Like-kind exchanges, general rules from IRS

What is a like-kind exchange?

You can defer tax on your gain through the “like-kind” exchange rules. A like-kind exchange is any exchange (1) of property held for investment or for productive use in your trade or business for (2) like-kind investment property or trade or business property. For these purposes, “like-kind” is very broadly defined.

 

Qualifying for a Like Kind Exhange

As long as the exchange is real estate (land and/or buildings) for real estate, or personalty (non-real estate) for personalty, it should qualify. However, exchanges of some types of property (for example, inventory or shares of stock), do not qualify. If you are unsure whether the property involved in your exchange is eligible for a tax-free like-kind exchange, please call and we can discuss the matter. Assuming the exchange qualifies, here’s how the tax rules work: If it’s a straight asset-for-asset exchange, you will not have to recognize any gain from the exchange.

 

What happens after a like-kind exchange?

You will take the same “basis” (your cost for tax purposes) in your new property that you had in the old property. Even if you do not have to recognize any gain on the exchange, you still have to report the exchange on Form 8824. Frequently, however, the properties are not equal in value, so some cash or other (non-like-kind) property is tossed into the deal. This cash or other property is known as “boot.” If boot is involved, you will have to recognize your gain, but only up to the amount of boot you receive in the exchange. In these situations, the basis you get in the like-kind property you receive is equal to the basis you had in the property you gave up reduced by the amount of boot you received but increased by the amount of gain recognized.

 

Example of Like-Kind Exchange

Example. Ted exchanges land (investment property) with a basis of $100,000 for a building (investment property) valued at $120,000 plus $15,000 in cash. Ted’s gain on the exchange is $35,000: he received $135,000 in value for an asset with a basis of $100,000. However, since it’s a like-kind exchange, he only has to recognize $15,000 of his gain: the amount of cash (boot) he received. Ted’s basis in his new building will be $100,000: his original basis in the land he gave up ($100,000) plus the $15,000 gain recognized, minus the $15,000 boot received. Note that no matter how much boot is received, you will never recognize more than your actual (“realized”) gain on the exchange. If the property you are exchanging is subject to debt from which you are being relieved, the amount of the debt is treated as boot.

 

Debt and Like-Kind Exchanges

The theory is that if someone takes over your debt, it’s equivalent to his giving you cash. Of course, if the property you are receiving is also subject to debt, then you are only treated as receiving boot to the extent of your “net debt relief” (the amount by which the debt you become free of exceeds the debt you pick up). Like-kind exchanges are an excellent tax-deferred way to dispose of investment or trade or business assets.

Converting Primary Residence into Rental Property

Renting out your personal residence carries potential tax benefits and pitfalls. The tax consequences of Airbnb and other homesharing services could begin to fall under these rules. People using Airbnb to rent their homes must be considerate of the tax consequences and tax benefits.  Taxpayers are able to take advantage of special tax deductions, but also must be very careful reporting income. Again, this includes people who use Airbnb and similar services.

 

What happens when you convert house to rental property?

Taxpayers generally are treated like a regular real estate landlord once you begin renting your home to others. That means you must report rental income on your return, but also are entitled to offsetting landlord-type deductions for the money you spend on utilities, operating expenses, and incidental repairs and maintenance (e.g., fixing a leak in the roof). Additionally, you can claim depreciation deductions for your home.

 

Offsetting Rental Income with Tax Deductions

You can fully offset your rental income with otherwise allowable landlord-type deductions. However, under the tax law passive activity loss (PAL) rules, you may not be able to currently deduct the rent-related deductions that exceed your rental income unless an exception applies. Under the most widely applicable exception, the PAL rules won’t affect your converted property for a tax year in which your adjusted gross income doesn’t exceed $100,000, you actively participate in running the home-rental business, and your losses from all rental real estate activities in which you actively participate don’t exceed $25,000.

 

Tax Deductions on Rental Property

You should also be aware that potential tax pitfalls may arise from the rental of your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for homesellers if you finally sell the home at a profit. In general, you can escape taxation on up to $250,000 ($500,000 for certain married couples filing joint returns) of gain on the sale of your home. However, this tax-free treatment is conditioned on your having used the residence as your principal residence for at least two of the five years preceding the sale. So renting your home out for an extended time could jeopardize a big tax break.

 

 

Taking Tax Deductions on Rental Property

Even if you don’t rent out your home so long as to jeopardize your principal residence exclusion, the tax break you would have gotten on the sale (i.e., exclusion of gain up to the $250,000/$500,000 limits) will not apply to the extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997, or to any gain allocable to a period of nonqualified use (i.e., any period during which the property is not used as the principal residence of the taxpayer or the taxpayer’s spouse or a former spouse, such as a rental) after Dec. 31, 2008. A maximum tax rate of 25% applies to this gain (attributable to depreciation deductions). Some homeowners who bought at the height of a market may ultimately sell at a loss. In such situations, the loss is available for tax purposes only if the owner can establish that the home was in fact converted permanently into income-producing property, and isn’t merely renting it temporarily until he can sell.

 

Example of Rental (Airbnb) Deduction

Here, a longer lease period helps an owner. However, if you are in this situation, you should be aware that you probably won’t wind up with much of a loss for tax purposes. That’s because basis (cost for tax purposes) is equal to the lesser of actual cost or the property’s fair market value when it’s converted to rental property. So if a home was bought for $300,000, converted to rental property when it’s worth $250,000, and ultimately sold for $225,000, the loss would be only $25,000.

Qualified Personal Residence Trust (QPRT)

A special kind of irrevocable trust can be used to transfer your residence to your children at a significantly reduced gift tax cost and with no estate tax, yet allow you to continue to live in the residence for as long as you wish.

 

What is a qualified personal residence trust (QPRT)?

This special type of trust is known as a qualified personal residence trust (QPRT). (QPRTs are sometimes also referred to as “residence GRITs” or “house GRITs”.) These special trusts should be created with the skilled lawyer who is familiar with their tax consequences.

 

Transferring Residence into Trust

During your lifetime, you transfer your residence to the trustee, who (if state law permits) can be yourself. The trustee must allow you to continue to use the residence rent-free for a fixed number of years specified in the trust instrument (the “fixed term”), which should be a term you are likely to survive.

 

Why transfer residence into a trust for taxes?

During the fixed term, you will continue to pay mortgage expenses, real estate taxes, insurance, and expenses for maintenance and repairs, and will continue to deduct mortgage interest and real estate taxes on your individual income tax return. When the fixed term ends, the residence is distributed to your children, or remains in further trust for them.

Residence Trust

Even after the fixed term ends, you can continue to use the residence in one of two ways. First, rather than immediately distributing the residence to your children, the residence can be retained in trust for your spouse’s lifetime, thus assuring that the residence is available to you. Second, you can enter into a lease with your children which will allow you to live in the residence for as long as you wish. (If you do so, however, you must pay fair market value rent to your children after the fixed term ends in order to keep the residence from being subject to estate tax on your death.)

 

Taxable Gifts and Trusts

Although your transfer of the residence to the trust is a taxable gift, you are allowed to subtract, from the fair market value of the residence, the value of your right to live rent-free in the residence for the fixed term. Thus, the amount of the taxable gift will usually be substantially less than the fair market value of the residence. If the amount of the gift is less than your available exclusion from the gift tax ($5,250,000 in 2013, reduced by amounts allowed for gifts in previous years), no gift tax will be due as a result of your gift to the trust.

 

QPRT Trust Effect

If you survive the fixed term of the QPRT, the value of the residence will not be included in your estate for estate tax purposes. Even if you don’t survive the fixed term, the estate tax consequences will be no worse than they would have been if you hadn’t created the trust in the first place. A QPRT is an effective way to remove a residence’s value from your estate at a greatly reduced gift tax cost.

Information about Mortgage Debt Forgiveness Cancellation 2015

If your lender cancels a portion or the entire amount of your debt, you would normally have to pay taxes on that amount that is cancelled. However, the law provides an exception that can apply to homeowners whose mortgage debt was canceled in 2014. In most cases where this exception applies, the amount of forgiven debt is not subject to tax.

 

Mortgage Debt Cancellation and Taxes

Here are ten tips on mortgage debt cancellation that will save you money on taxes when filing in 2015:

  1. Principal residence.   If the canceled debt was a loan for your main home, you may be able to exclude the forgiven amount of their income. To qualify, should have used the loan to buy, build or substantially improve your principal residence. Your primary residence must also insure the mortgage.
  2. Loan Modification.   If the lender canceled part of your mortgage through a loan modification or an ‘arrangement’, perhaps to exclude that amount from your income. It is also possible to exclude certain amount that has been liquidated as part of the Affordable Modification Program Home,HAMP . Exclusion may also apply to the amount of debt canceled because of a foreclosure.
  3. Mortgage Refinance.   The exclusion may apply to canceled a refinanced mortgage amounts.This would apply only if used profits from refinancing to buy, build or substantially improve your principal residence. The quantities have been used for other purposes not qualify.
  4. Another Type of Debt Cancelled.   Other types of canceled debts such as a second property, rental properties and business credit cards or car loans does not qualify for this special exclusion.Moreover, there are some other rules that could allow such canceled debts are tax exempt.
  5. Form 1099-C.   If your lender reduced or canceled at least $ 600 of your debt, you should receive Form 1099-C , Cancellation of Debt in January next year. This form shows the amount of canceled debt as well as other information.
  6. Form 982.   If you qualify, report the amount of debt excluded on Form 982 , Reduction of Tax Attributes for Debt Settlement. Submit the form with your federal tax return.
  7. Tool on IRS.gov.   The IRS offers several free tools on the website to help you file your tax return. Use the Interactive Tax Assistant on IRS.gov to find out if your mortgage debt canceled is taxable.
  8. Exclusion Ext. The law gave authority to the exclusion had expired at the end of 2013. The Act Tax Increase Prevention extended it to apply for one year, until December 31, 2014.
  9. More Information. For more information on this topic, see Publication 4681 , Canceled Debts, Foreclosures, Repossessions and Abandonments.

Rental Property Tax Deductions Allowed

Generally, a person is not entitled to deduct the cost of maintaining a personal residence. There are certain exceptions, allowing a deduction for items such as qualified mortgage interest and real estate taxes. With the advent of Airbnb and other home sharing services, more and more people may become rental property owners and be entitled to take these tax deductions on rental property.

 

Common Tax Deductions for Rental Property

If the property qualifies as a residence and is rented for fewer than 15 days, the owner is not permitted to claim expenses associated with rental. However, expenses associated with a personal residence that are allowed irrespective of whether the home is rented are permitted.

If the property qualifies as a residence and is rented for 15 days or more, the owner may claim expenses associated with rental. He or she may claim expenses only to the extent the gross income exceeds deductions otherwise allowable with respect to the property. Such otherwise allowable deductions include qualified home mortgage interest or real estate taxes.

 

What happens when expenses exceed income?

To the extent the expenses exceed rental income, they must be carried forward to the next year. Expenses associated with a personal residence that are allowed irrespective of whether the home is rented are not limited to income received from the rental.

To determine the correct amount of allowable expenses associated with rental of the vacation/second home, expenses must be allocated. Expenses are allocated between rental and personal use of the property.

 

How to Determine if Rental Expenses are Deductible?

When determining the deductibility of costs associated with rental of a vacation/second home, the costs will fall into one of the three following categories:

  • Deductible in full in the year paid.
  • Deductible over time (depreciable or amortizable).
  • Neither currently deductible or nor deductible over time.

 

Currently Deductible Expenses

Currently deductible expenses are those that are ordinary and necessary expenses of renting the property, including the cost of repairs.  A “repair” is the cost of keeping an asset in ordinary operating condition. It does not materially add to the value of the property or substantially prolong its life.  Examples of repairs include:

  • Painting.
  • Cleaning and maintenance.
  • Advertising.
  • Utilities.
  • Insurance.
  • Interest.

 

What Capital Expenses for Rental Property are Deductible?

Capital expenditures are amounts spent for an item that lasts more than one year or has a benefit that lasts more than one year. If the asset does not wear out over time, the cost cannot be recovered through depreciation. If the asset does wear out, the cost may be recovered over time through depreciation deductions. An improvement is treated as a capital expenditure. An “improvement” is an expenditure that puts an asset in normal operating condition. It materially adds to the value of the property, substantially prolongs its life, or adapts the property to a new or different use. Examples of improvements include:

  • Updating wiring.
  • Replacing the roof.
  • Installing a new washer and dryer.
  • Repairs made as part of an extensive remodeling or restoration of the property.

The cost of real property (not including the cost of land) used for rental purposes is recovered ratably over 27.5 years.

 

 

IRS Classes of Property Life

The IRS has provided charts setting forth the class life of property, which is the number of years over which the cost must be recovered. The property class lives are:

  • 3-year property;
  • 5-year property.
  • 7-year property.
  • 10-year property.
  • 15-year property.
  • 20-year property.
  • 27.5 years for nonresidential real property.
  • 39 years for residential real property.

 

Most property used for rental purposes will be classified as five-, seven-, or 15-year property. Five-year property includes items such as appliances, carpeting, some furniture, computers, office machines, and automobiles. Seven-year property includes items such as some furniture and desks. Roads and shrubbery are examples of 15-year property.

 

MACRS and Rental Property

Under MACRS, the cost of tangible personal property is recovered in an accelerated manner. More depreciation is allocated to the earlier years and less to the later years. In addition, for the first year the asset is placed in service, the owner is entitled to only one-half the year’s depreciation.

The correct prorated amounts have been converted into percentages and organized on charts. By locating the correct year on the chart for the correct class life, it is easy to calculate the amount of allowable depreciation for the year. Simply multiply the cost of the property by the percentage from the chart

It is possible to elect out of MACRS and recover the cost using the straight-line method. In essence, if the election is made, the cost of the property is recovered over 40 years rather than 27.5 years.

 

Placing MACRS Property Into Service

For the year the person places the property in service, she is not entitled to a full year of depreciation. Rather, for the month the owner begins using the property in a rental business, she gets one-half a month of deprecation. The owner receives a full month’s worth of depreciation for the remaining months of the year.

The correct prorated amounts have been converted into percentages and placed on charts. By locating the correct year and month, an individual can easily calculate the amount of allowable depreciation for the year. Simply multiply the cost of the building by the percentage from the chart.  The cost of property used for rental purposes is recovered using the following percentages:

Tax Effects of Buying and Renting a House

If a person owns a vacation/second home, they may deduct qualified mortgage interest paid with respect to the property.

 

Deducting Qualified Mortgage Interest on Second Home

If the second home is rented out, there might be additional tax benefits. Whether the owner must report rental income, and whether he or she can deduct expenses associated with renting it, depends on two factors. The factors are whether the owner uses the vacation/second home as a residence and the amount of time the owner rents out the property.

 

Deduct Qualified Mortgage Interest

An individual may deduct qualified mortgage interest paid with respect to a vacation or second home. Additional deductions may be available if the owner rents out the vacation/second home for a specified amount of time during the year instead of using it as a personal residence.  However, in that case, rental income may also need to be reported Partial deductions may be allowed for a residence that is converted to rental property.

 

What is minimal rental use?

A person might have a home, apartment, condominium, mobile home, boat, vacation home, or similar property used as a second/vacation home. The individual might use the vacation/second home entirely for personal purposes or might rent out the second home for part of the year. The proper tax treatment depends on whether the taxpayer uses the vacation/second home as a residence. Expenses associated with renting out the property may be deductible, while rental income may need to be included in income.

 

How time is minimal rental use?

If a person rents out a second/vacation home for part of the year, some tax issues depend on whether the property is a residence. Such issues include whether the person must report the rental income, and the extent to which he or she may claim expenses associated with rental of the property. Property is treated as a “residence” if the taxpayer uses it for personal purposes for more than the greater of:

  • 14 days; or
  • 10 percent of the number of the days during which the home was rented out.

 

Determining Personal Use of Rental Property

There is a formula for determining the number of days the property was used for personal purposes. The property is considered as being used by the owner when used by any of the following people:

  • The owner.
  • Any other person who has an interest in the property.
  • A member of the owner’s family if the family member does not pay fair rental value.
  • A family member of a person who has an interest in the property if the family member does not pay fair rental value.
  • Anyone under an arrangement that lets the owner use some other dwelling unit.
  • Anyone else who rents the property but pays less than fair rental value.

 

Property may also be used for personal purposes when:

  • Use of the property is donated to a charitable organization;
  • The organization sells the use of the unit at a fund-raising event; and
  • The “purchaser” uses the unit.

Income that Landlords Receive Taxable

Not all money received by a landlord is table. There are certain types of payments that will not be considered income. First start by asking what what types of rent payment did you receive in 2014?

 

Advanced Rent

Advance rent is any amount you receive before the period that it covers.

This information is found in Publication 527, Residential Rental Property.

 

Lease Cancellation

If your tenant pays you to cancel a lease, the amount you receive is rent.

This information is found in Publication 527, Residential Rental Property.

 

Security Deposit

Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.

If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.

This information is found in Publication 527, Residential Rental Property.

 

Services

If you receive property or services as rent, instead of money, include the fair market value of the property or services in your rental income.

This information is found in Publication 527, Residential Rental Property.

 

Tenant Paid Expenses

If your tenant pays any of your expenses, those payments are rental income. Because you are including this amount in income, you can also deduct the expenses if they are deductible rental expenses.

This information is found in Publication 527, Residential Rental Property.

 

Personal Use of Rental Property

A day of personal use of a dwelling unit is any day that the unit is used by any of the following persons.

  1. You or any other person who owns an interest in it, unless you rent it to another owner as his or her main home under a shared equity financing agreement.
  2. A member of your family or a member of the family of any other person who owns an interest in it, unless the family member uses the dwelling unit as his or her main home and pays a fair rental price. Family includes only your spouse, brothers and sisters, half-brothers and half-sisters, ancestors (parents, grandparents, etc.), and lineal descendants (children, grandchildren, etc.).
  3. Anyone under an arrangement that lets you use some other dwelling unit.
  4. Anyone at less than a fair rental price.

Reporting Rental Income From Vacation Home

Income received from the rental of your vacation property or rental home should generally be reported on your federal taxes. However, if you rent the property a short time each year, you may not be to report rental income. The IRS offers these tips on how to report rental income from a vacation home as a house, apartment, condominium, mobile home or a sailboat:

 

Reporting Rental Income on Tax Return

  • Rental Income and Expenses, Rental Income and certain rental expenses that can be deducted, and is usually reported in WS-E Supplemental Income and Loss.
  • Limited House Rentals – When a holiday home used as a residence and rent it to others, you must divide the expenses between rental use and personal use and may not deduct the portion of rental expenses in excess of rental income. For example, if you live in the holiday home for 17 days and rents 160 days during the year, the property is considered used as residence and your deductible rental expenses will be limited to the amount of rental income.
  • Special Rule for Limited Rental Use – If the home is used as a holiday home and the taxpayer rents it fewer than 15 days a year, it does not have to report the rental income. WS-A detailed expenses, can be used to report regularly deductible, such as qualified mortgage interest, property taxes and casualty losses personal expenses.

 

Examples of expenses that you may deduct from your total rental income include:

  • Depreciation – Allowances for exhaustion, wear and tear (including obsolescence) of property. You begin to depreciate your rental property when you place it in service. You can recover some or all of your original acquisition cost and the cost of improvements by using Form 4562 (PDF), Depreciation and Amortization, (to report depreciation) beginning in the year your rental property is first placed in service, and beginning in any year you make improvements or add furnishings.
  • Repair Costs – Expenditures made to keep your property in good working condition but do not add to the value of the property.
  • Operating Expenses – Other expenditures necessary for the operation of the rental property, such as the salaries of employees or fees charged by independent contractors (groundkeepers, bookkeepers, accountants, attorneys, etc.) for services provided.

 

IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes)

IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes), is available at IRS.gov or by calling 800-TAX-FORM (800-829-3676). The brochure provides information about rental property, including special rules for personal use and how to report rental income and expenses.

Selling Your Home Tax Information and Tax Tips

What kind of tax benefits are available to people who sell their home for a gain?

Typically, the home is the most valuable asset of a taxpayer and taxpayers will face numerous tax related issues when selling a home. If a taxpayer has gains from the sale of their main home, you may be entitled to exclude from income up to $ 250,000 of those gains.You can exclude up to $ 500,000 of those gains if filing a joint return with your spouse.P ublication 523, Selling Your Home (Selling your home) provides certain rules and sheets of relevant work.

 

To qualify for exclusion, you must meet both proof of ownership as proof of use requirements.

You are eligible for the exclusion if your business has been owned and used the home as a principal residence for a total period of at least two years of the 5 years preceding the date of sale.

Usually, you are not eligible for the exclusion if you excluded the gain from the sale of another home during the two-year period before the sale of your home. See Publication 523 contains all the eligibility requirements, limits the amount of exclusion and the exceptions to the rule of two years.

 

Form 1099-S and Form 8949

If you receive a document about the statement of income as Form 1099-S, Proceeds From Real Estate Transactions (Proceeds from real estate transactions), you must report the sale of the house, even if the gain the sale is excludable. In addition, you must report the sale of the house if you can not exclude all capital gains income. Use Schedule D (Form 1040), Capital Gains and Losses (losses and capital gains) and Form 8949 , Sales and Other Dispositions of Capital Assets (Sales and other disposals of capital goods) when be required to report the sale of the house. See Publication 523, which contains the rules on how state sales taxes on your income.

 

Selling Your Home Tax Information and Tax Tips

If you or your spouse qualify for extended active duty in the Armed Forces, the Foreign Service or intelligence community, you may choose to suspend the trial period of 5 years for a maximum of 10 years. It is considered that you are in the official personnel if prolonged for more than 90 days or for an indefinite period, is:

  • In an official service station located at least 50 miles away from your principal residence or
  • Resides under government orders in government housing.

If you sold your home under a contract stating that some or all of the sales price is paid in a later year, you conducted an “installment sale.” If you have an installment sale, report the sale according to the method of limits, unless waived its option. For more information, refer to Topic 705 Installment Sales (Installment Sales).

Deduct Property Taxes on Federal Return

How do you deduct state property tax on a tax return?

The IRS allows you to take a deduction for the property tax payments you make on your home , provided that your local government imposes the tax using a uniform rate that’s based on your home’s value. If you end up paying personal property taxes to your local government, the IRS allows you to claim a deduction for it on your federal tax return. However, the IRS requires you to satisfy certain requirements, regardless of how your government classifies the tax.Although subject to conditions and restrictions, the property tax deduction still affords helpful financial assistance to homeowners, many of whom are subject to property taxes as well as income and sales taxes in their state

 

Personal property tax is deductible if it is a state or local tax that is:

  • Charged on personal property,
  • Based only on the value of the personal property, and
  • Charged on a yearly basis, even if it is collected more or less than once a year.

 

Deduct Property Taxes on Federal Return

Following the following guidelines will help determine if you are able to take a property tax deduction on your federal tax return when you file taxes.

  1. The property tax deduction is only available to the people who are legally responsible for making the tax payments, regardless of who actually makes them. Therefore, if you make property tax payments for another taxpayer, you’re not able to claim the deduction.
  2. The property tax deduction you report must only include the tax payments that are actually made during the tax year.  This could be less than the actual tax liability

 

Property Taxes and Itemized Deductions

Property taxes can only be deducted if a taxpayer itemizes their deductions. The first thing a taxpayer will want to do is compare their itemized deduction to the standard deduction. If the total of your deductible expenses reported on Schedule A, including all property tax payments, is less than the standard deduction for your filing status, you can save more money in tax with the standard deduction rather than itemizing your property taxes.

Report your annual property tax payments on Schedule A if itemizing. The Schedule A has a section entitled “Taxes You Paid” where you should report all property taxes. Once you complete the Schedule A form, you must attach it to your 1040.

 

Eligible to claim a deduction for property taxes?

If you are eligible to claim a deduction for property taxes, there are additional home-related deductions you should also consider claiming on Schedule A such as mortgage and home equity loan interest and mortgage insurance premiums.

You must use Form 1040 to report your taxes because it is the only form you can use when itemizing deductions.