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When Rental Real Estate Qualifies as a Business

Cartoon picture of someone holding a white sign with dollars and coins.

The Tax Cuts and Jobs Act (TCJA) was signed and enacted in December 2017. In September 2019, almost two years later, the IRS issued final guidelines about whether taxpayers who rent real estate qualify for a new deduction under TCJA, the Qualified Business Income Deduction, aka “Code Section 199A”.  Section 199A allows business owners to deduct 20% of net business income on her or his individual income tax return. 

This new deduction is a very attractive tax benefit for eligible taxpayers. Who is eligible? TCJA extended the benefit to the owners of rental real estate but did not make clear what properties qualify and how to substantiate rental activities. Taxpayers and tax professionals had to use their best judgement to file 2018 income tax returns. Good news – guidance released last month clarifies when rental real estate is treated as a trade or business and how to substantiate the 199A deduction.

The September 2019 IRS guidelines state that rental real estate will be treated as a trade or business if the following requirements are satisfied during the tax year:

  • Maintain separate books and records of income and expenses for each rental property. You’ve already been doing that all along, right?
  • Perform 250 or more hours of rental services on rental activities. Good news – taxpayers with more than one rental property combine all activities to meet the 250 hours (i.e., the hours requirement is NOT per property).  Activities include advertising to rent the real estate; negotiating and executing leases; and management, operation, maintenance, and repair of the property, even services performed by a contractor or employee.
  • Maintain contemporaneous records, including time reports, logs, or similar documentation of the description and hours of all services performed; dates when such services were performed; and who performed the services (i.e., a contractor). Records could be requested by the IRS to substantiate rental activities.

As usual, the IRS guidelines address exclusions from Section 199A eligibility, including:

  1. Travel to and from the rental property does not count towards the 250 hours of rental services. 
  2. Real estate used by the taxpayer as a residence for any part of the year is not eligible.
  3. Real estate rented under a triple net lease is also not eligible, although the activity may qualify as a trade or business, depending on the owner’s business activities. 

There’s more! Starting with 2019 individual income tax returns, taxpayers with activities that qualify for the Section 199A deduction must include a statement indicating that the 199A deduction is being claimed using a new form, Form 8995, Qualified Business Income Deduction

Want more details? The IRS website has them here https://www.irs.gov/newsroom/irs-finalizes-safe-harbor-to-allow-rental-real-estate-to-qualify-as-a-business-for-qualified-business-income-deduction

Will Your Wishes be Granted?

You’ve spent years planning for your financial future, accumulating assets. If the unexpected were to happen, would your assets be given to the people that you want to get them? Will your wishes be granted? 

Estate planning is a complicated topic that should be addressed by an attorney. However, one simple and important estate planning action you can take immediately is to designate a beneficiary for your financial assets. If you’ve already named beneficiaries to inherit your assets, check them periodically to make sure that they reflect current reality.

Financial assets to name and check on beneficiary designations include: 

  • Bank accounts
  • Brokerage accounts
  • Retirement accounts
  • Company benefit plans
  • Life insurance policies
  • Annuities
  • 529 College savings accounts

Sure, we all think that we have plenty of time to designate beneficiaries and make sure our wishes are followed. But putting it off can lead to unforeseen and undesirable consequences. If you need motivation, here’s a real-life horror story to light a fire under you.

“Dad” failed to change the beneficiary designations for his pension benefits and life insurance after his divorce, so Dad’s former wife was still the named beneficiary. Two months later, Dad died in a car crash. The Court ruled that the beneficiary designations overruled a state law that would have automatically disinherited the ex-wife. So, the ex-wife received the money, and the kids were handed the bills for an unsuccessful legal fight.

Divorce is not the only situation where failing to turn in or update beneficiary designation forms can cause heartache for your intended heirs—it’s just the most obvious situation. You get the idea. When things in your life change, you may need to refresh your beneficiary designations.

Other tips:

  1. Probate – Another big reason to designate beneficiaries: it avoids probate. Also, consider naming contingent beneficiaries. These are individuals who stand in line behind your primary beneficiaries. 
  2. Living Trusts and WillsAs a general rule, whoever is named on the most recent beneficiary form will get the money automatically when you die—regardless of what other documents might say.      
  3. Check – Review your designations at least once a year or whenever significant life events occur. It usually takes only a few minutes to conduct a checkup and make any needed changes. Often you can access the necessary forms online. 

Don’t wait if you want your wishes to be granted.

Extended Tax Returns Due October 15

Way back in April when you got an extension to file your 2018 income tax returns, you breathed a sigh of relief. Phew! Six additional months to file. Seemed like all the time in the world. Well, “all the time in the world” had passed and you are up against another deadline to file – by next Tuesday. No more extensions and no more excuses.

Two tips about filing extended income tax returns:

File by October 15th

It’s really down to the wire now. No additional filing extensions are available after October 15th. The mad scramble is on to get replacement copies of missing wage statements, organize your business expenses and scan your bank account statement for charitable contributions. If you really cannot get your business expense information organized as thoroughly as you should, use your best estimates and file a return by the due date. Then, finish getting those documents together and file an amended return. Failure-to-file penalties are expensive.

If You Still Owe

Even if you paid with your extension request, you could still end up owing more. If that’s the case, pay as much as possible with your return to reduce interest and penalties. Keep in mind that interest accrues daily on unpaid tax balances. It’s free to use IRS Direct Pay to securely pay from your checking or savings accounts. Can’t pay it all now? The IRS offers payment plan options, allowing you to pay over time. Details about all of these options (and their costs) are all found at the Paying Your Taxes page on IRS.gov.

Filing an extension in April feels terrific, until that six-month reprieve flies by and you there you are. Confronted with another deadline. Less than a week to go. No more excuses. Go ahead and get started. Maybe it won’t be as painful as you imagine. Need help meeting the October 15th tax filing deadline? Go to the IRS website at https://www.irs.gov/newsroom/the-filing-deadline-for-extension-filers-is-almost-here. Need more guidance? Consult a qualified tax professional.

Start-up with Financial Success Workshop

If you’ve started a business within the last year, you know how easy it is to get overwhelmed by the financial aspects. From choosing the right accounting software, to setting up your service agreements, to paying your quarterly tax estimates, there are so many big decisions that you make up-front that can affect the long-term health of your business. 

Unless you have a formal business or finance background, handling all the details can be rather intimidating. On the other hand, even if you do have business finance skills, should you be spending that time away from building your business? No!

Start-up business owners need straight answers from experts with the experience and knowledge that will lead to financial success. My upcoming Start-Up with Financial Success workshop is just what you need! This one-day, in-person workshop is presented by me and four other professionals to cover the basics of financial management for small businesses to set up healthy financial habits from the start. 

Unlike other trainings that only focus on one financial discipline, this workshop is led by five experts in different aspects of financial management: Legal, Bookkeeping, Taxes, Accounting and Business Operations. These experts bring decades of combined expertise to cut through the confusion and overwhelm and pave the way to financial success.

Register here – https://www.eventbrite.com/e/start-up-with-financial-success-tickets-72274235183

The Start-Up with Financial Success workshop will answer common questions, such as:

  • What type of legal business entity should I establish?
  • What’s the difference between a bookkeeper and an accountant, and how can they help my business? 
  • How do I choose the right accounting software?
  • How do I make sure the language in my services agreement or other contracts give me the legal protections I need?
  • How do I keep all my financial information organized?
  • What are quarterly tax estimates and how do I pay them? 

Can you tell that it’s going to be a jam-packed day? Interested?  Register now at this link – https://bit.ly/2m6UWP7 Look forward to seeing you there!

Is Your Price Right?

Have you ever watched the game show, The Price is Right? It’s been on TV for a long time. The winner is the contestant who guesses closest to the actual price of an appliance, car, vacation or other item (without going over). Over the years, winning contestants seem to have done their homework. People who guess without doing any homework generally don’t win.

Something similar happens with business. When launching a new business or a new service or product line, how do you know that your price is right? Too high, no one will buy from you. Too low, you’ll be out of money – and business – pretty quickly. You’ve got to do your homework or you could guess wrong.

Getting your price right boils down to three elements: Cost, Competition, and Value

  • Cost – Start by figuring out all the costs you need to cover, both direct and indirect. Direct costs are usually the most obvious, like materials and labor. Indirect costs, like rent and marketing, also need to be included in the total cost per service or product. Don’t forget to also recover the cost to replace equipment that wears out every five to ten years. 
  • Competition – Once you know your costs, check out the competition to get some perspective. Take care not to use competitor prices as your only guide. You don’t know enough about how their situation or profitability. Consider unmet market demand, competitive pricing and customer service when establishing your prices.
  • Value – Should your price reflect your superior quality, experience and qualifications? Absolutely! Don’t hesitate to charge more than the competition as long as you can distinguish your service or product from the others. Identify your value to your customers and reflect it in your price structure. 

Want to make sure that Your Price is Right? Consider Cost, Competition, and Value. It’s not as simple as covering your costs and checking out competitor’s prices. Reflect your value and what distinguishes you from your competitors in your price while covering your costs and you’ll win the game.

Is Your New Worker an Employee or a Contractor?

When your organization needs more help, worker classification — employee or contractor — takes a back seat to more immediate concerns, like the worker’s start date and assignments. In reality, how your workers are classified should be your first consideration because it impacts the worker relationship, the on-boarding process and your organization’s overall cost.

What does “Worker Classification” mean? 

Workers can be employees or independent contractors. The IRS spells out around 20 tests to determine worker classification. But they all boil down to the amount of control over the worker and the work itself in three ways:

  • Behavioral: Do you control what the worker does and how the job is done? For example, do you determine work hours and processes to perform work tasks? If you set work hours and procedures, your worker is an employee.
  • Financial: Do you provide the tools for the worker to perform the job, such as a work space and computer? Your worker is an employee.
  • Relationship: Is the work permanent or temporary? Are employee-type benefits provided? Permanent workers who receive employer-provided benefits are employees. Temporary worker? Depends on #1 and #2.

What is the Cost Impact of Worker Classification?

Costs can be higher when workers are classified as employees vs. contractors. Employee wages are subject to the employer portion of social security taxes and any federal and state unemployment taxes. Employees may also get employer-provided benefits, such as insurance. An independent contractor is responsible for paying all of her or his social security taxes and insurance. Do some cost projections based on worker classification to know how it impacts your bottom line.

What If a Worker is Misclassified?

Even if the costs are higher, workers whose job duties are controlled by the organization must be classified as employees. No choice. Organizations that misclassify employees as independent contractors to save on employment taxes may be held liable for unpaid employment taxes, plus interest and penalties. Making a worker classification error, accidentally or intentionally, can get pretty expensive. 

Worker classification is an important consideration to your organization’s overall cost and worker relationship, so it’s essential to get it right. The IRS has helpful to do just that at https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee. Still have questions? Consider consulting a qualified tax professional to help you figure it out.

Time to Think About Estimated Income Taxes — Again

Labor Day marks the unofficial end of summer. So does the September 15th deadline for individuals to pay their third quarterly estimated income tax payments for 2019.  That’s right; those tax payments are due before your sun tan fades. The sad news is, the IRS and state tax agencies want you to pay your taxes as income comes in.

Estimated tax payments are due April 15, June 15, September 15, and January 15, unless, those dates fall on a weekend or a holiday. Technology makes the process a little less painful, with various online payment options. Of course, the IRS and state tax agencies still take checks. Some options, like credit cards, add service fees.

Three things to know about estimated tax payments:

Who Needs to Pay Estimated Taxes?

If all of your income comes from wages, the taxes that your employer withholds and remits for you probably cover your income tax liability. (More on withholdings later.) If you are self-employed or receive investment or rental income, you should check whether you need to make estimated income tax payments. The IRS website explains how to see if estimated payments apply to you and how to estimate federal income tax at this link

How Much Do You Need to Pay?

Estimated tax payments are based on your estimated income and tax liability. To avoid underpayment penalties, pay estimated taxes if you expect to owe at least $1,000 in tax after subtracting withholding and refundable credits. Total withholdings and estimated payments must equal or exceed the lesser of 90% of your current year tax liability, or 100% of your prior year tax liability. Figure your 2019 federal income tax bill with the IRS Withholding Estimator – https://www.irs.gov/individuals/tax-withholding-estimator.

What if You Don’t Pay Enough?

Interest is calculated on the unpaid balance due, accrued daily from the time the tax liability was created (aka when your income was earned or received) and when it is paid. Daily interest accruals can really add to your tax bill, so staying on top of your income tax payments is important. Annualized interest rates charged vary with market rates. At this writing, the IRS accrues 5% annual interest on unpaid individual income tax balances. Clearly, the IRS is serious about getting paid on time. 
If you paid a lot when you filed your 2018 income tax return or have income from which taxes are not withheld, use the links above to see if you need to make estimated tax payments for 2019. Don’t feel comfortable doing this yourself? The IRS can also help you find a qualified tax professional – here https://www.irs.gov/tax-professionals/choosing-a-tax-professional.

IRS Imposters Strike Again

Automation, including the magic of email, is a fantastic thing. That is, until criminals use that magical email to scam you out of your hard-earned money. Far too many email “phishing” scams exist. You’ve probably gotten at least one message luring you to click on a link to funds in a bank you’ve never banked with. That’s bad enough. To me, the most insidious phishing scams come from IRS imposters. Another one recently unleashed itself on U.S. taxpayers.

Last week, the IRS alerted taxpayers and the tax professional community to a new scam. They had received a high volume of taxpayer submissions to [email protected] about unsolicited emails from IRS imposters. Taxpayers reported various email subject lines, like “Automatic Income Tax Reminder” or “Electronic Tax Return Reminder.” That kind of subject line coming from what appears to be the IRS would scare anyone into opening and responding!

These taxpayer-reported emails include an IRS.gov-like link appearing to be about the taxpayer’s refund, electronic return or tax account. The emails contain a “temporary password” or “one-time password” to “access” the files and obtain the refund. But you can guess what happens next…when the taxpayer tries to access the file, it turns out to be malicious and infects her or his computer or device. Or, it asks for bank account and other personal information to access or transfer funds. Bad news, either way.

Protect yourself! Remember that the IRS does not send emails about your tax refund or sensitive financial information. Most IRS communication is still through the good old-fashioned USPS. Essentially, that means you should be suspicious of ANY email from the IRS. If you want to be absolutely sure, the easiest way to check for phishing is to place your cursor over the sender’s name, revealing the sender’s e-mail address. An address that doesn’t look legitimate is a scam. 

No matter what, do not reply to any unsolicited email, texts or social media from the IRS (or anyone else, for that matter) to request money or financial information. This includes requests for PIN numbers, passwords or similar access information for credit cards, banks or other financial accounts. 

Just in case you receive an email claiming to be from the IRS that contains a request for delinquent tax balances or financial information, immediately do the following:

  1. Don’t reply, open any attachments or click on any links. 
  2. If it’s too late and you did something from #1, visit the IRS’ identity protection page.
  3. Forward the email as-is to the IRS at [email protected]
  4. Delete the original email.

Tax scams are a year-round business, so taxpayers need to be on-guard at all times for IRS imposters. Need to report an IRS imposter? See Report Phishing and Online Scams for more details.