Thinking of Renting Out Your Vacation Home?

Oakland Tax Attorneys

If you own a home in a vacation locale – whether it is your primary residence or a vacation home – and are considering renting it out to others, there are complicated tax rules, referred to as the “vacation home rental rules,” that you need to be aware of.

Generally, the tax code breaks a “vacation rental” into three categories, each with a different treatment for income and expenses:

  • Rented Less Than 15 Days – If you rent your home for less than 15 days during the tax year, the tax code says that you do not need to report the income and you can still deduct 100% of the property taxes and qualified mortgage interest as an itemized deduction. Yes, you heard me correctly: the government is actually allowing you to ignore the income, regardless of the amount, if you rent the home for less than 15 days during the year. This rule offers some opportunities for substantial tax-free income, especially for more expensive homes. Here are some examples:
    • Rental as a film location – typically, film production companies will pay substantial amounts (thousands per day) for the short-term use of homes as movie sets. Individuals with unique properties can register with a local film location company.
    • Home in a vacation locale – individuals with homes in a popular tourist or vacation locales can rent their homes out to vacationers in their area while they are on vacation themselves.
    • Home in the area of a special event – when a one-time or special event such as a major sports event (think the Super Bowl) or convention comes to town, hotel rooms may be scarce or even fill up. Homeowners in these locations may want to rent their homes short-term during the activity while getting out of town to avoid the crowds.

However, be careful; if the rental goes over 14 days, the income is no longer tax-free. When calculating the number of days, the definition of a day is generally “the 24-hour period” for which a day’s rental would be paid. Thus, a person using a dwelling unit from Saturday afternoon through the following Saturday morning would generally be treated as having used the unit for seven days even though the person was on the premises on eight calendar days.

  • Rented 15 Days or More – When the home is rented 15 days or more, the income must be reported. However the tax treatment depends upon how many days you used the home personally:
    • Personal Use More Than 10% of the Rental Days – If your personal use of the home totals more than 10% of the rental days, the expenses are allocated according to personal versus rental days. In figuring your rental profit, the expenses must be deducted in the following order: allocated taxes and interest first, then maintenance and other cash expenses, and, finally, depreciation. However, the net result is limited to zero; i.e., a loss cannot be claimed.
    • Personal Use 10% or Less of the Rental Days – If your personal use of the home totals 10% or less of the rental days, the expenses are allocated according to personal versus rental days in the same manner as when the personal use exceeds 10% except that a loss is allowed, but the loss cannot include any amount attributed to depreciation.

When figuring the personal use days, include days used by an owner, co-owner, or family member of the owner/co-owner and days used under a reciprocal arrangement. However, you can exclude “fix-up” days, which are days spent repairing and maintaining the property.

Assisting Your Child in Buying a Home

Oakland Tax Attorneys

If you are a parent who wants to assist your child in obtaining his or her first home, there are a number of ways you can help.

  1. Help with the down payment – Real estate lending laws generally will not allow the parents to loan the down payment on the home, since that is considered part of the debt. However, you can make an outright gift of the down payment. Just keep in mind that to avoid reducing your lifetime gift tax exclusion and filing a gift tax return, the gift cannot exceed the annual $13,000 gift tax exemption. If you are married, the limit could double to $26,000 since both you and your spouse are allowed a separate $13,000 exemption. If your child is married, the gift limit could double again to $52,000, since the annual exemption limit applies to each donee, not the donor.
  2. Buy the house in your name – Let your child make payments to you in order to buy the property. Over time, in most cases, the property will have appreciated enough in value to provide the necessary equity required for your child to obtain a favorable bank loan.
  3. Slowly gift the home to the child – If you are financially secure, you could purchase the home and then gift a portion of the property to your child each year. By making these gifts over a period of time, you are able to take advantage of the annual gift tax exemption rules.

Sometimes, an elderly parent will transfer the title to their home to their children. Although this might seem to be a good idea at the time, it generally is not for the following reasons:

  • If the home title is transferred to a child while the parent is still living, it constitutes a gift and a gift tax return will generally need to be filed.
  • The tax basis (point from where gain or loss is measured) will be the parent’s basis. Had the child, instead, inherited the home, the child’s basis would be the fair market value of the home at the parent’s date of death, which means the child would have no taxable gain if the home is immediately sold. On the other hand, if the home had been previously gifted to the child, the gain would be measured from the parent’s basis.

Eldercare as a Medical Deduction?

Oakland Tax Attorneys: Ainer & Fraker, LLP

With people living longer, many individuals find themselves becoming the care provider for elderly parents, spouses and others who can no longer live independently. When this happens, questions always come up regarding the tax ramifications associated with the cost of nursing homes or in-home care. 

Generally, the entire cost of nursing homes, homes for the aged, and assisted living facilities are deductible as a medical expense if the primary reason for the individual being there is for medical care or the individual is incapable of self-care. This would include the entire cost of meals and lodging at the facility. On the other hand, if the individual is in the facility primarily for personal reasons, then only the expenses directly related to medical care would be deductible, and the meals and lodging would not be a deductible medical expense.

As an alternative to nursing homes, many care providers are hiring day help or live-in employees to provide the needed care at home. When this is the case, the services provided by the employees must be allocated between household chores and deductible nursing services. To be deductible, the nursing services need not be provided by a nurse so long as the services are the same services that would normally be provided by a nurse, such as administering medication, bathing, feeding, dressing, etc. If the employee also provides general housekeeping services, then the portion of the employee’s pay attributable to household chores would not be a deductible medical expense.

Household employees, like other employees, are subject to Social Security and Medicare taxes, and it is the responsibility of the employer to withhold the employee’s share of these taxes and to pay the employer’s payroll taxes. Special rules for household employees greatly simplify these payroll withholding and reporting requirements and allow the Federal payroll taxes to be paid annually in conjunction with the employer’s individual 1040 tax return. Federal income tax withholding is not required unless both the employer and the employee agree to withhold income tax, but the employer is still required to issue a W-2 to the employee and file the form with the Federal government. A Federal Employer ID Number and a state ID number must be obtained for reporting purposes, and most states have special provisions for reporting and paying state payroll taxes on an annual basis similar to the Federal reporting requirements. Note: if the caregiver is hired through an agency, generally the agency is considered the employer.

To the extent the payroll taxes are for deductible nursing services, the employer’s portion of those taxes is also deductible as a medical expense.

Is a Reverse Mortgage Right for You?

San Jose Tax Attorneys

In recent months, we have seen a growing number of celebrities on TV promoting reverse mortgages. In today’s economy, many retirees are faced with mounting debt and inadequate incomes. For many, their home is their most valuable, and perhaps only, asset, but it is also their home and they really don’t want to sell it.

An option is the “reverse mortgage,” which allows homeowners to borrow against the equity they have built up over the years. The loan is not due until the homeowner passes away or moves out of the home. If the homeowner dies, the heirs can pay off the debt by selling the house, and any remaining equity goes to them. If at that time the loan balance is equal to or more than the value of the home, the repayment amount is limited to the home’s worth.

To be eligible for this loan, the borrower must be at least 62 years of age and have equity in the home. The loan amount will depend on factors such as the borrower’s age, the value of the home, interest rates and the amount of equity built up. The borrower has the option of taking the loan as a lump sum, a line of credit or as fixed monthly payments. In addition, the money can be used for any purpose, without restrictions imposed.

Reverse mortgages are considered loan advances and not income, so the amount received is not taxable. The interest accrued on a reverse mortgage is not deductible until it is actually paid, which in most cases is when the loan is fully paid off. The interest deduction may also be limited by the general home mortgage deduction rules.

A reverse mortgage can help provide financial security to many seniors so that they can live a comfortable life. But individuals are cautioned to explore other alternatives as well before entering into a reverse mortgage. It may be a solution for some, but not necessarily a panacea for all. If you are struggling with your finances, carefully explore your options, including the possibility of a reverse mortgage.

How Much Could You Save?

Saratoga Tax Attorneys

Taxpayers frequently ask what benefit is derived from a tax deduction. Unfortunately, there is no straightforward answer. The reason the benefit cannot be determined simply is because some deductions directly reduce gross income, while others must be itemized, must exceed a threshold amount before being deductible, or are not deductible for alternative minimum tax purposes. Meanwhile, business deductions can offset both income and self-employment tax. In other words, there are many factors to consider, and the tax benefits differ for each individual, depending on his or her particular situation.

For most non-business deductions, the savings are based upon your tax bracket. For example, if you are in the 25% tax bracket, a $1,000 deduction would save you $250 in taxes. However, if taxable income approaches the next lower tax bracket, the benefit will be less. You also need to consider whether the particular deduction is allowed on your state return and what your state tax bracket is in order to determine the total tax saving.

Some deductions, such as IRA and self-employed retirement plan contributions, alimony, student loan interest, moving expenses, and so forth, are adjustments to income, or what we call above-the-line deductions. These deductions provide a dollar-for-dollar benefit. Deductions that fall into the itemized category must exceed the standard deduction for your filing status before any benefit is derived. In addition, medical deductions are reduced by 7.5% (to be adjusted to 10% in 2013 except for seniors) of your AGI (income), and the miscellaneous deductions are reduced by 2% of your AGI. For taxpayers subject to the alternative minimum tax, the medical adjustment goes to 10%, while deductions for taxes, home equity interest, and miscellaneous deductions above the 2%-of-AGI floor are not allowed at all.

Business deductions, the most beneficial deductions, fall into two categories: employee business expenses, which are treated as miscellaneous itemized deductions subject to the limitations described previously, and self-employed business expenses that offset both income tax and, depending upon the circumstances, self-employment tax. For 2012, the self-employment tax rate is 10.4% of the first $110,100 of income subject to SE tax plus 2.9% for the Medicare tax with no cap. For self-employed businesses with a net income (profit) of $110,100 or less, the effective SE tax rate is 13.3%, and the benefit derived from deductions generally includes the taxpayer’s tax bracket plus 13.3%. For example, for a taxpayer in the 25% tax bracket, the benefit could amount to as much as 38.3% (25% + 13.3%) of the deduction. If the deduction were $2,000, tax savings could be as much as $766 or more when the taxpayer’s state income tax bracket is included.

Adequate Charitable Gift Documentation

Family Philanthropy Lawyers – Ainer & Fraker, LLP

The IRS recently denied a taxpayer’s substantial charitable contribution to his church because the acknowledgement letter from the church lacked the required no goods or services provided statement. The church supplied the taxpayer (we’ll call him Bill) with a replacement acknowledgement letter that included the statement, but the IRS rejected the replacement since it was not received contemporaneously. An obviously upset Bill took the issue to tax court but ended up with the same result – no deduction – because his documentation did not meet the law’s requirements.

To make sure you don’t get caught up in similar unfortunate circumstances, take a moment to review the rules for monetary charitable contributions:

  1. For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record (for example, a canceled check or a credit card receipt) or a written communication from the donee organization showing its name, plus the date and amount of the contribution. It’s not sufficient to maintain other written records, such as a log of contributions.
  2. No charitable deduction is allowed for any contribution of $250 or more, even if you have the documentation listed in #1 above, unless you substantiate the contribution by a
    contemporaneously written acknowledgement of the contribution by the donee organization. Contemporaneously means you must have the receipt in hand by the time you file your return (or by the due date, if earlier); if you don’t, you won’t be able to claim the deduction. It is up to the donor to request the acknowledgment from the donee organization; the law does not require the organization to automatically provide the acknowledgment.
  3. The acknowledgement must include the amount of cash and a description (but not value) of any property other than cash contributed. In addition, the acknowledgement must include a statement indicating whether the donee provided any goods or services other than intangible benefits, and if so, a good-faith estimate of the value of any such goods or services.

However, if Bill had made separate contributions of less than $250 each and had met the requirements of #1 above, he would not have had the problems he did. Certainly, Bill and his church have learned a valuable but costly lesson.

Make sure you don’t end up with the same problem. Review your charitable acknowledgements and make sure they meet the requirements above.

Understanding IRS Inquiries

San Jose Tax Attorney

Correspondence from the IRS has a tendency to escalate a taxpayer’s pulse rate. However, most of the letters received are not of the feared “come on down” type that requests an appearance for a face-to-face audit; they would be more likely to just require a written explanation. Generally, all types of income (wages, interest, dividends, etc.) are reported by the payer to the IRS, which, in turn, matches the reported income to the recipient’s tax return based on Social Security number (SSN). Over the past few years, the IRS has become very proficient in using its matching software to pick up unreported income and other discrepancies on tax returns. Discrepancies will generate an IRS inquiry, so in addition to income, take note of the following items which are frequently monitored by the IRS computer:

  • Dependent SSN – The IRS allows only one taxpayer to claim the exemption for a dependent. Frequently, a dependent will claim the exemption himself or herself, or in other cases, separated or divorced individuals will both attempt to claim the dependent. Expect correspondence when the exemption for any SSN has been claimed twice.
  • Gross Proceeds of Sale – All brokerage firms are required to report security sales to the IRS as “gross proceeds of sale” on Form 1099-B. The 1099-B copy provided to the account owner is generally combined with interest and dividend reporting requirements and included in a consolidated 1099 statement. These statements can be confusing, and the “gross proceeds of sale” line is frequently buried in the multi-page statements. If a taxpayer fails to report these security sales, the IRS will treat the gross proceeds as all profit, recompute the tax owed and send a bill.
  • Stock Basis – For stocks purchased beginning in 2011, the IRS requires the brokerage houses to track the cost of the stock and report that information on Form 1099-B when the stock is ultimately sold, so the IRS can then verify profit or loss.
  • Pension and IRA Rollovers – Unless it is a direct (trustee-to-trustee) rollover, the plan administrator is required to issue a Form 1099-R whenever a taxpayer withdraws funds from an IRA or other type of qualified plan. If the 1099-R income is not properly accounted for on the tax return, the IRS may treat it as unreported, taxable pension income and issue a revised tax bill. Even if it is directly rolled over, ALWAYS bring rollovers to our attention.
  • Alimony – The person paying alimony must include the recipient’s name and Social Security Number with the deduction claimed for alimony payments. The IRS will match the payments to income reported by the recipient. If the two amounts are not the same, the IRS will initiate correspondence to both parties.
  • Home Sales – Technically, escrow companies are not required to issue 1099-S forms to taxpayers who sell their primary residence for less than the home sale gain exclusion amount and certify that they meet the exclusion qualifications ($250,000 for a single taxpayer and $500,000 for married taxpayers). Despite this, many escrow companies choose to issue them, making it necessary to report the home sale on the seller’s tax return to avoid IRS correspondence.
  • Home Mortgage Interest – Since all lenders who are in the business of lending money are required to report home mortgage interest, the IRS can verify the amount claimed as deductible mortgage interest on Schedule A of a tax return, and any significant discrepancy can lead to IRS correspondence. If a private party holds the loan (not in the course of business), Form 1098 is not required to be filed, but the taxpayer claiming the mortgage interest as a deduction is required to include that party’s name, contact information and SSN on Schedule A. The IRS can then match the claimed interest deduction to the amount reported by the private party as interest income. However, if a third party lent money to the taxpayer to purchase the home, the third party’s information is not required.
  • Education Benefits – Colleges and universities are required to report the tuition payments that may qualify for the American Opportunity or Lifetime Learning tax credits on Form 1098-T. Educational lenders report the amount of student loan interest paid on Form 1098-E. Both are used to match against claimed deductions and credits on the tax return

Are You a Self-Employed Tax Payer?

Bay Area Tax Attorneys – Self-employed taxpayers should consider their options carefully when it comes to applying tax benefits for their own education tuition and expenses.

Tax law provides multiple ways to benefit from the educational expenses and one may provide more benefit to you than another based on your particular set of circumstances. In addition, your tuition may qualify for one tax benefit while other education expenses qualify for another. 

• As a Business Expense – Generally, if the education qualifies, it is better to take the cost as a business expense since as a business expense it will offset both income taxes and self-employment tax. The expenses can include tuition, books, supplies, and allowable travel for the education. To qualify as a business expense, the education must either be to maintain or improve your skills or be required in your business. You may, however, not wish to use the education’s costs as a business expense when doing so limits your net profit and consequently limits your retirement plan contribution. Another situation when you may not want to claim the education costs as a business expense is when your Schedule C only has a very small profit or shows a loss for the year.

• As an Adjustment to Income – If the education expense is tuition at an institution of higher education and you are under the AGI phase-out limit for this deduction, you have the option to deduct up to $4,000 as an adjustment to overall income for the year. You can take this above-the-line education deductionwhether or not the education maintains or improves your skills required in your business. Other expenses related to this education such as books, supplies, and travel can still be deducted on your Schedule C as long as the education maintains or improves your skills required in your business. The deduction is a maximum of $4,000 if AGI does not exceed $65,000 ($130,000 for married couples filing jointly) or a maximum of $2,000 if AGI doesn’t exceed $80,000 ($160,000 for married joint filers). This provision is scheduled to expire at the end of 2013, unless extended by Congress.

• As a Tax Credit – As with the adjustment to income above, if the education expense is tuition at an institution of higher education, you might qualify for the lifetime learning credit. It may be more beneficial than the business expense or AGI adjustment for the tuition portion of the expenses, especially if you are in a lower tax bracket or the business profits are low. The lifetime learning credit allows you a credit of 20% of the cost of your tuition (up to $10,000 of costs annually) as a tax credit. It, too, has an AGI phase-out limitation. For 2013, the credit for single taxpayers phases out between $53,000 and $63,000 and $107,000 to $127,000 for joint filers. The phase-out ranges are inflation adjusted each year. Please call this office for the phase-out ranges for years other than 2013. If you meet the full-time student requirement, you may qualify for the more beneficial American Opportunity credits.

Do You Qualify For Child Care Tax Credit?

Saratoga Tax Lawyers Ainer & Fraker, LLP

Do You Qualify for Child Care Tax Credits?

Many parents who work or are looking for work must arrange for care of their children during the school vacation. If you are one of those, and your children requiring care are under 13 years of age, you may qualify for a child care tax credit.

The credit ranges from 20% to 35% (the IRS provides a table) of non-reimbursed expenses based upon your income, with the higher percentages applying to lower income taxpayers and the lower percentages applying to higher income taxpayers. As example, if your income (AGI) is below $15,000, the credit percentage is 35% and gradually reduces as your income increases, until it caps out at 20% for incomes above $43,000. The maximum expense amout allowed is $3,000 for one child and $6,000 for two or more. The credit is non-refundable, which means it can only reduce your tax to zero and the excess is lost.

The Child and Dependent Care Credit is available for expenses incurred during the lazy hazy days of summer and throughout the rest of the year. You must claim the qualifying child for whom you pay care expenses as your dependent to qualify to claim the credit (but there’s an exception for divorced or separated parents).

Click the following link for further information on The Child and Dependent Care Credit.