The rules that define real estate activities for tax purposes can be confusing. Is the real estate business you conduct considered passive activity or could you be defined as a real estate professional?
Generally, your deductions for investments in passive activities — business activities in which the taxpayer does not materially participate, such as rental real estate and other classic “tax shelters” — are limited to the annual income from those activities. Thus, you can’t deduct a loss. Any excess losses are suspended and may be carried over to the next year.
However, you may be able to salvage a partial loss tax deduction if you actively participate in a real estate activity. Furthermore, if you prove you’re a real estate professional, you can deduct your losses in full.
Although rental real estate activity is automatically treated as a passive activity, there’s a limited exception for active participants who interview tenants, arrange repairs, etc. In such cases, you may use a loss of up to $25,000 to offset non-passive income. This $25,000 offset is phased out if your modified adjusted gross income (MAGI) is between $100,000 and $150,000.
But real estate professionals don’t face these restraints. If you meet the following two key requirements, you can fully deduct your loss against other highly taxed income without regard to your MAGI.
1. More than half of the personal services you perform in all trades or businesses during the tax year are performed in real estate trades or businesses in which you materially participate.
2. You perform more than 750 hours of services during the tax year in real estate trades or businesses in which you materially participate.
Interestingly, the IRS has contested this classification in court. In one new case, the owner of an insurance company who also owned ten rental properties couldn’t convince the Tax Court that he spent more than half of his time on real estate services (Jones, TC Summary Opinion 2017-6). But a dentist who saw patients only four afternoons a week was able to prove that he spent more time on his four rental units (Zarrinnegar, TC Memo 2017-34).
If you claim to be a real estate professional, recordkeeping is essential. Keep in mind that you do not have to navigate these complex rules alone. Give Carl Heinemann, your Chattanooga CPA, a call. We’re here to help.
Do you help support an elderly relative like your mom or dad? If you meet the two-part test for qualifying relatives, you may claim an “extra” dependency exemption for a loved one, on top of exemptions claimed for your children that you support. Each exemption in 2017 is $4,050.
You’re entitled to take an exemption for a qualifying relative, such as your mother or father, only if you meet both of the following conditions:
1. You provide more than half of that person’s total support for the year.
2. The qualifying person’s gross income for the year doesn’t exceed the personal exemption amount of $4,050.
It’s the second item that often trips up taxpayers because the personal exemption amount is relatively low. Note, however, that this part of the test doesn’t apply to a qualifying child under age 19 or a full-time student under age 24.
On the positive side, while Social Security benefits are treated as support provided by the relative for himself or herself, they don’t count towards the “gross income” part of the test.
Let’s look at a hypothetical example. Assume you pay monthly rent of $1,200 for your mom. She receives $4,000 in annual taxable income from her investments and $10,000 in Social Security benefits. Thus, you provide more than half of her total support — $14,400 — in rent compared to her income of $14,000. Although she receives $10,000 in Social Security benefits, that case excluded, makes her gross income $4,000, which is less than the $4,050 personal exemption. As a result, you can claim the $4,050 dependency exemption for your mom in 2017.
If you’re running just short of the half-support mark for the year, you might increase your support to secure the extra dependency exemption. The support you provide may include food, housing, utilities, medical and dental bills, recreation, and transportation costs.
Finally, be aware that the tax benefits of personal exemptions, including dependency exemptions, are reduced for certain upper-income taxpayers. Contact Carl Heinemann, your Chattanooga CPA, to see if this applies to you.
The dependent care credit may be changed by Congress in the coming years, but you can still take advantage of it now. It offers some surprising benefits that may apply to your situation.
Under current law, the credit may be claimed for the expenses of caring for children under age 13, as long as both parents work. The credit is equal to between 20 percent and 35 percent of your qualified expenses, depending on your income.
The percentage applies to the first $3,000 of qualified expenses for one dependent and $6,000 for two or more dependents. For example, if a couple has an adjusted gross income (AGI) of $150,000 and three young children, the maximum credit they can claim is $1,200 (or 20 percent of $6,000 in expenses).
Typically, the credit is associated with expenses like daycare centers and nurseries, but in-home babysitters may qualify, too. Furthermore, you may claim the credit for childcare expenses paid to a relative who is not your dependent, such as a niece or nephew. You may even claim the credit for childcare expenses provided to your own child, if he or she is over age 18. You may also take a credit for wages paid to a domestic worker who provides other services, like cooking or light household chores related to the care of the qualifying individual.
Perhaps you have plans to send your child to summer camp this year. The cost of day camp also qualifies for the credit (but not overnight camp).
Finally, be aware that the current credit isn’t limited to just childcare expenses. If you incur expenses for the care of a dependent relative, such as an elderly parent, the credit is available with the same limitations discussed above. Give us a call to discuss whether the dependent care credit can be of benefit to you.
If you have a child graduating from college this year, money can be tight as he or she embarks on a career. So it’s often hard to convince your child to set aside money for a retirement date that may be more than 40 years away.
Nevertheless, the sooner a new wage-earner can start saving for retirement, the better, especially when you consider the benefit from tax-deferred compounding within a qualified retirement plan, like a 401(k), or an IRA. What’s more, to your child’s surprise, he or she may be eligible for a little-known tax credit.
This tax break is called the retirement saver’s credit. As you might think, it may be claimed for your contributions to a qualified retirement plan or IRA. But only the first $2,000 of your annual contribution counts toward the credit if you’re a single filer ($4,000 for joint filers).
How much is the credit? That’s tricky because the credit percentage depends on your adjusted gross income (AGI) for the year. For instance, the credit percentages for single filers who make a contribution for 2017 are as follows:
- If your AGI is $18,500 or below, the credit percentage is 50%.
- If your AGI is between $18,501 and $20,000, the credit percentage is 20%.
- If your AGI is between $20,001 and $31,000, the credit percentage is 10%.
Thus, a single filer with an AGI of $30,000 in 2017 is limited to a $200 credit (10% of $2,000).
These thresholds are doubled for joint filers. Although the IRS adjusts the thresholds annually for inflation, movement in recent years has been minimal.
Note that other restrictions may apply. For instance, this credit can’t be claimed by a child who is under age 18, a full-time student, or a dependent on your return. Finally, be aware that the credit is non-refundable, so it cannot reduce your tax bill below zero. If you have questions, we’re here to help. Just call Carl Heinemann, your Chattanooga CPA.
For most people, wealth accumulation is a long-term proposition. If you’re counting on the lottery to fund your retirement or hoping an unforeseen windfall will put your kids through college, it might be time to reconsider. Instead, take a hard look at your current saving and spending habits. Achieving your financial goals requires tangible and specific steps taken day in and day out. By adopting a few simple practices, you can learn to save more and spend less.
- Automate your savings. You’ve heard the expression: “Out of sight, out of mind.” This is a great way to think of your savings. Don’t deposit your entire paycheck into a regular checking account. Direct a portion to a savings account and another portion to a 401(k) or IRA account and then don’t touch them. If you don’t see these amounts in your everyday checking account you’re less likely to spend them.
- Pay off your credit cards every month. For many people those little pieces of plastic are a toxic trap. On average, Americans between the ages of 18 and 65 carry $4,717 of credit card debt. If the average credit card’s interest rate is 15 percent, paying off that debt with the minimum payment of $189 will take more than ten years and cost more than $22,000. To build wealth, join the 35 percent of credit card users who make a habit of paying off their bill each month.
- Curb impulse purchases. Letting emotions rule is a sure way to break the budget, max out your credit cards, and fill your home with unnecessary stuff. Make a list before you shop. Then stick to it. Eat a big meal before buying groceries. You’ll be less likely to let your hunger influence your decisions. Learn to procrastinate on non-essential purchases. If you wait a few days, you may find you don’t really need the item(s).
- Use cash. It may be old fashioned, but paying with currency instead of plastic can short-circuit the urge to buy stuff you don’t need. Studies have shown that paying with a credit card is less painful than paying with cash. As a result, shoppers tend to spend more money when using plastic.
- Pump up your emergency fund. Life happens. Routinely setting aside money in a rainy-day account can relieve stress today and lessen the tendency to use debt when times get tough. How much is enough? Many advisors suggest an emergency fund covering at least three months of living expenses. Automating deposits to an emergency fund is a great way to start.
The concept of spending less and saving more seems simple enough, but it requires changing old habits. If you take on these steps, perhaps one at a time, slowly you will begin to save and be better prepared for unexpected future expenses.
Although most small businesses fail in the first year of operation, business survival rates tend to improve as a company ages. According to the Small Business Administration, about two-thirds of businesses with employees survive at least two years. About half make it through the first five years. You can increase your odds of weathering those initial start-up years by avoiding a few all-too-common mistakes.
- Inadequate planning. Many factors go into your business strategy: the company’s structure, market demographics, capital requirements, and expected cash flow. When it comes to a start-up, it’s all about attention to details. Develop a realistic budget forecast. Research the marketplace, and know what sets your product apart. Family expectations can also be important. Hold frank discussions with family members to avert misunderstandings when business requirements claim more of your time and energy.
- Insufficient cash. Don’t rely on credit cards or bankers to bail you out if cash flows don’t meet expectations. Before opening your doors to the public, establish a cash reserve that’s three times your first year’s estimated need. All sorts of unforeseen expenses can cripple your business while you build your customer base. A healthy cash reserve can make the difference between a viable business and a failure statistic.
- Inflexible management. Adapt your business model to varying conditions. If customers, competitors, or markets change, be willing to change with them. Last year’s tactics shouldn’t be sacrosanct. Experiment and consider new ideas. Evaluate how your product or service is currently addressing market demands. Modify or discard your original idea if it’s clearly failing. As your company grows, don’t be afraid to hire employees who are willing to challenge your long-established strategies.
- Incompetent advice. Don’t assume you can download free online guidance that will address specific legal or accounting issues — it’s worth paying for expertise. Hire a lawyer trained in small business matters. Set up accounting systems with the aid of an accounting expert. If you ever decide to sell your business or are faced with a lawsuit, you’ll be glad you paid for professional legal advice. If you want a clear understanding of your business expenses and tax issues from year to year, don’t scrimp on accounting expertise. And remember to schedule regular consultations with your experts to ensure the company stays on track.
Starting a business is never easy. Learning from the mistakes of other start-ups may help your business grow successfully through the most challenging early years.