Author Archive

Grouping Passive Activities

January 6, 2014

By Darren Morrow

If you own rental properties or have other similar passive activities that generate a loss each year and you want to be able to utilize that loss, then grouping activities may be a good option for you.

Grouping activities is the process of treating one or more passive trade or business activities, or rental activities, as a single activity, including rental real estate. This can only be done if those activities form an appropriate economic unit for measuring gain or loss under the passive activity rules. The simple definition of an economic unit is activities that are similar in nature, industry, and control. See IRS publication 925 for specific criteria regarding what constitutes and economic unit.

Grouping is important for a number of reasons. If two activities are grouped into one larger activity, you need only show that you materially participate in the activity as a whole. But if the two activities are separate, you must show that you materially participate in each one of the activities individually. This is especially beneficial if you own multiple rental properties and are trying to qualify for the material participation test or active participation test. Qualifying for these tests may allow you to potentially recognize all of the losses in the year incurred (materially participating real estate professional) or up to $25k of losses in the year incurred (active participation test). Grouping can also be important in determining whether you qualify for the 10% ownership requirement for actively participating in a rental real estate activity .

One of the downsides to look out for when grouping your activities is if you plan on disposing of one of your activities that accumulated suspended passive losses before it was grouped with other activities.  If you group two activities into one larger activity and you dispose of only one of the two activities, then you are considered to have disposed of only part of your entire interest in the activity. In this case, you are not allowed le to recognize the previously suspended passive losses of the disposed of activity since it is now considered part of the one larger activity. But if the two activities are separate and you dispose of one of them, then you are considered to have disposed of your entire interest in that activity and are able to recognize the suspended passive losses associated with the disposed of activity.

To group an activity all you need to do is file a written statement with your original income tax return for the first tax year in which two or more activities are originally grouped into a single activity. The statement must provide the names, addresses, and employer identification numbers (EIN), if applicable, for the activities being grouped as a single activity. In addition, the statement must contain a declaration that the grouped activities make up an appropriate economic unit for the measurement of gain or loss under the passive activity rules.

Certain activities are restricted from being be grouped. They are listed below:
– Motion picture films
– Farming
– Leasing 1245 property
– Oil and Gas resources
– Geothermal deposits.

For more information about grouping passive activities and material participation please contact us at http://www.ntcpas.com or contact our offices at (714) 836-8300.

Installment Sale Basics

August 20, 2013

By Darren Morrow, CPA

Ever heard of an installment sale?  This article will help you understand the basics of installment sales, including what you need to know to help you make the best decisions when selling property.

An installment sale is the sale of a property where both parties have agreed to terms where the payments will be made over a number of years instead of receiving the entire purchase price at the time of sale. For instance, a person may choose to sell their home to someone and receive payments over a ten year period. The technical definition of an installment sale for tax purposes requires that payments must be made in at least two separate tax years.

Calculating the taxable income to be recognized under an installment sale is quite simple. The first step is to calculate the gain on sale as you normally would (sales price less tax basis). Then a percentage is calculated taking the principal portion of payments received in the current year divided that by the total sales price.  Taxable income for the current year must include this percentage of the overall gain on the sale of the property.

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There are some benefits to taxation under the installment sale rules.  One of the most obvious benefits is the deferral of capital gains taxes. Since you are only recognizing a portion of the gain in the current year you are only taxed on that amount.  The additional tax due from the sale is deferred to future years. Another benefit that is not quite as obvious is that you could possibly be in a lower tax bracket each year since you are not recognizing a large amount of income in one year. Additionally, an often overlooked benefit of the transaction is the additional interest income that can be structured into the sale. Generally sellers will receive a higher rate of interest on the deferred funds than can be realized elsewhere, and the note receivable is secured by the real property. 

Installment sales are not always an option for every transaction. Installment sales cannot be used (for tax calculation purposes) if your sale results in a loss (sales price exceeds your basis), or if it is a sale of inventory, stocks, or securities traded on an established securities market. Additionally, if you choose to do an installment sale and defer your capital gains into future years and the tax rate on capital gains goes up, you could potentially pay a higher amount of tax in the future.

Knowing how installment sales work and how to use them to your advantage is a great tool when negotiating a sale. It will let you have more control over your income and may even earn you a little extra interest income along the way. For more information about installment sales please contact us at http://www.ntcpas.com or contact our office at (714) 836-8300.

A Construction Surety Bond Program – Are you ready and can you prove it?

May 30, 2013

By Jon Fosburg – Reed Surety

Contractors face widespread bonding requirements today. Contractors performing work for federal, state, county or municipal entities will be required to post a bond. With tighter budgets governing projects everywhere, owners want stronger protection against contractor default.

Some construction companies face the challenge of establishing a surety line from scratch, while others seek to maintain or increase their limits. Regardless, every contractor should be aware of the critical factors that affect whether or not you get bond credit.

CPA prepared financial statements – To secure or increase your bond capacity rests primarily on the results posted in your company’s financial statements and these statements must be prepared on an accrual, percentage of completion basis. Surety companies take a hard look at a contractor’s net worth and working capital. They generally discount assets that are not easily converted to cash such as aged receivables older than 90 days and inventory. Sureties also look at how assets are allocated. A contractor may show a strong bottom line, but if its working capital consists almost entirely of equipment and fixed assets, can it really fund a job? If such a company’s cash and credit line were to dry up, it couldn’t simply sell equipment to pay wages and other job costs, because then it couldn’t do the job at all. That’s why a surety company likes to see contractors with strong working capital (defined as current assets minus current liabilities). Current assets include cash, receivables under 90 days and some inventory, assets that can likely be turned into cash within a year as opposed to property, plant, equipment and other long-term resources. Working capital gauges a firm’s ability to finance its operations and indicates the level of protection creditors and surety companies can expect when they underwrite the firm’s operations.

Company information – What’s the largest job your company has completed, has there ever been a claim, what accounting system do you use, resumes of your team, who’s your CPA? These are just several questions that are covered on a contractor’s questionnaire. The more complete your information is to the surety underwriter, the fewer roadblocks you’ll encounter in securing bond credit.

Banking  – Sureties will look for good banking relationships and balances. A bank line of credit is always helpful and it is becoming more of a requirement for larger programs. Have a bank reference letter ready to submit in the underwriting package.

Work in Progress (WIP) – The importance of a WIP report cannot be overemphasized. Typically a WIP is included in the year-end financial statement, however consistent reporting of a WIP to the surety will produce benefits. The WIP report is perhaps the most important report a contractor has to manage the profitability of the jobs it has in the backlog. In securing and maintaining your bond program, sureties will closely examine your WIP report.

For more information or assistance with your surety bonding needs, please contact Jon Fosburg of Reed Surety.

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Real Estate Development Costs: Capitalize or Expense?

January 30, 2013

In the real estate development industry the question of capitalization as always been a tricky subject. Many questions come up such as what expenses get capitalized, when do these items get capitalized, and what items can be expensed.  In this article we hope to provide a basic understanding of the concepts of capitalizing certain carrying costs.

During the development of a project, the developer will incur certain carrying costs related to the property.  Many costs can be considered carrying costs, but typically these include property taxes, insurance and interest.  Generally, these types of costs are considered period costs that are expensed as incurred, but during development, these costs must be accumulated as part of the cost of the asset being developed.

The basic rule related to carrying costs is that they should be capitalized as part of the cost of the asset being developed, and not expensed, during the capitalization period.  The capitalization period has been defined as the period in which the property is “undergoing activities necessary to get it ready for its intended use”.

The term activities has been construed broadly, and encompasses more than just physical construction, but includes all steps necessary to prepare the asset for its intended use, such as developing plans or obtaining permits before construction.

During development, projects may experience interruptions.  Generally, the capitalization period should continue, and carrying costs should be capitalized during brief interruptions.  However, if the entity suspends substantially all activities related to the development of the asset, capitalization of carrying costs should cease.

The capitalization period ends when the asset is substantially complete and ready for its intended use.  The end of the capitalization period generally coincides with the ceasing of all development activities, physical completion of the project or obtaining of a certification of completion or certificate of occupancy.

Effects of Proposition 30

December 7, 2012

The Californian’s have spoken and they have decided on higher taxes. Proposition 30 has officially passed and higher taxes are on the way. What most people do not know about proposition 30 is that most of the laws do not start in 2013 but are actually retroactive to begin January 1, 2012.

Proposition 30 increased state taxes in 2 ways. The first increase is the 0.25% increase in the state sales tax rate. This state sales tax rate is effective for four years beginning January 1 ,2013. The second increase is in the income tax rate on taxpayers making more than $250,000 a year. This increase is retroactive to January 1, 2012. See the table below for the new rates.

10.3% (1% increase) on income of:
$250,001–$300,000 for Single
$340,001–$408,000 for Head of Household
$500,001–$600,000 for Married Filing Joint

11.3% (2% increase) on income of:
$300,001–$500,000 for Single
$408,001–$680,000 for Head of Household
$600,001–$1,000,000 for Married Filing Joint

12.3% (3% increase) on income of:
More than $500,000 for Single
More than $680,000 for Head of Household
More than $1,000,000 for Married Filing Joint

These rates do not include the income in excess of $1 million that is subject to an additional 1% mental health surcharge.

This raises the question of estimated tax payments. Many taxpayers have made their estimated state tax payments according the their estimated liability at the old taxes rates for 2012. Now that the law is retroactive to January 1, 2012 are they are worried that they are going to get penalized for an underpayment penalty. Fortunately proposition 30 provides that affected taxpayers who are underpaid will be held harmless from the underpayment penalty (California Constitution, Article XIII, Section 36(f)(2)(C)(i)). To obtain relief, taxpayers must pay any balance due by April 15, 2013 (calendar-year taxpayers), and complete form FTB 5805, "Underpayment of Estimated Tax by Individuals and Fiduciaries." The FTB will not provide automatic penalty relief.

Client Spotlight: Greenlaw Partners

August 10, 2012

We are pleased this quarter to spotlight our client, Greenlaw Partners. Greenlaw Partners is an Irvine based real estate investment, management and development company. The company’s focus is acquiring and developing real estate in joint venture with a select group of institutions and individuals.

1551 N. Tustin Building

You may have seen articles about Greenlaw Partners in the business news these days due to their involvement in some high profile commercial real estate transactions, one of which is the popular entertainment center known as Triangle Square. As detailed recently in the Orange County Business Journal, in 2006 Greenlaw Partners assembled a group to purchase the center and now has big plans for its future. Along with other changes Triangle Square will now be known as “The Triangle”, this name change is the first of many ways that the landmark is trying to change its image. The most notable change that the plan will take will be the lack of retail stores. The center will try to focus on being a restaurant and entertainment center. The new designs include a 24 hour fitness sport, A bowling alley, and 17,000 more square feet of restaurant space.

Greenlaw has been acquiring and managing properties since 2003. It currently has over $230 million in transactions in the last 12 months and over $1.2 Billion since its inception. The company has over 40 professionals all with in depth and diverse experience.

We are proud of our relationship with Greenlaw Partners.  Through a strategic approach in partnership with Greenlaw personnel, we have assisted Greenlaw in providing timely, accurate tax reporting information to their many important partners.  Our focus is to leverage our real estate expertise to the services we provide Greenlaw so that they remain in compliance with the uniquely complicated tax rules applicable to real estate transactions, while at the same time taking full advantage of those provisions of the law that allow them and their partners to minimize taxes.

You can learn more about Greenlaw Partners at their website here.

IRS Sheds Light on New Tax Preparer Exam

September 6, 2011

The IRS issued some specifications on the new upcoming tax preparer exam including what topics will be tested on and how much emphasis will be put on each area. The test will focus on document gathering and taxpayer data, preparation, and timely filing of an individual’s form 1040. The test is going to include an ethics portion that will count for around 15% of the overall exam. Individuals who wish to prepare taxes under the title of “Registered Tax Return Preparer” must complete this test.

To see the full detailed specifications issued click here.

GOP Plans To Cut Taxes and Regulations in Winter session

August 30, 2011

Eric Cantor the House Majority Leader plans to introduce legislation to eliminate 10 major regulations and approve some major small business tax cuts.

The proposed legislation intends to allow small business owners to take a deduction equal to 20% of their income from their taxes.  This is intended to free up funds for small businesses and make more cash available for hiring new employees and reinvesting in their businesses.

One of the regulations the GOP plans to eliminate is the upcoming 3% withholding for contractors.  This law is set to being in 2013 and would require federal, state and local governments to withhold 3% of all government payments made to contractors in excess of $100 Million.

To see the full proposal click here.