Tax

During this COVID-19 pandemic, landlords have two big possible problems:

1. Tenants who can’t pay the rent.
2. Tax losses they can’t deduct.

We’ll start with the tenants and then move on to the rental property tax-loss issues.

For the first time in U.S. history, residential landlords are subject to a sweeping nationwide federal moratorium on evictions for nonpayment of rent through the end of 2020.

There is no moratorium on landlords’ responsibility to pay their bills. Thus, landlords need to prepare for some of the rockiest times in decades.

The Federal Moratorium on Residential Evictions

The Centers for Disease Control and Prevention (CDC) and the Department of Health & Human Services issued the latest federal moratorium on evictions. It is an emergency health measure intended to help prevent the spread of COVID-19.

The CDC order is effective September 4, 2020, through December 31, 2020. The order replaces an eviction moratorium put in place on March 27, 2020, by the Coronavirus Aid, Relief, and Economic Security (CARES) Act that expired July 24, 2020. 

The CDC order generally bars residential landlords from evicting tenants for nonpayment of rent if a tenant’s estimated 2020 income is no more than $99,000 (single) or $198,000 (married, filing jointly).

Unlike the CARES Act moratorium, which applied only to multifamily rental properties with rental subsidies or federally backed mortgages, the CDC order applies to all types of residential rentals: houses, duplexes, apartment buildings, mobile homes, and mobile home spaces. There is no requirement that the rental be federally financed or rent subsidized.

The CDC order does not apply to commercial properties, including motels and hotels. Nor does it apply to guesthouses rented to temporary guests or seasonal tenants—this presumably excludes most Airbnb and similar short-term rentals. 

To prevent an eviction, a tenant need only give the landlord a declaration signed under penalty of perjury providing that the tenant

• has used his or her best efforts to obtain all available government assistance for rent or housing; 
• falls within the income restrictions ($99,000 or $198,000 in income for 2020); 
• is unable to pay the full rent due to substantial loss of household income, loss of work or wages, or extraordinary out-of-pocket medical expenses;
• is using his or her best efforts to make partial payments that are as close to the full rental payments as the tenant’s circumstances permit; and
• would likely become homeless or forced to move into and live in close quarters or a shared living space.

Tenants need not provide their landlord with any proof that the statements in the declaration are true. The CDC has created a form declaration for tenants to use.

There is no time limit on when tenants must provide this declaration to their landlord—they can do so anytime before or after receiving a termination notice.

Individual landlords who violate the CDC order are subject to a fine of up to $100,000 and up to one year in jail, if the violation does not result in a death.

The fine goes up to $250,000 if the violation results in a death (it’s unclear how the government could prove an eviction caused a tenant’s death).

The fines are doubled for organizations such as LLCs, corporations, and REITs.

Help Tenants Get Help

The CDC order requires tenants to seek government aid to help pay their rent. But they need not seek help from nongovernment sources such as churches or private charities.

It is to your advantage to help your tenants obtain such aid. After all, you would like the rent to get paid. And you likely would want to keep the tenant—assuming this is a good tenant. Links to government programs providing financial assistance for renters are available at https://legalfaq.org. 

Work Out a Payment Plan

Try to work out payment plans with struggling tenants. This is in their best interests as well as your own. Be sure to get the terms in writing.

For example, if a tenant’s income has declined by 20 percent, you could agree to accept a 20 percent rent reduction through the end of the year and require the tenant to pay the balance due over 2021. Make it clear that this is a partial rent payment and does not satisfy the tenant’s full rental obligation.

You are under no obligation to offer a tenant a permanent rent reduction or any form of rent forgiveness. 

And keep in mind that your government is not going to reward your generosity. You get no tax deduction or other tax benefit for reducing or forgiving rent. This doesn’t mean you shouldn’t do it. Just don’t expect the tax code to reward your generosity.

Unpaid Rent Is Not Tax-Deductible

Bad news. Unpaid rent is not a tax-deductible rental expense. Rather, it is a debt owed to you by your tenant. You get no tax deduction for the unpaid rent even if tenants never pay the rent they owe.

Good news. On the plus side, unpaid rent is not taxable as income, is not reported on your tax return, and increases the chances that you will have a rental property tax loss (deductible, we hope). This assumes you are a cash-basis taxpayer, as virtually all residential landlords are. 

Deducting Rental Property Tax Losses

You have a rental loss if the total annual expenses you incur for your rentals (mortgage interest, taxes, utilities, insurance, maintenance, depreciation, and other expenses) exceed your total rental income (which does not include unpaid rent).

It’s likely that many landlords who ordinarily have profitable rentals will suffer rental losses for 2020 because their tenants failed to pay all or part of their rent.

The dreaded passive activity loss rules prevent many landlords from deducting all or part of their rental losses from their non-rental income.

Rental losses are always classified as passive losses. Subject to two important exceptions, the general rules are as follows:

• Passive losses are deductible only from passive income—income from rental activities and from businesses in which you do not materially participate.
• Passive losses are not deductible either (a) from ordinary income such as salary and self-employment earnings, or (b) from investment income such as dividends or interest.

Exception 1. $25,000 Allowance for Rental Real Estate

The tax law takes pity on landlords with a relatively modest income and permits them to deduct a limited amount of rental losses from non-rental income.

If your modified adjusted gross income for the year is under $100,000, you may deduct up to $25,000 in total annual rental losses from your nonpassive income, provided that you actively participate in the management of your rentals (an easy standard to meet). 

Exception 2. Real Estate Professional Exemption from Passive Loss Rules

There’s another way you may be able to deduct your rental losses from non-rental income no matter how high your income: the real estate professional exemption from the passive loss rules.

If you qualify as a tax law–defined real estate professional and materially participate in your rental activity, you may treat rental losses as nonpassive and deduct them from all other nonpassive income without limit for 2020. 

Either you or your spouse will qualify as a real estate professional for the year if one of you spends

• more than half your personal service work time in real property trades or businesses in which you materially participate, and
• more than 750 hours of your personal service work and investment analysis time in real property trades or businesses in which you and/or your spouse materially participate.

In addition to the standard described above, you and/or your spouse must materially participate in a rental activity to enable the tax loss deduction against your other income. There are various methods for establishing material participation. The two most common are working more than 500 hours in a tax law–grouped multi-rental activity and working more than 100 hours more than anyone else on individual non-grouped properties.

People with a full-time job outside the tax law–defined real estate industry can rarely qualify as real estate professionals.

Non-deductible Rental Losses Become Suspended Passive Losses

You don’t lose rental losses you can’t deduct because of the passive loss rules. Instead, the losses become suspended passive losses. They are carried forward indefinitely and deducted from passive income each year until they are used up.

You may also deduct your suspended passive losses if you sell or otherwise dispose of substantially all your interest in your rental property in a taxable transaction. 

If you would like my help with your rental properties, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 15, 2020

Do you have a mileage log that will survive an IRS audit? If so, good for you! If not, get ready to give up all (not some, but all) of your vehicle tax deductions for not just one year but three years, as you will see in this true story.

The story is about Therone Johnson, president of Diversified Innovative Products Co, Inc. (Dip Co), a corporation in Colorado that manufactures and sells disposable ink pans for printing presses.

Mr. Johnson and the rest of Dip Co’s management work from home offices because the manufacturing facility does not have enough office space for all of them to work there regularly.

Need for the Mileage Log

Tax code Section 274 imposes strict substantiation requirements for business mileage.

As the court noted in this case, for expenses such as the pickup truck Mr. Johnson used for business purposes, he had to substantiate the following with adequate records or with sufficient evidence corroborating his own statement: 

• The amount of the expense
• Mileage for each business use of the pickup, as well as the total mileage for all purposes during the taxable period 
• The time and place Mr. Johnson used the pickup 
• The business purpose of the use

Planning note. Don’t latch on to the “with sufficient evidence corroborating his own statement” thinking that you have a real alternative to keeping a good mileage log. From the myriad court cases we have read regarding the mileage log, this is an impossible task.

The Outlook Calendar

The primary evidence Mr. Johnson submitted to the court (and previously to the IRS) in support of his claimed travel-related and car and truck expense deductions was a Microsoft Outlook calendar reflecting his travel during the periods at issue, supplemented by his testimony.

He used the calendar for all appointments and events, including those related to his work at the ranch, his work for Dip Co, and his personal activities. 

But many of the entries in his calendar noted only that he traveled to and/or from a ranch; they did not note the purpose for his visit (hay farming business, Dip Co work, property maintenance, or personal).

The Court’s Take on the Calendar

The court noted that without the business purpose information, it could not determine which of Mr. Johnson’s trips were for business purposes as required by tax code Section 162. It then cited various cases that disallowed the expenses because the taxpayer

• could not establish the business purpose for each expense,
• did not differentiate between business travel purposes and personal travel purposes, or
• gave broad testimony and receipts that were insufficient to establish the business purpose of travel.

Ruling

Because the court could not determine that Mr. Johnson’s business use of the truck for Dip Co and the ranch exceeded 50 percent of Mr. Johnson’s total use as required by Section 179, it simply denied the entire Section 179 deduction and the other car and truck expenses for the three years before the court.

Takeaways

The failed mileage log cost Mr. Johnson all of his car and truck deductions, not just in Year Three when he purchased and expensed the pickup truck. Also gone were all his deductions for depreciation of his prior vehicle—and all gas, insurance, and repair deductions for a combined three years.

So the vehicle deduction equation for you is clear: if you want to keep your vehicle deductions, you need a good mileage log.

If you would like my help with your mileage log, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• November 13, 2020

Do you operate your business as an S or a C corporation?

Do you drive a vehicle titled in your personal name for corporate business? 

Beware. The Tax Cuts and Jobs Act (TCJA) changed the rules for tax years 2018-2025.

Before the TCJA, you had to pay attention to the use of your personal vehicle for corporate business in order to avoid losing deductions to the 2 percent miscellaneous itemized deduction rule and the alternative minimum tax. 

But now, because of the TCJA, you face a narrow road during tax years 2018-2025 if you want tax benefits for the corporate business use of your personal vehicle.

Big Picture

1. The personal vehicle used for corporate business is a business vehicle to the extent of corporate use.
2. If you don’t want to lose your rightful tax benefits from your business use, your corporation must reimburse you for your business use.
3. Your corporation may reimburse you using the IRS standard mileage rate or actual expenses.
4. When you trade in or sell the vehicle you used for corporate business, you will report a taxable gain or claim a deductible loss on IRS Form 4797.
5. To obtain your reimbursements from your corporation, you submit expense reports under the accountable plan rules.

Make Sure to Do This

You need a mileage log. The mileage log defines the dollar amount of the corporate reimbursement—regardless of whether you seek reimbursement using (a) actual expenses or (b) the IRS mileage method. The mileage log saves you in an IRS audit.

Accountable Plan

Because your corporation is reimbursing you for your personal vehicle, using either IRS mileage rates or actual expenses, it needs an accountable plan.

Reimbursements from the Corporation

A corporation can reimburse an employee for all expenses allowable under sections 161 to 199 of the tax code—which includes Section 179 expensing and Section 168 bonus and other depreciation. 

Here’s what happens when your corporation properly reimburses you for the expenses:

1. You, as the employee, receive the cash reimbursement from the corporation but do not have taxable income from the reimbursement.
2. The corporation gets the full deduction for the reimbursed expenses.
3. If the corporation is an S corporation, then those expenses reduce the corporate income and the corporation passes that reduced income to you—say, as the sole shareholder of your S corporation.

If you are using a personal vehicle for corporate business, please call me on my direct line at 408-778-9651, because we should discuss what’s required.

• By Leon Clinton
• November 11, 2020