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Home Affordable Modification Program HAMP and Its Tax Consequence

To help financially distressed homeowners lower their monthly mortgage payments, the Dept. of the Treasury and the Dept. of Housing and Urban Development (HUD) established HAMP. In appropriate cases, HAMP has been offering the Principal Reduction Alternative (PRA) as part of a HAMP loan modification since the last quarter of 2010. Current plans call for HAMP to continue accepting new borrowers through the end of 2013.

Mortgage Reduction – Where the borrower satisfies certain conditions during a trial period, the principal of the borrower's mortgage may be reduced over three years by a predetermined amount called the “PRA Forbearance Amount.”

Trial Period – Before a loan modification becomes permanent, the borrower must meet certain conditions during a three-year trial period. If those conditions are met, the borrower will be offered a permanent modification of the terms of the mortgage loan. Until the effective date of a permanent modification, the terms of the existing mortgage loan continue to apply.

After the mortgage loan is permanently modified under HAMP, if the loan is in good standing on the first, second and third annual anniversaries of the effective date of the 3-year trial period, the loan servicer reduces the unpaid principal balance of the loan by one-third of the initial PRA Forbearance Amount on each anniversary date. Accordingly, if the borrower continues to make timely payments on the loan for three years, the entire PRA Forbearance Amount is forgiven.

Tax Consequences – The borrower realizes cancellation of debt income equal to any excess of the balance of the old mortgage loan (which was satisfied in the deemed exchange) over the issue price of the new (post-modification) mortgage loan.

Where the taxpayer qualifies, the cancellation of debt income can be excluded using either or both insolvency exclusion and/or principal residence acquisition debt relief exclusion. The latter exclusion is only available through 2013, unless further extended by Congress.

· When Income Is Realized – To the extent the cancellation of debt income cannot be excluded, the borrower may treat the cancellation of debt income as being realized in either of the following ways:

(1) One hundred percent of the PRA Adjusted Forbearance Amount at the time of the permanent modification; or

(2) One-third of the PRA Adjusted Forbearance Amount on each of the first three annual anniversaries of the trial period plan effective date, when, as required by the terms of the new mortgage loan, the servicer reduces the unpaid principal balance of the new mortgage loan. If some or all of the reduction in the unpaid principal balance is accelerated because the HAMP-PRA borrower prepays the non-forbearance portion of the mortgage loan, then the HAMP-PRA discharge represented by the amount of the reduction that was accelerated is treated as being realized at the time of the accelerated reduction.

· Incentive Payments to Lenders – Incentive payments made by the HAMP administrator to mortgage lenders to encourage their participation in the program are treated as payments on the mortgage loans by the U.S. government on behalf of the borrowers. The borrower treats these payments as follows:

o Personal residence – Under the “general welfare exclusion”, the borrower excludes the incentive payments from income if the property that is encumbered by the mortgage is used by the borrower as his principal residence or the property is occupied by his legal dependent, parent or grandparent without rent being charged or collected. No information return (1099) will be issued.

o Rental property – If the borrower uses the property as a rental, or it is vacant but available to be rented, the incentive payments made to the lender are includible in the borrower’s income in the year in which the payments are applied to the loan. The lender is obligated to issue a Form 1099-MISC reporting the amount.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him at david@saacpa.com or visit www.saacpa.com or www.SilkRoadRealtyInc.com. Thank you.

IRS Introduces New Safe Harbor Home Office Deduction

Effective for tax years beginning in 2013, taxpayers can elect a simplified deduction for the business use of the taxpayer’s home. The deduction is $5 per square foot with a maximum square footage of 300. Thus, the maximum deduction is $1,500 per year. Here are the details of this simplified method:

· Annual Election – A taxpayer may elect the safe-harbor method or the regular method on an annual basis. Thus, a taxpayer may freely switch between the methods each year. The election is made by choosing the method on a timely filed original return and is irrevocable for that year.

· Depreciation – When the taxpayer elects the safe-harbor method, no depreciation deduction for the home is allowed, and the depreciation for the year is deemed to be zero.

· Additional Office Expenses – Additional office expenses such as utilities, insurance, office maintenance, etc., are not allowed when the safe-harbor method is used.

· Home Interest and Taxes – Prorated home interest and taxes are not allowed as an office expense when using the safe-harbor method. Instead, 100% of the home interest and taxes are deductible as usual on Schedule A.

· Deduction Limited by Business Income – As is the case with the regular method, under the safe harbor method the home office deduction is limited by the business income. For the safe-harbor, the deduction cannot exceed the gross income derived from the qualified business use of the home for the taxable year reduced by the business deductions (deductions unrelated to the qualified business use of a home). However, unlike the regular method, any amount in excess of this gross income limitation is disallowed and may not be carried over and claimed as a deduction in any other taxable year.

· Home Office Carryover – This cannot be used in a year the safe harbor method is used. The carryover continues to future years and can only be used when the regular method is used.

· Qualifications – A taxpayer must still meet the regular qualifications to use the safe-harbor method.

· Reimbursed Employee – The safe harbor method cannot be used by an employee who receives advances, allowances, or reimbursements for expenses related to qualified business use of his or her home under a reimbursement or other expense allowance arrangement with the employer.

· Determining Square Footage - To determine the average square footage of the business, use these guidelines:

o Square Feet Maximum - Never use more than 300 square feet for any month, even if the taxpayer has multiple businesses. Where there are multiple businesses use a reasonable method to allocate between businesses.

o Determining Average Square Feet for the Year - Use zero for months where there was no business use, or where the business was not for a full year.

o 15-Day Minimum – Don’t count any month in which the business use is less than 15 days.

As example, a taxpayer begins using 400 square feet of her home for business on July 20, 2013 and continues using the space as a home office through the end of the year. Her average monthly allowable square footage for 2013 is 125 square feet (300 x 5 months = 1500/12 = 125).

o Multiple Businesses - Where there are multiple businesses, only one method may be used for the year—either the regular or safe harbor.

o Mixed Use Property - A taxpayer who has a qualified business use of a home and a rental use for purposes of § 280A(c)(3) of the same home cannot use the safe harbor method for the rental use.

o Taxpayers sharing a home - Taxpayers sharing a home (for example, roommates or spouses, regardless of filing status), if otherwise eligible, may each use the safe harbor method, but not for a qualified business use of the same portion of the home.

As example, a husband and wife, if otherwise eligible and regardless of filing status, may each use the safe harbor method for a qualified business use of the same home for up to 300 square feet of different portions of the home.

o Depreciation Rate When Switching Methods – When the safe harbor method is used, and the taxpayer subsequently switches back to the regular method, use the depreciation factor from the appropriate optional depreciation table as if the property had been depreciated all along.

When choosing between the methods, the following factors should be considered.

· There is no reduction in basis for depreciation or depreciation recapture when using the safe harbor method.

· When using the regular method, the income limitation takes into account home interest, taxes, and other expenses before allowing the depreciation portion of the deduction. That is not true for the safe harbor method as the interest, taxes, and other business-use-area expenses are not considered.

The IRS has not yet released a form for this new method.

If you have questions related to this new simplified method of claiming a deduction for the business use of your home, please give this office a call. However, keep in mind that this new method does not apply to 2012 returns and does not take effect until 2013.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com orwww.SilkRoadRealtyInc.com. Thank you.

Installment Sale a Useful Tool to Minimize Taxes

Two new laws that take effect in 2013 can significantly impact the taxes owed from the sale of property that results in capital gains. They include:

Higher Capital Gains Rates – Starting in 2013, capital gains can be taxed at 0%, 15%, or 20% depending upon the taxpayer’s regular tax bracket for the year. Therefore, if your regular tax bracket is 15% or less, the capital gains rate is zero. If your regular tax bracket is 25% to 35%, then the top capital gains rate is 15%. However, if your regular tax bracket is 39.6%, the capital gains rate is 20%.

Unearned Income Medicare Contribution Tax – This new tax is sometimes referred to as the “surtax on net investment income,” which more aptly describes this 3.8% tax on net investment income. Capital gains (other than those derived from a trade or business) are considered investment income for purposes of this tax. For individuals, the surtax is 3.8% of the lesser of (1) the taxpayer’s net investment income, or (2) the excess of the taxpayer’s modified adjusted gross income (MAGI) over the threshold amount for his or her filing status. The threshold amounts are:

· $125,000 for married taxpayers filing separately.

· $200,000 for taxpayers filing as single or head of household.

· $250,000 for married taxpayers filing jointly or as a surviving spouse.

Selling a property one has owned for a long period of time will frequently result in a large capital gain, and reporting all of the gain in one year will generally push the taxpayer’s income within the reach of these two new taxes.

This is where an installment sale could fend off these additional taxes by spreading the income over multiple years.

Here is how it works. If you sell your property for a reasonable down payment and carry the note on the property yourself, you only pay income taxes on the portion of the down payment (and any other principal payments received in the year of sale) that represents taxable gain. You can then collect interest on the note balance at rates near what a bank charges. To qualify as an installment sale, at least one payment must be received after the year in which the sale occurs.

Example: You own a lot for which you originally paid $10,000. You paid it off some time ago, leaving you with no outstanding mortgage on the lot. You sell the property for $300,000 with 20% down and carry a $240,000 first trust deed at 3% interest using the installment sale method. No additional payment is received in the year of sale. The sales costs are $9,000.

 

Computation of Gain

Sale Price $300,000

Cost < $10,000>

Sales costs < $9,000>

Net Profit $281,000

Profit % = $281,000/$300,000 = 93.67%

 

Of your $60,000 down payment, $9,000 went to pay the selling costs, leaving you with $51,000 cash. The 20% down payment is 93.67% taxable, making $56,202 ($60,000 x .9367) taxable the first year. The amount of principal received and reported each subsequent year will be based upon the terms of the installment agreement. In addition, the interest payments on the note are taxable and also subject to the investment surtax.

Here are some additional considerations when contemplating an installment sale.

Existing mortgages – If the property you are considering selling is currently mortgaged, that mortgage would need to be paid off during the sale. Even if you do not have the financial resources available to pay off the existing loan, there might be ways to work out an installment sale by taking a secondary lending position or wrapping the existing loan into the new loan.

Tying up your funds – Tying up your funds into a mortgage may not fit your long-term financial plans, even though you might receive a higher return on your investment and potentially avoid a higher tax rate and the net investment income surtax. Shorter periods can be obtained by establishing a note due date that is shorter than the amortization period. For example, the note may be amortized over 30 years, which produces a lower payment for the buyer but becomes due and payable in five years. However, a large lump sum payment at the end of the 5 years could cause the higher tax rate and surtax to apply to the seller in that year – so close attention to the tax consequences needs to be considered in structuring the installment agreement.

Early payoff of the note – The buyer of your property may decide to pay off the installment note early, or sell the property, in which case your installment plan would be defeated and the balance of the taxable portion would be taxable in the year the note is paid off early or the property is sold, unless the new buyer assumes the note. Or, you can have a clause for an early prepayment penalty to deter the buyer from paying it off early.

Tax law changes – Income from an installment sale is taxable under the laws in effect when the installment payments are received. If the tax laws are changed, the tax on the installment income could increase or decrease. Based on recent history, it would probably increase.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com orwww.SilkRoadRealtyInc.com. Thank you.

Flipping Homes A Reviving Trend in Real Estate

Prior to the recent economic downturn, flipping real estate was popular. With mortgage interest rates low and home prices at historical lows, flipping appears to be on the rise again. House flipping is, essentially, purchasing a house or property, improving it, and then selling it (presumably for a profit) in a short period of time. The key is to find a suitable fixer-upper that is priced under market for its location, fix it up, and resell it for more than it cost to buy, hold, fix up and resell it.

If you are contemplating trying your hand at flipping, keep in mind that you will have a silent partner, Uncle Sam, who will be waiting to take his share of any profits in taxes. (And most likely, Sam’s cousin in your state capitol will also expect a share, too.) Taxes play a significant role in the overall transaction, and tax treatment can be quite different depending upon whether you are a dealer, an investor or a homeowner. The following is the tax treatment for each in years after 2012.

o Dealer in Real Estate – Gains received by a non-corporate taxpayer from business operations as a real estate dealer are taxed as ordinary income (10% to 39.6% ), and in addition, individual sole proprietors are subject to self-employment tax of 15.3% of their net profit (the equivalent of the FICA taxes for a self-employed person). Higher-income sole proprietors are also subject to an additional 0.9% Medicare surtax on their earnings. Thus, a dealer will generally pay significantly more tax on the profit than an investor. On the other hand, if the flip results in a loss, the dealer would be able to deduct the entire loss in the year of sale, which would generally reduce his tax at the same rates.


o Investor – Gains as an investor are subject to capital gains rates (maximum of 20%) if the property is held for more than a year (long-term). If held short-term, ordinary income rates (10% to 39.6%) will apply. An investor is not subject to the self-employment tax, but could be subject to the 3.8% surtax on net investment income for higher income taxpayers. A downside for the investor who has a loss from the transaction is that, after combining all long- and short-term capital gains and losses for the year, his deductible loss is limited to $3,000, with carryover to the next year of any excess capital loss. The rules get a bit more complicated if the investor rents out the property while trying to sell it, and are beyond the scope of this article.


o Homeowner – If the individual occupies the property as his primary residence while it is being fixed up, he would be treated as an investor with three major differences: (1) if he owns and occupies the property for two years and has not used a homeowner gain exclusion in the two years prior to closing the sale, he can exclude gain of up to $250,000 ($500,000 for a married couple), (2) if the transaction results in a loss, he will not be able to deduct the loss or even use it to offset gains from other sales, and (3) some fix-up costs may be deemed to be repairs rather than improvements, and repairs on one’s primary residence are not deductible nor includible as part of the cost basis of the home.


Being a homeowner is easily identifiable, but distinguishing between a dealer and an investor is not clearly defined by the tax code. A real estate dealer is a person who buys and sells real property with a view to the trading profits to be derived and whose operations are so extensive as to constitute a separate business. A person acquiring property strictly for investment, though disposing of investment assets at intermittent intervals, is generally not regularly engaged in dealing in real estate.

This issue has been debated in the tax courts frequently, and both the IRS and the courts have taken the following into consideration:

· whether the individual is already a dealer in real estate, such as a real estate sales person or broker;

· the number and frequency of sales (flips);

· whether the individual is more committed to another profession as opposed to fixing and selling real estate; and

· how much personal time is spent making improvements to the “flips” as opposed to another profession or employment.

The distinction between a dealer and an investor is truly based on the facts and circumstances of each case. Clearly, an individual who is not already in the real estate profession and flips one house is not a dealer. But one who flips five or more houses and/or property and has substantial profits would probably be considered a dealer. Everything in between becomes various shades of grey and the facts and circumstances of each case must be considered.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com orwww.SilkRoadRealtyInc.com. Thank you.

Avail Yourself of Your Employers Tax Advantaged Benefits

If your employer provides the following employee benefits, you should participate in the ones that are applicable to you. Each one will reduce your federal and in most cases state taxes too.

· Employer dependent care benefits allow you to exclude up to $5,000 in childcare expenses from your wages.


· Employer health care plans allow you to exclude the cost of insurance for you and your family from your wages.


· Employer 401(k) plans allow you to set aside $17,500 ($23,000 if you are 50 years or over) of year wages per year, tax deferred for your retirement.


· Employer flexible spending arrangements allow you to pay up to $2,500 of medical and dental expenses with pre-tax dollars.


· Employer’s education assistance plans allow the employer to reimburse you by up to $5,250 tax-free for education expenses.


· Employer stock purchase or option plans allow you to acquire the employer’s stock at favorable prices.


· Employers can provide certain transportation, commuting, and parking costs free of tax.

Employers have the option of providing a number of tax-advantaged benefits to their employees. The following is a rundown of those benefits. You may wish to check with your employer to see if the company provides any that interest you. Generally, larger employers provide these benefits.

· Dependent Care Benefits—If you incur childcare expenses so that you can work, you should check to see if your employer has a dependent care program. If dependent care benefits are provided by your employer under a qualified plan, you may be able to exclude up to $5,000 ($2,500 if Married Filing Separately) of child care expenses from your wages, which generally provides a greater tax benefit than the child care credit.

· Health Care Insurance—Many employers offer income-excludable group medical and even dental plans. Generally, everyone, under the Patient Protection Act, will be required to have basic affordable health insurance in 2014 or face penalties on their tax return. If you are currently uninsured, utilizing your employer’s plan may be your best option to avoid a penalty.


· Adult Children’s Health Care Insurance—Employers are allowed, but not required, to provide insurance coverage for your children under the age of 27. If allowed under your employer’s plan, enrolling your young adult children in your employer’s medical insurance is an option to get them covered, and at the same time, avoid their penalties for being uninsured in 2014.


· 401(k) or Similar Retirement Plans—If your employer has a 401(k) plan, you can elect to defer (pre-tax) a maximum of $17,500 for 2013. If you are 50 years or older, the maximum is increased to $23,000. These plans are especially beneficial when the employer provides a matching contribution.


· Flexible Spending Accounts—Some employers provide flexible spending accounts, which allow an employee to make contributions on a pre-tax salary reduction basis to provide coverage for up to $2,500 of medical and dental expenses. However, the participant must use the contributed amounts for qualified expenses, or else forfeit any amounts remaining in the account at the end of the plan year. Medical expenses paid for or reimbursed through pre-tax plans cannot be deducted as part of itemized deductions on your tax return.


· Educational Assistance Programs—An educational assistance program provided by your employer can provide up to $5,250 per year of educational assistance benefits that can be excluded from your income. If you have been thinking about continuing your education and your employer offers an educational assistance program, taking advantage of it is a great way to make going back to school more affordable.


· Stock Purchase and Option Plans—A variety of plans available to employers are designed to allow the employees to invest in the employer’s stock at favorable prices. The most commonly encountered are:

(1) Employee stock ownership plan (ESOP);

(2) Nonqualified stock option; and

(3) Incentive Stock Options (ISOs). Note: Because of the tax ramifications, it may be prudent for you to consult with this office prior to exercising a stock option, especially an ISO.

· Tax-Free (income excludable) Employee Fringe Benefits—If the employer provides them, the law allows an exclusion from the employee’s taxable income for the following benefits:

(1) The cost of up to $50,000 of group-term life insurance.

(2) $245 (in 2013) per month for qualified parking.

(3) $245 (in 2013) per month for transit passes and commuter transportation.

(4) $20 per month for bicycle commuting expenses.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com orwww.SilkRoadRealtyInc.com. Thank you.