Look Out For These Tax Traps in 2015


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Income TaxReal estate is the best thing going if you want to build wealth AND not pay tax. Tax is a drag on an economy. It slows down the ability to re-invest. So, the less tax you pay, the more money you have to re-invest.

Real estate is also the best (and sometimes only) way to build passive income stream to eventually replace a W-2 job. Cash flow, appreciation, tax breaks – you can have it all with real estate, provided you buy the right property and have a solid tax strategy in place.

First, let’s talk about a misused tax strategy when it comes to real estate. In fact, some people who didn’t know what they were doing with this strategy have made it more difficult for the people who use it correctly. I’m talking about the real estate professional status. If your income is under $100,000 per year (adjusted gross income), you can take a deduction of $25,000 per year. If your AGI is over $150,000, you can’t take any deduction. The exception is if you’re a real estate professional (REP). If you’re a qualifying REP, you can take all of the real estate losses against your other income no matter how much the loss is or how much your other income is.Apartments for Rent

There are three very specific rules that you must follow to qualify as a REP:

  1. You or your spouse must individually have 750 hours of real estate activities per year and more hours than any other trade or business,
  2. You and your spouse must materially participate in running the properties, and
  3. Each property alone must qualify.

That’s the quick summary. Some of the things to consider: what are real estate activities (hint: think active), if you have a business outside real estate you’ll need to track your business hours too, be prepared for the IRS to require 500 hours of participation if you have a property manager, what constitutes participation for a property and the option of making an aggregation election for your properties so that you only have to meet one material participation qualification.

The REP status is still a viable strategy in 2015. Be prepared for IRS pushback if you’ve got a property manager and avoid stupid mistakes like putting something down as occupation that is not real estate-centric.

If you do happen to get audited, make sure you have a qualified IRS rep right from the start. The scope of the audit will be determined by the first phone call. Don’t make a mistake!

Form 3115The big hot button for 2014 tax returns is Form 3115. The IRS has said that they are checking all businesses that do NOT file the form with the 2014 tax form. That may or may not mean an audit. Personally, I’d say every business, business structure and real estate investor needs to file this complicated form. Without filing the complicated tax form this year, though, you’re getting IRS scrutiny and that can’t be a good thing.

Medical insurance and S Corporations has gotten a lot more complicated due to conflicting opinions from the IRS and DOL (Dept of Labor). This has to do with the Affordable Care Act (ACA) aka Obamacare. The problem is with S Corporations who have just a few employees In the past, the S Corp has been able to reimburse employees for their insurance and provide a tax free benefit to their employees. No more! The S Corp must have a separate policy in the name of the corporation that covers the employees. Without that, the policy premium is taxable to the employees. No argument on that one. That’s what the law says. Medical Insurance

The conflict has come about because the IRS and DOL have issued completely different opinions based on their interpretation of ACA as it applies to shareholders and medical insurance. The IRS says that you can take a deduction for medical insurance premiums paid on behalf of the shareholder, provided the S Corp reimburses the employee or pays the premium directly. They are then reported by the shareholder as an ‘above the line’ deduction on the first page of their Form 1040. The DOL says it can’t be deducted unless the policy is in the name of the S Corp, something that is impossible in many areas of the country. (Many areas can’t get single insured medical insurance in the name of the corporation.)

I think most business owners who have tried to do-it-yourself on tax prep are discovering that 2014 is the tax year where they finally need to break down and hire a tax pro. It’s getting more and more complicated.



3 Comments

  1. Diane Kennedy says:

    Gloria, Rev Proc 2015-20 issued 2/13/15 changes it all again! Right now, I’m advising that everyone just waits until we see exactly how to handle the reporting and safe harbor elections. I’ll be posting an update to this by the end of the month.

  2. Gloria says:

    I am confused about the Form 3115. According to the IRS website, this is a form for a change in accounting method. But I thought I read somewhere on your site that it has to do with not being able to expense anything and that everything has to be capitalized. How does a change in accounting method relate to expense vs capitalization?
    Thanks for yoru help.

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