If you donate valuable items to charity and you want to deduct them on your tax return, you may be required to get an appraisal. The IRS requires donors and charitable organizations to supply certain information to prove their right to deduct charitable contributions.

How can you protect your deduction?

First, be aware that in order to deduct charitable donations, you must itemize deductions. Due to today’s relatively high standard deduction amounts, fewer taxpayers are itemizing deductions on their federal returns than before the Tax Cuts and Jobs Act became effective in 2018.

If you clear the itemizing hurdle and donate an item of property (or a group of similar items) worth more than $5,000, certain appraisal requirements apply. You must:

• Get a “qualified appraisal,”
• Receive the qualified appraisal before your tax return is due,
• Attach an “appraisal summary” to the first tax return on which the deduction is claimed,
• Include other information with the return, and
• Maintain certain records.

Keep these definitions in mind. A “qualified appraisal” is a complex and detailed document. It must be prepared and signed by a qualified appraiser. An “appraisal summary” is a summary of a qualified appraisal made on Form 8283 and attached to the donor’s return.

While courts have allowed taxpayers some latitude in following these rules, you should aim for exact compliance.

The qualified appraisal isn’t submitted to the IRS in most cases. Instead, the appraisal summary, which is a separate statement prepared on an IRS form, is attached to the donor’s tax return. However, a copy of the appraisal must be attached for gifts of art valued at $20,000 or more and for all gifts of property valued at more than $500,000, other than inventory, publicly traded stock and intellectual property. If an item of art has been appraised at $50,000 or more, you can ask the IRS to issue a “Statement of Value” that can be used to substantiate the value.

What if you don’t comply with the requirements?

The penalty for failing to get a qualified appraisal and attach an appraisal summary to the return is denial of the charitable deduction. The deduction may be lost even if the property was valued correctly. There may be relief if the failure was due to reasonable cause.

Are there exceptions to the requirements?

A qualified appraisal isn’t required for contributions of:

• A car, boat or airplane for which the deduction is limited to the charity’s gross sales proceeds,
• Stock in trade, inventory or property held primarily for sale to customers in the ordinary course of business,
• Publicly traded securities for which market quotations are “readily available,” and
• Qualified intellectual property, such as a patent.

Also, only a partially completed appraisal summary must be attached to the tax return for contributions of:

• Nonpublicly traded stock for which the claimed deduction is greater than $5,000 and doesn’t exceed $10,000, and
• Publicly traded securities for which market quotations aren’t “readily available.”

What if you have more than one gift? 

If you make gifts of two or more items during a tax year, even to multiple charitable organizations, the claimed values of all property of the same category or type (such as stamps, paintings, books, stock that isn’t publicly traded, land, jewelry, furniture or toys) are added together in determining whether the $5,000 or $10,000 limits are exceeded.

The bottom line is you must be careful to comply with the appraisal requirements or risk disallowance of your charitable deduction. Contact us if you have any further questions or want to discuss your charitable giving plans.

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Many people dream of turning a hobby into a regular business. Perhaps you enjoy boating and would like to open a charter fishing business. Or maybe you’d like to turn your sewing or photography skills into an income-producing business.

You probably won’t have any tax headaches if your new business is profitable over a certain period of time. But what if the new enterprise consistently generates losses (your deductions exceed income) and you claim them on your tax return? You can generally deduct losses for expenses incurred in a bona fide business. However, the IRS may step in and say the venture is a hobby — an activity not engaged in for profit — rather than a business. Then you’ll be unable to deduct losses.

By contrast, if the new enterprise isn’t affected by the hobby loss rules, all otherwise allowable expenses are deductible, generally on Schedule C, even if they exceed income from the enterprise.

Important: Before 2018, deductible hobby expenses could be claimed as miscellaneous itemized deductions subject to a 2%-of-AGI “floor.” However, because miscellaneous deductions aren’t allowed from 2018 through 2025, deductible hobby expenses are effectively wiped out from 2018 through 2025.

How to NOT be deemed a hobby 

There are two ways to avoid the hobby loss rules:

1. Show a profit in at least three out of five consecutive years (two out of seven years for breeding, training, showing or racing horses).
2. Run the venture in such a way as to show that you intend to turn it into a profit maker rather than a mere hobby. The IRS regs themselves say that the hobby loss rules won’t apply if the facts and circumstances show that you have a profit-making objective.

How can you prove you have a profit-making objective? You should operate the venture in a businesslike manner. The IRS and the courts will look at the following factors:

• How you run the activity,
• Your expertise in the area (and your advisors’ expertise),
• The time and effort you expend in the enterprise,
• Whether there’s an expectation that the assets used in the activity will rise in value,
• Your success in carrying on other activities,
• Your history of income or loss in the activity,
• The amount of any occasional profits earned,
• Your financial status, and
• Whether the activity involves elements of personal pleasure or recreation.

Case illustrates the issues

In one court case, partners operated a farm that bought, sold, bred and raced Standardbred horses. It didn’t qualify as an activity engaged in for profit, according to a U.S. Appeals Court. The court noted that the partnership had a substantial loss history and paid for personal expenses. Also, the taxpayers kept inaccurate records, had no business plan, earned significant income from other sources and derived personal pleasure from the activity. (Skolnick, CA 3, 3/8/23)

Contact us for more details on whether a venture of yours may be affected by the hobby loss rules, and what you should do to avoid tax problems.

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Vacation homes in upscale areas may be worth way more than owners paid for them. That’s great, but what about taxes? Here are three scenarios to illustrate the federal income tax issues you face when selling an appreciated vacation home.

Scenario 1: You’ve never used the home as your primary residence

In this case, the home sale gain exclusion tax break (up to $250,000 or $500,000 for a married couple) is unavailable. Your vacation home sale profit will be treated as a capital gain.

If you’ve owned the property for more than one year, the gain will be taxed at no more than the 20% maximum federal rate on long-term capital gains (LTCGs), plus the net investment income tax (NIIT), if applicable. However, the 20% rate only applies to the lesser of:

• Your net LTCG for the year, or
• The excess of your taxable income, including any net LTCG, over the applicable threshold.

For 2024, the thresholds are $518,900 for single filers, $583,750 for married joint filers and $551,350 for heads of households. If your taxable income is below the applicable threshold, the maximum federal rate on net LTCGs is 15%.

If you also owe the 3.8% NIIT, the effective federal rate on some or all of your net LTCG will be 18.8% (15% + 3.8%) or 23.8% (20% + 3.8%).

You may owe state income tax, too.

Scenario 2: You’ve rented out the vacation home

In this situation, you probably deducted depreciation for rental periods. If so, the federal rate on gain attributable to depreciation (so-called unrecaptured Section 1250 gain) can be up to 25%, assuming you’ve held the property for over one year. You may also owe the 3.8% NIIT on the unrecaptured Section 1250 gain. Any remaining gain will be taxed at the federal rates explained earlier.

Plus, if you rented out the vacation home but used it only a little for personal purposes, it has probably been classified as a rental property for federal tax purposes. If so, you may have had rental losses that couldn’t be deducted currently due to the passive activity loss (PAL) rules. You can deduct these suspended PALs when the property is sold.

Scenario 3: You used the vacation home as a principal residence for a time

In this case, you might be able to claim the tax-saving principal residence gain exclusion break. Specifically, if you owned and used the property as your principal residence for at least two years during the five-year period ending on the sale date, you probably qualify for the exclusion.

There’s another major qualification rule for the home sale gain exclusion tax break. The exclusion is generally available only when you’ve not excluded an earlier gain within the two-year period ending on the date of the later sale. In other words, you generally cannot claim the gain exclusion until two years have passed since you last used it.

Of course, if you have a really big gain from selling your vacation home, it may be too big to fully shelter with the gain exclusion — even if you qualify for the maximum $250,000/$500,000 break. Assuming you’ve owned the property for more than one year, the part of the gain that can’t be excluded will be an LTCG taxed under the rules explained earlier.

Conclusion

Taxes on vacation home sales can get complicated, and we haven’t covered all the potential issues here. However, the tax results are simple if you’ve never rented out the property and never used it as a principal residence. We can fill in the blanks in your situation and answer any questions that you may have.

© 2024

Most people are genuinely appreciative of inheritances, and who wouldn’t enjoy some unexpected money? But in some cases, it may turn out to be too good to be true. While most inherited property is tax-free to the recipient, this isn’t always the case with property that’s considered income in respect of a decedent (IRD). If you have large balances in an IRA or other retirement account — or inherit such assets — IRD may be a significant estate planning issue.

How it works

IRD is income that the deceased was entitled to, but hadn’t yet received, at the time of his or her death. It’s included in the deceased’s estate for estate tax purposes, but not reported on his or her final income tax return, which includes only income received before death.

To ensure that this income doesn’t escape taxation, the tax code provides for it to be taxed when it’s distributed to the deceased’s beneficiaries. Also, IRD retains the character it would have had in the deceased’s hands. For example, if the income would have been a long-term capital gain to the deceased, such as uncollected payments on an installment note, it’s taxed as such to the beneficiary.

IRD can come from various sources, including unpaid salary, fees, commissions or bonuses, and distributions from traditional IRAs and employer-provided retirement plans. In addition, IRD results from deferred compensation benefits and accrued but unpaid interest, dividends and rent.

The lethal combination of estate and income taxes (and, in some cases, generation-skipping transfer tax) can quickly shrink an inheritance down to a fraction of its original value.

What recipients can do

Although IRD must be included in the income of the recipient, a deduction may come along with it. The deduction is allowed (as an itemized deduction) to lessen the “double tax” impact that’s caused by having the IRD items subject to the decedent’s estate tax as well as the recipient’s income tax.

To calculate the IRD deduction, the decedent’s executor may have to be contacted for information. The deduction is determined as follows:

• First, you must take the “net value” of all IRD items included in the decedent’s estate. The net value is the total value of the IRD items in the estate, reduced by any deductions in respect of the decedent. These are items which are the converse of IRD: items the decedent would have deducted on the final income tax return, but for death’s intervening.
• Next you determine how much of the federal estate tax was due to this net IRD by calculating what the estate tax bill would have been without it. Your deduction is then the percentage of the tax that your portion of the IRD items represents.

Calculating the deduction can be complex, especially when there are multiple IRD assets and beneficiaries.

Be prepared

As you can see, IRD assets can result in an unpleasant tax surprise. Because these assets are treated differently from other assets for estate planning purposes, contact us. Together we can identify IRD assets and determine their tax implications.

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If you’re buying a new home, you may have thought about keeping your current home and renting it out. In March, average rents for one- and two-bedroom residences were $1,487 and $1,847, respectively, according to the latest Zumper National Rent Report.

In some parts of the country, rents are much higher or lower than the averages. The most expensive locations to rent a one-bedroom place were New York City ($4,200); Jersey City, New Jersey ($3,260); San Francisco ($2,900); Boston ($2,850) and Miami ($2,710). The least expensive one-bedroom locations were Wichita, Kansas ($690); Akron, Ohio ($760); Shreveport, Louisiana ($770); Lincoln, Nebraska ($840) and Oklahoma City ($860).

Becoming a landlord and renting out a residence comes with financial risks and rewards. However, you also should know that it carries potential tax benefits and pitfalls.

You’re generally treated as a real estate landlord once you begin renting your home. That means you must report rental income on your tax return, but also are entitled to offsetting landlord deductions for the money you spend on utilities, operating expenses, incidental repairs and maintenance (for example, fixing a leaky roof). Additionally, you can claim depreciation deductions for the home. And you can fully offset rental income with otherwise allowable landlord deductions.

Passive activity rules

However, under the passive activity loss (PAL) rules, you may not be able to currently claim the rent-related deductions that exceed your rental income unless an exception applies. Under the most widely applicable exception, the PAL rules won’t affect your converted property for a tax year in which your adjusted gross income doesn’t exceed $100,000, you actively participate in running the home-rental business, and your losses from all rental real estate activities in which you actively participate don’t exceed $25,000.

You should also be aware that potential tax pitfalls may arise from renting your residence. Unless your rentals are strictly temporary and are made necessary by adverse market conditions, you could forfeit an important tax break for home sellers if you finally sell the home at a profit. In general, you can escape tax on up to $250,000 ($500,000 for married couples filing jointly) of gain on the sale of your principal home. However, this tax-free treatment is conditioned on your having used the residence as your principal residence for at least two of the five years preceding the sale. So renting your home out for an extended time could jeopardize a big tax break.

Even if you don’t rent out your home long enough to jeopardize the principal residence exclusion, the tax break you would get on the sale (the $250,000/$500,000 exclusion) won’t apply to:

• The extent of any depreciation allowable with respect to the rental or business use of the home for periods after May 6, 1997, or
• Any gain allocable to a period of nonqualified use (any period during which the property isn’t used as the principal residence of the taxpayer or the taxpayer’s spouse or former spouse) after December 31, 2008.

A maximum tax rate of 25% will apply to this gain (attributable to depreciation deductions).

Selling at a loss

What if you bought at the height of a market and ultimately sell at a loss? In such situations, the loss is available for tax purposes only if you can establish that the home was in fact converted permanently into income-producing property. Here, a longer lease period helps. However, if you’re in this situation, be aware that you may not wind up with much of a loss for tax purposes. That’s because basis (the cost for tax purposes) is equal to the lesser of actual cost or the property’s fair market value when it’s converted to rental property. So if a home was purchased for $300,000, converted to a rental when it’s worth $250,000, and ultimately sold for $225,000, the loss would be only $25,000.

The question of whether to turn a home into rental property is complicated. We can help you make a decision.

© 2024

The tax filing deadline for 2023 tax returns is April 15 this year. If you need more time, you can file for an extension until October 15. In either case, once your 2023 tax return has been successfully filed with the IRS, there may still be some issues to bear in mind. Here are three considerations.

1. Waiting for your refund? You can check on it

The IRS has an online tool that can tell you the status of your refund. Go to irs.gov and click on “Get your refund status” to find out about yours. You’ll need your Social Security number or Individual Taxpayer Identification Number, filing status, and the exact refund amount.

2. Throwing away tax records

You should hold on to tax records related to your return for as long as the IRS can audit your return or assess additional taxes. The statute of limitations is generally three years after you file your return.

However, the statute of limitations extends to six years for taxpayers who understate their gross income by more than 25%.

You should keep certain tax-related records longer. For example, keep your actual tax returns indefinitely, so you can prove to the IRS that you filed a legitimate return. (There’s no statute of limitations for an audit if you didn’t file a return or you filed a fraudulent one.)

What about your retirement account paperwork? Keep records associated with a retirement account until you’ve depleted the account and reported the last withdrawal on your tax return, plus three (or six) years. And retain records related to real estate or investments for as long as you own the asset, plus at least three years after you sell it and report the sale on your tax return. (You can keep these records for six years if you want to be extra safe.)

3. Filing an amended return if you failed to report something

In general, you can file an amended tax return on Form 1040-X and claim a refund within three years after the date you filed your original return or within two years of the date you paid the tax, whichever is later. So for a 2023 tax return that you file on April 15, 2024, you can generally file an amended return until April 15, 2027.

However, there are a few opportunities when you have longer to file an amended return. For example, the statute of limitations for bad debts is longer than the usual three-year time limit for most items on your tax return. In general, you can amend your tax return to claim a bad debt for seven years from the due date of the tax return for the year that the debt became worthless.

We’re here all year

Contact us if you have questions about tax record retention, your refund or filing an amended return. We’re not just available at tax filing time. You can reach us year-round.

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