost of local business transportation includes rail fare and bus fare, as well as costs associated with use and maintenance of an automobile used for business purposes. If your main place of business is your personal residence, then business trips from your home office and back are considered deductible transportation and not non-deductible commuting.

You generally cannot deduct lodging and meals unless you stay away from home overnight. Meals may be partially deductible as an entertainment expense.

Away From-Home Travel Expenses

You can deduct one-half of the cost of meals (50 percent) and all of the expenses of lodging incurred while traveling away from home. The IRS also allows you to deduct 100 percent of your transportation expenses–as long as business is the primary reason for your trip.

Here’s a list of some deductible away-from-home travel expenses:

  • Meals (limited to 50 percent) and lodging while traveling or once you get to your away-from-home business destination.
  • The cost of having your clothes cleaned and pressed away from home.
  • Costs for telephone, fax or modem usage.
  • Costs for secretarial services away-from-home.
  • The costs of transportation between job sites or to and from hotels and terminals.
  • Airfare, bus fare, rail fare, and charges related to shipping baggage or taking it with you.
  • The cost of bringing or sending samples or displays, and of renting sample display rooms.
  • The costs of keeping and operating a car, including garaging costs.
  • The cost of keeping and operating an airplane, including hangar costs.
  • Transportation costs between “temporary” job sites and hotels and restaurants.
  • Incidentals, including computer rentals, stenographers’ fees.
  • Tips related to the above.

Entertainment Expenses

There are limits and restrictions on deducting meal and entertainment expenses. Most are deductible at 50 percent, but there are a few exceptions. Meals and entertainment must be “ordinary and necessary” and not “lavish or extravagant” and directly related to or associated with your business. They must also be substantiated (see below).

Your home is considered a place conducive to business. As such, entertaining at home may be deductible providing there was business intent and business was discussed. The amount of time that business was discussed does not matter.

Reasonable costs for food and refreshments for year-end parties for employees, as well as sales seminars and presentations held at your home are 100 percent deductible.

If you rent a skybox or other private luxury box for more than one event, say for the season, at the same sports arena, you generally cannot deduct more than the price of a non-luxury box seat ticket. Count each game or other performance as one event. Deduction for those seats is then subject to the 50 percent entertainment expense limit.

If expenses for food and beverages are separately stated, you can deduct these expenses in addition to the amounts allowable for the skybox, subject to the requirements and limits that apply. The amounts separately stated for food and beverages must be reasonable.

Deductions are disallowed for depreciation and upkeep of “entertainment facilities” such as yachts, hunting lodges, fishing camps, swimming pools, and tennis courts. Costs of entertainment provided at such facilities are deductible, subject to entertainment expense limitations.

Dues paid to country clubs or to social or golf and athletic clubs however, are not deductible. Dues that you pay to professional and civic organizations are deductible as long as your membership has a business purpose. Such organizations include business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards.

Tip: To avoid problems qualifying for a deduction for dues paid to professional or civic organizations, document the business reasons for the membership, the contacts you make and any income generated from the membership.

Entertainment costs, taxes, tips, cover charges, room rentals, maids and waiters are all subject to the 50 percent limit on entertainment deductions.

How Do You Prove Expenses Are Directly Related?

Expenses are directly related if you can show:

  • There was more than a general expectation of gaining some business benefit other than goodwill.
  • You conducted business during the entertainment.
  • Active conduct of business was your main purpose.

Record-keeping and Substantiation Requirements

Tax law requires you to keep records that will prove the business purpose and amounts of your business travel, entertainment, and local transportation costs. For example, each expense for lodging away from home that is $75 or more must be supported by receipts. The receipt must show the amount, date, place, and type of the expense.

The most frequent reason that the IRS disallows travel and entertainment expenses is failure to show the place and business purpose of an item. Therefore, pay special attention to these aspects of your record-keeping.

Keeping a diary or log book–and recording your business-related activities at or close to the time the expense is incurred–is one of the best ways to document your business expenses.

If you need help documenting business travel and entertainment expenses, don’t hesitate to call us. We’ll help you set up a system that works for you–and satisfies IRS record-keeping requirements.

Can I Deduct Demolition Costs in the Current Year?

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I get this question a lot, in reference to commercial property or residential rental property.  If you demolish a building leaving nothing but the foundation, or even bare land, the answer is no.  But hey, yo u say, I bought this property and it had a structure that I paid for, it was perfectly good, but now it’s gone.    The answer is still no, even though the structure demolished was in great condition.  Think farm house standing in the way of a new development.     If it was so valuable, why did you knock it down?  Because you wanted the land it sat on.  The theory underlying the rules stated below make sense.

In the case of the demolition of any structure, no deduction is allowed to the owner or lessee of the structure for any amount expended for the demolition or any loss sustained as a result of the demolition.   Instead, such amounts are added to the cost of the land on which the structure was located per I.R.C. § 280B. Thus, the tax life of the adjusted basis of the demolished building goes on, now as in nondepreciable land.  Other than a historical building or hazmat removal, the only other rules that might help are those of the “Partial Demolition”safe harbor rules in Rev. Proc. 95-27, 1995-1 C.B. 704. The safe harbor rules require:

  1. Seventy-five percent or more of the existing external walls of the building remain in place as internal or external walls; and
  2. Seventy-five percent or more of the existing internal structural framework of the building remains in place.

But don’t get too excited, if you meet the safe harbor rules, you still don’t get to deduct it this year, it increases the amount you get to depreciate.

The Mortgage Meltdown, Where Did the People Go and “Whole Mortgages”

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We have been living for years now with two ways of getting mortgage loans, going to a loan broker and they find a bank (typically out of your area) to make the loan or going into your local bank directly.   And for years it was  a dirty little secret that those banks sold off those loans to other banks.  But then it got worse, those banks started selling your loan, or even pieces of your loan, to investors.  At the peak of the mortgage crisis, the person you owned the money to was far different than the person you borrowed from.

It is my belief that this distance placed between borrower and lender was the single most important factor that created the meltdown.  Where did the people go? You can point to faulty laws, predatory lending practices, greedy homeowners using their home’s equity like an ATM, but the laws were merely enablers and the green on both sides merely symptoms of this disconnect between borrower and lender.  You used to go to a bank, and talk to a loan officer, and you’d be interviewed by that loan officer and answer serious personal questions in person.  And you’d have to look the loan officer in they eye and answer the question “Why should we give you this loan?”  People today (belonging to what I think of as the entitlement generation) would be offended by such a question.  And in turn, the loan officer had to have the guts to look you in the eye and tell you “no” if they thought you weren’t a good credit risk. And they would submit your loan application to some superior for review and actually have to defend their decision to pass your application on to be considered for a loan.  And trust me, as a former loan officer myself (back in the Jurassic era when dinosaurs roamed the earth) impressions you got during the interview like “this guy comes off as a flake” or “she seems like a honest hardworking person who takes loan obligations very seriously” played a huge part in loan decision making process – especially in the all-to-often case where the decision of yes or no was not obvious.

Technology and the credit score changed all that.  Now you can apply online to virtually any lending in America – they don’t know you, and to you they are just a faceless institution with a web page and and application form.  Or you go to a broker who gets paid to place that loan with that faceless institution.   The broker gets paid by that faceless institution and the broker really couldn’t care less if you pay that loan back, and quite frankly neither does the faceless institution, because they have sold it to another faceless institution that sold it to a faceless mortgage hedge fund.  And they don’t care because it’s backed by Fannie Mae and by the way  – we are too big to fail!

If you don’t pay your loan you wont be getting a phone call from that old fashioned loan officer, nor the person you might have only talked to over the phone when you first made your application if you talked to anybody at all.  Many loans get made where the only person the borrower talks to is the notary who comes to your home or the title officer when it comes time to sign.  Where did the people go.  A borrower will feel bad about not paying someone back who not only they never met, but a faceless nobody who’s probably just a computer anyway.  That loan officer is not going to be knocking on your door (as  I did back in the day) and have to face them when they say “Hey you looked me in the eye and said you were good for this loan!”

And its just the same going the other direction.  In the lending process, you have a right to feel the way Bob Seger sings of in his hit “Feel Like a Number”  – “Feel like a number . . . Feel like a stranger.”   Well you are just a number – its called a credit score.  That credit score replaced the person you are.  You are not that flakey guy or that nice hard working lady with obvious respect for a borrower’s obligation.  Your credit score is supposed to tell them all that information without the decision maker ever having to meet you.  You ARE as stranger.  And the bank is a stranger to you.  And who is a person more likely to do right by, somebody they have met and maybe been referred to by a friend,  or a total stranger.  The total stranger loses every time.

And the credit score became so important that if you had a good credit score (you are that nice hard working lady now) that you would pay them back even though the payment was more than half your take home and don’t bother documenting that take-home income, we believe you (because we’ll sell it to another stranger and we’ll get our money regardless).  And nobody had put the nice hard-working lady to the acid test before.  The temptation for any hard-working man or woman to take advantage of a skyrocketing real estate market to hop aboard and get the house of their dreams before it was priced totally out of reach was too tempting for many.  And then the real estate bubble burst.  NONE of that would have happened if the strangers had become acquaintances that would stay in a relationship that didn’t end until the loan was paid back.

And in all the hullabaloo after the meltdown, the new Dodd-Frank law (in my opinion that was the foxes writing new laws for guarding the hen house) etc., not much has changed.

Well the “people” did not all go away.  There are a few portfolio lenders out there.  The term portfolio lender is a new label for that old-fashioned kind of lender.  A portfolio lender is a bank, etc. that keeps your loan after they make it in their loan “portfolio” – thus the term.  And they actually collect the loans they make.  And if you don’t pay, somebody from that bank will be calling you and saying “Hey, deadbeat.”   What I like about portfolio lenders is a great majority of home loans are made by non-portfolio lenders and they all follow Fannie Mae/Freddie Mac/FHA guidelines.  The wisdom is that these guidelines are so absolutely perfect, that if you don’t fit into these guidelines, you don’t get a loan.  The idea that we are still using the same guidelines that played a huge part in creating the whole mess in the first place astounds me.

Portfolio lenders get it.  At least to some extent.  They follow their own criteria.  Yes they too are creatures of remote application technology and credit scores, but if you don’t fit into those absolutely “perfect” guidelines I just mentioned, they are a source of possible funding.  The most “creative” of these portfolio lenders are what we call “hard money” lenders.   Typically you will pay a huge premium, so much so that they in some ways don’t care if you pay them back because they get great collateral.  But there are banks, etc. doing all or at least some of their lending on a portfolio basis.  None of them are  In the Sacramento area where I live, I have compiled this non-exhaustive clearly partial list of portfolio lenders in no particular order:

  • El Dorado Savings and Loan
  • Folsom Lake Bank
  • River City
  • Five Star Bank
  • American River Bank

So if you need a home loan, or a loan as an investor to buy a rental property, consider looking for a portfolio lender.  These are local banks.  Maybe they too need to become part of the localism movement, like Whole Foods – buy local, sell local.  Maybe we need a new bank – we can call it “Whole Mortgages.”

If you have a kid going to college and w

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If you have a kid going to college and want financial aid, you have to fill out the dreaded FAFSA forms. There is a controversy about whether you have your investment real estate assets. One advisor recommended my client put his two rentals in an LLC. The client thought this sounded fishy and called me.

Business assets are excluded under FAFSA. Real estate assets generally are not. However, if your real estate “enterprise” rises to the level of a trade or business, the theory goes, you exclude them. I think most advisors tell clients that putting the real estate in an LLC makes it a virtual lock on treating it as a business under the rules, others admit it is merely obfuscation, and do it anyway. You’d think you could research this and flesh out the answer with a college finance version of the IRS regulations, but I could find none.

Bottom line – In my opinion, two rentals don’t a business make. I could not recommend my client go throught the bother and cost of setting up an LLC to do something possibly shady.

Written by rpwcpa

August 24, 2012 at 3:07 pm

Posted in Uncategorized