The recent riots around the country have resulted in many storefronts, office buildings and business properties being destroyed. In the case of stores or other businesses with inventory, some of these businesses lost products after looters ransacked their property. Windows were smashed, property was vandalized, and some buildings were burned to the ground. This damage was especially devastating because businesses were reopening after the COVID-19 pandemic eased.

A commercial insurance property policy should generally cover some, or all, of the losses. (You may also have a business interruption policy that covers losses for the time you need to close or limit hours due to rioting and vandalism.) But a business may also be able to claim casualty property loss or theft deductions on its tax return. Here’s how a loss is figured for tax purposes:

Your adjusted basis in the property
MINUS
Any salvage value
MINUS
Any insurance or other reimbursement you receive (or expect to receive).

Losses that qualify

A casualty is the damage, destruction or loss of property resulting from an identifiable event that is sudden, unexpected or unusual. It includes natural disasters, such as hurricanes and earthquakes, and man-made events, such as vandalism and terrorist attacks. It does not include events that are gradual or progressive, such as a drought.

For insurance and tax purposes, it’s important to have proof of losses. You’ll need to provide information including a description, the cost or adjusted basis as well as the fair market value before and after the casualty. It’s a good time to gather documentation of any losses including receipts, photos, videos, sales records and police reports.

Finally, be aware that the tax code imposes limits on casualty loss deductions for personal property that are not imposed on business property. Contact us for more information about your situation.

© 2020 Covenant CPA

The law providing relief due to the coronavirus (COVID-19) pandemic contains a beneficial change in the tax rules for many improvements to interior parts of nonresidential buildings. This is referred to as qualified improvement property (QIP). You may recall that under the Tax Cuts and Jobs Act (TCJA), any QIP placed in service after December 31, 2017 wasn’t considered to be eligible for 100% bonus depreciation. Therefore, the cost of QIP had to be deducted over a 39-year period rather than entirely in the year the QIP was placed in service. This was due to an inadvertent drafting mistake made by Congress.

But the error is now fixed. The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020. It now allows most businesses to claim 100% bonus depreciation for QIP, as long as certain other requirements are met. What’s also helpful is that the correction is retroactive and it goes back to apply to any QIP placed in service after December 31, 2017. Unfortunately, improvements related to the enlargement of a building, any elevator or escalator, or the internal structural framework continue to not qualify under the definition of QIP. 

In the current business climate, you may not be in a position to undertake new capital expenditures — even if they’re needed as a practical matter and even if the substitution of 100% bonus depreciation for a 39-year depreciation period significantly lowers the true cost of QIP. But it’s good to know that when you’re ready to undertake qualifying improvements that 100% bonus depreciation will be available.

And, the retroactive nature of the CARES Act provision presents favorable opportunities for qualifying expenditures you’ve already made. We can revisit and add to documentation that you’ve already provided to identify QIP expenditures.

For not-yet-filed tax returns, we can simply reflect the favorable treatment for QIP on the return.

If you’ve already filed returns that didn’t claim 100% bonus depreciation for what might be QIP, we can investigate based on available documentation as discussed above. If there’s QIP that was eligible for 100% bonus depreciation, note that the IRS has, for past retroactive favorable depreciation changes, provided taxpayers with detailed guidance for how the benefit is claimed. Specifically, the IRS clarified how much flexibility taxpayers have in choosing between a one-time downward adjustment to income on their current returns or an amendment to the return for the year the QIP was placed in service. We will evaluate what your options are as anticipated IRS guidance for the QIP correction is released. 

If you have any questions about how you can take advantage of the QIP provision, don’t hesitate to contact us.

© 2020 Covenant CPA

If you’ve invented something during your lifetime and had it patented, your estate includes intellectual property (IP). The same goes for any copyrighted works. These assets can hold substantial value, and, thus, must be addressed by your estate plan. However, bear in mind that these assets are generally treated differently than other types of property.

4 categories of IP

IP generally falls into one of four categories: patents, copyrights, trademarks and trade secrets. Let’s focus on only patents and copyrights, which are protected by federal law in order to promote scientific and creative endeavors by providing inventors and artists with exclusive rights to benefit economically from their work for a certain period.

In a nutshell, patents protect inventions, and the two most common are utility and design patents. Under current law, utility patents protect an invention for 20 years from the patent application filing date. Design patents last 15 years from the patent issue date. For utility patents, it typically takes at least a year to a year and a half from the date of filing to the date of issue.

When it comes to copyrights, they protect the original expression of ideas that are fixed in a “tangible medium of expression,” typically in the form of written works, music, paintings, film and photographs. Unlike patents, which must be approved by the U.S. Patent and Trademark Office, copyright protection kicks in as soon as a work is fixed in a tangible medium.

Valuing and transferring IP

Valuing IP is a complex process. So, it’s best to obtain an appraisal from a professional with experience valuing this commodity.

After you know the IP’s value, it’s time to decide whether to transfer the IP to family members, colleagues, charities or others through lifetime gifts or through bequests after your death. The gift and estate tax consequences will affect your decision. But you also should consider your income needs, as well as who’s in the best position to monitor your IP rights and take advantage of their benefits.

If you’ll continue to depend on the IP for your livelihood, for example, hold on to it at least until you’re ready to retire or you no longer need the income. You also might want to retain ownership of the IP if you feel that your children or other transferees lack the desire or wherewithal to take advantage of its economic potential and monitor and protect it against infringers.

Whichever strategy you choose, it’s important to plan the transaction carefully to ensure your objectives are achieved. There’s a common misconception that, when you transfer ownership of the tangible medium on which IP is recorded, you also transfer the IP rights. But IP rights are separate from the work itself and are retained by the creator.

Revise your plan accordingly

If you own patents or copyrights, you probably have great interest in who’ll take possession of your work after you’re gone. Contact us with any questions on how to incorporate IP in your estate plan.

© 2020 Covenant CPA

If you’re in line to inherit property from a parent or other loved one, it’s critical to understand the basis consistency rules. Current tax law, passed in 2015, provides that the income tax basis of property received from a deceased person can’t exceed the property’s fair market value (FMV) as finally determined for estate tax purposes.

Prior law

Before the 2015 tax law change, estates and their beneficiaries had conflicting incentives when it came to the valuation of a deceased person’s property. Executors had an incentive to value property as low as possible to minimize estate taxes, while beneficiaries had an incentive to value property as high as possible to minimize capital gains, if they decided to sell the property.

Current law

The 2015 law requires consistency between a property’s basis reflected on an estate tax return and the basis used to calculate gain when it’s sold by the person who inherits it. It provides that the basis of property in the hands of a beneficiary may not exceed its value as finally determined for estate tax purposes.

Generally, a property’s value is finally determined when:

  • Its value is reported on a federal estate tax return and the IRS doesn’t challenge it before the limitations period expires,
  • The IRS determines its value and the executor doesn’t challenge it before the limitations period expires, or
  • Its value is determined according to a court order or agreement.

But the basis consistency rule isn’t a factor in all situations. The rule doesn’t apply to property unless its inclusion in the deceased’s estate increased the liability for estate taxes. So, for example, the rule doesn’t apply if the value of the deceased’s estate is less than his or her unused exemption amount.

Beware of failure-to-file penalties

Current law also requires estates to furnish information about the value of inherited property to the IRS and the person who inherits it. Estates that fail to comply with these reporting requirements are subject to failure-to-file penalties.

An accurate valuation is key

The basis consistency rules can be complex. The bottom line is that if you inherit property from a person whose estate is liable for estate tax, it’s important that the property’s value be accurately reported on the deceased’s estate tax return. Contact us with any questions.

© 2020 Covenant CPA

Don’t be afraid of probate

The word “probate” may conjure images of lengthy delays waiting for wealth to be transferred and bitter disputes among family members. Plus, probate records are open to the public, so all your “dirty linen” may be aired. The reality is that probate doesn’t have to be so terrible, and often isn’t, but both asset owners and their heirs should know what’s in store.

Defining probate

In basic terms, probate is the process of settling an estate and passing legal title of ownership of assets to heirs. If the deceased person has a valid will, probate begins when the executor named in the will presents the document in the county courthouse. If there’s no will — the deceased has died “intestate” in legal parlance — the court will appoint someone to administer the estate. Thereafter, this person becomes the estate’s legal representative.

Probate is predicated on state law, so the exact process varies from state to state. This has led to numerous misconceptions about the length of probate. On average, the process takes six to nine months, but it can run longer for complex situations in certain states.

Planning to avoid probate

Certain assets are automatically exempt from probate. But you also may be able to avoid the process with additional planning. The easiest way to do this is through the initial form of ownership or use of a living trust.

By using joint ownership with rights of survivorship, you acquire the property with another party, such as your spouse. The property then automatically passes to the surviving joint tenant on the death of the deceased joint tenant. This form of ownership typically is used when a married couple buys a home or other real estate. Similarly, with a tenancy by entirety, which is limited to married couples, the property goes to the surviving spouse without being probated.

A revocable living trust is often used to avoid probate and protect privacy. The assets transferred to the trust, managed by a trustee, pass to the designated beneficiaries on your death. Thus, you may coordinate your will with a living trust, providing a quick transfer of wealth for some assets. You can act as the trustee and retain control over these assets during your lifetime.

Achieving all estate planning goals

When it comes to probate planning, discuss your options with family members to develop the best approach for your personal situation. Also, bear in mind that avoiding probate should be only one goal of your estate plan. We can help you develop a strategy that minimizes probate while reducing taxes and achieving your other goals.

© 2019 Covenant CPA

Is your business depreciating over a 30-year period the entire cost of constructing the building that houses your operation? If so, you should consider a cost segregation study. It may allow you to accelerate depreciation deductions on certain items, thereby reducing taxes and boosting cash flow. And under current law, the potential benefits of a cost segregation study are now even greater than they were a few years ago due to enhancements to certain depreciation-related tax breaks.

Depreciation basics

Business buildings generally have a 39-year depreciation period (27.5 years for residential rental properties). Most times, you depreciate a building’s structural components, including walls, windows, HVAC systems, elevators, plumbing and wiring, along with the building. Personal property — such as equipment, machinery, furniture and fixtures — is eligible for accelerated depreciation, usually over five or seven years. And land improvements, such as fences, outdoor lighting and parking lots, are depreciable over 15 years.

Often, businesses allocate all or most of their buildings’ acquisition or construction costs to real property, overlooking opportunities to allocate costs to shorter-lived personal property or land improvements. In some cases — computers or furniture, for example — the distinction between real and personal property is obvious. But the line between the two is frequently less clear. Items that appear to be “part of a building” may in fact be personal property, like removable wall and floor coverings, removable partitions, awnings and canopies, window treatments, signs and decorative lighting.

In addition, certain items that otherwise would be treated as real property may qualify as personal property if they serve more of a business function than a structural purpose. This includes reinforced flooring to support heavy manufacturing equipment, electrical or plumbing installations required to operate specialized equipment, or dedicated cooling systems for data processing rooms.

Identifying and substantiating costs

A cost segregation study combines accounting and engineering techniques to identify building costs that are properly allocable to tangible personal property rather than real property. Although the relative costs and benefits of a cost segregation study depend on your particular facts and circumstances, it can be a valuable investment.

Speedier depreciation tax breaks

The Tax Cuts and Jobs Act (TCJA) enhances certain depreciation-related tax breaks, which may also enhance the benefits of a cost segregation study. Among other things, the act permanently increased limits on Section 179 expensing, which allows you to immediately deduct the entire cost of qualifying equipment or other fixed assets up to specified thresholds.

The TCJA also expanded 15-year-property treatment to apply to qualified improvement property. Previously this break was limited to qualified leasehold-improvement, retail-improvement and restaurant property. And it temporarily increased first-year bonus depreciation to 100% (from 50%).

Making favorable depreciation changes

Fortunately, it isn’t too late to get the benefit of speedier depreciation for items that were incorrectly assumed to be part of your building for depreciation purposes. You don’t have to amend your past returns (or meet a deadline for claiming tax refunds) to claim the depreciation that you could have already claimed. Instead, you can claim that depreciation by following procedures, in connection with the next tax return that you file, that will result in “automatic” IRS consent to a change in your accounting for depreciation.

Cost segregation studies can yield substantial benefits, but they’re not right for every business. We must judge whether a study will result in overall tax savings greater than the costs of the study itself. To find out whether this would be worthwhile for you, contact us.

© 2019 Covenant CPA

A common estate planning mistake that people make is to own property jointly with an adult child or other family member. True, adding a loved one to the title of your home, bank account or other property can be a simple technique for leaving property to that person without the need for probate. But any convenience gained is usually outweighed by a variety of negative consequences. Here are four:

1. Higher gift and estate taxes. Depending on the size of your estate, joint ownership may trigger gift and estate taxes. When you add a family member’s name to an asset’s title as joint owner, for example, it’s considered a taxable gift of half the asset’s value. And your interest in the asset — including any future appreciation — remains in your taxable estate. These taxes usually can be minimized or even eliminated by transferring the asset to an irrevocable trust.

2. Higher income taxes. Generally, property transferred at death receives a stepped-up basis, allowing your heirs to sell it without incurring capital gains tax liability. But if you add an heir to the property’s title as joint owner, only your interest in the property will enjoy this benefit. Any appreciation in the value of your heir’s interests between the date he or she is added to the title and the date of your death is subject to capital gains tax.

3. Exposure to creditors’ claims. Unlike property transferred to a properly designed trust, jointly held property may be exposed to claims by the joint owner’s creditors (and also claims from a former spouse).

4. Loss of control. A joint owner has the right to sell his or her interest to an outside buyer without your consent and the buyer may be able to go to court to force a sale of the property. In addition, when you die, the entire property will go to the surviving owner(s), regardless of the terms of your will or other estate planning documents.

If you currently jointly own property with a family member, contact us at 205-345-9898 and info@covenantcpa.com. We can suggest alternative estate planning techniques to ease any gift, estate and income tax liability, and limit your exposure to creditors’ claims.

© 2019 CovenantCPA

Prepaying property taxes related to the current year but due the following year has long been one of the most popular and effective year-end tax-planning strategies. But does it still make sense in 2018?

The answer, for some people, is yes — accelerating this expense will increase their itemized deductions, reducing their tax bills. But for many, particularly those in high-tax states, changes made by the Tax Cuts and Jobs Act (TCJA) eliminate the benefits.

What’s changed?

The TCJA made two changes that affect the viability of this strategy. First, it nearly doubled the standard deduction to $24,000 for married couples filing jointly, $18,000 for heads of household, and $12,000 for singles and married couples filing separately, so fewer taxpayers will itemize. Second, it placed a $10,000 cap on state and local tax (SALT) deductions, including property taxes plus income or sales taxes.

For property tax prepayment to make sense, two things must happen:

  1. You must itemize (that is, your itemized deductions must exceed the standard deduction), and
  2. Your other SALT expenses for the year must be less than $10,000.

If you don’t itemize, or you’ve already used up your $10,000 limit (on income or sales taxes or on previous property tax installments), accelerating your next property tax installment will provide no benefit.

Example

Joe and Mary, a married couple filing jointly, have incurred $5,000 in state income taxes, $5,000 in property taxes, $18,000 in qualified mortgage interest, and $4,000 in charitable donations, for itemized deductions totaling $32,000. Their next installment of 2018 property taxes, $5,000, is due in the spring of 2019. They’ve already reached the $10,000 SALT limit, so prepaying property taxes won’t reduce their tax bill.

Now suppose they live in a state with no income tax. In that case, prepayment would potentially make sense because it would be within the SALT limit and would increase their 2018 itemized deductions.

Look before you leap

Before you prepay property taxes, review your situation carefully to be sure it will provide a tax benefit. And keep in mind that, just because prepayment will increase your 2018 itemized deductions, it doesn’t necessarily mean that’s the best strategy. For example, if you expect to be in a higher tax bracket in 2019, paying property taxes when due will likely produce a greater benefit over the two-year period.

For help determining whether prepaying property taxes makes sense for you this year, contact us. We can also suggest other year-end tips for reducing your taxes. Call us today at 205-345-9898.

© 2018 Covenant CPA

If your estate includes forms of intellectual property (IP), such as patents and copyrights, it’s important to know how to address them in your estate plan. Although these intangible assets can have great value, in many ways they’re treated differently from other property types.

2 estate planning questions

For estate planning purposes, IP raises two important questions: 1) What’s it worth? and 2) How should it be transferred? Valuing IP is a complex process, so it’s best to obtain an appraisal from an experienced professional.

After you know the IP’s value, it’s time to decide whether to transfer the IP to family members, colleagues, charities or others through lifetime gifts or through bequests after your death. The gift and estate tax consequences will affect your decision, but also consider your income needs, as well as who’s in the best position to monitor your IP rights and take advantage of their benefits.

If you’ll continue to depend on the IP for your livelihood, for example, hold on to it at least until you’re ready to retire or you no longer need the income. You also might want to retain ownership if you feel that your children or other transferees lack the desire or wherewithal to exploit its economic potential and protect it against infringers.

Achieving your objectives

Whichever strategy you choose, it’s important to plan the transaction carefully to ensure that your objectives are achieved. There’s a common misconception that, when you transfer ownership of the tangible medium on which IP is recorded, you also transfer the IP rights. But IP rights are separate from the work itself and are retained by the creator — even if the work is sold or given away.

Suppose, for example, that you leave to your child a film, painting or written manuscript. Unless your estate plan specifically transfers the copyright to your child as well, the copyright may pass as part of your residuary estate and end up in the hands of someone else.

Revise your plan accordingly

If you own patents or copyrights, you probably have great interest in who’ll take possession of your work after you’re gone. Addressing IP in your estate plan can give you peace of mind that your wishes will be carried out, but the law surrounding such property can be complex. Discuss your options with us by calling 205-345-9898.

© 2018 Covenant CPA

Do you own a vacation home? If you both rent it out and use it personally, you might save tax by taking steps to ensure it qualifies as a rental property this year. Vacation home expenses that qualify as rental property expenses aren’t subject to the Tax Cuts and Jobs Act’s (TCJA’s) new limit on the itemized deduction for state and local taxes (SALT) or the lower debt limit for the itemized mortgage interest deduction.

Rental or personal property?

If you rent out your vacation home for 15 days or more, what expenses you can deduct depends on how the home is classified for tax purposes, based on the amount of personal vs. rental use:

Rental property. If you (or your immediate family) use the home for 14 days or less, or under 10% of the days you rent out the property, whichever is greater, the IRS will classify the home as a rental property. You can deduct rental expenses, including losses, subject to the real estate activity rules.

Your deduction for property tax attributable to the rental use of the home isn’t subject to the TCJA’s new SALT deduction limit. And your deduction for mortgage interest on the home isn’t subject to the debt limit that applies to the itemized deduction for mortgage interest. You can’t deduct any interest that’s attributable to your personal use of the home, but you can take the personal portion of property tax as an itemized deduction (subject to the new SALT limit).

Nonrental property. If you (or your immediate family) use the home for more than 14 days or 10% of the days you rent out the property, whichever is greater, the IRS will classify the home as a personal residence. You can deduct rental expenses only to the extent of your rental income. Any excess can be carried forward to offset rental income in future years.

If you itemize deductions, you also can deduct the personal portion of both property tax and mortgage interest, subject to the TCJA’s new limits on those deductions. The SALT deduction limit is $10,000 for the combined total of state and local property taxes and either income taxes or sales taxes ($5,000 for married taxpayers filing separately). For mortgage interest debt incurred after December 15, 2017, the debt limit (with some limited exceptions) has been reduced to $750,000.

Be aware that many taxpayers who have itemized in the past will no longer benefit from itemizing because of the TCJA’s near doubling of the standard deduction. Itemizing saves tax only if total itemized deductions exceed the standard deduction for the taxpayer’s filing status.

Year-to-date review

Keep in mind that, if you rent out your vacation home for less than 15 days, you don’t have to report the income. But expenses associated with the rental (such as advertising and cleaning) won’t be deductible.

Now is a good time to review your vacation home use year-to-date to project how it will be classified for tax purposes. By increasing the number of days you rent it out and/or reducing the number of days you use it personally between now and year end, you might be able to ensure it’s classified as a rental property and save some tax. But there also could be circumstances where personal property treatment would be beneficial. Please contact us at 205-345-9898 to discuss your particular situation.

© 2018 Covenant CPA