Tag Archive for: Commercial Real Estate
Cost Segregation is an application by which commercial property owners accelerate depreciation and reduce the amount of taxes owed! I have used this myself quite successfully. This savings generates substantial cash flow that the investor can use to reinvest into other investments or pay now their loans for principal reductions thus generating more cash flow!
A Cost Segregation Study is an engineering-based calculation that you can provide to your CPA. These calculations are used to change the way their commercial property is depreciated. This is an affordable, legal method of reducing income so the investor pays less in income taxes. The AICPA and Journal of Accountancy both suggest the use of Cost Segregation Studies for clients who own commercial and residential rental income properties.
When I sell a piece of commercial property, it is likely that my client is not taking advantage of all the tax strategies and write-downs, written to their benefit, that are available to them through new and existing tax code. This information could not only benefit them on the property they just purchased, but on others in their portfolio. Most of my clients would love additional cash flow from a reduction in their largest expense: taxes.
If you have an interest in this, I have a good source for this service. Schedule a call with me today. If even you are thinking of purchasing or have already purchased.
One fourplex saved me $12,000 to offset against my own tax bill!!! I am always looking out for your bottom line!!!
I hope that everyone is doing well. The Phoenix Market is absolutely on fire.
Call me and as you know I answer my phone 602-688-9279.
Hold open Title policies are very useful for a few reasons. First, what is a hold open policy?
A hold open policy must be requested prior to the Close of Escrow of the purchase of the property. This is used for investors that are intending to resell the property in 2-4 years. What this does is save the Investor fees for the owner’s title policy that is issued when the Seller sells the property.
The Buyer soon to be Seller will pay a small fee at Close of Escrow when they aquire the property. However, when this person sells the property there is a substantial savings in the Title Insurance. NOTE-The Seller must use the same Title Company when sellig the Property without fail. When we have a hold oen policy I disclose it in the listings to the agents.
What if the owner decides to kepp the property after close? It is important that the Seller contact the Title Company and have them close the policy in order to maintain the Title Insurance. There is not a fee for this but this is an often overlooked item.
What if the Seller is not quite finished with the repositioning of the property and the hold open time period os about to expire? It is easy to extend for a small fee. The Seller must contact the Title Company prior to the expiration of the policy and request an extension. There will be a small fee for this but it still saves quite a bit at closing.
There are different time limits on policies depending on who is the underwriter of the policy. The Buyer-Seller needs to decide how long that the repositioning is going to take and buy the policy accordingly.
Wait till next week for more education!
Remember that I answer my phone. It’s funny people say, “You answered your phone!”. I say “Well you called me!”.
The Books and Records of a multifamily can be not only hard to understand but incomplete as well!
When I am asked to review books and records, it is always important to understand two items.
First, knowing what to look for as real expenses. Most owners and property managers simply lump both operating and capital expenses together. Here is the good news-this is an easy way to evaluate the “major” work done to the building. Here is the bad news-this makes it harder to ascertain the real operating numbers on a building. Remember that capital expenses are considered nonrecurring expenses.
A good rule of thumb is to see if these expenses are completed on a routine basis. Pest control may not be done every month, maybe every three months but a termite treatment would be considered a capital expense. Carpet may or may not be considered a capital expense as this may need to be replaced whenever a tenant moves out but tile flooring is a capital expense. Maintaining the landscape is an operating expense but installing new landscape is a capital expense. When I look at books and records and I see a plumbing expense over $500 I will question what it was for. Often I can find new hot water heaters in the books and records.
Once we have removed the capital expenses from the operating numbers, this makes it easier to do an honest evaluation on the property. WAIT I said that there are two factors that I look for on Books and Records.
Secondly, it is important to make sure that all expenses are accounted for. One of the biggest issues that I see with books and records on the MLS is that uneducated agents (again why you need use an experienced commercial Broker) is that they will not add a vacancy rate or management fees on the MLS. This will give you a higher cap rate but not accurate figures. When I question them, here is what I often hear, “Oh, the owners manage the building themselves!”, or “The building is full.” When I respond, I will ask, “Does this mean that the owner will manage for my clients forever for nothing?”‘ or “Does this mean that the owner will guarantee 100% occupancy forever?”. The answer is of course not. Then my answer to the agent is get your numbers right. Even a self managed building should show these numbers.
Often the taxes and insurance are not shown on the books and records. This may be due to the fact that the owner has the building self managed and pay these expenses out of the their account vs. the property manager’s account.
What about additional income? Laundry, storage and pet fees etc? Some property managers keep the late fees as part of their income. So this as additional income may not be used.
Once you have the actual numbers and they have been verified, it becomes pretty easy to figure out if the property makes sense.
In the Phoenix market, where rents are easily increased, I usually run two spreadsheets. One with the VERIFIED actuals and one with the projected income based on the actual expenses.
I had a client this past week not understand that without this being done completely, I would not provide the analysis on the building. This type of analysis usually takes me 3-4 hours to completely do depending on the information that has been provided. Often it is a back and forth between myself and the other agent in order to get the correct answers. The above mentioned client was frustrated with me instead of welcoming the information being done correctly.
Often times we can obtain a building that other investors overlook due to the inability or lack of knowledge to understand the books and records. This is a great benefit for my clients.
Next week we are going to discuss inspections and I will give an overall view of what kinds and when they are needed.
Remember that I answer my phone and WELCOME you comments at the bottom of this Blog!
Have a great day!
Let’s speak about Rent Rolls in income producing properties!
Rent Rolls on an income producing property can either generate an offer (whether you are a Buyer or a Seller). Giving the most up to date and accurate information is critical not only for a Buyer or Seller but the lender and also to attain an overall view of where the property stands. This means not only performance but also in the market place.
Rent Rolls and what should be on every rent roll:
- Tenant name
- Effective Date of Lease
- Expiration or Month to Month
- Security Deposit (both nonrefundable and refundable and these need to be stated)
- Market Rent
- Amount of Rent
- Rental Sales Tax column and who pays it
- Additional fees (Pet, Parking and Storage as an example)
- Total Monthly fees Due from Tenant
- Date last paid
- Any balances due from Tenant
- Another column should be for notes
It should be noted that all of these items should be able to ascertained from the leases (and/or addendums).
Protecting your Rent Rolls:
The rent roll for an income property is absolutely critical whether you want to sell, buy or even keep your property.
If you plan to sell this should be prepared and available to the Real Estate Broker and all potential Buyers. When I list a property, this is why I want copies of ALL leases. One of the first things that I like to do is take the leases and create a rent roll, then compare my rent roll to the Property Manager’s Rent Roll. There are often differences but are usually easily handled will good communication with the Property Manager. For example, maybe I was not given an addendum.
If you are a Buyer, you certainly want to see a rent roll. It is a great way to evaluate the Property and even the job that the current Property Manager is doing. If the current owner cannot provide you with a rent roll, the best idea is to start with the leases. Then you have the ability to ask good questions instead of simply asking for a rent roll that may or may not be accurate. Remember that a Lease is a legal contract and if you are buying the building, you are also buying the leases as they will convey as written to you.
If you are planning on keeping the building, you should evaluate your rent roll for accuracy at lease once a year. What is you want to re-finance the property? The Lender will ask for a complete rent roll almost immediately. Do not overlook this very important piece of your investment.
One of the most common errors I see on rent rolls are concessions. FIRST, if you are going to give a move in special, no not give it in the first month. Do it at least in the 4th or 6th month. Here is an idea that I like to use. Do not give a rent concession, but a grocery store or gas gift card. You can expense this but not HURT the rent roll. On a fourplex a $25.00 per month per unit has either decreased or increased the value by approximately $25,000.
One last thought on your rent roll-this is a very valuable tool and a great way to evaluate your rents against the market and also a ten thousand mile overview of your Property Manager.
Questions, call me 602-688-9279. Next week I will be discussing the essence of books and records.
Have a great week and remember that I answer my phone!
Linda Gerchick, CCIM
BEFORE I list an investment property for sale, there are several items that I really like to prepare. Sometimes it may take a month or so to complete some of the items that are needed.
First and foremost, I want to see the rent roll and books and records. Rent rolls are so important to the overall sale ability of the property. I personally do a drive by to view the area and the property. It is also important that I get to get into the units. Wouldn’t be awful if we get a great contract and good buyer and when we get to inspections there are inspection or maintenance issues that will kill the deal wither on appraisal or inspection? I never want a Seller to spend money where it is not needed but sometimes it is really important.
Next week I am going to blog in depth about the rent toll and books and records. This will be one of the more important blogs that I will do this quarter.
I also want copies of ALL pages of the leases. Even if the tenant is month to month. This is not disclosed to the public but it is important that we have these on file. We also, go through the leases to make sure that they match the rent roll.
If there is a laundry room lease I will need this as well.
It is important that if the property is owned in an entity or trust that I receive these documents as well. Not only do I need to verify that the person signing contracts is the correct person but the Title Company will need this as well.
The Insurance Loss run is needed and I will help the Seller prepare a schedule of personal property and capital expense list.
The Seller’s Disclosure Statements will need to be prepared and signed.
Once these items are done or being done, I then schedule professional photos or videos depending on the property.
As you can see there are a number of items that are done prior to and at the time of listing.
In future blogs, I will be discussing marketing and the extensive marketing that I invest in my Seller’s properties.
If you need to speak to me; please call my cell at 602-688-9279. Remember that I built my reputation on the FACT that I either answer my phone or return my calls promptly!
Businesses make promises to its customers. A brand promise spells out what customers can expect from the organization’s product or services. Those promises are communicated verbally and in writing in a multitude of ways every day. For example, a company’s website or app lists details about the products or services. Marketing materials such as flyers, brochures and ads tout visually and in writing what is special about the company’s offers. Employees talk up the organization’s purpose. Signs scream the business’ intent. The mission statement communicates the company’s promises. So do corporate filings for publicly-traded entities. And Contracts and Sales Agreements spell out in legally-binding detail the particulars of the brand’s commitment.
That is just the tip of the ‘brand promises’ iceberg. Brand promises are also communicated through professional oaths as well, like a physician’s Hippocratic Oath to “do no harm”. Attorneys take an oath when they are admitted to a State Bar Association. And CPAs take an oath after passing the exam. For example, the North Carolina CPA oath says: “I will support the laws and regulations of the State of North Carolina and the United States. I will perform my professional duties to the best of my ability and abide by the rules of professional ethics and conduct; and I will uphold the honor and dignity of the accounting profession by serving with integrity, objectivity, and competence. That communicates what a CPA in that state has committed to do. That professional designation implies brand promises to clients.
There are a myriad of other actions and representations that spell out what a brand pledges to do or provide for its customers. Those promises are sometimes legally-binding and ethically-binding, but they are always socially-binding. There is a social pact between a seller and a buyer based, in part, on the brand’s promises. Companies are expected to live up to their brand promises.
For example, for many years Bounty paper towels proclaimed that it was the “quicker-picker-upper” in its ads and on its packaging. Introduced in 1965, this Procter & Gamble brand touted fast absorbency as a key selling point. In 2010, they changed their brand message – and thus their overall product promise – to say the “clean picker upper”. The package also says “One sheet keeps cleaning” and, on the back of the wrapper, it says “thick and absorbent Bounty helps you clean up quickly and easily, so you can get more out of each day.” Procter & Gamble’s marketing team felt that consumers wanted a competent clean they could trust on surfaces their families encounter every day so their brand’s promise shifted to a “functional benefit” rather than how fast Bounty could pick up spills. Bounty promised that a single sheet of their paper towel was strong and absorbent enough to get surfaces clean. The subtext was that they were promising to be cost effective for frugal shoppers who watch how many paper towels they use each time there is a mess that needs to be wiped. And, for the most part, Bounty is a solid brand that has lived up to its promises. But, what happens when a company fails to live up to one or more of its brand promises repeatedly? Routinely? On a regular basis?
Do Companies break promises regularly?
In a 2001 Gallup research and development survey of more than 3,100 customers, less than half of current customers felt that the brands they use keep the promises they make. Specifically, just 38% of U.S. bank customers felt that their bank always kept its promises, while only 31% of auto owners felt that their car’s manufacturer always kept their promises, and a mere 22% of the previous year’s airline customers felt that the airline they flew most always kept its promises. So, sadly, customers have become accustomed to companies breaking promises. That may be, in part, because only 27% of employees report that they always deliver on the promises they make to their customers. So most companies break brand promises and their customers know it.
Of course, no company is perfect because companies are comprised of people, and people are not perfect. To err is human. So, it is understood that brand promises are sometimes broken unintentionally due to human error and because of issues beyond a company’s control. For example, airlines cannot control the weather but they take the blame for flight delays due to ice, snow, hail and lightning. Also, logistics companies Fed Ex and UPS deliver nearly 6.5 billion packages a year, 99% of which are on time and undamaged, but some packages get lost or damaged or both. It happens despite massive, intricate systems that protect against such errors. No company is perfect and none gets it right 100% of the time.
That said, every organization should be committed to doing its level best to uphold the pledges it makes to its customers. But, as the Gallup poll indicates, many companies aren’t doing that. So, what happens when companies regularly fail to live up to the promises made? After all, if most companies are breaking promises and people expect it, is that really a problem? Simply put, yes, it is a problem in the way that a ticking time bomb is a problem.
Several things that happen when a company breaks its brand promises.
- Customers are disappointed.
- Customers feel disconnected from the company and its employees.
- Customers learn not to trust the brand.
- Customers feel disrespected.
- Customers no longer feel a sense of loyalty to the brand.
When that happens, brand dismantling begins.
What is Brand Dismantling?
Brand dismantling is what happens when a company regularly breaks its brand promises. It can happen to any brand that consistently or cavalierly fails to deliver on the commitments it makes to customers. So what exactly is brand dismantling? It is the corrosive and ultimately destructive effect that broken promises have on the strength and stability of a brand. Sometimes the effect is slow and is not felt right away. Over time, customers slowly reduce their business or remove their business altogether, taking with them friends, family, and colleagues. The attrition is like a slow leak. In the case of a company that sells a product, customers might start trying competing products in search of one that is better. Or, if the brand promises broken were by a company that provides a service, customers might start asking for references to other vendors. The decline happens bit by bit.
However, thanks to social media, brand dismantling is happening more quickly now than ever before. Betrayed customers not only suddenly and abruptly disappear — taking friends, family, and colleagues with them – but they also take people they don’t personally know but are connected to through social media. The bigger the person’s social media platform and megaphone, the more devastating the impact to the company. Broken brand promises can destroy a company with alarming speed, especially when one tweet has the potential to be retweeted ten thousand times over and viewed by over a million people within a matter of minutes.
Case in point. Chipotle’s brand promise is that they make food with integrity. Their entire brand was built on the promise of serving fresh, local food that is ethically grown and locally sourced. Their website even proudly claimed that the company used only vegetables grown in healthy soil. So, it was more than a shock when hundreds of consumers across 13 states were sickened after eating contaminated food from Chipotle in 2016. The news spread on social media like wildfire. It sent the company’s stock, which had hit a record high in 2015, spiraling downward 40%. It also launched a federal criminal investigation because Chipotle could not identify the source[s] of the contaminated ingredients that went to stores at specific times. They broke brand promises by having an outsourced supply chain, which meant they lacked end-to-end visibility of the food from the source to store delivery in the chain. This allowed the contamination to spread. The lesson? Be careful what thy promises to thy customers. It wasn’t just that they made hundreds of customers sick, it is that their main brand promise had been badly broken and customer trust was crushed.
Though scarce, trust in brand promises is universally a top priority for consumers in determining whether to do business with a company. That trust is in very short supply, and it cannot be bought, stockpiled or artificially made. It must be earned by organizations through their actions daily. It is not something that is ‘one and done.’ Consistency is a key factor in gaining and keeping consumer’s trust in a brand promise. It is not about fulfilling the promise once and moving on to the next exercise, effort or engagement. Only routinely kept promises will nurture brand reputation and generate customer loyalty.
Over the next few weeks you will see Blog Posts not only from me but from our Referral Partners-HIGHLY EDUCATIONAL in our world today!
As always please let me know if you need to speak to me! I am always available!
It’s finally possible for self-employed borrowers or independent contractors who have difficulty documenting their income to actually get a stated income loan to buy a non-occupant property for investment purposes.
The “debt-service-coverage” loan program helps these investors, house flippers and landlords who have multiple expense write-offs on their tax returns to buy investment properties without having to document their income.
The new option – use the anticipated monthly rent as income to qualify for the loan.
No Income Stated or Verified
If you have been aggressive with deductions on your tax return but have adequate cash flow, this type of loan may be for you.
The debt coverage ratio measures the ability to pay the property’s monthly mortgage payments from the cash generated from renting the property.
Lenders use this ratio as a guide to help them understand whether the property will generate enough cash to pay the mortgage expense.
The debt coverage ratio is calculated by dividing the property’s month net operating income (NOI) by a property’s monthly debt service. The monthly debt service is the total of the mortgage principal and interest payment, taxes, insurance, and any HOA fees.
Investors can qualify if the net operating income from the property is equal to or greater than 1.0 times the monthly debt service.
So, if you have a property that can generate $2,000 per month in rent, investors can qualify with an “all-in” mortgage payment of $2,000!
Debt Service Coverage Ratio (DSCR) Investor Loan
- Loan-To-Values up to 80%
- Credit Score down to 600
- Qualification based upon cash flow of subject property
- Interest only option available
- 5/1, 7/1, and 30-year fixed options available
Non-Owner Occupied and Investment Purposes Only
This is only for Non Owner Occupied properties for investment purposes. You will be required to sign a statement that states you live in another property that you own.
Please do contact Tom Bonetto for more specific information regarding qualification!
Here’s the link to the article: https://lendingcoach.net/debt-service-coverage/
As I’m sure you’re aware, the Tax Cuts and Jobs Act of 2017 (TCJA) was enacted at the end of last year. It’s the largest tax overhaul since the 1986 Tax Reform Act and will affect almost every business in the United States. Considering all the changes that took effect this year, It may be appropriate for us to meet as early as possible to discuss how these changes might affect your 2018 business tax return and to nail down any actions that may need to be taken before the end of the year.
Here’s a quick recap of the new rules, followed by some thoughts on steps we can take to reduce your 2018 tax liability.
- New Business-Related Tax Rules for 2018
The business-related provisions in the TCJA are permanent and generally take effect beginning with 2018 tax years. For businesses, highlights of the new law include: (1) an increase in amounts that may be expensed under Section 179 and an increase in the bonus depreciation deduction; (2) a 21 percent flat corporate tax rate; (3) a new business deduction for sole proprietorships and pass-through entities; (4) the elimination of the corporate alternative minimum tax (AMT); (5) modifications of rules relating to accounting methods; and (6) several changes involving partnerships and S corporations. The following is a brief overview of some of the more significant aspects of the new tax law that may affect your business.
Section 179 Deduction. For 2018, businesses can write off up to $1,000,000 of qualifying property under Section 179. The theory is that the money a business saves on taxes, as a result of deducting the full amount of equipment and other business property, can be reinvested back into the business. Additionally, writing off an asset in the year it is purchased, saves you the time and money it takes to keep track of the remaining basis of an asset after its yearly depreciation. The $1,000,000 amount is reduced (but not below zero)
by the amount by which the cost of the qualifying property placed in service during the tax year exceeds $2,500,000.
In addition, the definition of property that qualifies for the Section 179 deduction has been expanded to include certain depreciable tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging, as well as any of the following improvements to nonresidential real property: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
Bonus Depreciation Deduction. The new tax law extended and modified the additional first-year (i.e., “bonus”) depreciation deduction, which had generally been scheduled to end in 2019. An enhanced bonus depreciation deduction is now available, generally, through 2026. Under the new rules, the 50-percent additional depreciation allowance that was previously allowed is increased to 100 percent for property placed in service after September 27, 2017, and before January 1, 2023, as well as for specified plants planted or grafted after September 27, 2017, and before January 1, 2023. These deadlines are extended for certain longer production period property and certain aircraft.
The 100-percent allowance is phased down by 20 percent per calendar year in tax years beginning after 2022 (after 2023 for longer production period property and certain aircraft).
Another new provision removes the requirement that, in order to qualify for bonus depreciation, the original use of qualified property must begin with the taxpayer. Thus, the bonus depreciation deduction applies to purchases of used as well as new items.
Additional Depreciation on ‘Luxury’ Automobiles and Certain Personal Use Property. Another benefit of the new tax law is that it increases the depreciation limitations that apply to certain “listed” property such as vehicles with a gross unloaded weight of 6,000 lbs or less (known as “luxury” automobiles). For luxury automobiles placed in service after 2017, an additional $8,000 deduction is available, thus making the write-off for the first year $18,000. The deduction is $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period.
New Deduction for Qualified Business Income. One of the biggest changes for 2018 is the new qualified business income deduction. If you are a sole proprietor, a partner in a partnership, a member in an LLC taxed as a partnership, or a shareholder in an S corporation, you may be entitled to a deduction for qualified business income for tax years beginning after December 31, 2017, and before January 1, 2026. Trusts and estates are also eligible for this deduction.
While there are important restrictions to taking this deduction, the amount of the deduction is generally 20 percent of qualifying business income from a qualified trade or business. A qualified trade or business means any trade or business other than (1) a specified service trade or business, or (2) the trade or business of being an employee. A “specified service trade or business” is defined as any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, including investing and investment management, trading, or dealing in securities, partnership interests, or commodities, and any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees. Engineering and architecture services are specifically excluded from the definition of a specified service trade or business.
However, there is a special rule which allows you to take this deduction even if you have a specified service trade or business. Under that rule, the provision disqualifying such businesses from being considered a qualified trade or business for purposes of the qualified business income deduction does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the restriction is phased in over a range of $50,000 in taxable income ($100,000 for joint filers). Thus, if your income falls within the range, you are allowed a partial deduction. Once the end of the range is reached, the deduction is completely disallowed.
For purposes of the deduction, items are treated as qualified items of income, gain, deduction, and loss only to the extent they are effectively connected with the conduct of a trade or business within the United States. In calculating the deduction, qualified business income means the net amount of qualified items of income, gain, deduction, and loss with respect to the qualified trade or business of the taxpayer.
Qualified business income does not include any amount paid by an S corporation that is treated as reasonable compensation of the taxpayer, or any guaranteed payment (or other payment) to a partner in a partnership for services rendered with respect to the trade or business. Qualified items do not include specified investment-related income, deductions, or losses, such as capital gains and losses, dividends and dividend equivalents, interest income other than that which is properly allocable to a trade or business, and similar items.
If the net amount of qualified business income from all qualified trades or businesses during the tax year is a loss, it is carried forward as a loss from a qualified trade or business to the next tax year (and reduces the qualified business income for that year).
W-2 Wage Limitation. The deductible amount for each qualified trade or business is the lesser of: (1) 20 percent of the taxpayer’s qualified business income with respect to the trade or business; or (2) the greater of: (a) 50 percent of the W-2 wages with respect to the trade or business, or (b) the sum of 25 percent of the W-2 wages with respect to the trade or business and 2.5 percent of the unadjusted basis, immediately after acquisition, of all qualified property (generally all depreciable property still within its depreciable period at the end of the tax year).
The W-2 wage limitation does not apply to individuals with taxable income of less than $157,500 ($315,000 for joint filers). After an individual reaches the threshold amount, the W-2 limitation is phased in over a range of $50,000 in taxable income ($100,000 for joint filers).
In the case of a partnership or S corporation, the business income deduction applies at the partner or shareholder level. Each partner in a partnership takes into account the partner’s allocable share of each qualified item of income, gain, deduction, and loss, and is treated as having W-2 wages for the tax year equal to the partner’s allocable share of W-2 wages of the partnership. Similarly, each shareholder in an S corporation takes into account the shareholder’s pro rata share of each qualified item and W-2 wages.
The deduction for qualified business income is subject to some overriding limitations relating to taxable income, net capital gains, and other items which are beyond the scope of this letter and will not affect the amount of the deduction in most situations.
Changes in Accounting Method Rules. The new tax law has also expanded the number of businesses eligible to use the cash method of accounting as long as the business satisfies a gross receipts test. This test allows businesses with annual average gross receipts that do not exceed $25 million for the three prior tax-year period to use the cash method. A similar gross receipts threshold provides an exemption from the following accounting requirements/methods: (1) uniform capitalization rules; (2) the requirement to keep inventories; and (3) the requirement to use the percentage-of-completion method for certain long-term contracts (thus allowing the use of the more favorable completed-contract method, or any other permissible exempt contract method).
We need to discuss whether or not your business might benefit from these changes. If the answer is yes, we’ll need to file tax forms with the IRS to initiate the changes, as well as set up your books and records to appropriately reflect the new methods being used. The sooner we do this, the better.
Carryover of Business Losses Is Now Limited. Beginning in 2018, excess business losses of a taxpayer other than a corporation are not allowed for the tax year. Under this excess business loss limitation, your loss from a non- passive trade or business is limited to $500,000 (married filing jointly) or $250,000 (all other taxpayers). Thus, such losses cannot be used to offset other income. Instead, if your business incurs such excess losses, you must carry them forward and treat them as part of your net operating loss carry forward in subsequent tax years. In fact, net operating losses carried over from a prior year can only offset current business income up to 80%.
New Interest Deduction Limitations. You may have heard about a new limitation on the deduction of interest expense. Effective for 2018, the deduction for business interest is limited to the sum of business interest income plus 30 percent of adjusted taxable income for the tax year. However, there is an exception to this limitation for certain small taxpayers, certain real estate businesses that make an election to be exempt from this rule, businesses with floor plan financing (i.e., a specialized type of financing used by car dealerships), and for certain regulated utilities.
The new law exempts from the interest expense limitation taxpayers with average annual gross receipts for the three-taxable year period ending with the prior taxable year that do not exceed $25 million. Further, at the taxpayer’s election, any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business is not treated as a trade or business for purposes of the limitation, and therefore the limitation does not apply to such trades or businesses.
Elimination of Entertainment Deduction. The new tax law also eliminated business deductions for entertainment. As a result, no deduction is allowed with respect to: (1) an activity generally considered to be entertainment, amusement or recreation; (2) membership dues with respect to any club organized for business, pleasure, recreation or other social purposes; or (3) a facility or portion thereof used in connection with any of the above items.
Under prior law, there was an exception to this rule for entertainment, amusement, or recreation directly related to (or, in certain cases, associated with) the active conduct of a trade or business. This is no longer the case.
In addition, no deduction is allowed for expenses associated with providing any qualified transportation fringe benefits to your employees, except as necessary for ensuring the safety of an employee, including any expense incurred for providing transportation (or any payment or reimbursement) for commuting between the employee’s residence and place of employment.
A business may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees during work travel). If meals are combined with entertainment, the meal portion needs to be separately stated in order for the business to deduct the meal expense.
Changes to Partnership Rules. Several changes were made to the partnership tax rules. First, gain or loss from the sale or exchange of a partnership interest is treated as effectively connected with a U.S. trade or business to the extent that the transferor would have had effectively connected gain or loss had the partnership sold all of its assets at fair market value as of the date of the sale or exchange. Any gain or loss from the hypothetical asset sale by the partnership is allocated to interests in the partnership in the same manner as nonseparately stated income and loss.
Second, the transferee of a partnership interest must withhold 10 percent of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.
Third, the definition of a substantial built-in loss has been modified so that a substantial built-in loss is considered to exist if the transferee of a partnership interest would be allocated a net loss in excess of $250,000 upon a hypothetical disposition by the partnership of all of the partnership’s assets in a fully taxable transaction for cash equal to the assets’ fair market value, immediately after the transfer of the partnership interest. This could necessitate the adjustment of the basis of partnership property.
Fourth, TCJA modifies the basis limitation on partner losses to provide that a partner’s distributive share of items that are not deductible in computing the partnership’s taxable income, and not properly chargeable to capital account, are allowed only to the extent of the partner’s adjusted basis in the partner’s partnership interest at the end of the partnership tax year in which an expenditure occurs. Thus, the basis limitation on partner losses applies to a partner’s distributive share of charitable contributions and foreign taxes.
Lastly, the rule providing for technical terminations of partnerships has been repealed.
Changes to S Corporation Rules. Several changes were also made to the tax rules involving S corporations. First, income that must be taken into account when an S corporation revokes its S corporation election is taken into account ratably over six years, rather than the four years under prior law. Second, a nonresident alien individual can be a potential current beneficiary of an electing small business trust (ESBT). Third, the charitable contribution deduction of an ESBT is not determined by the rules generally applicable to trusts but rather by the rules applicable to individuals. Thus, the percentage limitations and carryforward provisions applicable to individuals apply to charitable contributions made by the portion of an ESBT holding S corporation stock.
International Tax Changes. TCJA makes sweeping changes to the United States’ international tax regime through a series of highly complex provisions that are beyond the scope of this letter.
- II. Year-End Tax Plannin Section 179 Expensing and Bonus Depreciation. As discussed above, the Section 179 expensing and bonus depreciation rules have been generously enhanced under TCJA. These changes may create new opportunities to reduce current year tax liabilities through the acquisition of qualifying property – including property placed in service between now and the end of the year.
Vehicle-Related Deductions and Substantiation of Deductions. Expenses relating to business vehicles can add up to major deductions. If your business could use a large passenger vehicle, consider purchasing a sport utility vehicle weighing more than 6,000 pounds. Vehicles under that weight limit are considered listed property and deductions are more limited. However, if the vehicle is more than 6,000 pounds, up to $25,000 of the cost of the vehicle can be immediately expensed.
Vehicle expense deductions are generally calculated using one of two methods: the standard mileage rate method or the actual expense method. If the standard mileage rate is used, parking fees and tolls incurred for business purposes can be added to the total amount calculated.
Since the IRS tends to focus on vehicle expenses in an audit and disallow them if they are not property substantiated, you should ensure that the following are part of your business’s tax records with respect to each vehicle used in the business: (1) the amount of each separate expense with respect to the vehicle (e.g., the cost of purchase or lease, the cost of repairs and maintenance); (2) the amount of mileage for each business or investment use and the total miles for the tax period; (3) the date of the expenditure; and (4) the business purpose for the expenditure. The following are considered adequate for substantiating such expenses: (1) records such as a notebook, diary, log, statement of expense, or trip sheets; and (2) documentary evidence such as receipts, canceled checks, bills, or similar evidence. Records are considered adequate to substantiate the element of a vehicle expense only if they are prepared or maintained in such a manner that each recording of an element of the expense is made at or near the time the expense is incurred.
Retirement Plans and Other Fringe Benefits. Benefits are very attractive to employees. If you haven’t done so already, you may want to consider using benefits rather than higher wages to attract employees. While your business is not required to have a retirement plan, there are many advantages to having one. By starting a retirement savings plan, you not only help your employees save for the future, you can also use such a plan to attract and retain qualified employees. Retaining employees longer can impact your bottom line as well by reducing training costs. In addition, as a business owner, you can take advantage of the plan yourself, and so can your spouse. If your spouse is not currently on the payroll, you may want to consider adding him or her and paying a salary up to the maximum amount that can be deferred into a retirement plan. So, for example, if your spouse is 50 years old or over and receives a salary of $24,500, all of it could go into a 401(k), leaving your spouse with a retirement account but no taxable income.
By offering a retirement plan, you also generate tax savings to your business because employer contributions are deductible and the assets in the retirement plan grow tax free. Additionally, a tax credit is available to certain small employers for the costs of starting a retirement plan. Please let me know if this is an option you would like to discuss further.
Increasing Basis in Pass-thru Entities. If you are a partner in a partnership or a shareholder in an S corporation, and the entity is passing through a loss for the year, you must have enough basis in the entity in order to deduct the loss on your personal tax return. If you don’t, and if you can afford to, you should consider increasing your basis in the entity in order to take the loss in 2018.
De Minimis Safe Harbor Election. It may be advantageous to elect the annual de minimis safe harbor election for amounts paid to acquire or produce tangible property. By making this election, and as long as the items purchased don’t have to be capitalized under the uniform capitalization rules and are expensed for financial accounting purposes or in your books and records, you can deduct up to $2,500 per invoice or item (or up to $5,000 if you have an applicable financial statement).
S Corporation Shareholder Salaries. For any business operating as an S corporation, it’s important to ensure that shareholders involved in running the business are paid an amount that is commensurate with their workload. The IRS scrutinizes S corporations which distribute profits instead of paying compensation subject to employment taxes. Failing to pay arm’s length salaries can lead not only to tax deficiencies, but penalties and interest on those deficiencies as well. The key to establishing reasonable compensation is being able to show that the compensation paid for the type of work an owner-employee does for the S corporation is similar to what other corporations would pay for similar work. If you are in this situation, we need to document the factors that support the salary you are being paid.
As you can see, a lot is going on with respect to business income and taxes for 2018. The new tax law provisions are quite extensive and also quite complicated.
Please call me at your earliest convenience so we can discuss how these changes will impact your business, and what kind of strategies we can adopt to ensure that your business gets the best possible tax outcome under the new rules.
Anne Cornelius, CPA