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Red Alert – Test Alert A – July 12 expiration
Red Alert – Test Alert A – July 12 expiration
Owners of certain rental real estate interests have final guidance on what qualifies for the qualified business income (QBI) deduction.
QBI in a nutshell
QBI equals the net amount of income, gains, deductions and losses — excluding reasonable compensation, certain investment items and payments to partners for services rendered. The deduction is subject to several significant limitations; however, QBI generally allows partnerships, limited liability companies (LLCs), S corporations and sole proprietorships to deduct as much as 20% of QBI received.
Many taxpayers involved in rental real estate activities were uncertain whether they would qualify for the deduction. The final guidance leaves no doubt that individuals and entities that own rental real estate directly or through disregarded entities (entities that are not considered separate from their owners for income tax purposes, such as single-member LLCs) may be eligible.
The safe harbor applies to qualified “rental real estate enterprises.” For purposes of the safe harbor only, the term refers to a directly held interest in real property held to produce rents. It may consist of an interest in a single property or multiple properties.
You can treat each interest in a similar property type as a separate rental real estate enterprise or treat interests in all similar properties as a single enterprise. Properties are “similar” if they are part of the same rental real estate category (that is, residential or commercial). In other words, you can only hold commercial real estate in the same enterprise with other commercial real estate. The same applies for residential properties.
Bear in mind, if you opt to treat interests in similar properties as a single enterprise, you must continue to treat interests in all properties of that category — including newly acquired properties — as a single enterprise. If, however, you choose to treat your interests in each property as a separate enterprise, you can later decide to treat your interests in all similar commercial or all similar residential properties as a single enterprise.
Notably, the guidance provides that an interest in mixed-use property may be treated as a single rental real estate enterprise or bifurcated into separate residential and commercial interests.
Safe harbor requirements
The final guidance clarifies the requirements you must fulfill during the tax year in which you wish to claim the safe harbor. Requirements include:
Keeping separate books and records. You must maintain separate books and records reflecting income and expenses for each rental real estate enterprise. If the enterprise includes multiple properties, you can meet this requirement by keeping separate income and expense information statements for each property and consolidating them.
Performing rental services. For enterprises in existence less than four years, at least 250 hours of rental services must be performed each year. For those in existence at least four years, the safe harbor requires at least 250 hours of rental services per year in any three of the five consecutive tax years that end with the tax year of the safe harbor.
The rental services may be performed by owners or by employees, agents or contractors of the owners. Rental services include:
Financial or investment management activities, studying or reviewing financial statements or reports, improving property, and traveling to and from the property do not qualify as rental services.
Maintaining contemporaneous records. For all rental services performed, you must keep contemporaneous records that describe the service, associated hours, dates and the individuals who performed the service. If services are performed by employees or contractors, you can provide a description of them, the amount of time employees or contractors generally spent performing those services, and time, wage or payment records for the individuals.
This requirement does not apply to tax years beginning before January 1, 2020. The IRS cautions, though, that taxpayers still must establish their right to any claimed deductions in all tax years, so be prepared to document your QBI deduction.
Providing a tax return statement. You must attach a statement to your original tax return (or, for the 2018 tax year only, on an amended return) for each year you rely on the safe harbor. If you have multiple rental real estate enterprises, you can submit a single statement listing the requisite information separately for each.
Excluded real estate arrangements
The safe harbor is not available for all rental real estate arrangements. The guidance excludes:
The guidance states that taxpayers that do not qualify for the safe harbor may still be able to establish that an interest in rental real estate is a business for purposes of the deduction.
The final safe harbor rules apply to tax years ending after December 31, 2017, and you have the option of instead relying on the earlier proposed safe harbor for the 2018 tax year. Plus, you must determine annually whether to use the safe harbor.
Contact your trusted advisor to determine whether you are eligible for this and other valuable tax breaks.
Bitcoin and other forms of virtual currency are gaining popularity worldwide. Yet many businesses, consumers, employees and investors are still confused about how they work and how to report transactions on their federal tax returns. The IRS recently announced that it is reaching out to taxpayers who potentially failed to report income and pay tax on virtual currency transactions or did not report them properly.
The nuts and bolts
Unlike cash or credit cards, small businesses generally don’t accept bitcoin payments for routine transactions. However, a growing number of larger retailers and online businesses now accept payments. Businesses can also pay employees or independent contractors with virtual currency. The trend is expected to continue, so more small businesses may soon get on board.
Virtual currency has an equivalent value in real currency and can be digitally traded between users. It can also be purchased and exchanged with real currencies (such as U.S. dollars). The most common ways to obtain virtual currency like bitcoin are through virtual currency ATMs or online exchanges, which typically charge nominal transaction fees.
Virtual currency has triggered many tax-related questions. The IRS has issued limited guidance to address them. In 2014, the IRS established that virtual currency should be treated as property, not currency, for federal tax purposes.
As a result, businesses that accept bitcoin payments for goods and services must report gross income based on the fair market value of the virtual currency when it was received. This is measured in equivalent U.S. dollars.
From the buyer’s perspective, purchases made using bitcoin result in a taxable gain if the fair market value of the property received exceeds the buyer’s adjusted basis in the currency exchanged. Conversely, a tax loss is incurred if the fair market value of the property received is less than its adjusted tax basis.
Wages paid using virtual currency are taxable to employees and must be reported by employers on W-2 forms. They are subject to federal income tax withholding and payroll taxes, based on the fair market value of the virtual currency on the date of receipt.
Virtual currency payments made to independent contractors and other service providers are also taxable. In general, the rules for self-employment tax apply and payers must issue 1099-MISC forms.
The IRS announced it is sending letters to taxpayers who potentially failed to report income and pay tax on virtual currency transactions or did nott report them properly. The letters urge taxpayers to review their tax filings and, if appropriate, amend past returns to pay back taxes, interest and penalties.
By the end of August, more than 10,000 taxpayers will receive these letters. The names of the taxpayers were obtained through compliance efforts undertaken by the IRS. The IRS Commissioner warned, “The IRS is expanding our efforts involving virtual currency, including increased use of data analytics.”
Last year, the tax agency also began an audit initiative to address virtual currency noncompliance and has stated that it is an ongoing focus area for criminal cases.
Implications of going virtual
Contact your trusted advisor if you have questions about the tax considerations of accepting virtual currency or using it to make payments for your business. If you receive a letter from the IRS about possible noncompliance, consult with your trusted business advisor before responding.