Real Estate
Preserve Section 1031 exchanges
The IRS has recently announced that it will be scrutinizing “Section 1031 exchanges” of real estate to ensure that such exchanges comply with all the tax law requirements in this area. Nevertheless, you can still avoid current tax by following the rules to the letter.
Under Section 1031 of the tax code, you may defer taxable gains when exchanging properties that are similar in nature, except to the extent that you receive cash or other “boot” as part of the transaction. In that case, you must pay current tax on the gain up to the amount of boot received. Otherwise, you owe no tax until you sell the newly acquired property.
This is one of the rare instances when the tax law lets you off the hook for a disposition of appreciated property.
To qualify as a like-kind exchange, both the property being relinquished and the property being acquired must be investment or business property. You can’t swap personal property tax-free under Section 1031.
“Like-kind” refers to the property’s nature or character. Tax regulations provide a liberal interpretation of this standard. Examples: You can swap improved real estate for raw land, a shopping mall strip for an apartment building, a marina for a golf course. But you can’t swap real estate for personal-property assets such as equipment or vehicles.
The tax law also imposes timing restrictions on Section 1031 exchanges. You must identify (or actually receive) the replacement property within 45 days of transferring legal ownership of the relinquished property. Also, the title to the replacement property must be transferred within the earlier of 180 days or your tax return due date, plus extensions, for the tax year of the transfer.
Obviously, this is a complex area of the tax law. If you are considering a like-kind exchange of real estate, we can help address your personal situation. Call 562-868-6333 to arrange a meeting with an experienced tax professional.
Year-end tax moves for individulas for 2010
Dear Friends of Our Firm,
It’s difficult to formulate a year-end plan in the current political environment. Nevertheless, following are seven sensible tax strategies for individual taxpayers in 2010. Caution: Tax rates are scheduled to go up next year, so consider the long-term implications of any year-end moves.
1. Generate energy tax credits. If you install certain energy-saving devices, you may qualify for the “residential energy credit.” The credit for 2010 is 30% of qualified expenses up to a maximum credit amount of $1,500 (reduced by any credit claimed for 2009).
2. Audit-proof charitable gifts. A recent tax law change requires you to substantiate all monetary gifts to charity. Keep all the records required by the IRS now instead of trying to resurrect them at tax return time.
3. Harvest losses from securities sales to shelter previous capital gains. On the other hand, if you’re showing a net loss for the year, you may trigger some capital gains before year-end. The earlier losses can shelter later gains from taxes.
4. Have a child trigger capital gains. For 2008 through 2010, the normal 5% rate for individuals in the regular 10% and 15% tax brackets is reduced to a rock-bottom 0%. But don’t forget about potential “kiddie tax” complications.
5. Review alternative minimum tax (AMT) liability. You may be able to reduce or eliminate the damage by postponing tax preferences to 2011. However, if you definitely will pay the AMT in 2010, you might accelerate taxable income into this year if the extra income will be taxed at a lower rate than your normal rate.
6. Seek a tax underpayment shelter. To avoid an “estimated tax” penalty for an underpayment, meet one of these three safe-harbor rules.
- Pay at least 90% of the current year’s tax liability.
- Pay at least 100% of the prior year’s tax liability (110% if your AGI for that year exceeded $150,000).
- Pay installments under a special annualized basis. This option is only available if you receive more income on a seasonal basis.
7. Sell real estate on the installment basis. As long as at least one payment is received in the year after the year of the sale, you’re taxed on just the portion of each payment attributable to the gain for each year, plus the interest.
These are only seven potential tax moves to make at the end of the year. Others may be appropriate for your situation. Contact our office at 562-868-6333 to discuss the possibilities.
Very truly yours,
Emil Estafanous, CPA
P.S. Every situation is different. To develop a comprehensive year-end tax plan tailored to your particular circumstances, schedule a meeting by calling us at 562-868-6333.
Tax Break in small business law
Dear Friends of Our Firm,
The Small Business Jobs and Act of 2010, signed by President Obama on Sept. 27, 2010, includes a bevy of tax breaks for small business owners. Here are the highlights of this important new legislation.
Section 179: For tax years beginning in 2010 and 2011, your business can immediately write off up to $500,000 of qualifying assets (including purchased software). The new $500,000 maximum allowance doubles the previous $250,000 maximum deduction. More good news: The threshold for the Section 179 deduction phase-out rule jumps from $800,000 to $2 million, for tax years beginning in 2010 and 2011. Also, for tax years beginning in 2010 and 2011, up to $250,000 of qualified real property costs can also be deducted under Section 179. Previously, real property costs did not qualify for Section 179 deductions.
Bonus depreciation: The new law retroactively reinstates 50% first-year bonus depreciation for qualifying new (not used) assets placed in service by Dec. 31, 2010. This tax break had officially expired after 2009, but it’s now been resurrected for qualified assets placed in service by year-end.
Qualified small business stock: Previously, you could exclude up to 75% of the gain from qualified small business stock (QSBS) acquired between Feb. 18, 2009 and Dec. 31, 2010 if you held the stock more than five years. The new law increases the potential gain exclusion to 100% for QSBS acquisitions made between Sept. 28, 2010 and Dec. 31, 2010. For these shares, the new law also removes the QSBS gain exclusion from the list of items that count as income for alternative minimum tax (AMT) purposes.
BIG tax: When a C corporation converts to an S corporation, it may be liable for a “built-in gains” (BIG) tax on gains recognized in its first 10 years of operation. First, the 10-year recognition period was reduced to seven years for built-in gains recognized in tax years beginning in 2009 and 2010. Now the new law cuts the recognition period to five years for gains in tax years beginning in 2011.
Start-ups: The new law increases the maximum deduction for qualified start-up expenditures to $10,000 for tax years beginning in 2010 (up from $5,000). The threshold for the start-up deduction phase-out rule increases from $50,000 to $60,000, but only for tax years beginning in 2010.
AMT: Normally, general business credits can’t offset the AMT. But the new law allows an “eligible small business” an AMT offset for general business credits arising in tax years beginning in 2010. Also, the business can carry back general business credits arising in tax years beginning in 2010 for up to five years.
Health insurance deduction: For 2010 only, a self-employed individual can reduce his or her self-employment income by deductible health insurance premiums when calculating the self-employment tax.
Cell phones: Cell phones and similar devices used for business will no longer be subject to super-strict recordkeeping requirements for business versus personal use, retroactive to tax years beginning after 2009.
Retirement accounts: Several provisions help facilitate transfers from 401(k), 403(b) and 457 retirement plans to designated Roth accounts.
This is only a brief summary of several key provisions in the new small business law. Contact our office at 562-868-6333 for more details.
Very truly yours,
Emil Estafanous, CPA
P.S. It’s not too late to develop year-end tax strategies based on the new small business law. Call us at 562-868-6333 as soon as possible to schedule a meeting.
Advice to Clients in Uncertain Markets
In the “flash crash” on May 6, 2010, the Dow Jones Industrial Average dropped nearly 1,000 points only to recover more than 600 points by the market close. On the heels of the financial crisis of 2008, this incident only exacerbated investors’ concerns. Some strategies to manage volatility risk that CPAs can recommend to clients are:
Diversify. Overall risk can be reduced by investing in a variety of assets and asset classes, not just stocks.
Refrain from market timing. Individual investors who maintained a long-term, diversified investment strategy and did not sell at market lows in 2009 have recovered a large portion of their paper losses. Those who sold at market lows only to buy back into the market as the market rose committed a classic investment mistake.
Only use limit orders. A limit order is an order to trade at a specified or better price. In contrast, a market order is an offer to trade at whatever the market price happens to be when the trade is executed. During the flash crash, trades ranged from $0.01 to $100,000 (although certain trades were later canceled).
Never use stop-loss orders. A stop-loss order becomes a market order when a security trades at or below the order price. Use of stop-loss orders means a position could be liquidated at potentially very low prices during periods of extreme volatility.
Avoid excessive use of exchange-traded funds (ETFs). By design, ETFs are diverse investment vehicles that trade throughout the day like common stock. While ETFs can be an effective tool for certain investors, their short-term price risks are typically not recognized by many individual investors. During the flash crash, many less liquid ETFs experienced large price aberrations. ETFs represented a staggering 70% of all trades canceled on May 6, 2010.
Avoid margin. The use of margin (money borrowed from a broker with investments as collateral) can be very risky in volatile markets. The use of excessive margin can force sales when markets suffer an intraday minicrash such as the flash crash.
Refrain from writing puts or uncovered calls. In exchange for upfront premiums, the seller of a put option must purchase a stock at a specified price, and the seller of a call option is obligated to sell a stock at a specified price. Writing puts and calls can be extremely risky. Use of uncovered calls is a fundamental mistake (an uncovered call obligates the seller to sell stock not owned at a set price, in essence creating unlimited liability). Although writing covered calls and buying puts can be a risk-reduction strategy, it is costly in terms of forgoing upside appreciation potential above a call’s strike price.
Unless investors are satisfied with the returns of strictly short-term (and low-yield) U.S. Treasury securities, some degree of market exposure and risk is necessary to earn a return. Investors who simply held on to their positions during the flash crash had recovered all or most of their paper losses within about a week. While future market directions are unknown, individual investors who did not panic or were not forced to sell during this latest market instability were in positions to re-evaluate their investment strategies at little or no cost.
By Luis Betancourt, CPA, Ph.D., William M. VanDenburgh, Ph.D. and Philip J. Harmelink, CPA, Ph.D.
Article Source: Journal of Accountancy
Dealing With Clients in Financial Distress
Managing receivables is difficult in the best of times, and these challenges have been made even more difficult by the current economic environment. But there are several steps your CPA firm can take.
Get a handle on billing issues at the outset. First, send out invoices in a timely manner. Invoices are more likely to be paid when the value of your services is still fresh in mind. The earlier an invoice goes out, the earlier it will get paid. Second, if your client has certain requirements or guidelines for processing payment, find out what they are upfront (this can be particularly important for companies requiring the electronic submission of invoices, which is becoming more prevalent). Third, provide clear explanations of the work performed and, if the invoice is likely to draw complaints for being out of line with estimated costs, a phone call to the client with an explanation before the invoice goes out can help eliminate surprises.
Many companies have a 30- or 45-day payment policy. Consider having the client agree to a shorter time frame. This is especially important when the client is experiencing financial difficulties.
Whether or not your client is facing financial difficulties, when your work is expected to take several months, you should have your client agree to progress billing. The shorter the period covered by the billing, the better. But be prepared to stop work if bills are not paid on time. When your client is weak financially, consider an advance retainer agreement.
FOLLOW UP REGULARLY
Once the invoice is out and becomes overdue, follow up regularly. Don’t just send a balance overdue notice. Speak directly with your client and try to get an explanation for any significant outstanding balance, which may provide some guidance as to how concerned you need to be. Also, it is more difficult to avoid a personal phone call than a standard form letter.
Consider setting reserves for any anticipated uncollectible amounts. This is an art, not a science, and the amount reserved may depend on the client’s financial condition, payment history, whether any amounts are disputed and myriad other factors. Also consider setting an across-the-board reserve for all receivables based on collections history. For example, if in any given year the firm is unable to collect 3% of total billings, consider reserving 3% of total receivables.
WATCH FOR RED FLAGS
Throughout the engagement, keep a lookout for red flags that payment problems may be ahead. Is the client hinting at financial difficulty, complaining about work product or more aggressively demanding that your firm adhere to a budget? Did the firm’s large corporate client recently submit a Form 8-K with the SEC stating that it is unable to make a large loan payment coming due? If a client is in jeopardy of declaring bankruptcy, consider timing issues. For example, payments made 90 days before the bankruptcy filing are typically considered preferential payments (or preferences) and, subject to certain exceptions, the bankruptcy trustee may sue your firm for repayment. If your firm holds a retainer, consider when it’s best to apply it to any outstanding balance.
Also determine whether any significant engagement milestones are approaching, such as a deadline for an audit report. And then consider whether your firm should stop work or at least inform the client that you will need to do so if an outstanding balance is not brought current.
CONSIDER DISPUTE RESOLUTION OPTIONS
When disputes elevate to the level of client dissatisfaction or where there is even the possibility of such elevation, consider having a colleague sit in on meetings or calls with the client to discuss overdue fees. Some firms have a designated workout partner who fills such a role, or it may be done on an ad hoc basis. Either way, that colleague can help diffuse difficult situations, represent the “firm’s” position and oftentimes mediate a beneficial resolution. If litigation ever develops, it may be helpful to have a second person as a witness to conversations with the client.
As part of the collections process, clients may request discounts. If the discount is based on dissatisfaction with service, consider obtaining a release of liability in connection with any reduction in fees. Restructuring payment terms is a frequent request by clients in economic dire straits. If the firm and client agree to new payment terms or the scope of the engagement is revised due to budget issues, it is advisable to document these new details in an amended engagement letter or agreement.
If legal action becomes necessary, weigh the pros and cons. A common response to many collection lawsuits is a counterclaim accusing the CPA of malpractice. This brings additional costs and expenses. Careful consideration must be given before suing a client, who is soon to be (if not already) a former client.
If legal action is required, be sure to review the engagement agreement. This is, in essence, the contract on which the firm would be suing. For example, does the engagement letter provide for the recovery of attorneys’ fees, are fee disputes subject to arbitration, and is the firm entitled to interest on unpaid amounts? These answers may dictate whether legal action makes sense. Also consider with your legal counsel whether to include such clauses in engagement letters. Keep in mind that, if you perform services requiring independence, unpaid bills, for example, from a prior year’s audit would make your firm not independent to perform the next year’s audit.
Communication is one of the keys to collection. Keep clients informed and address any potential collection problems upfront. This may be the easiest way to prevent them from becoming actual collection problems.
by Jason M. Rosenthal, Esq.
Article Source: Journal of Accountancy
