Dallas CPA Firm

Real estate investor vs. professional: Why it matters

Income and losses from investment real estate or rental property are passive by definition — unless you’re a real estate professional. Why does this matter? Passive income may be subject to the 3.8% net investment income tax (NIIT), and passive losses generally are deductible only against passive income, with the excess being carried forward.

Of course the NIIT is part of the Affordable Care Act (ACA) and might be eliminated under ACA repeal and replace legislation or tax reform legislation. But if/when such legislation will be passed and signed into law is uncertain. Even if the NIIT is eliminated, the passive loss issue will still be an important one for many taxpayers investing in real estate.

“Professional” requirements

To qualify as a real estate professional, you must annually perform:

  • More than 50% of your personal services in real property trades or businesses in which you materially participate, and
  • More than 750 hours of service in these businesses.

Each year stands on its own, and there are other nuances. (Special rules for spouses may help you meet the 750-hour test.)

Tax strategies

If you’re concerned you’ll fail either test and be subject to the 3.8% NIIT or stuck with passive losses, consider doing one of the following:

Increasing your involvement in the real estate activity. If you can pass the real estate professional tests, the activity no longer will be subject to passive activity rules.

Looking at other activities. If you have passive losses from your real estate investment, consider investing in another income-producing trade or business that will be passive to you. That way, you’ll have passive income that can absorb some or all of your passive losses.

Disposing of the activity. This generally allows you to deduct all passive losses — including any loss on disposition (subject to basis and capital loss limitations). But, again, the rules are complex.

Also be aware that the IRS frequently challenges claims of real estate professional status — and is often successful. One situation where the IRS commonly prevails is when the taxpayer didn’t keep adequate records of time spent on real estate activities.

If you’re not sure whether you qualify as a real estate professional, please contact us at (214) 696-1922. We can help you make this determination and guide you on how to properly document your hours.

© 2017

2016 IRA contributions — it’s not too late!

Yes, there’s still time to make 2016 contributions to your IRA. The deadline for such contributions is April 18, 2017. If the contribution is deductible, it will lower your 2016 tax bill. But even if it isn’t, making a 2016 contribution is likely a good idea.

Benefits beyond a deduction

Tax-advantaged retirement plans like IRAs allow your money to grow tax-deferred — or, in the case of Roth accounts, tax-free. But annual contributions are limited by tax law, and any unused limit can’t be carried forward to make larger contributions in future years.

This means that, once the contribution deadline has passed, the tax-advantaged savings opportunity is lost forever. So it’s a good idea to use up as much of your annual limit as possible.

Contribution options

The 2016 limit for total contributions to all IRAs generally is $5,500 ($6,500 if you were age 50 or older on December 31, 2016). If you haven’t already maxed out your 2016 limit, consider making one of these types of contributions by April 18:

1. Deductible traditional. If you and your spouse don’t participate in an employer-sponsored plan such as a 401(k) — or you do but your income doesn’t exceed certain limits — the contribution is fully deductible on your 2016 tax return. Account growth is tax-deferred; distributions are subject to income tax.

2. Roth. The contribution isn’t deductible, but qualified distributions — including growth — are tax-free. Income-based limits, however, may reduce or eliminate your ability to contribute.

3. Nondeductible traditional. If your income is too high for you to fully benefit from a deductible traditional or a Roth contribution, you may benefit from a nondeductible contribution to a traditional IRA. The account can still grow tax-deferred, and when you take qualified distributions you’ll be taxed only on the growth. Alternatively, shortly after contributing, you may be able to convert the account to a Roth IRA with minimal tax liability.

Want to know which option best fits your situation? Contact us.

© 2017

Do you qualify for a moving expense deduction? Four questions to ask.

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Finding the right tax-advantaged account to fund your health care expenses

With health care costs continuing to climb, tax-friendly ways to pay for these expenses are more attractive than ever. Health Savings Accounts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimbursement Accounts (HRAs) all provide opportunities for tax-advantaged funding of health care expenses. But what’s the difference between these three accounts? Here’s an overview:

HSA. If you’re covered by a qualified high-deductible health plan (HDHP), you can contribute pretax income to an employer-sponsored HSA — or make deductible contributions to an HSA you set up yourself — up to $3,350 for self-only coverage and $6,750 for family coverage for 2016. Plus, if you’re age 55 or older, you may contribute an additional $1,000.

You own the account, which can bear interest or be invested, growing tax-deferred similar to an IRA. Withdrawals for qualified medical expenses are tax-free, and you can carry over a balance from year to year.

FSA. Regardless of whether you have an HDHP, you can redirect pretax income to an employer-sponsored FSA up to an employer-determined limit — not to exceed $2,550 in 2016. The plan pays or reimburses you for qualified medical expenses.

What you don’t use by the plan year’s end, you generally lose — though your plan might allow you to roll over up to $500 to the next year. Or it might give you a 2 1/2-month grace period to incur expenses to use up the previous year’s contribution. If you have an HSA, your FSA is limited to funding certain “permitted” expenses.

HRA. An HRA is an employer-sponsored account that reimburses you for medical expenses. Unlike an HSA, no HDHP is required. Unlike an FSA, any unused portion typically can be carried forward to the next year. And there’s no government-set limit on HRA contributions. But only your employer can contribute to an HRA; employees aren’t allowed to contribute.

Questions? We’d be happy to answer them — or discuss other ways to save taxes in relation to your health care expenses.

© 2016

Properly fund your living trust to shield assets from probate

Many people set up a revocable, or “living,” trust to shield assets from probate and take advantage of other benefits. For the trust to work, you must transfer assets to it that would otherwise go through probate — a process known as “funding” the trust. Most people fund their trusts around the time they sign the trust documents.

Once your estate plan is complete, however, it’s easy to overlook the need to transfer later-acquired assets to your trust. If you don’t transfer them, those assets may be subject to probate and will be outside the trust’s control.

How to transfer assets

Procedures for transferring assets to a trust vary depending on the asset type:

To transfer real estate, you must execute and record a deed conveying title to the trust.
Transferring bank and brokerage accounts typically involves providing forms or letters of instruction to the institution holding the accounts.
Interests in closely held businesses usually require a simple assignment.
Tangible personal property may require an assignment or bill of sale.

Assets that shouldn’t be transferred

Be aware that certain assets shouldn’t be transferred to a living trust, such as IRAs and qualified retirement plan accounts. These are “nonprobate” assets, so avoiding probate isn’t an issue, and transferring them to a trust is considered a taxable withdrawal.
Instead, you can name an individual as beneficiary. Or, if you don’t want an individual to have complete control over the account, you can name a trust as beneficiary.

Reap the full benefits

Avoiding probate is an important estate planning objective for many taxpayers because probate can be costly and time consuming, and its public nature raises privacy concerns. A living trust can also be used to manage your assets if you become incapacitated.

To ensure that your living trust is properly funded so you can reap the full benefits, contact us any time you acquire a major asset.

© 2016

Various Tax Benefit Increases for 2016

For tax year 2016, the IRS recently announced many annual inflation adjustments. IRS Revenue Procedure 2015-53 provides details about these amounts.

Because inflation is low, many of the amounts for 2016 will not change from 2015. For example, the elective deferrals to 401(k) and 403(b) plans will remain $18,000 next year. Other retirement plan contribution limits also will not change.

Recently, the Social Security Administration announced that the Social Security wage base (the amount of earnings subject to taxation) will remain at $118,500 for 2016, the same as 2015.

Here are some of the other tax amounts for 2016, as compared with 2015

Tax Item

2016

2015

Highest tax rate of 39.6 percent Will affect singles with income exceeding $415,050 ($466,950 for married taxpayers filing jointly) Affects singles with income exceeding $413,200 ($464,850 for married couples filing jointly)
Standard deduction Remains $6,300 for singles and married persons filing separately; $12,600 for married couples filing jointly. For heads of household, the amount rises to $9,300 $6,300 for singles and married persons filing separate returns and $12,600 for married couples filing jointly. The standard deduction for heads of household is $9,250
Limitation for itemized deductions For singles, will begin at incomes of $259,400 ($311,300 for married couples filing jointly) For singles, begins at incomes of $258,250 ($309,900 for married couples filing jointly)
Personal exemption $4,050 $4,000
Alternative minimum tax exemption $53,900 ($83,800, for married couples filing jointly) $53,600 ($83,400, for married couples filing jointly)
Estates Decedents who die during 2016 will have a basic exclusion amount of $5,450,000 Decedents who die during 2015 have a basic exclusion amount of $5,430,000
Annual exclusion for gifts $14,000 $14,000
Foreign earned income exclusion $101,300 $100,800
Gifts to non-U.S. citizen spouse The exclusion from tax on a gift to a spouse who is not a U.S. citizen will be $148,000 The exclusion from tax on a gift to a spouse who is not a U.S. citizen is $147,000
Kiddie Tax Amount used to reduce the net unearned income reported on a child’s return that is subject to the Kiddie Tax remains $1,050 Amount used to reduce the net unearned income reported on a child’s return that is subject to the Kiddie Tax is $1,050
Flexible spending arrangements (FSAs) The annual limit on employee contributions to employer-sponsored health FSAs will remain $2,550. The annual dollar limit on employee contributions to employer-sponsored healthcare FSAs is $2,550.

If you are seeking guidance of CPAs who understand the implications these changes can have on your tax obligations, call 214-696-1922 and ask for Mark Patten.

McKinnon Patten is a leading CPA Accounting Firm that specializes in tax planning strategies for high net worth individuals and small to mid-size owner operated businesses.