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

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.

Converting Your Home Into a Rental Property: Tax Issues

Converting Your Home Into a Rental Property

The simple maneuver of converting your personal residence to a rental property brings with it many tax rules, mostly good when you know how they work.

The first question that arises when you convert a personal residence into a rental is how to determine the property’s tax basis for depreciation purposes during the rental period and for gain/loss purposes when you eventually sell.

Oddly enough, two different basis rules apply: 

1. If, after conversion to a rental, you sell at a gain, your basis on the conversion date is the usual computed amount (cost of home plus improvements, minus depreciation—such as from a home office).

2. If, after conversion to a rental, you sell at a loss, your basis on the conversion date is the lesser of the computed basis or the fair market value.

Once you’ve converted a former personal residence into a rental, you must follow the tax rules for landlords. Here is a quick summary of the most important things to know:

• You can deduct mortgage interest and real estate taxes on a rental property.

• You can also write off all the standard operating expenses that go along with owning a rental property: utilities, insurance, repairs and maintenance, yard care, association fees, and so forth.

• Finally, you can also depreciate the cost of a residential building over 27.5 years, even while it is (you hope) increasing in value.

Rental Real Estate Losses

If your rental property throws off a tax loss, things can get complicated.

The so-called passive activity loss (PAL) rules will usually apply. In general, the PAL rules allow you to deduct passive losses only to the extent you have passive income from other sources, such as positive income from other rental properties or gains from selling them.

Eventually your rental property should start throwing off positive taxable income instead of losses, because escalating rents will surpass your deductible expenses. Of course, you must pay income taxes on those profits. But if you piled up suspended passive losses in earlier years, you now get to use them to offset your passive profits.

Prior Losses Can Offset Future Positive Income

Another nice thing: positive taxable income from rental real estate is not hit with the dreaded self-employment (SE) tax, which applies to most other unincorporated profit-making ventures. The SE tax rate can be up to 15.3 percent, so it’s a wonderful thing when you don’t have to pay it.

One other good thing is that your net rental profits may qualify for the Section 199A deduction.

Another good thing is that if your rental property rises to the level of a trade or business, your rental profits avoid getting socked with the 3.8 percent net investment income tax (NIIT).

Taxes When Selling Rental Real Estate

When you sell a rental property that you’ve owned for more than one year, the profit (the difference between the net sales proceeds and the tax basis of the property after subtracting depreciation deductions during the rental period) is generally treated as a long-term capital gain.

Always keep in mind the good news here. You don’t pay the taxes on the property appreciation until you sell.

Remember those suspended passive losses we mentioned above? The suspended losses are ordinary losses. When you sell a rental, you can find two great benefits: 

1. Gains are tax-favored capital gains.

2. And then, to the extent of your gains, you release suspected passive losses that offset ordinary income.

Avoid Paying Taxes on Real Estate Capital Gains

And always keep this in mind: rental real estate owners can avoid taxes indefinitely using Section 1031 exchanges (named after the applicable section of our beloved Internal Revenue Code).

The tax code totally mislabeled the 1031 exchange. It’s absolutely not an exchange or a swap. It works like this:

1. You sell your property.

2. You buy a new, more expensive property.

3. Your Section 1031 exchange intermediary (such as a bank) handles the paperwork, and that makes the taxes go away.

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.