How to Get a Business Deduction For Your Vacation Home

Have you ever wondered if you could get a business deduction for your vacation home or condo? This post is for you!

Here’s good news: the properly used business vacation home or condo does not suffer from:

• the vacation-home rules,

• the passive-loss rules, or

• the entertainment-facility rules.

In these days of COVID-19, you may have solid reasons to use your vacation home or condo for two purposes only:

• personal pleasure, and

• business lodging.

How Business Use Escapes the Dreaded Vacation-Home Rules

Do you use your business vacation home or condo solely for business lodging?

If so, you escape the vacation-home rules and may deduct your business-lodging costs. The law is very clear on this. The vacation-home section of the tax law, Section 280A(f)(4), states that nothing in the vacation-home rules shall disallow any business deduction for business travel.

Example 1. You use your beach home for overnight business lodging 37 times during the year. You have no personal or rental use of the beach home. Your beach home is a business asset and deductible as such. 

One exception to this business-lodging rule. The law does not grant the business-lodging exception to landlords who rent dwelling units. If you have apartment buildings or other residential rentals, staying at your vacation home or condo to look after your rentals does not let you escape the unfavorable vacation-home rules.

Example 2. Fred uses his beach home for 70 nights of business lodging and 30 nights of personal lodging. He has a 70 percent business-use beach home and a 30 percent personal-use beach home.

Planning note. Fred has his tax home where he regularly works, in New Jersey. He travels to his South Carolina beach home location to conduct business in South Carolina. His business activity is what makes his overnight stays at the beach home business stays.

How Rental Use Changes the Landscape 

If you rent the vacation home or condo, you really change the tax picture. For example, if you use the vacation home or condo for personal, business, and rental purposes, you could trigger 

• vacation-home rules that require a split between the rental- and personal-use deductions;

• vacation-home rules that classify the rental part of your property as either a personal residence or a rental property;

• loss of tax-favored hotel status for qualified rentals; and

• passive-loss rules that defer current tax benefits to future years.

 Looking at this list, you might ask, “How can I avoid all these additional considerations and still rent out the vacation home or condo?” Answer: rent for 14 days or less. Technically, that works.

Build Proof

In addition to keeping receipts for the business condo’s expenses and improvements, you need to prove how many nights you slept in the vacation home or condo for both business and personal purposes.

Notations on your business and personal calendars are helpful but not conclusive. For your business activities, you want proof of why you had to be at the beach home.

Example 3. Sara sells real estate at both her tax and beach home locations. She tracks her prospects and activities at each location.

Do as Sara does. Also, keep your eyes open for third-party and other corroborative evidence of use. Do you have emails, letters, and other proof of why you had to travel to the beach home? If so, print the emails and save them along with the written letters in your tax file.

Do you have evidence of being in the area, such as gas, grocery, and dining receipts?

Proving use of your business condo is easy and takes very little time. Documentation is essential. Don’t pass over this critical step.

Ownership

Do you own the vacation home or condo in your personal name?

If so, and you operate as a:

• proprietorship or LLC taxed as a proprietorship, no problem. Simply treat the business percentage as business expenses on your Schedule C.

• corporation, submit an expense report to the corporation to obtain reimbursement. See TCJA Creates New Reasons for Accountable Plan Expense Reimbursements for how this works.

 Why not use a rental arrangement with your corporation? Because you are an employee who likely uses the vacation home or condo for more than 14 days of personal use, you want to avoid a rental arrangement that could cost you your depreciation, repairs, and similar expenses.

 The reimbursement method works and creates no complications. Use it.

If the corporation owns the vacation home or condo, you should reimburse the corporation for your personal use so as to avoid the monies showing on your W-2 and increasing your taxes  

Want to make rental us of your vacation home

Let’s set up a time to talk here.

~ Chad Pavel, CPA

Tax Savings Double Play: Combine Your Home Sale With a 1031 Exchange

You don’t often get the opportunity to even consider making a tax-saving double play.  

But your personal residence combined with a desire for a rental property can provide just such an opportunity.

The tax-saving strategy is to combine the tax-avoidance advantage of the principal residence gain exclusion break with the tax-deferral advantage of a Section 1031 like-kind exchange. With proper planning, you can accomplish this tax-saving double play with full IRS approval.

The double play is available if you can arrange a property exchange that satisfies the requirements for both:

1. the principal residence gain exclusion break, and

2. tax deferral under the Section 1031 like-kind exchange rules.

The kicker is that tax-deferred Section 1031 exchange treatment is allowed only when both the relinquished property (what you give up in the exchange) and the replacement property (what you acquire in the exchange) are used for business or investment purposes (think rental here).

Clarifying Example

Let’s say your principal residence—owned for many years by you and your spouse—is worth $3.3 million.

You convert it into a rental property, rent it out for two years, and then exchange it for a small apartment building worth $3 million plus $300,000 of cash boot paid to you to equalize the values in the exchange.

Your basis in the former residence is only $400,000 at the time of the exchange. You realize a whopping $2.9 million gain on the exchange: proceeds of $3.3 million (apartment building worth $3 million plus $300,000 in cash) minus basis in the relinquished property of $400,000.

Now, let’s check on your tax bite.

You can exclude $500,000 of the $2.9 million gain under the principal residence gain exclusion rules. So far, so good!

Because the relinquished property was investment property at the time of the exchange (due to the two-year rental period before the exchange), you can defer the remaining gain of $2.4 million under the Section 1031 like-kind exchange rules. Nice! No taxes on this deal.

How To Pay No Income Taxes On Real Estate Ever

If you hang on to the apartment building until you depart this planet, the deferred gain will be eliminated from federal income taxes thanks to the date-of-death basis step-up rule.

Under the date-of-death rule, the tax code steps up the basis of the building to its fair market value as of the date of your death.

Example. You die. Your heirs inherit the building at its new stepped-up basis. They sell the building for its date-of-death fair market value. Presto, no income taxes.

Of course, you do need to consider estate taxes if your estate is greater than $11.4 million.

If you are considering selling your investment property at a gain and you are not sure how much you will pay in taxes and want strategies on how to minimize your taxes, book a call below.

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.

How Cost Segregation Can Turn Your Property Into a Cash Cow

Do You Own Rental Property?

Cost segregation breaks your real property into its components, some of which you can depreciate much faster than the typical 27.5 years for a residential rental or 39 years for nonresidential real estate.

What Exactly Is A Cost Segregation Study?

When you buy real property, you typically break it into two assets for depreciation purposes: 

• land, which is non-depreciable; and

• building (residential is 27.5-year property; nonresidential is 39-year property).

 With a cost segregation study, you make your property much more than a building on land. Here’s what’s possible with a cost segregation study: 

• land, which is non-depreciable

• 5-year property

• 7-year property

• 15-year property

• for the remainder, 27.5-year property or 39-year property, depending on building use

 With a cost segregation study, you front-load your depreciation deductions and take them sooner, but you’ll take the same total depreciation amount over the lifetime of the property.

Tax reform under the Tax Cuts and Jobs Act boosted bonus depreciation from 50 percent to 100 percent, and this new law also allows bonus depreciation on qualifying used property. Cost segregation is made to take advantage of these new law changes.  

What Is The Timing Requirement?

And you can apply cost segregation to rentals and offices you have had for 10 years or that you are buying tomorrow.

But if the passive activity loss rules affect your ability to take immediate rental losses, we need to run the numbers to see if you can benefit and also identify what you could do to benefit even more.

Watch Out for Tax Reform Changes

Tax reform in one of its “not beneficial to you” new law sections took away your ability to do a like-kind exchange for non-real property. Therefore, if you do a cost segregation and then later use a like-kind exchange on that property, you’ll have taxable gain attributable to everything that’s not land or 27.5-year or 39-year property.

We recently saw a cost study on a new $400,000 property purchased this year. The study enabled a speed-up of $50,000 of deductions to this year’s tax return. For this taxpayer, who was in a combined federal and state income tax bracket of 40 percent, this put $20,000 in his pocket this year!

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.

Tax Considerations To Renting A Room in Your Home

Rental Property Real Estate Taxes

When you rent a bedroom or two or 20, you first examine Section 280A of the tax code to determine whether your bedroom rental is:

• tax-free because your rentals were for fewer than 15 days during the tax year.

• subject to section 280a vacation home rules.

• exempt from Section 280A.

When exempt from Section 280A, your bedroom rental faces four tax code sections:

1. Section 183, which requires a profit motive for you to claim any rental business tax deductions. Failing Section 183 requires the IRS to tax your bedroom income and give you no bedroom deductions other than mortgage interest and property taxes.

2. Section 469, which requires that you (or you and your spouse) materially participate in the property to claim any tax losses on the bedroom rental activity.

3. Section 1402, which requires you to report the activity on Schedule C and pay self-employment taxes on the net income when you provide services as part of the bedroom rentals.

4. Section 199A, which includes a tax deduction that you could claim if the bedroom rental is a business that qualifies.

 As you can see, bedroom rentals travel a torturous path. Please call me on my direct line so we can set a time to review your bedroom rentals to achieve the best results.

If you are considering converting your home into a rental property and would like my advice on the conversion, please contact me below.

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.

Cashing Out Real Estate Profits Without A 1031 Exchange

Would You Volunteer To Pay Taxes?

Paying taxes on the sale of your real estate investment is indeed voluntary. You do not need to volunteer to pay the IRS more than it deserves…

But if you MUST cash out your investment property there are a few ways to reduce or defer your tax on the gain to minimize the impact on your bank account.

Section 1031 Alternatives

While growing your real estate portfolio, you likely used Section 1031 to avoid paying capital gains taxes when you acquired bigger and better properties.

But now, when you want to cash out, Section 1031 is not the vehicle of choice (since it requires you to invest your gains into a larger property).

So if you need the liquid cash for a reason other than investing in larger properties, your options are limited when trying to minimize your capital gains taxes.

So what do you do?

Here are three strategies we can help you with when you want to cash out some or all of your real estate profits: 

1. Use the combination of a charitable remainder trust and a wealth replacement trust to avoid taxes, increase personal cash flow, and increase the estate distribution to your children.

2. Use IRC Section 721 to invest the property in a real estate investment trust and defer taxes.

3. Use an installment sale to pay taxes slowly.

If you are considering selling your investment property at a gain and you are not sure how much you will pay in taxes and want strategies on how to minimize your taxes, book a call below.

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.