Watch out for potential tax pitfalls of donating real estate to charity

Charitable giving allows you to help an organization you care about and, in most cases, enjoy a valuable income tax deduction. If you’re considering a large gift, a noncash donation such as appreciated real estate can provide additional benefits. For example, if you’ve held the property for more than one year, you generally will be able to deduct its full fair market value and avoid any capital gains tax you’d owe if you sold the property. There are, however, potential tax pitfalls you must watch out for:

Donation to a private foundation. While real estate donations to a public charity generally can be deducted at the property’s fair market value, your deduction for such a donation to a private foundation is limited to the lower of fair market value or your cost basis in the property.

Property subject to a mortgage. In this case, you may recognize taxable income for all or a portion of the loan’s value. And charities might not accept mortgaged property because it may trigger unrelated business income tax. For these reasons, it’s a good idea to pay off the mortgage before you donate the property or ask the lender to accept another property as collateral for the loan.

Failure to properly substantiate your donation. This can result in loss of the deduction and overvaluation penalties. Generally, real estate donations require a qualified appraisal. You’ll also need to complete Form 8283, “Noncash Charitable Contributions,” have your appraiser sign it and file it with your federal tax return. If the property is valued at more than $500,000, you’ll generally need to include the appraisal report as well.

Sale of the property within three years. The charity must report the sale to the IRS, and if the price is substantially less than the amount you claimed as a tax deduction, the IRS may challenge your deduction. To avoid this result, be sure your initial appraisal is accurate and well documented.

Sale of the property to someone related to you. If the charity sells the property you donated to your relative (or to someone with whom you negotiated a potential sale), the IRS may argue that the sale was prearranged and tax you on any capital gain.

If you’re considering a real estate donation, plan carefully and contact us for help ensuring that you avoid these pitfalls.

The ABCs of the tax deduction for educator expenses

At back-to-school time, much of the focus is on the students returning to the classroom — and on their parents buying them school supplies, backpacks, clothes, etc., for the new school year. But let’s not forget about the teachers. It’s common for teachers to pay for some classroom supplies out of pocket, and the tax code provides a special break that makes it a little easier for these educators to deduct some of their expenses.

The miscellaneous itemized deduction

Generally, your employee expenses are deductible if they’re unreimbursed by your employer and ordinary and necessary to your business of being an employee. An expense is ordinary if it is common and accepted in your business. An expense is necessary if it is appropriate and helpful to your business.

These expenses must be claimed as a miscellaneous itemized deduction and are subject to a 2% of adjusted gross income (AGI) floor. This means you’ll enjoy a tax benefit only if all your deductions subject to the floor, combined, exceed 2% of your AGI. For many taxpayers, including teachers, this can be a difficult threshold to meet.

The educator expense deduction

Congress created the educator expense deduction to allow more teachers and other educators to receive a tax benefit from some of their unreimbursed out-of-pocket classroom expenses. The break was made permanent under the Protecting Americans from Tax Hikes (PATH) Act of 2015. Since 2016, the deduction has been annually indexed for inflation (though because of low inflation it hasn’t increased yet) and has included professional development expenses.

Qualifying elementary and secondary school teachers and other eligible educators (such as counselors and principals) can deduct up to $250 of qualified expenses. (If you’re married filing jointly and both you and your spouse are educators, you can deduct up to $500 of unreimbursed expenses — but not more than $250 each.)

Qualified expenses include amounts paid or incurred during the tax year for books, supplies, computer equipment (including related software and services), other equipment and supplementary materials that you use in the classroom. For courses in health and physical education, the costs for supplies are qualified expenses only if related to athletics.

An added benefit

The educator expense deduction is an “above-the-line” deduction, which means you don’t have to itemize and it reduces your AGI, which has an added benefit: Because AGI-based limits affect a variety of tax breaks (such as the previously mentioned miscellaneous itemized deductions), lowering your AGI might help you maximize your tax breaks overall.

Contact us for more details about the educator expense deduction or tax breaks available for other work-related expenses.

Summer is a good time to start your 2017 tax planning and organize your tax records

You may be tempted to forget all about taxes during summertime, when “the livin’ is easy,” as the Gershwin song goes. But if you start your tax planning now, you may avoid an unpleasant tax surprise when you file next year. Summer is also a good time to set up a storage system for your tax records. Here are some tips:

Take action when life changes occur. Some life events (such as marriage, divorce, or the birth of a child) can change the amount of tax you owe. When they happen, you may need to change the amount of tax withheld from your pay. To do that, file a new Form W-4 with your employer. If you make estimated payments, those may need to be changed as well.

Keep records accessible but safe. Put your 2016 tax return and supporting records together in a place where you can easily find them if you need them, such as if you’re ever audited by the IRS. You also may need a copy of your tax return if you apply for a home loan or financial aid. Although accessibility is important, so is safety.

A good storage medium for hard copies of important personal documents like tax returns is a fire-, water- and impact-resistant security cabinet or safe. You may want to maintain a duplicate set of records in another location, such as a bank safety deposit box. You can also store copies of records electronically. Simply scan your documents and save them to an external storage device (which you can keep in your home safe or bank safety deposit box). If opting for a cloud-based backup system, choose your provider carefully to ensure its security measures are as stringent as possible.

Stay organized. Make tax time easier by putting records you’ll need when you file in the same place during the year. That way you won’t have to search for misplaced records next February or March. Some examples include substantiation of charitable donations, receipts from work-related travel not reimbursed by your employer, and documentation of medical expenses not reimbursable by insurance or paid through a tax-advantaged account.

For more information on summertime tax planning or organizing your tax-related information, contact us.

Donating a vehicle might not provide the tax deduction you expect

All charitable donations aren’t created equal — some provide larger deductions than others. And it isn’t necessarily just how much or even what you donate that matters. How the charity uses your donation might also affect your deduction.

Take vehicle donations, for example. If you donate your vehicle, the value of your deduction can vary greatly depending on what the charity does with it.

Determining your deduction

You can deduct the vehicle’s fair market value (FMV) if the charity:

• Uses the vehicle for a significant charitable purpose (such as delivering meals-on-wheels to the elderly),
• Sells the vehicle for substantially less than FMV in furtherance of a charitable purpose (such as a sale to a low-income person needing transportation), or
• Makes “material improvements” to the vehicle.

But in most other circumstances, if the charity sells the vehicle, your deduction is limited to the amount of the sales proceeds.

Getting proper substantiation

You also must obtain proper substantiation from the charity, including a written acknowledgment that:

• Certifies whether the charity sold the vehicle or retained it for use for a charitable purpose,
• Includes your name and tax identification number and the vehicle identification number, and
• Reports, if applicable, details concerning the sale of the vehicle within 30 days of the sale.

For more information on these and other rules that apply to vehicle donation deductions — or deductions for other charitable gifts — please contact us.

Real estate investor vs. professional: Why it matters

Income and losses from investment real estate or rental property are passive by definition — unless you’re a real estate professional. Why does this matter? Passive income may be subject to the 3.8% net investment income tax (NIIT), and passive losses generally are deductible only against passive income, with the excess being carried forward.

Of course the NIIT is part of the Affordable Care Act (ACA) and might be eliminated under ACA repeal and replace legislation or tax reform legislation. But if/when such legislation will be passed and signed into law is uncertain. Even if the NIIT is eliminated, the passive loss issue will still be an important one for many taxpayers investing in real estate.

“Professional” requirements

To qualify as a real estate professional, you must annually perform:

• More than 50% of your personal services in real property trades or businesses in which you materially participate, and
• More than 750 hours of service in these businesses.

Each year stands on its own, and there are other nuances. (Special rules for spouses may help you meet the 750-hour test.)

Tax strategies

If you’re concerned you’ll fail either test and be subject to the 3.8% NIIT or stuck with passive losses, consider doing one of the following:

Increasing your involvement in the real estate activity. If you can pass the real estate professional tests, the activity no longer will be subject to passive activity rules.

Looking at other activities. If you have passive losses from your real estate investment, consider investing in another income-producing trade or business that will be passive to you. That way, you’ll have passive income that can absorb some or all of your passive losses.

Disposing of the activity. This generally allows you to deduct all passive losses — including any loss on disposition (subject to basis and capital loss limitations). But, again, the rules are complex.

Also be aware that the IRS frequently challenges claims of real estate professional status — and is often successful. One situation where the IRS commonly prevails is when the taxpayer didn’t keep adequate records of time spent on real estate activities.

If you’re not sure whether you qualify as a real estate professional, please contact us. We can help you make this determination and guide you on how to properly document your hours.

A timely postmark on your tax return may not be enough to avoid late-filing penalties

Because of a weekend and a Washington, D.C., holiday, the 2016 tax return filing deadline for individual taxpayers is Tuesday, April 18. The IRS considers a paper return that’s due April 18 to be timely filed if it’s postmarked by midnight. But dropping your return in a mailbox on the 18th may not be sufficient.

An example

Let’s say you mail your return with a payment on April 18, but the envelope gets lost. You don’t figure this out until a couple of months later when you notice that the check still hasn’t cleared.

You then refile and send a new check. Despite your efforts to timely file and pay, you’re hit with failure-to-file and failure-to-pay penalties totaling $1,500.

Avoiding penalty risk

To avoid this risk, use certified or registered mail or one of the private delivery services designated by the IRS to comply with the timely filing rule, such as:

• DHL Express 9:00, Express 10:30, Express 12:00 or Express Envelope,
• FedEx First Overnight, Priority Overnight, Standard Overnight or 2Day, or
• UPS Next Day Air Early A.M., Next Day Air, Next Day Air Saver, 2nd Day Air A.M. or 2nd Day Air.

Beware: If you use an unauthorized delivery service, your return isn’t “filed” until the IRS receives it. See IRS.gov for a complete list of authorized services.

Another option

If you’re concerned about meeting the April 18 deadline, another option is to file for an extension. If you owe tax, you’ll still need to pay that by April 18 to avoid risk of late-payment penalties as well as interest.

If you’re owed a refund and file late, you won’t be charged a failure-to-file penalty. However, filing for an extension may still be a good idea.

We can help you determine if filing for an extension makes sense for you — and help estimate whether you owe tax and how much you should pay by April 18.