Author: Leon Clinton

I have to share the highlights of this tax case with you.

Steven Hoakison took his case to court, where the IRS asserted that

• Hoakison was a collector of antique tractors, and
• the 40 farm tractors in dispute due to the IRS audit were purchased by Hoakison primarily for personal reasons and served no business purpose.

To push its no-business-purpose position, the IRS noted that 37 of the 40 tractors in dispute were more than 40 years old at the time Hoakison purchased them and that there “is obviously an element of nostalgia” involved because the tractors were similar to those he used while growing up. (Some of the tractors were over 75 years old.)

The IRS further asserted that Hoakison could not actually have needed the number of tractors reported for the years at issue because the work performed by each of the newly acquired 29 tractors could also have been performed by the existing 17 tractors.

(Yes, this totals 46 tractors. We are focusing on the 40 that the IRS wants to disallow.)

How the Court Ruled

The court noted that

• although Hoakison could have performed the same work with the 17 original tractors, that fact is not relevant to the deductibility of the newly acquired tractors; and
• the only requirement for the newly-acquired-older tractors (the 40 tractors in dispute with the IRS) is that they be used in Hoakison’s farm business—which they were.

Thus, the court ruled for Hoakison.

The IRS brought up the antique issue. The court allowed the tractor deductions based on use in the business and in its ruling cited both the Simon and Liddle antique music instrument cases.

Key point. The Hoakison case involved an Iowa farmer outside the Second and Third Circuit Courts of Appeal, where precedent from the Simon and Liddle cases did not have to be followed. But the court did follow both the Simon and Liddle cases and cited them as authority.

Most everyone operates their business differently. The key to business assets and their deductions is how you use the assets.

If you are considering antiques for use in your business as business assets and would like to discuss them, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 11, 2023

The real estate boom appears to be over for now.

Morgan Stanley predicts that house prices could fall by 10 percent by the end of 2024, perhaps twice as much in a worst-case scenario. Homeowners who purchased their homes at the top of the market could be in trouble, especially if the U.S. falls into a recession.

No homeowner wants to go through foreclosure and its credit rating destruction. Fortunately, there is an alternative: a short sale.

In a short sale, homeowners sell their home in a regular sale through a real estate agent for less than the amount of their mortgage. The lender accepts the sale proceeds, releases the mortgage lien on the property, and typically writes off the remainder of the loan as an uncollectible debt.

Lenders agree to short sales only where it’s clear that

• the home is worth less than what the homeowner owes, and
• the homeowner is financially unable to keep up the mortgage payments due to job loss, health issues, death, or other hardship circumstances.

Typically, a short sale involves forgiveness of part of the mortgage debt owed by the homeowner. Debt forgiveness can constitute taxable income to the borrower. Whether the debt forgiven in a short sale is taxable income depends on several factors, including whether

• the mortgage is a recourse or a non-recourse loan,
• the forgiven debt qualifies for the qualified principal residence indebtedness exclusion, or
• the homeowner was insolvent at the time of the debt cancellation.

Forgiveness of a non-recourse loan (a loan for which the borrower is not personally liable) does not result in taxable income to the borrower. Twelve states allow only non-recourse home loans.

But recourse loans are standard practice in the other 38 states.

Fortunately, for underwater homeowners who have recourse loans, Congress passed the Mortgage Forgiveness Debt Relief Act in 2007. Thanks to this law, up to $750,000 of “qualified principal residence indebtedness” forgiven by a lender is excluded from tax. This exclusion remains in effect through 2025 and applies only to debt to acquire or build the taxpayer’s principal residence.

Homeowners who don’t qualify for the qualified principal residence indebtedness exclusion can still avoid paying tax on their canceled indebtedness if they were insolvent when the debt was canceled. Taxpayers are insolvent if their total liabilities exceed the fair market value of all their assets immediately before the debt cancellation. It’s likely that most homeowners who can get their lenders to agree to a short sale qualify as insolvent.

If you have questions about short sales, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• February 3, 2023

Do you owe self-employment tax on Airbnb rental income?

That’s a good question.

In Chief Counsel Advice (CCA) 202151005, the IRS opined on this issue.

But before we get to what the IRS said, understand that the CCA’s conclusions cannot be cited as precedent or authority by others, such as you or your tax professional.

Even so, we always consider what the CCA says as semi-useful information, so here’s some analysis that goes beyond what the IRS came up with.

The Exact Question

To be specific, the CCA asks whether net income from renting out living quarters is excluded from self-employment income under Section 1402(a)(1) of our beloved Internal Revenue Code when you’re not classified as a real estate dealer.

If excluded under IRC Section 1402(a)(1), you don’t owe self-employment tax on your net rental income. Needless to say, that’s the outcome you want to see, and I’m here to help.

The taxpayer addressed in this CCA was an individual who owned and rented out a furnished beachfront vacation property via an online rental marketplace (such as Airbnb or VRBO).

The taxpayer provided kitchen items, linens, daily maid service, Wi-Fi, access to the beach, recreational equipment, and prepaid vouchers for ride-share services between the rental property and a nearby business district.

The CCA’s Conclusions

According to the CCA, when you’re not a real estate dealer, net rental income from renting out living quarters is considered rental from real estate and is therefore excluded from self-employment income—as long as you don’t provide services to rental occupants.

The self-employment income exclusion for net rental income collected by a non-dealer is a statutory provision. The statute itself doesn’t say anything about providing services.

But IRS regulations state that providing services to renters can potentially cause you to lose the exclusion from self-employment income.

According to the CCA, you must include the net rental income in calculating your net self-employment income—which could cause you to owe the dreaded self-employment tax (ugh!)—if you provide services to renters and the services

• are not clearly required to maintain the living quarters in a condition for occupancy and
• are so substantial that compensation for the services constitutes a material portion of the rent.

So, according to the CCA, determining whether providing services to renters will trigger exposure to the self-employment tax is the big issue for folks who rent out living quarters.

The CCA’s anti-taxpayer conclusion rests on the giant assumption that the services provided by the taxpayer were above and beyond what was required. But were they? Probably not!

The Customarily Issue

According to IRS regulations, services are generally considered above and beyond the norm only if they exceed the services that are customarily provided to renters of living quarters.

Therefore, services that simply maintain a vacation rental property in a condition that is customary for rental occupancy should not be considered above and beyond and therefore should not trigger exposure to the self-employment tax.

In assessing whether services provided to renters are above and beyond what’s customary, circumstances obviously matter.

In the real world of vacation rentals in expensive resort areas, renters customarily expect and receive lots of services that might be considered above and beyond in other circumstances.

For instance, in resort areas, renters customarily expect and receive cable service; Wi-Fi access; periodic housekeeping services, including changing bedding and towels; repair of failed appliances; replacement of burned-out lightbulbs; replacement of dead smoke alarm batteries; access to recreational equipment such as bicycles, kayaks, beach chairs, umbrellas, and coolers; and so forth and so on. That’s a lot of services!

Why are lots of services provided in expensive resort areas? Because rental charges in expensive resort areas are—wait for it—expensive! The cost may be $2,000 or more per week or $5,000 or more per month, or even higher during peak periods—maybe much higher! So, rental amounts that could be attributed to the provision of all the aforementioned services would almost always be a small fraction of the overall rental charges.

In the context of expensive resort area vacation rentals, it’s hard to imagine what services would be so above and beyond the norm that the property owner’s net rental income would be exposed to the self-employment tax.

It shouldn’t matter if the services are provided directly by the owner of the property (unlikely) or indirectly by a rental management agency and included as part of the fee paid by the owner of the property (likely).

The Substantiality Issue

In assessing whether services provided to renters are above and beyond the norm, substantiality also matters.

A Tax Court decision addressed a situation where the taxpayer rented out trailer park spaces and furnished laundry services to tenants. The laundry services were clearly provided for the convenience of the tenants and not to maintain the trailer park spaces in a condition for rental occupancy. Tenants were not separately billed for the laundry services, and they were not separately paid for.

The Tax Court concluded that any portion of the rental payments that was attributable to the laundry services was not substantial enough to trigger exposure to the self-employment tax. Accordingly, the Tax Court opined that all of the trailer park owner’s net rental income was excluded from self-employment income.

As stated above, in the context of the rental of expensive vacation properties, any portion of rental charges that could be attributed to the provision of services would likely be insubstantial in relation to the overall rental charges. If so, according to the Tax Court, the provision of such services would not expose the property owner to the self-employment tax.

If you would like to discuss your rental property and your exposure to the self-employment tax, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• January 31, 2023