Brian Borawski CPA, PC

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Doing a cost segregation study could be a beneficial exercise for a company that owns real estate but the Tax Court recently dealt a blow to those looking at a cost segregation study on assets acquired in an asset acquisition.  While usually more beneficial to the purchaser because the goodwill is amortizable for tax purposes, one of the exercises of an asset purchase is Form 8594 which basically makes you pool the assets purchased into buckets based on their character.  The Form is then filed with both the seller’s and purchaser’s tax return.

Putting a little extra time into Form 8594 is even more important now because of the Peco Foods Tax Court Case.  What the tax court determined was that the allocation done on Form 8594 is binding and that you’re not allowed to subsequently do a cost segregation study on the assets that were purchased.  You’re not even allowed to elect a Change in Method of Accounting on Form 3115 to effectuate a change in the allocation so once the Form 8594 is done, you’re stuck.

The moral of the story is, take the extra time to get this allocation done and as much to your benefit as you can.  You can usually work with the seller to get a solid allocation done that helps both of you so put in the extra time either during the negotiations or once the sale is getting close to being finalized because the final allocation could have ramifications for years to come.

March 15 is when corporate returns are due.  For a lot of people, Form 7004 is an annual tradition.  This is the form that lets you extend your corporate for six months until September 15.  It’s a pretty straightforward form but keep in mind if your extending a Form 1120, it’s an extension to file not an extension to pay so if you think you’re going to owe money, you have to make your payment at the time of the extension.

One nice thing about 7004 is it doesn’t require a signature what I do is send an email to all of my clients, get their approval for an extension and then mail them out en mass.  You should still file one extension per envelope but not having to run down a signature makes it a lot easier.  So be sure to get those corporate extensions in by March 15, which is Thursday.

Alright, over the last few weeks I’ve gone through the requirements you have to meet in order to deduct real estate losses as a real estate professional.  If you didn’t catch them, I did it in three parts and you can click through from here.

Real Estate Professional Rule 1
Real Estate Professional Rule 2
Real Estate Professional Rule 3

Now we’re going to talk about some planning ideas.  This is going to be a living post in that whenever I have a thought or learn something new on being a real estate professional, I’m going to add it here.  As always, I’m going to keep things general and you should always consult with your tax adviser before you implement any of these ideas.

1)  We’ve talked about how it can be tough meeting the 50% rule if you have a full time job.  That means if you work full time, you have to come up with at least 2,000 in your real estate business.  That doesn’t leave a lot of time for sleep.  One was to meet the requirements is if you have a spouse who’s either been out of work or is a stay at home parent.  If they’re not involved in the business and you find yourself not being able to take your losses because of the passive activity rules then it’s time to get them involved.  They still have to meet all three rules though.  One spouse can’t meet one rule and the other spouse two rules, in order to qualify one spouse has to meet all of the three rules.

Fortunately, while being a full time parent is as hard as any job, it doesn’t qualify as a business so most of the time, if the spouse can meet the 750 rules, then they’ll meet the other two rules as well.  So get your husband or wife involved and that can help you deduct those losses.

2)  Remember about the grouping election.  If you don’t elect to group your real estate activities, then you have to meet the active participation for each one individually which can get challenging as your real estate portfolio grows.

3)  Short term rentals don’t apply. If you have a vacation rental where the average lease term is seven days or less, then the hours devoted to that activity don’t qualify.

Alright, we’ve talked about what you need to do to qualify as a real estate professional for tax purposes.  Rule one was the 750 hour rule.  Rule two was the material participation rule.  The final rule that we’ll be talking about today is what I call the 50% rule and for a lot of people, it’s the one that trips up most people and disqualifies them from being a real estate professional.  How the 50% rule works is, you have to spend more then 50% of the time you spend on personal services for the year in real estate and rental real estate trade or business activities.

Where most people run into problems is when they have a full time job.  If you spend 2,000 hours at your job, you then have to spend 2,001 hours on real estate to qualify as a real estate professional.  That doesn’t leave people too much time to sleep.  And these people (those who get a W-2 and then claim to be a real estate professional) are some of the people the IRS is targeting.  So look at the 750 hour as the minimum but what you really need to get to is a match of time you put into your other businesses or jobs.

I’ll have one more post on the real estate professional status before I move on to something else.  It’ll be mostly some planning ideas.

A couple of weeks ago, I touched on qualifying as a real estate professional and I talked about the 750 hour test.  Rule two is that the 750 hour test has to apply to activities in which the person materially participates.  The catch here is you have to look at each activity individually (sort of, I’ll get to the exception in a minute).

In order to materially participate, you have to meet one of the following requirements:

1)  The taxpayer spends 500 hours on the property.
2)  The taxpayer does most of the work.
3)  The taxpayer works more then 100 hours and nobody else works more hours then he does (this is the one most people shoot for).
4)  The taxpayer has several activities and spend in which he spends 100-500 hours each and the total time spend is 500 hours.
5)  The taxpayer materially participated in an activity for five of the last ten years.

Where you run into the most problems is when you have multiple properties.  Fortunately the IRS lets you make an election to group all of your properties together as one activity.  You have to make a formal election on your tax return though and if you’ve never done this and have put yourself out as a real estate professional, you do have some risk.  The election isn’t all that complicated, but if you’d like a free template, feel free to send me an email or a Facebook message.

Real estate can be a great way to both build wealth and shield the money you make from your investment from taxes.  Of course the down side is, if you have a tax loss from your real estate investment, you can’t always use those losses especially against income you may receive from your job.  You’re even further limited the more money you make and while the passive activity rules are complicated enough and a discussion for another time, one way to ensure your losses are utilized as quickly as possible is to qualify as a real estate professional.  By qualifying as a real estate professional, you can usually take your losses in full and in the year you incur them.  It’s not always easy to qualify, but there’s three rules that have to be met.  As always, this is general information so be sure to talk to your tax adviser so he can opine on your particular situation.  We’ll cover the first one here today and the other two in subsequent columns.

The first rule is that you have to spend 750 hours to rental property activities.  I know I lead up to this and it’s one of the easier rules to understand, but you also have to be careful because in order to qualify as a rental activity, the average rent term has to be longer then a week.  If it’s shorter, then the time doesn’t count.   So if you have a short term rental property like a vacation home where you rent it out for six days and have a cleaning day, then you can’t count your time related to that activity.

Keep your eyes open for rule number two in the next couple of days.

The IRS is once again revamping it’s innocent spouse relief rules and they’re looking for some feedback.  Earlier this month, the IRS issued a notice that both revises the threshold requirements for requesting equitable relief and revises the factors used by the IRS in evaluating these requests.  This is a meaty 25 page document that I haven’t absorbed completely but if you have a specific question on the innocent spouse relief rules, I’d love to discuss them with you.

You should be getting your tax forms in the mail if you haven’t already.  The deadline for most forms we’re used to is January 31 so there could be some stragglers but I’ve also heard that some people already had their forms last week.  One form you may not recognize is the new Form 1099-K. If you accept credit cards or do a lot of business via a company like paypal, the Form 1099-K may be in your future.

In the IRS’s ongoing effort to have everyone else do their job for them, merchant services and third party payment processors are required to issue Form 1099-K to those they service.  If you accept any amount via credit card or use a third party payment processor like Paypal (and you have more then $20,000 in revenue and there are more then 200 transactions), then you should be receiving your forms soon.  Both the Schedule C and Schedule E have been changed to accommodate these new forms so be sure if you’re doing your return yourself, that you put everything on the right line.  For more information, here’s what the IRS has to say about the new form.

The IRS launched electronic filing for the 2011 tax year today.  The IRS is touting that if you efile and have a refund and elect direct deposit, you’ll get your money in about ten days.  If you have to pay, you can efile now and pay later (by April 17).

Of course the big problem right now is that most employees don’t have their W-2s yet.  Employers have until the end of the month to mail out their forms so you probably have a lot of people chomping at the bit to file but can’t quite yet.  Of course this is better then last year when efiling was delayed because Congress took so long to pass their tax reforms.

Here it is, January 15 and we’re about a quarter way through the two month payroll tax cut extension with no word as to whether it’s going to be extended or not.  We have a lot of news on the Republican nominee for president and if you head over to C-Span, I’m not seeing much on the schedule other then….primary stuff.  President Obama is talking about combining agencies in his latest move but I can’t find anything about extending the payroll tax through the end of the year.

When I searched for “payroll tax cut” on Google News, you can see what I get.  There’s a story from Friday where John Boehner talked about circumventing the Tea Party contingent of his party to get the tax cut pushed through and it talks about a new round of talks “in the coming days.”  Not sure what that means.  There are also a few stories about that make it sound like we should be surprised the mortgage fees went up to pay for two month tax cut (this was part of the deal).  Finally, this Washington Times piece talks about how most Congressman won’t even be back from their recess until later in the month and one of the quotes talk about the talks going down to the wire.  The House starts back up with the Thursday and the Senate doesn’t return until January 23.