IRS Provides a Trade or Business Safe Harbor under 199A for Rental Property
On January 18, 2019, the IRS issued long-awaited final IRC §199A regulations. In conjunction with these regulations, a proposed revenue procedure, Notice 2019-07, was also released to provide a safe harbor under which a rental real estate enterprise will be treated as a trade or business solely for purposes of IRC § 199A.
Trade of Business Requirement
The new IRC § 199A 20 percent deduction is available for “qualified business income” arising from a “qualified trade or business”. Since the issuance of the initial guidance on the deduction, taxpayers and practitioners alike were looking for guidance on when a taxpayer’s rental real estate activity is enough to meet the “qualified trade or business” standard.
New Safe Harbor for Real Estate Trade or Business
In response to the requests for more certainty, Notice 2019-07 was released and includes a proposed safe harbor under which a rental real estate enterprise may be treated as a trade or business solely for the purposes of IRC § 199A.
Under the guidance, taxpayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate may not be part of the same enterprise. Taxpayers may not vary this treatment from year-to-year unless there has been a significant change in facts and circumstances.
Safe Harbor Requirements
To meet the safe harbor requirements, the taxpayer must satisfy the following factors during the taxable year:
- Maintains separate books and records to reflect income and expenses for each rental real estate enterprise
- For taxable years beginning prior to January 1, 2023, perform 250 or more hours of rental services per year with respect to each rental real estate enterprise
- For taxable years beginning after December 31, 2022, in any three of the five consecutive taxable years that end with the taxable year (or in each year for an enterprise held for less than five years), perform 250 or more hours of rental services per year with respect to the rental real estate enterprise
- Maintains contemporaneous records – including time reports, logs, or similar documents – regarding the following:
- Hours of all services performed
- Description of all services performed
- Dates on which such services were performed
- Record of who performed the services
These records are to be made available for inspection at the request of the IRS. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2019.
What rental services qualify?
Rental services, for purposes of the revenue procedure, include the following:
- Advertising to rent or lease the real estate
- Negotiating and executing leases
- Verifying information contained in the prospective tenant applications
- Collection of rent
- Daily operation, maintenance, and repair of the property
- Management of the real estate
- Purchase of materials
- Supervision of employees and independent contractors
These activities may be performed by owners, employees, agents, or independent contractors of the owners.
What activities do not count?
Time devoted to the following financial or investment management activities will not constitute rental activities and cannot be counted toward the 250-hour requirement:
- Arranging financing
- Procuring property
- Studying and reviewing financial statements or reports on operations
- Planning, managing, or constructing long-term capital improvements
- Hours spent traveling to and from the real estate
Excluded from the Safe Harbor
The proposed revenue procedure excludes two types of rental arrangements from the protection of the safe harbor. These include:
- Real estate used by the taxpayer (or owner or beneficiary of a pass-through entity) as a residence for any part of the year
- Real estate rented or leased under a triple net lease
Procedural Requirements
A taxpayer using the safe harbor must include a statement attached to their income tax return specifying that the requirements of the revenue procedure have been satisfied. The statement must be signed by the taxpayer or an authorized representative of an eligible taxpayer, and it must say, “Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete”. The individual or individuals who sign must have personal knowledge of the facts and circumstances related to the statement.
Effective Date
The proposed revenue procedure may be applied generally to taxpayers with taxable years ending after December 31, 2017. Taxpayers may rely on it until final guidance is issued.
Self-Rental Rule Tweaked
It should also be noted that the final regulations continue to provide that rental activity that does not rise to the level of an IRC § 162 trade or business is nevertheless treated as a trade or business for purposes of IRC § 199A if the property is rented to a commonly controlled trade or business. In other words, self-rental activities do not have to rise to the level of a trade or business for the rental income to qualify as QBI. Common control under the final regulations means that the same person or group of persons, directly or by attribution under IRC §§ 267(b) or 707(b), owns 50 percent or more of each trade or business. Notably, the final rule was written to exclude self-rental income received by a C corporation from this special treatment.
A step-up in basis is the readjustment of the value of an appreciated asset, such as real estate, for income tax purposes upon inheritance. The value of the property is based on the fair market value on the date of the decedent’s death. While we love and miss the dearly departed, the assets they leave behind must be dealt with appropriately. It’s important for the beneficiaries to know that significant tax savings may be available to them, and are entitled to a step-up in basis.
Examples of Step-up in Basis
There are many different types of situations in which this may occur; here is a simple example:
A husband and wife jointly own a rental house. The rental house was originally purchased decades ago for $40,000 and the portion of the cost that was allocated to the building, $30,000, fully depreciated. Let’s say the husband passed away in 2018, when the rental property was valued at $320,000. At that time, the husband’s share of the fair value of the property, $160,000 (one half of $320,000) was transferred to the wife at a stepped-up basis. This would have added to the wife’s total cost basis in the rental property, thus greatly decreasing any taxable gain if she were to sell the property shortly thereafter. Also, after allocating a portion of the value of the property to land (which is not eligible for depreciation), say $40,000 of the $160,000, the remaining $120,000 would then be treated as a new asset and depreciated in full over the useful life of the property. This would provide deductions against the rental income generated by the property, thus reducing any taxable income.
Another example of a situation that would result in a step-up basis is when a property is passed on to the heirs of a decedent. Regardless of the original cost basis of the property, the stepped-up basis (equal to the fair market value at the time of the decedent’s death) is transferred to the respective heirs. Thus, if the property is sold for an amount equal to the stepped-up basis, then there would be no taxable gain for the heirs at the time of sale.
Obtain an Appraisal
TIP: A proper appraisal for any inherited property will greatly aid in providing adequate substantiation of the stepped-up basis being applied in the event of potential scrutiny by the Internal Revenue Service. Any applicable appraisal should be performed to represent, as closely as possible, the fair market value as of the date of the death of the decedent.
For more information regarding Step Up in Basis, please contact Greg Fusco at 401-921-2000 or gfusco@disantopriest.com.
The ever-changing market of cryptocurrencies presents an array of new tax challenges and the IRS has been urgently training its examiners to handle them. As quickly as miners create cryptocurrencies and investors buy and sell them all over the world, taxable events can occur every step of the way. Users of “virtual currencies”, the IRS’s term for cryptocurrencies, should be aware of the tax implications early on in order to comply with federal and state tax law to avoid potentially significant penalties.
What do cryptocurrency users need to keep in mind when making transactions?
Although substantial media attention and frequent discussions have centered on cryptocurrency for some time, the IRS still hasn’t provided guidance on every type of transaction relating to this new commodity. Although the word “currency” is in the name, virtual currencies are not treated as a form of currency for federal tax purposes. Instead, they are treated as property and must be accounted for and tracked similarly to any other capital asset. However, there are numerous types of cryptocurrency transactions and they don’t always follow the same guidelines.
As virtual currencies are purchased and sold, created by miners, exchanged for goods and services, and in some cases used as compensation through wages, users must maintain proper recordkeeping practices as transactions occur. Waiting until year-end to determine revenues, gains, and losses could be extremely burdensome, if not nearly impossible.
When goods and services are exchanged for virtual currency, taxpayers in receipt of virtual currency must include the fair market value (FMV) in US dollars on the day of the transaction in their gross income. On the other hand, those paying with virtual currency must recognize either a gain or loss at the time of the exchange depending on whether the FMV of property received is greater or less than their adjusted basis in the virtual currency. In fact, any time a virtual currency is exchanged for actual currency, other property, or services, a gain or loss should be recognized. However, the gains or losses may be either capital or ordinary, depending on whether the virtual currency is considered inventory or property held mainly for sale to customers in trade or business. Miners must recognize income at the FMV of the virtual currency received on the day it is mined. It is best to stay ahead of these tracking issues, and when in doubt, taking a conservative approach is best until further guidance has been issued by the IRS.
What about virtual currency held in foreign bank accounts?
Taxpayers may choose to keep their virtual currency in a foreign account. At this time, it is not explicitly required by the Financial Crimes Enforcement Network (FinCEN) to report virtual currency on a Foreign Bank Account Report (FBAR) filing. However, the penalties for not properly filing an FBAR are significant enough that taxpayers should still consider the reporting implications of virtual currency held in foreign accounts. Non-willful violations can result in penalties of $10,000 per year, and willful violations can result in penalties of 50% of account balances or $100,000 for every year, whichever is more. Taxpayers can take a more conservative approach by reporting virtual currency in foreign accounts when the aggregate high balance in all foreign accounts of the taxpayer is above $10,000.
DiSanto, Priest & Co. continues to stay up-to-date on the tax implications of virtual currencies as guidance is released by the IRS. If you have questions regarding your virtual currency and the effects it may have on your tax return, please contact our Tax Department.
Want to read more about Blockchain and Cryptocurrency?
Don’t miss Part 1: The New Technology Quickly Changing our World and Part 2: The Coin Behind the Technology.
Dealing with the Changing Landscape in the Manufacturing Workforce – Part 2
In Part 1 of this series, we outlined the transitional and educational challenges that the manufacturing workforce is facing. We identified two specific tactics to address these challenges: 1) enticing baby boomers to stick around longer; and 2) proactively planning for a changing work culture. The majority of the manufacturing workforce can retire at any moment. Many of the potential replacements for these retirees are not projected to enter the manufacturing field. What else can the manufacturing industry do to combat this employment gap?
Break the Stereotypes
Through history textbooks, media, and conversations with grandparents, today’s young workforce has come to believe that a career in manufacturing is a dirty, unappealing, and unstable career. Why work with machinery when it has led to diseases early in life? How would a maintenance job impact my social status? When will my job be moved overseas or replaced with technology? These questions are disheartening when, in fact, many manufacturing firms are now pristine, filled with some of the most cutting edge technology of our time, and offer loyal employment. The social and economical benefits of a career in manufacturing need to be broadcast. Jobs are returning to the United States amidst the tax reform and economical boost. Today’s manufacturers need to spread this news, include it in their recruitment, and break the stereotypes.
Develop STEM Skills
Many state governments, including here in New England, have identified STEM skills as critical for the future health of the economy. In 2018, Real Jobs Rhode Island (http://www.dlt.ri.gov/srealjobs) has three partnership programs for the manufacturing industry:
- Leadership Development Partnership of Rhode Island
- Phoenix Partnership
- Rhode Island Manufacturing Growth Collaborative
These partnership programs foster collaboration among manufacturers, universities, and other agencies to train and develop STEM skills in the young workforce. Local manufacturers have recently turned their attention to high school recruitment. By expressing interest in teenagers, these manufacturers hope to build up early desires to pursue math and science – two areas of study that have recently seen low scoring. Manufacturers need to engage the young work force and provide opportunities for training and education. The development of STEM skills is vital if the industry hopes to maintain a consistent work force supply.
The landscape in manufacturing is definitely changing. The actions taken by the industry in the next decade will be critical to its health. There are many great resources available to manufacturing companies – and even more that can be created. Let us do what we can to build up the next generation with knowledge and experience.
Manufacturers are facing transitional and educational challenges in their workforce, now more than ever. Finding and keeping skilled employees has been a constant struggle for many manufacturers, and recent surges in the economy have added to the challenge of keeping up with production. Close to one third of manufacturing employees are over the age of 55, which means companies have to strategize on how to deal with the imminent gap in knowledge and experience. Management has had to consider some creative tactics to retain its human capital. In this two part series, we will identify specific tactics to consider in addressing these challenges.
Entice Baby Boomers to Stick Around Longer
Though it appears to be somewhat of a short-lived solution, some manufacturers are making company policy changes to delay retirement for the most loyal and experienced employees in their workforce. Programs like flexible schedules and job-sharing are making potential retirees re-consider making a clean break at 65. Creative manufacturers are taking measures to make their workplace more physically comfortable for this generation by making ergonomic adjustments to shop facilities. If these efforts to keep baby boomers working prove successful, companies can reap the advantage of having these “veterans” mentor and teach the younger, less experienced employees. Smart managers see these boomers as playing a crucial role in their succession plan.
Proactively Plan for a Changing Work Culture
How will management deal with succession planning when the new hires don’t think like the outgoing generation? Baby boomers and millennials don’t play the same, and it stands to reason they don’t work the same either. Jack Finning, a partner at AAFCPA, summarizes this well in his industryweek.com article The Massive Retiree Wave Demands Manufacturers Embrace Planning: “…boomers are known for using a direct management style through which they dictate the process for workflow management. Younger generations, on the other hand, are more open to a holistic managerial approach… motivated by transparency, engaged with workers in the field and thriving off ideas that help move processes along or evolve in a new direction.” Generational differences can become barriers to transitioning from senior to more junior workforce. The most successful companies planning for the inevitable changing of the guard will do so by collaborating with their workforce to establish thought-out best practices, determine common expectations, and stay communicative.
For more information, the following links offer two perspectives on how today’s manufacturers are adapting to the changing landscape in America’s workforce.
http://www.standard.net/Business/2017/07/18/Factories-to-baby-boomers-Please-keep-working.html
http://www.industryweek.com/leadership/massive-retiree-wave-demands-manufacturers-embrace-planning
For tax years beginning after December 31, 2017, the Tax Cuts and Jobs Act (TCJA) provides a new permanent deduction for domestic C-corporations that generate income from serving foreign markets. The deduction would reduce the federal tax rate on such income from 21% to 13.125% (increasing to 16.41% after 2025).
The name of the new deduction provision, Foreign-Derived Intangible Income (FDII), is a bit misleading as this new incentive is not connected to the ownership of specific intangible property. Instead, the deduction applies to the above-routine return arising from the taxpayer’s foreign-derived income – i.e., income earned from providing goods and services to customers outside the United States for foreign use. The above-routine return is considered the “deemed intangible income” and is generally the excess of the taxpayer’s total income over a 10% return on its depreciable tangible property (the routine or “deemed tangible income” return).
An important step in determining the FDII benefit is identifying the income that is considered “foreign-derived” income. The key aspect is that the new deduction applies to taxpayers that generate income from export sales and services. The property must be sold, licensed, or leased to a foreign person (related or unrelated) for use outside the United States; and services must be provided to persons located outside the United States, or with respect to property located outside the United States.
It is important that corporations begin to assess whether they may qualify for this new tax deduction as it can lower estimated tax payments and will have financial reporting implications.
DiSanto, Priest & Co. is experienced in preparing detailed FDII calculations which involve a multi-step process with certain data inputs.
Cryptocurrency has been around since 2008. However, it went from being generally unheard of by most to a frequent topic of household conversation within a few months. At the end of 2017 and the beginning of 2018, there was daily news coverage regarding cryptocurrencies caused by the significant spike in prices (upwards of a thousand percent) that increased the wealth of many coin holders.
What is a cryptocurrency?
A cryptocurrency is an electronic currency that is designed to be exchanged for goods or services (i.e., Bitcoin, Ethereum, Litecoin, and Monero are some of the most popular). Each “coin” can be “mined” utilizing the power of graphics cards to perform complex calculations to solve algorithms. Once a solution is found, a block (as in blockchain) is complete, and a coin is rewarded to the computer responsible for finding the answer. These calculations are verifying that the data batched into a block is accurate. The new block is then sent to all other computer systems on the block-chain network. The block cannot be altered because all systems possess the same information. We discussed blockchain technology in Part 1 here.
How can we use cryptocurrency?
The first transaction ever recorded with Bitcoin was used to order pizza in exchange for 10,000 Bitcoins (BTC). This was long before Bitcoin reached a value of over $19,000. However, ordering pizza is not the only thing we can use cryptocurrency for.
A valuable function created from cryptocurrencies is an immediate exchange of funds globally. Transfers can happen almost instantaneously. For example, $99 million worth of Lite Coin was moved in a single trade on April 23, 2018, and the transaction took about two minutes and thirty seconds to settle. The associated fees for this transaction cost about 40 cents. This process is substantially cheaper than other means of transferring funds from one entity to another. Typical funds exchange services can charge 10% or more for the service and take several days to settle.
Cryptocurrency trading has become quite popular recently and there are risks involved as with any other investment. Smartphone apps have been developed, including Coinbase, to act as an easy to use interface to trade a variety of cryptocurrencies. Prices are known to be extremely volatile and various online exchanges have been compromised where investors lose all the cryptocurrencies that they own. The most important distinction regarding blockchain and cryptocurrencies is that, while the blockchain is not a hackable system, the exchanges and your computer that holds your coin can be. Investors must take the necessary precautions when dealing with this new opportunity.
Up next!
We discuss the taxation of cryptocurrency and how it can affect investors and miners in Part 3.
Do you own a piece of real estate whose fair market value is greater than its basis? Are you contemplating selling and buying another? A 1031 Exchange may be for you!
In a Section 1031 Exchange, also known as a “like-kind” exchange or a Starker exchange, the taxpayer does not recognize and pay tax on the gain on an exchange of like-kind properties so long as both properties are held for use in a trade, business, or investment purposes.
There are specific guidelines to follow to qualify for a Section 1031 exchange. The first is the term “like-kind.” Luckily, like-kind is a broad term. For example, a rental property can be exchanged for raw land, and vice-versa. A multi-family rental property can be exchanged for commercial property, a warehouse for an office building, residential apartment building for a storefront, etc. According to the IRS, so long as the properties being exchanged are of the same nature, character, or class, they would qualify (e.g., Real Property for Real Property, etc.). Second, this provision applies to business or investment property only. You cannot exchange your primary residence for another home. For example, if you are moving from Rhode Island to another state, the sale of your home and purchase of a new home would not qualify for like-kind treatment.
Third, the IRS requires that the value of the property and equity purchased must be the same as or greater than the property given up in exchange. To qualify for 100% deferral of the gain, an example would be a piece of property worth $500,000 with a $100,000 mortgage attached. It would have to be exchanged for another piece of property with a minimum value of $500,000 and a $100,000 mortgage retained. This leads us to another rule: A taxpayer must not receive “boot” in the transaction to qualify for 100% deferral of the gain. Any boot received is considered taxable to the extent there is realized gain on the transaction. For example, you own a property worth $1,500,000, and you are exchanging it for a qualified property worth $900,000. The $600,000 cash received in this instance would be considered “boot,” and you would pay tax on the amount up to the gain on the property.
Because simultaneously swapping properties is rare between two owners, you’ll engage in a “deferred” exchange where you enlist the help of a QI (qualified intermediary). Additionally, there are a few time constraints when conducting like-kind exchanges. You, as the property owner, have up to 45 days after selling and closing on your original property to identify up to three potential pieces of like-kind exchange property. The replacement property needs to be received and the exchange completed within 180 days from the sale of your original property or the due date of your income tax return (including extensions) for the tax year in which the relinquished property was sold – whichever is earlier. Please note that there are no extensions available for the 45-day and 180-day periods.
To add more to the like-kind exchange gamut, the recently enacted Tax Cuts and Jobs Act (TCJA) changed a rule related to like-kind exchanges. For exchanges completed after December 31, 2017, the TCJA limits these like-kind exchanges to real property not held primarily for sale (real-property limitation.) Therefore, after December 31, 2017, personal property and intangible property no longer qualify. There are transition rules that only apply in certain circumstances.
All these rules and guidelines can confuse even the most astute investors. Many areas in the like-kind exchange arena can trip you up and therefore disqualify transactions from tax deferral. If you are contemplating a like-kind exchange, please give us a call at (401) 921-2000 and we would be more than happy to assist you.
Blockchain – What is this new buzzword? I’ve heard colleagues, clients, and even politicians throwing it around, but according to Accounting Today, only 1% of today’s workforce considers themselves an expert. So why is it becoming such a hot topic? Who is it affecting? And what does it mean for your business?
What is blockchain?
Blockchain is defined as “a digital database containing information (such as records of financial transactions) that can be simultaneously used and shared within a large decentralized, publicly accessible network” (Merriam-Webster definition). In other words, it’s a collection of transactions and data that is unchangeable and near-incorruptible. This system is known as distributed ledger technology. Blockchain isn’t just about recordkeeping; it’s about how the records are both created and kept. Each transaction is called a block, and each block is recorded sequentially, creating a chain (hence the name). Transactions are created authentically with layers of verification that make it easy to track, trust, and store. The most well-known use of blockchain is through Bitcoin and other cryptocurrencies. But its application is so much more vast than that, and its potential future usage is far more significant than most people realize.
Who’s using it and how?
A considerable number of the big banks and technology companies around the world are starting to implement blockchain technology including J.P. Morgan Chase, IBM, and Microsoft to name a few. Beyond the big business applications, many startups are using this technology for everything from payment systems, to information sharing, smart contracts, and more. Even governments around the world are starting to invest in this technology; the Dubai government has plans to issue all government documents using blockchain by the year 2020. This global change and innovation is sure to have a huge impact on businesses large and small alike. A major sector where privacy is important is the medical field. Blockchain is a solution where doctors, insurance companies, and hospitals can share patient medical files in real time if they are on the same network. The technology can maintain patient privacy while improving the quality of care received from a patient’s care provider.
Other thoughts
Is this technology safe?
Blockchain uses cryptography (secret code) which prevents records from being modified, altered, deleted, or destroyed. With this fast-paced electronic data stream, it makes it nearly impossible for a hacker to create an alternate chain more quickly than the actual valid chain.
The pace of technological change is continually accelerating. For example, as of the year 2000, the rate of technological progress was five times faster than the average rate of growth during the entire 20th century.
How can we help?
At DiSanto, Priest & Co. we’re keeping abreast of the latest technological innovations, including blockchain and its many applications. We understand that we live in a time of exponential technological advancement. With that rapid growth comes new rules and regulations for both tax and financial purposes. That’s where we come in! As your trusted advisor, we’re here to help you as we navigate through this new and exciting time.
Setting up a data interface between your QuickBooks file and your bank can dramatically reduce the time burden created by the manual data entry of transactional activity. Downloading bank feeds directly into QuickBooks eliminates the need to post transactions individually, keeps records current, and allows more time to address more pertinent business needs.
Initiating online banking service through QuickBooks is the first step in setting up a bank feed. Depending on the bank, you may be required to download a bank statement through their online portal for security purposes. You can specify the date range on your bank’s website to be downloaded into QuickBooks, of which a maximum of 90 transaction days is available to download when you first link an account. In cases where there are more than 90 days of transactions, you may upload the files to QuickBooks online via WebConnect if your bank supports QuickBooks Online (QBO), Quicken (QFX), Comma-Separated Values (CSV), or Microsoft Money (OFX).
Transactions are added either in batch form or individually, and users have the opportunity to review all operations before the download is accepted and applied in QuickBooks. Subsequent transaction downloads will be automatically matched and posted consistently with prior postings. The risk of posting duplicate transactions is eliminated because QuickBooks only accepts transactions that were not previously downloaded. Unmatched transactions are classified as an uncategorized income or expense, at which point you can assign and approve the appropriate category before allowing them.
For more information on whether your business is a candidate for this feature and how it could be beneficial, please contact our DiSanto Priest & Co.’s Business Resource Center.