Tax

Tax rules on rental income from second homes can be complicated, particularly if you rent the home out for several months of the year, but also use the home yourself. There is, however, one provision that is not complicated. Homeowners who rent out their property for 14 or fewer days a year can pocket the rental income, tax-free.

In other words, if you live close to a vacation destination such as the beach or mountains, you may be able to make some extra cash by renting out your home (principal residence) when you go on vacation–as long as it’s two weeks or less. Although you can’t take depreciation or deduct for maintenance, you can deduct mortgage interest, property taxes, and casualty losses on Schedule A (1040), Itemized Deductions.

In general, however, income from rental of a vacation home for 15 days or longer must be reported on your tax return on Schedule E, Supplemental Income and Loss. Your rental income may also be subject to the net investment income tax. You should also keep in mind that the definition of a “vacation home” is not limited to a house. Apartments, condominiums, mobile homes, and boats are also considered vacation homes in the eyes of the IRS.

Furthermore, the IRS states that a vacation home is considered a residence if personal use exceeds 14 days or more than 10 percent of the total days it is rented to others (if that figure is greater). When you use a vacation home as your residence and also rent it to others, you must divide the expenses between rental use and personal use, and you may not deduct the rental portion of the expenses in excess of the rental income.

Example: Let’s say you own a beach house (your “second home”) and rent it out during the summer between mid-June and mid-September. You and your family also vacation at the house for one week in October and two weeks in December. The rest of the time the house is unused.The family uses the house for 21 days, and it is rented out to others for 121 days for a total of 142 days of use during the year. In this scenario, 85 percent of expenses such as mortgage interest, property taxes, maintenance, utilities, and depreciation can be written off against the rental income on Schedule E. As for the remaining 15 percent of expenses, only the owner’s mortgage interest and property taxes are deductible on Schedule A.

Tax Reform and Vacation Rentals

Under tax reform, a homeowner is limited to writing off a maximum of $750,000 in mortgage interest. If you own a second home as well, the interest from the two properties combined could exceed the $750,000 cap. In addition, property tax deductions (combined with state income taxes) are capped at $10,000. If you do not rent out your second home, you could be losing out deductions (taxes and mortgage interest) that lower your taxable income. Therefore, it is prudent to consider renting out your second home as a vacation rental since you would then be able to deduct these expenses and possibly others such as Homeowners Association fees, maintenance expenses, and utilities. Furthermore, you can still use the home 14 days a year (more if you are staying there for home maintenance-related activities) and deduct these expenses. Even if you use it more than 14 days a year, you are still able to deduct these expenses proportional to the amount of rental use.

Questions about vacation home rental income?

Tax laws are complicated, and tax reform made it even more so. If you have any questions about renting out your second home or any other tax matters, please call.

• By Leon Clinton
• July 10, 2018

As a small business owner, figuring out which form of business structure to use when you started was one of the most important decisions you had to make; however, it’s always a good idea to periodically revisit that decision as your business grows.

For example, as a sole proprietor, you must pay a self-employment tax rate of 15% in addition to your individual tax rate. Electing to S-Corporation status could allow you to take advantage of a lower tax rate for a number of reasons.

What is an S-Corporation?

An S-Corporation (or S-Corp) is a regular corporation whose owners elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax (and sometimes state) purposes. That is, an S-corporation is a corporation or a limited liability company that’s made a Subchapter S election (so named after a chapter of the tax code). Rather than a business entity per se, it is a type of tax classification. Shareholders then report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates, which allows S-corporations to avoid double taxation on corporate income. S-corporations are, however, responsible for tax on certain built-in gains and passive income at the entity level.

To qualify for S-corporation status, the corporation must submit a Form 2553, Election by a Small Business Corporation to the IRS, signed by all the shareholders, and meet the following requirements:

• Be a domestic corporation
• Have only allowable shareholders. Shareholders may be individuals, certain trusts, and estates but may not be partnerships, corporations or non-resident alien shareholders.
• Have no more than 100 shareholders
• Have only one class of stock
• Not be an ineligible corporation (i.e. certain financial institutions, insurance companies, and domestic international sales corporations).

What are the Tax Advantages of an S-Corp?

1. Personal Income and Employment Tax Savings

S-corporation owners can choose to receive both a salary and dividend payments from the corporation (i.e., distributions from earnings and profits that pass through the corporation to you as an owner, not as an employee in compensation for your services). Dividends are taxed at a lower rate than self-employment income, which results in a lower tax bill. S-corp owners also save on Social Security and Medicare taxes because their salary is less than it would be if they were operating a sole proprietorship, for instance.

The split between salary and dividends must be “reasonable” in the eyes of the IRS, however, e.g., paying self-employment tax on 50% or less of profits or a salary that is in line with similar businesses. Furthermore, some S-corp owners may be able to take advantage of the 20% deductions for pass-through entities as well, thanks to tax reform.

2. Losses are Deductible

As a corporation, profits and losses are allocated between the owners based on the percentage of ownership or number of shares held. If the S-corporation loses money, these losses are deductible on the shareholder’s individual tax return. For example, if you and another person are the owners and the corporation’s losses amount to $20,000, each shareholder takes the $10,000 as a deduction on their tax return.

3. No Corporate Income Tax

Although S-corps are corporations, there is no corporate income tax because business income is passed through to the owners instead of being taxed at the corporate rate, thereby avoiding the double taxation of C-corporations, which occurs when dividend income is taxed at both the corporate level and at the shareholder level.

4. Less Risk of Audit

In 2014, S-corps faced an audit risk of just 0.42% compared to Schedule C filers with gross receipts of $100,000 who faced an audit rate of 2.3%. While still low, individuals filing Schedule C (Profit or Loss from Business) are at higher risk of being audited due to IRS concerns about small business owners underreporting income or taking deductions they shouldn’t be taking.

Questions?

Whether you keep your existing structure or decide to change it to a different one, keep in mind that your decision should always be based on the specific needs and practices of the business. If you have any questions about electing S-Corporation status or are wondering whether it’s time to choose a different business entity altogether, don’t hesitate to call.

• By Leon Clinton
• July 6, 2018

Under tax reform, individuals who itemize should be aware that deductions they may have previously counted on to reduce their taxable income have disappeared in 2018. Here are five of them.

1. Moving Expenses

For tax years 2018 through 2025, moving expenses are no longer deductible unless you are a member of the Armed Forces on active duty who moves because of a military order. Prior to tax reform (i.e., for tax years starting before January 1, 2018), taxpayers could deduct expenses related to moving for a job as long as the move met certain IRS criteria.

2. Unreimbursed Job Expenses

For tax years starting in 2018 and expiring at the end of 2025, miscellaneous unreimbursed job-related expenses that exceed 2% of adjusted gross income (AGI) are no longer deductible on Schedule A of Form 1040. Examples of unreimbursed job-related expenses include union dues, continuing education, employer-required medical tests, regulatory and license fees (provided the employee was not reimbursed), and out-of-pocket expenses paid by an employee for uniforms, tools, and supplies.

3. Tax Preparation Fees

Tax preparation fees, which fall under miscellaneous fees on Schedule A of Form 1040 and are also subject to the 2% floor, have been eliminated for tax years 2018 through 2025. Tax preparation fees include payments to accountants, tax prep firms, as well as the cost of tax preparation software.

4. Personal Exemptions

Repealed for tax years 2018 through 2025, the personal exemption enabled individual taxpayers to reduce taxable income by $4,050 (in 2017). Each household dependent was entitled to the deduction as well. While the standard deduction did increase significantly ($12,000 for individuals, $24,000 for married taxpayers filing jointly, $18,000 for heads of household), some taxpayers may still lose out.

5. Subsidized Parking and Transit Reimbursements for Employers

Before tax reform, employees could take advantage of a perk offered by many employers whereby parking and transit pass costs (up to $255 per month) were reimbursed by their employers tax-free (i.e., not included in the employee’s taxable income). These amounts were deductible to companies on their tax returns; however, for tax years 2018 through 2025, the deduction is no longer available leading to the possibility that some employers to stop reimbursing their employees for parking and transit costs.

Help is just a phone call away.

Don’t hesitate to call the office if you have any questions about tax reform and how it affects your particular tax situation.

• By Leon Clinton
• July 3, 2018