Does Renting My Home for Two Months Kill the $500,000 Exclusion?

Here’s how renting out your home while you take a two-month
vacation interacts with your ability to use the $500,000 home-sale exclusion
($250,000 if single).

Remember, you have to use the home as a home for two of the
five years before sale to qualify for the home-sale exclusion.

Exclusion Rule

The tax code allows you to exclude from gross income up to
$500,000 of gain (joint return, $250,000 if single) from the sale or exchange
of your home if

• during the five-year period ending on the date of the sale
  or exchange
• such property has been owned by you or your spouse for
  periods aggregating two years or more and
• used by both you and your spouse as your principal
  residence for periods aggregating two years or more.

Planning note. The ownership and use periods do not
have to be the same.

Vacation Rule

Here’s what the IRS said in an example that fits the vacation
activity:

Taxpayer E purchases a house on February 1, 1998, that he
uses as his principal residence. During 1998 and 1999, E leaves his residence for
a two-month summer vacation.

E sells the house on March 1, 2000.

Although, in the five-year period preceding the date of
sale, the total time E used his residence is less than two years (21 months),
the section 121 exclusion will apply to the gain from the sale of the residence
because, under paragraph (c)(2) of this section, the two-month vacations are
short temporary absences and are counted as periods of use in determining
whether E used the residence for the requisite period.

To summarize, E was living in the house for 21 months and on
vacation for four months, giving him a total of 25 months. To take advantage of
the $500,000 home-sale exclusion, E had to use the home for 24 months or more. The
IRS says he meets the 24-month rule because his vacation time counts as use of
the home as a home.

Rental

Your home is going to be a home under the vacation-home
rules when you use it as your home for a number of days that exceeds the
greater of

• 14 days, or
• 10 percent of the number of days during such year for
  which such unit is rented at a fair rental.

Example. You rent the home for 60 days and live in it
for 305 days. Your home is a home under the vacation-home rules because your
personal use is greater than 14 days and greater than six days (60 x 10
percent).

At the end of the year, you need to tally the rents you
received and allocate the home expenses to the rental based on the ratio of
rental days to personal days.

If you have a tax loss on the rental part, it’s not
deductible against other income, but all is not lost. The law allows you to
carry over any losses to the next tax year, when they again become available
against your home-rental activity.

If you have a situation or expect a situation that involves
the renting of your home while you are on a one- to two-month vacation and want
my insights, please call me on my direct line at 408-778-9651.

Five Answers to Spending the PPP Money on Your and Your Employees

If you report your business income and expenses on Schedule
C of your Form 1040, your PPP loan forgiveness is straightforward, as you see
in the four answers below.

1. Paying Myself

Question. I know that I can achieve full forgiveness based
solely on my 2019 Schedule C income in 10.8 weeks under the 24-week program. Do
I have to pay myself every week for 10.8 weeks?

Answer. No. Let’s say your PPP loan is for $20,000.
You could, for example, take $20,000 out of your business account in one lump
sum and put that in your personal savings anytime during the 10.8-week period
and then apply for forgiveness in week 11.

Because both your loan and forgiveness are based on your
2019 Schedule C net profit (yes, last year), you simply need to use the loan
money for personal purposes. This is how you pay yourself and obtain loan
forgiveness the easy way.

Sure, you need to use only 60 percent of the proceeds for
yourself and could use 40 percent for interest, rent, and utilities. But think
about it:

• Pay yourself only: simply paperwork.
• Pay interest, rent, and utilities: more rules and
  paperwork.

Keep it simple. Don’t make yourself suffer.

2. Waiting to Spend

Question. Can I wait a number of weeks before I spend
my loan proceeds?

Let’s say I receive the PPP proceeds on August 1, 2020. Can I
use the 24-week period and start on August 17, for 11 weeks? Would that be
okay? And would it be eligible for forgiveness?

Answer. Yes, no problem. But let’s be clear:

·
For PPP loans made on June 5 or later, the 24-week covered period
is the rule (there’s no “can” here—no eight-week possibility).

·
There’s no requirement that a Schedule C taxpayer spread out the
payments.

·
There’s no payroll or other impediment here.

3. Spending in Chunks

I am a Schedule C taxpayer with no employees. My PPP loan
amount was deposited into my business checking account on May 19, 2020. I am
not electing the eight-week covered period. Instead, I am choosing the 24-week
covered period, which ends on November 2, 2020.

I have two questions.

Question 1. Can I write one check for every four weeks
of payroll and deposit it in my personal checking account?

Answer 1. Yes—but this is not a payroll check. As a
Schedule C taxpayer with no employees, you have no payroll. Your PPP loan was
based on your 2019 net profit. And your forgiveness will be based on the same
amount. You don’t need to spread out your payments.

Question 2. Does this check have to be cashed within
that four-week period, or if it is written within that period, is that
sufficient to apply for forgiveness?

Answer 2. In general, your check is a payment on the
date it is written. Because you are dealing with yourself, you should ensure
that the check is cashed soon after it is written.

Also, we don’t see any wisdom (in fact, just the opposite)
in writing the check within the 24 weeks and then cashing it outside the 24
weeks.

4. Got the PPP Money but
Had a Loss in 2019

Question. I am a Schedule C filer, ran at a loss in
2019, but withdrew $120,000 from the business as the business increased its debt
position.

I used my draw amount to obtain a $120,000 PPP loan before
the guidance was issued on how sole proprietors should calculate their pay.

If the business now has two employees, can both of those
employees be used for the forgiveness application?

Answer. Yes, you can use the two employees on the
forgiveness application, and you can use 24 weeks of pay. In addition to
payroll, 40 percent of the forgiveness can come from interest, rent, and
utilities.

Example. Say the two-employee payroll for the 24
weeks totals $60,000 and the interest, rent, and utilities total $30,000. You would
achieve $90,000 of forgiveness.

If you would like my assistance with your forgiveness
application, don’t hesitate to call me on my direct line at 408-778-9651.

All About Limited Liability Companies (LLC)

Limited liability companies (LLCs) are a popular choice of
entity for small businesses and investment activities.

LLC owners are called members.

·
Single-member LLCs have one owner,
although spouses who jointly own an LLC in a community property state can elect
treatment as a single member LLC for federal income tax purposes.

·
We will call LLCs with two or more
members multimember LLCs.

Key point: LLCs are not corporations. But LLCs can
offer similar legal protection to their members (owners).

Here are the most important things to know about LLCs.

LLCs Offer Legal
Protection

Using an LLC to conduct a business or investment activity generally
protects your personal assets from LLC-related liabilities—similar to the legal
protection offered by a corporation.

As you know, liabilities can arise from simple things—like
the Federal Express guy slipping on the banana peel someone left on your front
steps—or in seemingly endless and complicated ways if you have employees.

Key point. As a general rule, no type of entity
(including an LLC) will protect your personal assets from exposure to
liabilities related to your own professional malpractice or your own tortious
acts.

Tortious acts are wrongful deeds other than by breach
of contract—such as negligent operation of a motor vehicle resulting in
property damage or injuries. The issue of liability protection offered by an
LLC is a matter of state law. Seek advice from a competent business attorney
for details.

Single-Member LLC Tax
Basics

Single-member LLC businesses owned by individuals are
treated as sole proprietorships for federal income tax purposes unless you elect
to treat the single-member LLC as a corporation.

In other words, the default federal income tax
treatment for a single-member LLC business is sole proprietorship status. Under the default
treatment, you simply report all the single-member LLC’s income and expenses on
Schedule C of your Form 1040.

If the single-member LLC business
activity generates net self-employment income, you will report that on Schedule
SE of your Form 1040.

Rental. If the single-member LLC activity is a rental
activity, you report the rental income and expenses on Schedule E of your Form
1040.

Farm or ranch. You report the numbers for a farming
or ranching activity on Schedule F.

Simple. You don’t need to file a separate federal
income tax return for the single-member LLC. And other things being equal,
simple is good.

Three key points

1.
The big federal income tax
advantage of operating as a single-member LLC is extreme simplicity.

2.
The big non-tax advantage is
liability protection, under applicable state law.

3.
As mentioned, you can elect to
treat a single-member LLC as a corporation for federal income tax purposes, but
we don’t recommend that, for reasons we explain later.

Multimember LLC Tax Basics

Multimember LLCs are treated as partnerships for federal
income tax purposes unless you elect to treat the LLC as a corporation.

In other words, the default federal income tax
treatment of a multimember LLC is partnership status. Under
the default treatment, you must file an annual partnership federal income tax
return on Form 1065.

From the Form 1065 partnership return, the LLC issues an
annual Schedule K-1 to each member to report that member’s share of the LLC’s
income and expenses. The member then takes those taxable and deductible amounts
into account on the member’s own return (Form 1040 for a member who is an
individual).

The LLC itself does not pay federal income tax. This
arrangement is called pass-through taxation, because the income and
expenses from the LLC’s operations are passed through to the members who then
take them into account on their own returns. (The same pass-through taxation
concept applies to entities set up as “regular” partnerships under applicable
state law.)

Electing to Treat the LLC
as a Corporation for Tax Purposes

You have the option of electing to treat a
single-member LLC or multimember LLC as a corporation for federal income tax
purposes. You do that by filing IRS Form 8832, Entity Classification
Election, to change the default classification of the single-member LLC or
multimember LLC to the new classification as a corporation.

If your desire is to have your LLC treated as an S
corporation, it can elect S corporation status directly using IRS Form 2553, or
it can elect C corporation treatment on Form 8832 and then S corporation
treatment on IRS Form 2553.

While there may be valid non-tax reasons for electing to
treat an LLC as a corporation, we think tax reasons generally dictate against
taking that step.

If you conclude that there are tax advantages to electing
corporate status, why not just actually incorporate your operation in
the first place? That’s simpler. Keeping your tax matters simple is generally
good policy.

Electing corporate status from the LLC could have unintended
tax consequences. For example, you can potentially collect
federal-income-tax-free gains from selling stock in a qualified small business
corporation (QSBC). But you must own shares and hold them for over five years
to cash in on this super-favorable deal. Can an
LLC membership (ownership) interest count as QSBC stock for this purpose?
Apparently not. It’s not stock.

If you are looking for the QSBC stock break, just set up as
a corporation in the first place.

Here’s another example: a special federal income tax break
allows you to annually deduct up to $50,000 of losses from selling eligible
small business stock, or $100,000 if you’re a married joint filer, and treat
the loss as a tax-favored ordinary loss instead of a tax-disfavored capital
loss.

Can an LLC membership interest count as eligible stock for
this purpose? Apparently not. It’s not stock. Avoid the problem—set up as a
corporation in the first place.

If you would like to discuss your entity choices, please
call me on my direct line at 408-778-9651.