Renting to a relative? Watch out for tax traps
If you own a home and rent it to a relative, you may be surprised to find out there could be tax consequences.
Quick rundown of the rules
Renting out a home or apartment that you own may result in a tax loss for you, even if the rental income is more than your operating costs. You’ll be entitled to a depreciation deduction for your cost of the house or apartment (except for the portion allocated to the land). However, if your tenant is related to you, special rules and limitations may apply. For this purpose, “related” means a spouse, child, grandchild, parent, grandparent or sibling.
No limitations apply if:
- You rent a home to a relative who uses it as his or her principal residence (that is, not just as a second or vacation home) for the year, and
- The home is rented at a fair market rent amount (not at a discount).
In these cases, you can deduct all the normal rental expenses, even if they result in a rental loss for the year. (If you have a loss, however, it’s a “passive” loss, which may be subject to a different set of limitations.)
Below fair market rent
Problems arise if you set the rent below the fair market rental value. The reason is this then becomes a rental property that you’re treated as using personally. So you’d have to allocate the expenses between the personal and rental portions of the year. Even more seriously, however, since all of the rental days (at a bargain rate to a relative) are treated as personal days, the rental portion would be zero. Thus, you’d have to report all of the rent you receive in income, but none of your expenses for the home would be deductible. (You’d still be able to deduct the mortgage interest, assuming it otherwise qualifies as deductible, and property taxes. These items are deductible even for nonrental homes.)
Given the above problems, it’s important to set the rent at a fair rate. Factors to look at include comparable rentals in the area and whether you made any “side” gifts to your relative (to help pay the rent) that could reasonably be interpreted to be a bargain element.
Contact us if you have any questions or would like to discuss any of these matters in more detail.
The standard business mileage rate is going up in 2023
Although the national price of gas is a bit lower than it was a year ago, the optional standard mileage rate used to calculate the deductible cost of operating an automobile for business will be going up in 2023. The IRS recently announced that the 2023 cents-per-mile rate for the business use of a car, van, pickup or panel truck is 65.5 cents. These rates apply to electric and hybrid-electric automobiles, as well as gasoline and diesel-powered vehicles.
In 2022, the business cents-per-mile rate for the second half of the year (July 1 – December 31) was 62.5 cents per mile, and for the first half of the year (January 1 – June 30), it was 58.5 cents per mile.
How rate calculations are done
The 3-cent increase from the 2022 midyear rate is somewhat surprising because gas prices are currently lower than they have been. On December 29, 2022, the national average price of a gallon of regular gas was $3.15, compared with $3.52 a month earlier and $3.28 a year earlier, according to AAA Gas Prices. However, the standard mileage rate is calculated based on all the costs involved in driving a vehicle — not just the price of gas.
The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, including gas, maintenance, repair and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the cents-per-mile rate midyear, as it did in 2022.
Standard rate versus actual expenses
Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases, certain limits apply to depreciation write-offs on vehicles that don’t apply to other types of business assets.
The cents-per-mile rate is beneficial if you don’t want to keep track of actual vehicle-related expenses. With this method, you don’t have to account for all your actual expenses. However, you still must record certain information, such as the mileage for each business trip, the date and the destination.
Using the cents-per-mile rate is also popular with businesses that reimburse employees for business use of their personal vehicles. These reimbursements can help attract and retain employees who drive their personal vehicles a great deal for business purposes. Why? Under current law, employees can’t deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.
If you do use the cents-per-mile rate, keep in mind that you must comply with various rules. If you don’t comply, the reimbursements could be considered taxable wages to the employees.
The standard rate can’t always be used
There are some cases when you can’t use the cents-per-mile rate. It partly depends on how you’ve claimed deductions for the same vehicle in the past. In other situations, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.
As you can see, there are many factors to consider in deciding whether to use the standard mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2023 — or claiming 2022 expenses on your 2022 income tax return.
SECURE 2.0 law may make you more secure in retirement
A new law was recently signed that will help Americans save more for retirement, although many of the provisions don’t kick in for a few years. The Setting Every Community Up for Retirement Enhancement 2.0 Act (SECURE 2.0) was signed into law on December 29, 2022.
SECURE 2.0 is meant to build on the original SECURE Act of 2019, which made major changes to the required minimum distribution (RMD) rules and other retirement provisions.
Here are some of the significant retirement plan changes and when they’ll become effective:
- The age for beginning RMDs is going up. Employer-sponsored qualified retirement plans, traditional IRAs and individual retirement annuities are subject to RMD rules. They require that benefits start being distributed by the required beginning date. Under the new law, the age distributions must begin increases from age 72 to age 73 starting on January 1, 2023. It will then increase to age 75 starting on January 1, 2033.
- There will be higher “catch-up” contributions for 401(k) participants ages 60 through 63. Currently, participants in certain retirement plans can make additional catch-up contributions if they’re age 50 or older. The limit on catch-up contributions to 401(k) plans is $7,500 for 2023. SECURE 2.0 will increase the 401(k) plan catch-up contribution limits for individuals ages 60 through 63 to the greater of $10,000 or 150% of the regular catch-up amount. The increased amounts will be indexed for inflation after 2025. This provision will take effect for taxable years beginning after December 31, 2024. (There will also be increased catch-up amounts for SIMPLE plans.)
- Tax-free rollovers will be allowed from 529 accounts to Roth IRAs. SECURE 2.0 will permit beneficiaries of 529 college savings accounts to make direct trustee-to-trustee rollovers from a 529 accounts in their names to their Roth IRAs without tax or penalty. Several rules apply. This provision is effective for distributions after December 31, 2023.
- “Matching” contributions will be permitted for employees with student loan debt. The new law will allow an employer to make matching contributions to 401(k) and certain other retirement plans with respect to “qualified student loan payments.” The result of this provision is that employees who can’t afford to save money for retirement because they’re repaying student loan debt can still receive matching contributions from their employers into retirement plans. This will take effect beginning after December 31, 2023.
Non-retirement plan provision
There are also some parts of the law that aren’t related to retirement plans, including a change to Achieving a Better Life Experience (ABLE) accounts. Tax-exempt ABLE programs are established by states to assist individuals with disabilities. Currently, in order to be the beneficiary of an ABLE account, an individual’s disability or blindness must have occurred before age 26. SECURE 2.0 increases this age limit to 46, which will make more people eligible to benefit from an ABLE account. This provision is effective for tax years beginning after December 31, 2025.
Just the beginning
These are only some of the many provisions in SECURE 2.0. Contact us if you have any questions about your situation.
Renting to a relative? Watch out for tax traps
If you own a home and rent it to a relative, you may be surprised to find out there could be tax consequences.
Quick rundown of the rules
Renting out a home or apartment that you own may result in a tax loss for you, even if the rental income is more than your operating costs. You’ll be entitled to a depreciation deduction for your cost of the house or apartment (except for the portion allocated to the land). However, if your tenant is related to you, special rules and limitations may apply. For this purpose, “related” means a spouse, child, grandchild, parent, grandparent or sibling.
No limitations apply if:
- You rent a home to a relative who uses it as his or her principal residence (that is, not just as a second or vacation home) for the year, and
- The home is rented at a fair market rent amount (not at a discount).
In these cases, you can deduct all the normal rental expenses, even if they result in a rental loss for the year. (If you have a loss, however, it’s a “passive” loss, which may be subject to a different set of limitations.)
Below fair market rent
Problems arise if you set the rent below the fair market rental value. The reason is this then becomes a rental property that you’re treated as using personally. So you’d have to allocate the expenses between the personal and rental portions of the year. Even more seriously, however, since all of the rental days (at a bargain rate to a relative) are treated as personal days, the rental portion would be zero. Thus, you’d have to report all of the rent you receive in income, but none of your expenses for the home would be deductible. (You’d still be able to deduct the mortgage interest, assuming it otherwise qualifies as deductible, and property taxes. These items are deductible even for nonrental homes.)
Given the above problems, it’s important to set the rent at a fair rate. Factors to look at include comparable rentals in the area and whether you made any “side” gifts to your relative (to help pay the rent) that could reasonably be interpreted to be a bargain element.
Contact us if you have any questions or would like to discuss any of these matters in more detail.
Strategies for investors to cut taxes as year-end approaches
The overall stock market has been down during 2022 but there have been some bright spots. As year-end approaches, consider making some moves to make the best tax use of paper losses and actual losses from your stock market investments.
Tax rates on sales
Individuals are subject to tax at a rate as high as 37% on short-term capital gains and ordinary income. But long-term capital gains on most investment assets receive favorable treatment. They’re taxed at rates ranging from 0% to 20% depending on your taxable income (inclusive of the gains). High-income taxpayers may pay an additional 3.8% net investment income tax.
Sell at a loss to offset earlier gains
Have you realized gains earlier in the year from sales of stock held for more than one year (long-term capital gains) or from sales of stock held for one year or less (short-term capital gains)? Take a close look at your portfolio and consider selling some of the losers — those shares that now show a paper loss. The best tax strategy is to sell enough losers to generate losses to offset your earlier gains plus an additional $3,000 loss. Selling to produce this loss amount is a tax-smart idea because a $3,000 capital loss (but no more) can offset the same amount of ordinary income each year.
For example, let’s say you have $10,000 of capital gain from the sale of stocks earlier in 2022. You also have several losing positions, including shares in a tech stock. The tech shares currently show a loss of $15,000. From a tax standpoint, you should consider selling enough of your tech stock shares to recognize a $13,000 loss. Your capital gains will be offset entirely, and you’ll have a $3,000 loss to offset against the same amount of ordinary income.
What if you believe that the shares showing a paper loss may turn around and eventually generate a profit? In order to sell and then repurchase the shares without forfeiting the loss deduction, you must avoid the wash-sale rules. This means that you must buy the new shares outside of the period that begins 30 days before and ends 30 days after the sale of the loss stock. However, if you expect the price of the shares showing a loss to rise quickly, your tax savings from taking the loss may not be worth the potential investment gain you may lose by waiting more than 30 days to repurchase the shares.
Use losses earlier in the year to offset gains
If you have capital losses on sales earlier in 2022, consider whether you should take capital gains on some stocks that you still hold. For example, if you have appreciated stocks that you’d like to sell, but don’t want to sell if it causes you to have taxable gain this year, consider selling just enough shares to offset your earlier-in-the-year capital losses (except for $3,000 that can be used to offset ordinary income). Consider selling appreciated stocks now if you believe they’ve reached (or are close to) the peak price and you also feel you can invest the proceeds from the sale in other property that’ll give you a better return in the future.
These are just some of the year-end strategies that may save you taxes. Contact us to discuss these and other strategies that should be put in place before the end of December.
© 2022
Scholarships are usually tax free but they may result in taxable income
If your child is fortunate enough to be awarded a scholarship, you may wonder about the tax implications. Fortunately, scholarships (and fellowships) are generally tax-free for students at the elementary, middle, and high schools, as well as those attending college, graduate school or accredited vocational schools. It doesn’t matter if the scholarship makes a direct payment to the individual or reduces tuition.
Requirements for tax-free treatment
However, scholarships are not always tax-free. Certain conditions must be satisfied. A scholarship is tax-free only to the extent it’s used to pay for:
- Tuition and fees are required to attend the school and
- Fees, books, supplies, and equipment are required of all students in a particular course.
For example, expenses that don’t qualify include the cost of room and board, travel, research, and clerical help.
To the extent a scholarship award isn’t used for qualifying items, it’s taxable. The recipient is responsible for establishing how much of an award is used to pay for tuition and eligible expenses. Maintain records (such as copies of bills, receipts, and canceled checks) that reflect the use of the scholarship money.
Payment for services doesn’t qualify
Subject to limited exceptions, a scholarship isn’t tax-free if the payments are linked to services that your child performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend your child receives for required teaching, research, or other services is taxable, even if the child uses the money for tuition or related expenses.
What if you, or a family member, are an employee of an educational institution that provides reduced or free tuition? A reduction in tuition provided to you, your spouse, or your dependents by the school at which you work isn’t included in your income and isn’t subject to tax.
What is reported on a tax return?
If a scholarship is tax-free and your child has no other income, the award doesn’t have to be reported on a tax return. However, any portion of an award that’s taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax. Your child should receive a Form W-2 showing the amount of these “wages” and the amount of tax withheld, and any portion of the award that’s taxable must be reported, even if no Form W-2 is received.
These are just the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. As we approach the new academic year, best wishes for your child’s success in school. Contact us if you’d like to discuss these or other tax matters further.
© 2021
Large cash transactions with your business must be reported to the IRS
If your business receives large amounts of cash or cash equivalents, you may be required to report these transactions to the IRS.
What are the requirements?
Each person who, in the course of operating a trade or business, receives more than $10,000 in cash in one transaction (or two or more related transactions), must file Form 8300. What is considered a “related transaction?” Any transactions conducted in a 24-hour period. Transactions can also be considered related even if they occur over a period of more than 24 hours if the recipient knows, or has reason to know, that each transaction is one of a series of connected transactions.
To complete a Form 8300, you’ll need personal information about the person making the cash payment, including a Social Security or taxpayer identification number.
Why does the government require reporting?
Although many cash transactions are legitimate, the IRS explains that “information reported on (Form 8300) can help stop those who evade taxes, profit from the drug trade, engage in terrorist financing and conduct other criminal activities. The government can often trace money from these illegal activities through the payments reported on Form 8300 and other cash reporting forms.”
You should keep a copy of each Form 8300 for five years from the date you file it, according to the IRS.
What’s considered “cash” and “cash equivalents?”
For Form 8300 reporting purposes, cash includes U.S. currency and coins, as well as foreign money. It also includes cash equivalents such as cashier’s checks (sometimes called bank checks), bank drafts, traveler’s checks and money orders.
Money orders and cashier’s checks under $10,000, when used in combination with other forms of cash for a single transaction that exceeds $10,000, are defined as cash for Form 8300 reporting purposes.
Note: Under a separate reporting requirement, banks and other financial institutions report cash purchases of cashier’s checks, treasurer’s checks and/or bank checks, bank drafts, traveler’s checks and money orders with a face value of more than $10,000 by filing currency transaction reports.
Can the forms be filed electronically?
Businesses required to file reports of large cash transactions on Form 8300 should know that in addition to filing on paper, e-filing is an option. The form is due 15 days after a transaction and there’s no charge for the e-file option. Businesses that file electronically get an automatic acknowledgment of receipt when they file.
The IRS also reminds businesses that they can “batch file” their reports, which is especially helpful to those required to file many forms.
How can we set up an electronic account?
To file Form 8300 electronically, a business must set up an account with FinCEN’s Bank Secrecy Act E-Filing System. For more information, visit: https://bsaefiling.fincen.
© 2021
DEI programs are good for business
Many businesses are spending more time and resources on supporting the well-being of their employees. This includes recognizing and addressing issues related to diversity, equity and inclusion (DEI).
A thoughtfully designed DEI program can do more than just head off potential conflicts and disruptions among coworkers; it can help you attract good job candidates, retain your best employees and create a more engaged, productive workforce.
Strategic objectives
Essentially, DEI programs are formal efforts to help employees better understand, accept and appreciate differences among everyone on staff. Differences addressed typically include race, ethnicity, gender identification, age, religion, disabilities and sexual orientation. They may also include education, personality types, skill sets and life experiences. A program can comprise training courses, seminars, guest speakers, group discussions and social events.
Strategic objectives may vary depending on the business. Some companies wish to improve collaboration and productivity within or among teams, departments or business units. Others are looking to attract more diverse job candidates. And still others want to connect with growing multicultural markets that don’t necessarily respond to “traditional” messaging.
Think of implementing a DEI program as an investment. It should include specific goals and achievable, measurable returns.
Key components
Many DEI programs fail because of lack of consensus regarding their value or faulty design. Begin with executive buy-in. Successful programs start with the support of ownership and senior leadership. If they’re not committed to the program, it probably won’t last long (if it gets off the ground at all). Typically, a champion will need to build the case of why a DEI program is needed and explain how it will positively impact the organization.
You’ll also need to assemble the right team. Form a DEI committee to identify objectives and give the program its initial size and shape. If you happen to employ someone who has been involved in launching a DEI program in the past, learn all you can from that employee’s experience. Otherwise, encourage your team to research successful and unsuccessful programs. You might even engage a consultant who specializes in the field.
For clarity and consistency, put your DEI program in writing. The committee needs to develop clear language spelling out each goal. The objectives can then be reviewed, discussed and revised. Ensure the objectives support your strategic plan and that you can accurately measure progress toward each. Don’t launch the program until you’re confident it will improve your organization, not distract it.
How work is done
Events of the last year or so have led most businesses to reconsider the size, composition and operational approach of their workforces. In many industries, DEI awareness and training is playing an important role in this reckoning. We’d be happy to help you assess the costs and feasibility of a program for your business.
© 2021
5 possible tax aspects of a parent moving into a nursing home
If you have a parent entering a nursing home, you may not be thinking about taxes. But there are a number of possible tax implications. Here are five.
1. Long-term medical care
The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income (AGI).
Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services required by a chronically ill individual that is provided under care administered by a licensed healthcare practitioner.
To qualify as chronically ill, a physician or other licensed healthcare practitioner must certify an individual as unable to perform at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity or severe cognitive impairment.
2. Long-term care insurance
Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to limitations explained below) to the extent they, along with other medical expenses, exceed the percentage-of-AGI threshold. A qualified long-term care insurance contract covers only qualified long-term care services, doesn’t pay costs covered by Medicare, is guaranteed renewable and doesn’t have a cash surrender value.
Qualified long-term care premiums are includible as medical expenses up to certain amounts. For individuals over 60 but not over 70 years old, the 2021 limit on deductible long-term care insurance premiums is $4,520, and for those over 70, the 2021 limit is $5,640.
3. Nursing home payments
Amounts paid to a nursing home are deductible as a medical expense if a person is staying at the facility principally for medical, rather than custodial care. If a person isn’t in the nursing home principally to receive medical care, only the portion of the fee that’s allocable to actual medical care qualifies as a deductible expense. But if the individual is chronically ill, all qualified long-term care services, including maintenance or personal care services, are deductible.
If your parent qualifies as your dependent, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction.
4. Head-of-household filing status
If you aren’t married and you meet certain dependency tests for your parent, you may qualify for head-of-household filing status, which has a higher standard deduction and lower tax rates than single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you.
5. The sale of your parent’s home.
If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In order to qualify for the $250,000 exclusion, the seller must generally have owned the home for at least two years out of the five years before the sale and used the home as a principal residence for at least two years out of the five years before the sale. However, there’s an exception to the two-out-of-five-year use test if the seller becomes physically or mentally unable to care for him or herself during the five-year period.
These are only some of the tax issues you may deal with when your parent moves into a nursing home. Contact us if you need more information or assistance.
© 2021
Can taxpayers who manage their own investment portfolios deduct related expenses? It depends
Do you have significant investment-related expenses, including the cost of subscriptions to financial services, home office expenses, and clerical costs? Under current tax law, these expenses aren’t deductible through 2025 if they’re considered investment expenses for the production of income. But they’re deductible if they’re considered trade or business expenses.
For years before 2018, production-of-income expenses were deductible, but they were included in miscellaneous itemized deductions, subject to a 2%-of-adjusted-gross-income floor. (These rules are scheduled to return after 2025.) If you do a significant amount of trading, you should know which category your investment expenses fall into because qualifying for trade or business expense treatment is more advantageous now.
To deduct your investment-related expenses as business expenses, you must be engaged in a trade or business. The U.S. Supreme Court held many years ago that an individual taxpayer isn’t engaged in a trade or business merely because the individual manages their own securities investments — regardless of the amount or the extent of the work required.
A trader vs. an investor
However, if you can show that your investment activities rise to the level of carrying on a trade or business, you may be considered a trader, who is engaged in a trade or business, rather than an investor who isn’t. As a trader, you’re entitled to deduct your investment-related expenses as business expenses. A trader is also entitled to deduct home office expenses if the home office is used exclusively regularly as the trader’s principal place of business. On the other hand, an investor isn’t entitled to home office deductions since the investment activities aren’t traded or business.
Since the Supreme Court decision, there has been extensive litigation on whether a taxpayer is a trader or investor. The U.S. Tax Court has developed a two-part test that must satisfy a taxpayer to be a trader. Under this test, a taxpayer’s investment activities are considered a trade or business only where both of the following are true:
- The taxpayer’s trading is substantial (in other words, sporadic trading isn’t considered a trade or business), and
- The taxpayer seeks to profit from short-term market swings rather than from long-term holding of investments.
Profit in the short term
So, the fact that a taxpayer’s investment activities are regular, extensive, and continuous isn’t in itself sufficient for determining that a taxpayer is a trader. To be considered a trader, you must show that you buy and sell securities with reasonable frequency to profit on a short-term basis. In one case, a taxpayer who made more than 1,000 trades a year with trading activities averaging about $16 million annually was held to be an investor rather than a trader because the holding periods for stocks sold averaged about one year.
Contact us if you have questions or would like to figure out whether you’re an investor or a trader for tax purposes.
© 2021