Small Business Tax

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Before You Start Development on that Land Investment…

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sale to s corporationLand prices have been recovering since the Great Recession. People who hold land for investment may be interested in developing then selling the land. If held for more than 12 months, gains from sales of investment real estate are subject to favorable capital gain rates (generally 15%, but up to 23.8% for high income individuals). However, people who do any development of the land generally will not qualify for capital gain treatment; they will be subject to ordinary income rates (up to 43.4%) on their entire gain from the sale of developed land.

Example: Jane owns a parcel of land she bought as an investment 20 years ago. She originally paid $200,000 for the parcel and it is now worth $300,000. Jane has not performed any development activity on the land. If she sells the land, her gain of $100,000 will be subject to the favorable capital gain tax rate of 15%. Her tax on the sale will be $15,000.

Example 2: Same as above, except that Jane spent $20,000 improving and developing the lane. She sells the parcel for $350,000. Her cost basis in the land is the $200,000 purchase price plus the $20,000 she spent on improvements–$220,000. If she sells the land for $350,000 her gain will be $130,000. Since she began developing the land, the gain of $130,000 no longer qualifies for capital gain treatment. The gain will be taxed at ordinary income rates. If Jane is in the 28% tax bracket, the tax on her gain will be $36,400.

Tax Strategy: Sell the Undeveloped Land to Your S Corporation

Through a tax-saving strategy, it is possible to have pre-development gains subject to the capital gain tax rate, and only gains from development will be subject to ordinary income rates. This is done by selling the investment land to an S corporation that the real estate investor owns before performing any development activity.

Example: Carrying on with the same fact scenario as above. Instead of developing the land herself, Jane first sells her investment property that she purchased for $200,000 to her 100% owned S corporation. The purchase price is the $300,000 market value of the land. She recognizes a $100,000 gain that is taxed at the 15% capital gain tax rate. Her tax on the pre-development gain is $15,000.

Her S corporation will now develop the land. The S corporation spends $20,000 to develop the land and the land is now worth $350,000. The S corporation’s cost basis in the land is the $300,000 purchase price plus $20,000 development costs–$320,000. When the S corporation sells the developed land for $350,000, it recognizes a $30,000 gain that is taxed at Joan’s ordinary tax rate of 28%. The tax on the $30,000 gain is $8,400. Her and her S corporation’s total tax is $23,400.

The Tax Savings

If she developed the land herself, her total tax would be $36,400 on $130,000 of total gain. By first selling the land to her S corporation, she is able to preserve capital gain treatment on the pre-development gain ($100,000) and only pays ordinary income tax rates on the gain allocable to development ($30,000). Her total tax with the S corporation strategy is $23,400. She saved $13,000.

Strategy Does NOT Work with an LLC

This strategy will generally only work with an S corporation. It will not work with LLCs because there is a rule denying capital gain treatment when an LLC owner sells property to his LLC and the property is ordinary income property of the LLC. Since the property held by the LLC will be sold at ordinary income rates, the LLC owner’s gain on the sale to the LLC will also be ordinary income.

Make Sure It’s a Bona Fide Sale for Fair Market Value

For this strategy to work, the sale to the S corporation must be a bona fide sale for fair market value. There should be a sales agreement, and if the sale is on an installment agreement, regular payments should be made and interest to the S corporation should be charged.

If you have any questions on how this applies to you, please feel free to give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

IRS Taxes Sweat Equity

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sweat equityWhen a taxpayer forms an LLC and contributes appreciated property to the LLC, the taxpayer generally does not recognize gain on the transfer.   The IRS does not force taxpayers to recognize gain on property contributions to LLCs because taxpayers didn’t sell or exchange the property; they continue to own an interest in the contributed property, albeit through a business entity.  Naturally, there are exceptions to this rule where gain can be recognized such as where debt encumbered property is transferred to the LLC or investments are transferred to an investment LLC.

On the other hand, when a taxpayer performs services (i.e., sweat equity) in exchange for an interest in an LLC, the taxpayer will usually recognize compensation income equal to the fair market value of the LLC interest received.  The IRS treats the transaction as if the taxpayer received cash compensation (which is taxable), and then used the cash to purchase the LLC interest at fair market value.

There are two forms of ownership interests in an LLC—a capital interest and a profits interest.  A capital interest gives the owner a claim to assets when the LLC is dissolved.  A profits interest is defined as an interest other than a capital interest.  Helpful.  Basically, a profits interest does not entitle the owner to assets upon the LLC’s liquidation, but instead entitles the owner to a share of the LLC’s profits (if any).

A taxpayer who performs services in exchange for a capital interest recognizes income in the amount of the fair market value of the capital interest.  However, a taxpayer who performs services in exchange for a profits interest will not recognize income on receipt of the profits interest.  This is because the profits interest holder is not entitled to liquidation proceeds of the LLC, but is instead entitled solely to LLC profits (if any).  Profits interests holders therefore have an speculative value in their interests and will not recognize income upon receipt of the interest, but will instead pay tax on any profits that are allocated to them.

Example 1:  Thelma and Louise form an LLC.  Thelma contributes land that is currently worth $50,000 and was originally purchased for $20,000 for a 50% capital interest.  Louise will perform real estate advisory services for a 50% capital interest.  Since both parties own a 50% capital interest, each would be entitled to 50% of the assets upon liquidation—Thelma and Louise would each own 50% of the land upon liquidation.  Thelma does not recognize income upon her contribution because it is a contribution of property.  Louise will recognize income of $25,000 because she contributed services in exchange for a capital interest.

Example 2:  Same as above except that Louise received a profits interest instead of a capital interest.  If the LLC liquidates, Louise will not share in the liquidation assets.  Instead, Thelma will receive 100% of the land.  Louise will not be taxed on her contribution of services because she received only a profits interest.  However, Louise will recognize income for any profits that are allocated to her in the future.

While a profits interest is generally not subject to tax because of their unascertainable value, there are circumstances where their value is ascertainable.  In these circumstances, the profits interests will be taxable upon receipt.  These circumstances include:

  • the profits interest relates to a substantially certain and predictable stream of income from the partnership assets (such as a net lease);
  • the partner disposes of the profits interest within two years of receipt; or
  • the profits interest is a limited partner interest in a publicly traded partnership.

While a capital interest received in exchange for services usually is taxable, it is not immediately taxable if the capital interest is subject to a substantial risk of forfeiture.  Property is subject to a substantial risk of forfeiture if the rights to its full enjoyment are conditioned (directly or indirectly) upon either of the following:

  • Future Performance of Substantial Services. A requirement of future performance (or refraining from performance) of substantial services by the recipient is a substantial risk of forfeiture. The regularity of the performance of services and the time spent in performing them tend to indicate whether the required services are substantial.
  • Occurrence of a Condition Related to a Purpose of the Transfer. For example, a requirement that the recipient complete an advanced educational degree, obtain a professional designation, or attain a certain job position within the company to receive unrestricted access to the property would likely be a substantial risk of forfeiture, which would exist until that condition was met.

When the capital interest is subject to a substantial risk of forfeiture, the service provider will not recognize gain until the substantial risk of forfeiture is eliminated.

Example:  Same as Example 1 above except that Louise’s capital interest will be forfeited if Louise does not provide 5 years of services to the LLC.  Since Louise’s capital interest is subject to a substantial risk of forfeiture, it is not taxable in the year of receipt.  Instead, it will be taxable after Louise completes 5 years of service and her capital interest is fully vested.

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 Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

New Deadlines for 2016 Tax Forms–Avoid Late Penalties!

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time-371226_1920As you know, the tax system is made up of all types of deadlines.  This year, deadlines that we have long been accustomed to are changing.  These changing deadlines apply to Forms W-2 and 1099-MISC as well as to income tax forms such as the Form 1065 for entities taxed as partnerships and the Form 1120 for C corporations.  This post will describe the new deadlines for each of these items.

Forms W-2 and 1099-MISC

When a business pays a worker who is not an employee $600 or more in a year, the business must file an information return using Form 1099-MISC (miscellaneous income) to report the payments.  Likewise, an employer must report wages paid to employees on Form W-2.  In prior years, these forms had to be provided to the worker by January 31 of the following year and copies were required to be filed with the IRS (Form 1099-MISC) and the Social Security Administration (Form W-2) by the last day of February, or by March 31 if filing electronically.

Starting with 2016 forms (due in 2017), the due dates for IRS and Social Security Administration have been accelerated to January 31 of the following year (no longer the last day of February, or March 31 for electronic filers).  So, 2016 Forms W-2 and 1099-MISC will need to be filed with the government by January  31, 2017–the same date that the forms have to be provided to workers.

Failing to file these returns timely can result in significant penalties–beginning at $50 per 1099-MISC or W-2 filed late.

Form 1065 (U.S. Return of Partnership Income)

Under prior law, partnership tax returns were due three and a half months after the end of the year (i.e., April 15).  Since the partnership tax return was due on the same day as personal income tax returns, many owners of partnerships (or LLCs taxed as partnerships) did not receive their Form K-1 from the partnership in time to file their personal returns by the April 15 personal income tax deadline.

Beginning with 2016 partnership tax returns, the deadline has been moved up to two and a half months after the end of the partnership tax year (i.e., March 15).  Six month extensions to September 15 are available.

It is important to either timely file the partnership tax return or to request an extension.  If the return is filed late, the penalty is $195 per owner per month!  So if a five member LLC unaware of the new deadline files a partnership tax return on April 15, the return is one month late and the penalty is $975.

Form 1120 (U.S. Corporation Income tax Return)

The deadline for C CORPORATION tax returns has been two and a half months after the end of the corporate year (generally March 15).  Beginning with 2016 C corporation tax returns, the deadline has been moved back to three and a half months after the end of the corporate tax year (generally April 15).  Since C corporations are not flow-through tax entities, the owner’s personal tax return is not dependent on the filing of the C corporation tax return.   Delaying the C corporation deadline and accelerating the partnership tax return deadline therefore makes some sense.

Form 1120S (U.S. Return of S Corporation Income)

No changes here–the deadline is still March 15.

FinCen Form 114 (FBAR)

In prior years, foreign bank accounts had to be reported to the IRS by June 30, and no extensions were allowed.  Beginning this year, the due date for FinCen 114 will be April 15 of the following year, but a six month extension will now be allowed.  The  extension will last to October 15.

Under the Internal Revenue Code, if a due date falls on a holiday or weekend, the return is due on the next business day.  Unfortunately, the FinCen 114 form is required under the Bank Secrecy Act of 1970 and not under the Internal Revenue Code–so if the April 15 deadline for FinCen 114 falls on a holiday or weekend, the due date will not be delayed to the next business day (even though the Form 1040 will be delayed to the next working day).

So this tax season, April 15 is on a Saturday and Monday, April 17 is Emancipation Day, so the Form 1040 due date will be April 18.  Since the FinCen 114 is outside of the Internal Revenue Code, its due date remains April 15.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

New Deadline for Form 1099-MISC–Avoid Late Penalties!

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Form 1099MISC deadlineForm 1099-MISC has to be filed when payments are made in the course of a trade or business.  Personal payments do not have to be reported on a Form 1099-MISC.  The IRS requires businesses to issue Form 1099-MISC to the payee and submit a copy to the IRS.  This is done to ensure that the payee reports and pays income tax on the payment.

NEW FILING DEADLINE FOR FORM 1099-MISC

Starting with 2016 Form 1099-MISCs, the IRS copy of the form must be filed with the IRS by January 31 if you are reporting payments in box 7 (non-employee compensation).  The prior due date was February 28 (and March 31 if filing electronically).  The form filing deadline for payments outside of box 7 (e.g., rent or royalty) have not changed (i.e., due February 28 or, if filed electronically, March 31).  The payee copy, regardless of the type of payment, is still due on January 31.

Penalties for Late Filing/Non-Filing

If the Form 1099 is filed within 30 days after the deadline, the penalty is $50 per 1099.  If the Form 1099 is filed between 30 days after the deadline and by August 1, the penalty is $100 per 1099.  If the Form 1099 is filed after August 1 (or not filed at all), the penalty is $260 per 1099.  If there is intentional disregard of the filing requirement, the penalty is $530 per 1099.

The above penalties apply if the form is not filed with either the IRS or the payee.  If the Form 1099 is not filed with either the IRS or the payee, the above penalty is essentially doubled.

What Type of Payments Have to Be Reported on Form 1099-MISC?

Payments that require the filing of a Form 1099-MISC include:

  • $10 or more in royalty payments
  • At least $600 in:
    • Rents
    • Services provided to you by someone who is not your employee (e.g., independent contractor)
    • Prizes and awards
    • Other income payments
    • Crop insurance proceeds
    • Cash payments for fish (or other aquatic life) you purchase from anyone engaged in the trade or business of catching fish
    • Cash paid from a notional principal contract to an individual, partnership, or estate
    • Payments to an attorney
    • Any fishing boat proceeds

In addition, Form 1099-MISC is used to report that you made direct sales of at least $5,000 of consumer products to a buyer for resale anywhere other than a permanent retail establishment.

What Payments Do NOT Have to Be Reported on Form 1099-MISC?

Certain payments do not have to be reported on Form 1099-MISC, although they may still be taxable to the payee.  Common payments that do not have to be reported on a Form 1099-MISC include:

  • Payments to a corporation (see exceptions below)
  • Payments to an LLC that elects to be treated as a corporation (again, see exceptions below)
  • Payments for merchandise
  • Wages paid to employees
  • Payments of rent to real estate agents (but the real estate agent must use Form 1099-MISC to report the rent paid over to the property owner)
  • Payments made by credit cards (the credit card company will issue a 1099-K to the recipient)

When Payments to Corporations Must Be Reported on Form 1099-MISC

Form 1099-MISC is required for payments to corporations for:

  • Medical and health care payments
  • Fish purchases
  • Attorney fees
  • Gross payments to attorneys (generally by insurance companies)
  • Substitute payments in lieu of dividends

When Backup Withholding is Required

You must withhold 28% of the payment you make to certain recipients.  This withholding is referred to as backup withholding and is paid to the IRS.  Backup withholding is required when:

  • The payee fails to furnish a SSN or TIN (it is recommended to get the payee’s SSN or TIN prior to the payee performing any services for you)
  • IRS notifies payer to impose backup withholding

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Crowdfunding & Taxes

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crowdfunding taxSome start-up businesses looking to raise capital have turned to crowdfunding as an alternative to venture capital.  Crowdfunding is a way for businesses and entrepreneurs to solicit online contributions from multiple parties.  This is typically done through a crowdfunding platform such as Kickstarter (www.kickstarter.com) or AngelList (www.angel.co).

Crowdfunding has increased in popularity since the enactment of Title III of the Jumpstart our Business Startups (JOBS) Act in 2012.  This act created a federal exemption under the securities law to permit companies to offer and sell securities through crowdfunding.  Since that time, this practice has generated billions in capital for startups and small businesses.

While this is becoming a more popular method of raising funds, little is known about how such fund-raising models are taxed.

As a general rule, crowdfunding contributions are includable in the startup’s taxable income.  However, depending on how the contribution is structured, the contribution may qualify as a tax-free loan, gift, or capital contribution.

Tax-Free Loan

Crowdfunding contributions structured as loans are tax-free.  However, the arrangement must have sufficient debt-like characteristics.  Debt-like characteristics include an unconditional promise to repay, a fixed interest rate, and a specified maturity date.  If the interest rate depends on the profitability or cash-flow of the business, then it may be considered an equity contribution (which may also qualify as tax-free).  Funds transferred without a bona fide repayment obligation will be taxable even if the parties characterize the deal as a loan.

Tax-Free Gift

If the contribution is a gift, then it is not taxable to the business.  To qualify as a gift, the contribution must be out of a detached and disinterested generosity.  Basically, the donor does not expect any repayment or return on the contribution—it is done out of generosity.  If the donor receives anything of benefit from the contribution, the contribution will be taxable to the business.

Some crowdfunding platforms offer rewards in exchange for contributions.  These rewards may negate a contributor’s donative intent unless the reward is clearly inconsequential.  There is no direct guidance on how to determine if a reward is inconsequential, but the IRS’ guidance on quid pro quo charitable contributions may provide some help.

If the contribution qualifies as a gift, the contributor may have a gift tax issue if the contribution exceeds $14,000.

Tax-Free Equity Contribution

If the crowdfunding contribution qualifies as a contribution to equity and the contributor becomes an owner, it will generally be tax-free to the business and the contributor.

Where We Stand

So far, there are no statutes, regulations, court cases, or IRS rulings that directly address the taxability of crowdfunding contributions.  For now, it is safe to assume that crowdfunding contributions will be taxable income unless it qualifies as a loan, gift, or capital contribution.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

How Long Should Tax Records be Kept?

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tax recordsBusinesses must maintain tax records to substantiate amounts reported on their tax returns.  Because of the hustle and bustle of business ownership, many business owners consider record keeping a low priority.

Bad Things Happen When Records Are Not Kept

However, if the IRS audits a business and the business owner has failed to maintain adequate records, the result can be catastrophic.  Imagine spending $20,000 on marketing and failing to keep records of this expense.  If the IRS disallows the deduction, and the taxpayer is in the 25% tax bracket, the IRS will send a bill for $5,000 plus significant penalties and interest.  Imagine if the business owner had $200,000 in expenses and didn’t keep adequate records.

The IRS Requires Records to be Kept

Every taxpayer is required by IRC Section 6001 to maintain adequate tax records and to make those records available to the IRS upon request.  When determining how long to keep tax records, we typically look at the relevant statute of limitations periods—the period of time a taxpayer can amend a tax return to claim a credit or refund or for the IRS to assess additional tax.  The statute of limitations begins running from the tax return’s original due date (generally April 15th), or the date filed, if later.

The statute of limitations is generally 3 years.  However, the limitations period is 6 years if the tax return understates gross income by more than 25%.  There is no statute of limitations if a tax return was never filed or a fraudulent return was filed. There are special statutes of limitations for certain types of deductions (e.g., a 7 year statute of limitations applies to bad debts and worthless securities).

How Long Should Records be Kept?

A good rule of thumb is to add one year to the statute of limitations period.  You often hear tax records should be kept for 7 years.  This is based on the 6 year statute of limitations for returns that have a greater than 25% understatement of income, plus one year.

Certain tax records, however, should be kept much longer than described above and, in some cases, indefinitely.  Records substantiating the purchase price of property that could eventually be sold, such as investment property and business assets, should be retained based on the record retention period for the year the property is sold.

Keep in mind that there may be nontax reasons to hold on to records beyond the time needed for tax purposes.  This might include documents such as insurance policies, leases, real estate closing statements, employment records, and other legal documents.

The 7 year retention policy for tax purposes is a good rule of thumb (unless a special statute of limitations applies).  The State of Michigan has a 4 year statute of limitations, in general.  The 7 year retention policy will thus work well in the State of Michigan.

Records Can be Scanned into Computer Files

It’s also important to know that the IRS allows taxpayers to store certain tax documents electronically.  The rules permit taxpayers to convert paper documents to electronic files (e.g., pdf or image files) and maintain only the electronic files.  Then, the paper documents can be destroyed.  Certain requirements must be met to take advantage of the electronic filing system, so contact us if you have any questions.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

When Driving from Home to Work is Deductible

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commuting expensesWhen it’s time to deduct auto expenses, people generally know that mileage from home to work (and from work back to home) is not deductible. The reason this mileage is not deductible is because it is considered personal commuting and is therefore a nondeductible, personal expense.

Fortunately for taxpayers, there are three exceptions that allow taxpayers to deduct mileage from home to work (and from work to home).

1. Your Home is Your Principal Place of Business

If your home qualifies as your principal place of business under the home office rules, then your home is considered a business location for auto transportation purposes. This means that driving from your home to other work locations and back home is considered business-to-business mileage and is now deductible.

A home office must be used regularly and exclusively as your principal place of business.

There are two ways to meet the principal place of business requirement:
• You meet the facts and circumstances test which is based on the nature of the work performed at each location and the amount of time you spend at each location
• You perform managerial or administrative work out of your home office, and you do not perform substantial administrative or managerial work at another fixed location

This greater ability to deduct mileage is perhaps the biggest advantage of the home office deduction.

2. Driving to Temporary Work Locations When Taxpayer Has a Regular Work Location Away From Personal Residence

If a taxpayer has one or more regular work locations away from the taxpayer’s personal home, the taxpayer may deduct auto expenses incurred in going between the taxpayer’s home and a temporary work location in the same trade or business.

A work location is temporary if employment at a work location is realistically expected to last (and does in fact last) for 1 year or less. If employment at a work location is realistically expected to last for more than 1 year or there is no realistic expectation that the employment will last 1 year or less, the employment is not temporary, regardless of whether it actually exceeds 1 year. If employment is initially expected to last less than 1 year but at some point the employment is expected to exceed 1 year, then the employment will be considered temporary until the date the taxpayer’s expectation changes.

Example: John is an attorney with an office in Farmington Hills. His house is in Royal Oak. Mileage from his home is Royal Oak to Farmington Hills is not deductible because it is considered personal commuting (assuming John’s home does not qualify under the home office rules as his principal place of business).

If John drives from his home to Ferndale to meet with a client, then he is driving to a temporary work location and his mileage from his home to Ferndale is deductible. Further, mileage from his temporary work location in Ferndale to his office in Farmington Hills is also deductible. At the end of the day, mileage from his office in Farmington Hills to his home is not deductible. If John has another business appointment with a client in Warren on the way home, then mileage from his office to his appointment in Warren and from Warren to his home is deductible.

3. Driving to Temporary Work Location When Taxpayer Does NOT Have a Regular Work Location Away From Personal Residence

If a taxpayer does not have a regular work location away from her personal home, the taxpayer may only deduct auto expenses in going between her home and a temporary work location outside the metropolitan area where the taxpayer normally works and lives.

Generally, a metropolitan area includes the area within the city limits and the suburbs that are considered part of that area. Since the taxpayer has no regular work location away from her personal home, mileage to her first business destination within a metropolitan area will be considered nondeductible personal commuting. However, if the business destination is outside the metropolitan area, then the IRS will allow a business deduction.

Example: Joan is a self-employed CPA in Detroit. She works out of her home. Unfortunately, her home office is not used exclusively for business because her kids use her home office to do homework so she does not qualify for the home office deduction. She does not have an office outside the home. Any mileage to her first destination in the metro Detroit area will not be deductible. However, if Joan meets with a client in Traverse City, the mileage will be deductible because Traverse City will most likely be considered outside the metro Detroit area.

It would be best for Joan to make sure her office qualifies as her principal place of business under the home office rules. Then any mileage she incurs for her CPA business will be deductible.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

More Businesses Now Qualify for Faster Write-Offs on Building Improvements

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qualified improvement propertyThe Protecting Americans from Tax Hikes (PATH) Act passed last year and provided taxpayers with goodies in time for the holidays. This post will focus on a new tax provision that helps taxpayers who make improvements to commercial buildings by making expenditures for these improvements eligible for bonus depreciation.

A prior post explaining the benefits to individual taxpayers can be found here.
A prior post explaining the favorable new rules for depreciation in general can be found here.

Background

Under prior law, qualified leasehold improvement property qualified for bonus depreciation. Generally, long lived assets have to be depreciated over a number of years. Leasehold improvement property is generally deducted over 39 years. Qualified leasehold improvement property can be deducted over 15 years. Additionally, since it qualified for bonus depreciation, 50% of the cost of the qualified leasehold improvements could be deducted in the year the improvements were placed in service.

Example: ABC Corp spends $200,000 to remodel its leased space. Before the favorable qualified leasehold improvement property rules took effect, the $200,000 would have to be deducted over 39 years ($5,128 each year for 39 years).

Under the favorable qualified leasehold improvement property rules, 50% of the $200,000 can be deducted in the year of service and the remaining $100,000 cost can be deducted over 15 years (or $6,666 per year). The total first year depreciation expense is $106,666 (substantially more than the $5,128 that would apply without these rules)

Qualified leasehold improvement property included any improvement to the interior of a commercial building if:
• The improvement was made pursuant to a lease
• The interior building portion was to be occupied by the lessee or sublessee
• The improvement was placed in service more than 3 years after the building itself was first placed in service by any person
• The improvement was a structural component of the building

Qualified leasehold improvement property did not include expenses for:
• An enlargement of a building
• Any elevator or escalator
• Any structural component of a common area
• The internal structural framework of the building

Unfortunately, the qualified leasehold improvement property rules did not apply if the building owner was related to the tenant.

The New Law

Beginning in 2016, qualified improvement property is eligible for bonus deprecation. Now, bonus depreciation applies to qualified improvements to commercial buildings regardless of whether the building is leased or owned.

The definition of qualified improvement property has also been expanded.

Qualified improvement property is any improvement to an interior portion of a commercial building if the improvement is placed in service after the date the building is first placed in service. The improvement no longer needs to be placed in service more than 3 years after the building was first placed in service.

The definition of qualified improvement property now also applies to structural components of a building that benefit a common area.

Unfortunately, qualified improvement property still does not include any improvement for which the expense is attributable to: the enlargement of the building; any elevator or escalator; or the internal structural framework of the building.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

Favorable Rules on Deducting Equipment Have Been Extended

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DepreciationDemocrats and Republicans in both the Senate and House of Representatives reached an agreement very early on December 16 to extend various beneficial tax provisions that expired at the end of 2014. The new law is named the Protecting Americans from Tax Hikes (PATH) Act of 2015.

While these tax provisions affect both individuals and businesses, this post will focus on the tax provisions affecting business depreciation. These provisions are very valuable for businesses that purchase long lived assets.

The $500,000 First Year Expensing Election is Now Permanent

The Act retroactively extends and makes permanent the $500,000 expensing limitation and $2 million phase-out amounts. Businesses can immediately deduct up to $500,000 of qualifying assets in the year of purchase. The $500,000 limit is reduced dollar-for-dollar for total qualifying asset purchases over $2 million. Both the $500,000 and $2 million limits are now indexed for inflation. For property placed in service after 2015, Section 179 will also apply to air conditioning and heating units.

Under pre-Act law, the maximum expensing limit dropped to $25,000 and the investment ceiling dropped to $200,000.

The Section 179 benefit is enhanced by the new provision that allows immediate deductions for small asset purchases. Under this provision, taxpayers can immediately deduct amounts paid to acquire or produce a unit of property, or acquire a material or supply if the amount doesn’t exceed $2,500 per invoice (or per item as substantiated by the invoice).

Example: Engineering Co purchases 50 computers at $2,000 each. It also purchased $500,000 of large equipment. Under prior law, Engineering Co could either depreciate the total $100,000 purchase price over five years or it could use $100,000 of its Section 179 limit to immediately deduct the purchase price. If it used Section 179 for the computers, it could use the remaining $400,000 of Section 179 to deduct part of the equipment purchase. The remaining $100,000 equipment purchase would have to be depreciated. With the new provision for small asset purchases, Engineering Co can immediately deduct the $100,000 purchase price since the per unit cost is under $2,500. Engineering Co can take this deduction without having to use any of its Section 179 deduction limit. It can now deduct the full $500,000 large equipment purchase through Section 179.

15 Year Write Off for Qualified Leasehold and Retail Improvement and Restaurant Property Made Permanent

Generally, leasehold improvements are depreciated over 39 years regardless of the term of the lease. In 2014, businesses were able to deduct over 15 years leasehold improvements that met certain qualifications. The new Act now permanently extends the favorable 15 year depreciation period for qualifying leasehold improvements property, qualified restaurant property, and qualified retail improvement property.

Bonus Depreciation Extended Through 2019

Under pre-Act law, businesses were able to immediately deduct 50% of the cost of qualified property. Generally, qualifying property was new (not used) property with a depreciable period of 20 years or less.

The new Act retroactively extends 50% first year bonus depreciation for a few years but gradually reduces it. Bonus depreciation will decrease until it reaches 30% in 2019.

Beginning in 2016, bonus depreciation will also apply to any improvement to an interior portion of a building which is nonresidential real property if such improvement is placed in service after the date the building was first placed in service (basically, improvements to an existing, not brand new, building)

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

 

IRS Makes it Easier to Immediately Deduct “Small” Asset Purchases

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small property safe harborIn September 2013, the IRS released 200 pages of guidance to business owners on when they should immediately deduct repair expenses or depreciate the repair expenses over several years. This guidance also addressed when business owners can immediately deduct asset purchases or when they should capitalize the asset purchase and deduct it over a number of years through depreciation.

Fortunately, the IRS has a de minimis safe harbor election that allows business owners to immediately deduct amounts paid for property if the business owner meets certain requirements.

This safe harbor was intended as an administrative convenience whereby a business owner can deduct small dollar expenditures for the purchase of new property or for the improvement of existing property. If the business owner spends an amount greater than the safe harbor amount, the safe harbor does not bar the business owner from immediately deducting the expense, but the business owner must establish that the expense qualifies as an item that can be expensed immediately.

How to Meet the Safe Harbor

To meet the safe harbor, the taxpayer:
• must have, at the beginning of the tax year, written accounting procedures treating as an expense for non-tax purposes amounts paid for property (1) costing less than $2,500 (per invoice or per item); or (2) with an economic useful life of 12 months or less
• treats the amount in its books and records as an expense

The original threshold limit was $500 per item or invoice. The IRS received a substantial number of comments noting that the cost of many commonly expensed items (for example, tablet-style computers, smart phones, and machinery and equipment parts) typically exceed the prior $500 per item or invoice threshold.

Example: ABC Corp has accounting procedures at the beginning of the year to expense amounts paid for property costing $2,500 or less and to expense amounts paid for property with an economic useful life of 12 months or less.

During the year, ABC buys 10 hand-held point-of-service devices at $600 each (total cost $6,000). Prior to the increase in the safe harbor threshold amount, ABC would have to capitalize the $6,000 purchase price and depreciate the expense over 5 years because each item cost more than the prior $500 safe harbor threshold.

Since the threshold has just been increased to $2,500 per item or invoice, ABC can now fully deduct the $6,000 purchase price of the items because the expense was less than $2,500 per item.

When Does the Safe Harbor Take Effect?

This increase is effective for costs incurred during tax years beginning 2016, but use of the new threshold won’t be challenged in tax years prior to 2016. And, if a taxpayer’s use of the de minimis safe harbor is an issue under consideration in examination, appeals, or before the U.S. Tax Court in a tax year beginning after Dec. 31, 2011 and ending before Jan. 1, 2016, and the issue relates to the qualification under the safe harbor of an amount that doesn’t exceed $2,500 per invoice (or item, as substantiated by invoice) and the taxpayer otherwise satisfies the applicable requirements, IRS won’t pursue the issue further.

To see how this applies to you, give us a call at 248-538-5331.

freeconsultation

Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

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