Sauder & Stoltzfus Blog

Preface: A cost segregation study identifies and reclassifies personal property assets to accelerate the depreciation expense benefit for taxation purposes, reducing current income tax costs. The primary goal of a cost segregation study is to identify all construction-related costs that can be depreciated over a shorter tax life (typically 5, 7 and 15 years) than say the 39 years for non-residential real property. 

Tax Benefits of A Cost Segregation Study

Business and individual taxpayers that build or acquire nonresidential real property, e.g. warehouses, manufacturing space or residential rental property, e.g. rental unit(s) have an opportunity to reap tax benefits with a reduction of the depreciable calendar period recovery on the assets which are qualifying building components. Certain assets may qualify for shorter depreciable lives and recovery periods under MACRS depreciation. The reduction of the qualify building component asset lives provides accelerated deductions to offset income under the current Tax Cuts and Jobs Acts tax regime.

Many taxpersons have mistakenly included the costs of such qualifying components in the depreciable basis of the building and the tax benefits and cost are therefore recovered over a longer depreciation period. A nonresidential real property is depreciated over a 39-year life and a residential rental property is depreciated over 27.5-years. Certain building components may qualify for a reduced recovery period over 5-years, 7-years, or 15-years.

Some examples of building components include: parking lots, sidewalks, curbs, roads, fences, storm water management, landscaping, signage, lighting, security and fire protection systems, removable partitions, removable carpeting and wall tiling, furniture, counters, appliances and machinery (including machinery foundations) unrelated to the operation and maintenance of the building, and the portion of electrical wiring and plumbing properly allocable to machinery and equipment that is unrelated to the operation and maintenance of the building.

A taxperson may engage a CPA specialist to conduct a cost segregation study to identify the separately depreciable components and their depreciable basis. Ideally, a cost segregation study should be conducted prior to the time that a building is placed into service (i.e., when it is under construction or at the time of purchase). However, a cost segregation study can be completed after a building is placed in service. Even if a detailed cost segregation study is impractical, a practitioner should carefully consider whether there are any obvious land improvements and personal property components of a building that can be separately depreciated over a shorter recovery life.

After the fact? The change(s) to the depreciation lives require either an amended return or an accounting method change (if two years after the property is acquired or placed in service). The reporting to the IRS includes the change of basis, depreciable lives, and any adjustments for the impact of the depreciation acceleration from the date placed in service to the year of the method change. Certain restrictions apply in certain instances, and you are advised to consult with a tax advisor on the possible tax benefits before beginning a cost segregation study for your real estate holding(s). This includes factoring the holding period of the real estate and management of possible depreciation recapture costs.

If you have built or acquired a nonresidential real property, e.g. warehouses, manufacturing space or residential rental property, e.g. rental unit(s) recently, please discuss the benefits of a cost segregation study with your tax advisor to obtain maximized tax benefits.

Preface: Navigation during times of inflation for business owners is often not as easy as adhering to textbook models. Yet with the right a toolkit of management knowledge you can reduce the risk of indecisive or wrongly assumed decisions on  both inventory management and pricing on changing costs of sales. The following blogs from 2008 provides a historic perspective on re-emerging inflation hazards.

A Precarious Road: How Retailers Can Navigate Inflation’s Hazards

That new thinking can begin with inventory. According to Gérard Cachon, a professor of operations and information management, from the 1990s to 2005, minimizing inventory was seen as a key to success. “The whole mindset has been, ‘Let’s get rid of it.’” But that was when most prices were stable or declining. Today, he says, it’s not as clear that this is the best strategy. In fact, some retailers may want to start holding much more inventory than they did in the past as a way to hedge against future price increases. “Of course … it’s a little risky to hold inventory that might [lose value], especially perishable goods and fashion-oriented goods… but to the extent [retailers] know that prices will be rising over time, they will start to try to hold more inventory.”

…….Grocers typically put more emphasis on their store brands during an inflationary period as a way to offer the customer a better deal without cutting into their own margins, he explained.

…….As complex as some of these adjustments might seem, Cachon is confident that retailers will adapt more quickly than in previous inflationary periods, such as during the 1970s oil shocks. He says retailers now have much more information because of bar coding and other technologies that allow them to track their goods from suppliers to the checkout line. “Retailers are much more flexible and agile than they used to be.

Read the entire article here:

A Precarious Road: How Retailers Can Navigate Inflation’s Hazards

Preface: Nature gives to every time and season some beauties of its own.” – Charles Dickens.

Highlights of the American Rescue Plan Act

Credit: Donald J. Sauder, CPA | CVA

The $1.9 trillion American Rescue Plan Act (ARPA) was signed into legislation on Thursday, March 11th, as a Covid-19 relief measure. This Act expands some key relief features for those tax persons needing funding program support for both businesses and individuals. 

While the minimum wage for employees of $15.00 per hour was not encapsulated in the legislation, we will highlight the following business and individual tax program provisions of the ARPA in this blog.

Individual Tax Program Highlights

Firstly, ARPA approves cash stimulus for eligible individuals and dependents. This one-time stimulus payment will be $1,400 or $2,800 per those filing taxes jointly, with an additional $1,400 for each qualifying dependent. This cash stimulus is subject to phase-out for tax-persons starting at $150,000 of AGI filing together and entirely phase-out above $160,000. For heads of household tax persons, phase-outs begin at $112,500, and for individual tax persons, $75,000. The calendar arrival of these program payments is in the process of scheduling.

Additionally, ARPA is committed to assist more financially disadvantaged children by providing legislated program expansion of the child tax credit (CTC). For 2021 tax-year, the CTC will increase to $3,000 per dependent and $3,600 for qualifying dependents below six. This CTC credit phase-out will begin at $150,000 for tax-persons filing jointly and $112,500 for heads of household tax persons. 

Unemployment Insurance Compensation the was set to expire March 14th has been extended to September 6th. This renews the $300 per week program assistance for tax persons and makes the first $10,200 not taxable for 2020 for those tax persons with an AGI below $150,000. 

The Earned Income Tax Credit (EITC) will be scaling eligibility to tax persons from age 19 without caps for those from 64 years of age or older. EITC maximums will increase from $4,220 to $9,820, providing relief program assistance for qualifying tax-persons. 

Dependent Care Assistance (DCA) has a temporary program shift for 2021 to increase credits for qualifying dependent care from $3,000 to $8,000 for one dependent and $6,000 to $16,000 for two or more qualifying dependents.

Business Tax Program Highlights

The Payroll Protection Program (PPP) loans have received $7.25B in additional funds and broader eligibility for non-profits.

Restaurant Revitalization Fund (RRF) provides $28B in funds for grants to restaurants and foodservice businesses in the industry of serving food and drinks. Specific eligibility rules apply. 

ARPA also includes housing-related assistance with an appropriated $21B for those tax persons who need program funds to pay rent or utilities, including funding to support rural renters, homeowners, and other at-risk tax persons.

March 11th, 2020, the World Health Organization declared Covid-19 a global pandemic and it has a seeming similarity to spring we can learn from a Mark Twain quote. “In the spring, I have counted 136 different kinds of weather inside of 24 hours.

Preface: Nassim Taleb (who wrote the best-selling books Fooled by Randomness and The Black Swan) and his coauthors argue that conventional risk-management textbooks don’t prepare us for the real world.

For instance, no forecasting model predicted the impact of the current (2008) economic crisis. Managers make six common mistakes when confronting risk:

They try to anticipate extreme events, they study the past for guidance, they disregard advice about what not to do, they use standard deviations to measure risk, they fail to recognize that mathematical equivalents can be psychologically different, and they believe there’s no room for redundancy when it comes to efficiency.

Companies that ignore Black Swan (low-probability, high-impact) events will go under. But instead of trying to anticipate them, managers should reduce their companies’ overall vulnerability.

The Six Mistakes Executives Make in Risk Management

Preface: If you are to read one book on executive self-management, it should be this, Peter Drucker’s definitive classic, The Effective Executive. It doesn’t matter the size of your organization, or even whether you run an organization at all. Anyone who has responsibility for getting the right things done—anyone who seeks how best to self-deploy on the few priorities that will make the biggest impact—is an executive.

The most effective among us have the same number of hours as everyone else, yet they deploy them better, often much better than people with far greater raw talent. As Drucker states early in these pages: people endowed with tremendous brilliance are often “strikingly ineffectual.” And if that’s true for the exceptionally brilliant, what hope is there for the rest of us? Actually, there is something much better than hope: Drucker’s practical disciplines.

I first read The Effective Executive in my early thirties, and it was a huge inflection point in my own development. Reading the text again, I’m reminded of how its lessons became deeply ingrained, almost as a set of commandments. Some of Drucker’s examples and language might be dated, but the insights are timeless and modern, as helpful today as when he wrote them more than five decades ago. Here are ten lessons I learned from Peter Drucker and this book, and that I offer as a small portal of entry into the mind of the greatest management thinker of all time.  — Jim Collins, Boulder, Colorado

Read Jim’s Ten lessons here:

Ten Lessons I Learned from Peter Drucker

 

Preface:

What is the Peter Drucker Challenge?
The Peter Drucker Challenge is an international essay competition held annually by the Drucker Society Europe, in conjunction with the Drucker Forum.

The Challenge affords honorable students the opportunity to be write essays on what they inherently believe from their own developing experiences and ideas with regards to the changing future of  business and industry. These students are incredible ambitious, incredibly talented and interested in sharing the influence of current and future business leadership icons.

The Challenge explores a current topic in management – typically related to the theme of the Forum – in the context of Peter Drucker’s human-oriented management philosophy.

Read Roy Cohen — Tel Aviv University – Essay Award #2 2020

“From Subjective Experience to Objective Reality: Three Necessary (but not Sufficient) Conditions for Effective Leadership”

 

Preface: “The vacation we often need is freedom from our own mind.” – Jack Adam Weber

Rentals of Vacation Property

Credit: Benuel B. Glick, EA

Maybe you own, or want to own, a rental dwelling at a strategic, beach-front location. Or perhaps it’s a cabin located in the mountains where vacationers go during the summer and hunters gather during hunting season. Whatever the scenario, likely the motive for owning it is partially for hunting, vacationing, or other personal benefits. You may be wondering if there are tax strategies that prove advantageous to these expensive hobbies.

If you rent out part or all of a dwelling unit and use any part of the dwelling for personal purposes, the IRS has some “tests” for you to apply in determining the allocation of qualifying expenses for appropriate tax treatment. These tests are applied on a per tax year basis.

First, to qualify as a dwelling unit it must provide basic living accommodations (i.e., sleeping space, and cooking facilities etc.). It can be mobile such as a recreational vehicle, boat etc., (no, a tent does not qualify). One structure can contain multiple dwelling units; think apartment, basement, garage, or any room that satisfies the basic living accommodations requirement. A dwelling unit does not include property used solely as a hotel, motel, inn, or similar establishment.

Consider the following 3 classifications of residential real estate, listed in the order of generally least favorable to most favorable tax treatment preferences;

• • • • Personal residence
      • Vacation home (a.k.a. Section 280A property)
      • Rental property

But, how do you know if your hunting cabin is a rental property, a vacation home, or a personal residence? This is where we refer to those tests from the IRS mentioned above. The following are two “minimum use” tests which we’ll refer to as rental use test, and personal use test.

“Rental Use” Test
This test examines the number of rental use days, defined as days the property was rented to unrelated third parties* at a fair rental price. Over 14 days during the tax year = pass. 14 days or less = fail. If your dwelling fails this test, it will be considered a personal residence. If it passes, we apply the next test.

“Personal Use” Test
This test considers the number of personal use days for the tax year. Assuming your dwelling passed the rental use test, if you or a related party* personally used this dwelling for more than the greater of 14 days or 10% of the days rented to others at a fair rental price, it fails the personal use test and is considered a vacation home. Conversely, if the personal use days are less than the greater of 14, or 10% of the days rented to others at fair market value, your dwelling passes the personal use test and is considered a rental property.

Now that you’ve determined whether you have a personal, vacation, or rental dwelling unit, let’s explore the tax treatment for each.

Personal Residence
You don’t need to report rental income if your home fails the rental use test.

Example; say you own a dwelling in a strategic location. Due to a famous horse race in the area, you rent it out for a premium of $700 per day for 10 days during the tax year. This creates $7,000 revenue that you don’t need to report to the IRS. Except for qualifying mortgage interest and real estate taxes on Schedule A, no expenses are reported either.

Vacation Home
If your dwelling is considered a vacation home for the tax year, you report all the income. The expenses are allocated to rental using the following ratio; fair rental days ÷ (fair rental days + personal use days). Note that the days you spend working substantially full time repairing and maintaining the property are ignored and treated the same as a vacant day.

Important to know for vacation homes is that a net rental activity on Schedule E may not show a loss. However, itemized deductions such as qualified mortgage interest and real estate taxes, may allow an overall deduction for the property in certain instances. Any deductions on Schedule E in excess of revenues are suspended. Suspended deductions may be taken in a future year if there is enough revenue but may not be taken when the property is disposed. Deductions need to be taken in the following order;

1. 1. 1. 1. deductions that normally appear on Schedule A,
         2. normal deductions, (utilities, etc.),
         3. depreciation.

Example; you own a dwelling that was used by you or your family for 30 days during said tax year. You rented it out for 158 days to non-related parties* at a fair rental price. For simplicity, we’ll say your total utility bill was $2,500. Following is the formula to determine how much of the $2,500 you allocate to your rental, 158 ÷ (158 + 30) = 84%. Therefore 84% of $2,500 may be deducted against gross income for that unit to the extent that it does not create a loss. The remaining 16% is a personal expense.

Let’s say qualified mortgage interest and real estate taxes are a combined total of $5,500 for the year. You may take 84% of $5,500 against gross income as well (applied before the utilities). The remaining 16% of the $5,500 may be included on Schedule A, itemized deductions. There are additional limitations here beyond the scope of this article.

Rental Property
If your dwelling unit passed both the rental and personal use tests, it is classified as a rental property. In which case you get to deduct the full applicable expenses against gross income.

Example; let’s use the example from the prior section but instead of personally using your dwelling for 30 days, you used it for 15 days. Since you are allowed up to the greater of 14 days or 10% of the days rented at fair rental value (158 x 10% = 15.8), you get to allocate 100% of the $2,500 utilities and $5,500 combined mortgage interest and taxes to the rental property.

Although there are temporary limitations for short-term rental losses, in this category you are not limited to the blanket net loss rule that applies to vacation homes. Just know that the tax code has limitations on offsetting passive losses against passive income.

The passive losses rules are beyond the scope of this article, but that can create a temporary limitation. A rental is considered short term if the average days rented out during the year are 7 days or less per party.

Conclusion
In this article, we glimpsed into the complexity of vacation homes. Keep in mind that this is not all encompassing. It is safe to say that there are numerous stipulations to consider in applying appropriate tax treatments to your rental property.

*Related party rentals do NOT qualify as rental use unless it is both rented at a fair rental value and the related party uses the unit as a principal residence. If both requirements are met, use by the related party is considered rental use. A related party is your, or any person with financial interest in the unit’s, brother, sister, spouse, ancestor, or lineal descendant.

This article is general in nature, and it does not contain legal or tax advice. Contact your advisors to discuss your specific tax situation.

“When we do the best we can, we never know what miracle is wrought in our life or the life of another.” — Helen Keller.

The American Rescue Plan

Following a year of challenges and days of seemingly never-ending rollercoaster rides across the business spectrum, more COVID-19 relief is awaiting finalization with President Biden’s American Rescue Plan (ARP). The bold and quick-action recovery plan includes the White Houses’ initiative to “act expeditiously to help working families, communities, and small businesses persevere through the pandemic,” with rescue and recovery for a more better, more healthier, and more secure America.

Key America Rescue Plan Bill Tax Provisions:

• • • Raise the minimum wage for employees to $15 per hour.
    • Revise the child tax credit as completely refundable for 2021, with an increased credit from $2,000 to $3,000 per child, and perhaps $3,600 for children younger than six years of age;
    • An expansion of the earned income tax credit for 2021 taxpayers without dependents is $1,500. Additionally, increasing the threshold limit for the tax credit up to $21,000 with workers above retirement age being eligible for the credit as well;
    • Introduction of an increase to the childcare tax credit to compensate for qualifying expenses for childcare expenses up to $4,000 per child or $8,000 for two or more children. This tax credit would be refundable to applicable taxpayers and accessible to any family making less than $125,000 a year, with threshold benefits up to $400,000 for joint filers.

Additional America Rescue Plan Bill Provisions

• • • $1,400 relief payments per qualifying persons in addition to the $600 in December.
    • Reinstate paid sick and family leave benefits until September 30 that expired at the end of December, to help provide relief for COVID-19 time off for workers;
    • Increase Federal Pandemic Unemployment Compensation from $300 to $400 per week.
    • An additional $15 billion in grants to the hardest-hit small businesses to help them back on their feet;
    • Health insurance assistance for families;
    • $25.0B Billion in pandemic rental assistance;
    • $5.0B for struggling renters to cover energy and water costs;
    • Aid for local municipalities to keep police, firefighters, and critical personnel working to keep communities safe and secure.

Nearly 70% of American’s approve of the stimulus. As the COVID-19 economic winter weather conditions continue, the approaching expansive economic roadwork costs should not make us discouraged. Don’t let your hope be uprooted. The yesterdays will likely not return, but there will be future new dawn ahead.

Preface: Why do we play games? The research indicates that it helps people experience emotions associated with intrinsic happiness reserves’ main factors

What Dutch Blitz Can Teach About Entrepreneurship 

Credit: Donald J. Sauder, CPA | CVA

Four decks of cards with forty cards in each deck…. two, three, or four players shuffling plows, pails, carriages, and pumps. Players can choose the deck they want. Each player shuffles their forty cards and places three top cards in the Post Pile, ten cards in the Blitz Pile. The objective? Dutch Blitz!

Dutch Blitz! The word to serious game enthusiast can conjure a gamut of feelings.

Winning at Dutch Blitz requires both luck and skill, and as with many games and trades, practice makes perfect. Enthusiasts create their own rules and add them to the standard rules to make the game more exciting and challenging.

So what is the connection between entrepreneurship and Dutch Blitz? With tax season approaching, we will take a moment to enjoy pace and look at a unique vantage point of business.

There is no business without a customer sale. That is a primary and elementary rule of business that every savvy entrepreneur appreciates. It differentiates companies from non-profits. Absent customer sales and revenue, everything is an expense!

Consider how Chegg earns revenue. College students will immediately recognize the name. Chegg Study is a $14.95 a month educational service that employs 70,000 subject experts to work free-lance online 24/7 providing step-by-step answers to questions from subscribers who are mostly students. Chegg helps students solve calculus problems, write bibliographies, and “get answers.”

A recent Forbes article on Chegg provides a surprising executive-level look at how CEO Dan Rosenwig has profited from building an online platform for higher education. College degrees can be now be achieved widely and with broad acceptance using techniques that breach university student honor policies. This has surged surprising with the conventional shifts to e-learning from the COVID-19 educational forums. Chegg bolstered degrees are the seeming growing future of the globe’s skilled trades. Future dentists, veterinarians, chemists, engineers are all onboard. The world is changing – rapidly.

These Chegg subscribers are who you may trust to help with provisions and health for your family. The social norms acceptance with modifications to the rules of education is likely to continue.

Many Dutch Blitz players migrate to more adventure, challenge, and thrill, as with entrepreneurship. And so, business norms continue to shift and advance.

Why do we play games? The research indicates that it helps people experience emotions associated with intrinsic happiness reserves’ main factors, i.e., we play games because they make us happy.

The game of business is to make a sale(s). Now, what Dutch Blitz teaches us about entrepreneurship? The majority of business sales are associated with credit. Credit cards bring purchasing power for fuel and food, bank financing for homes and autos, and HE-LOCS for lawnmowers.

The nation’s founding fathers gave clear warnings on the implications of credit-based economies and classic currencies. Two hundred forty-five years later, few are searching the scrips of 17th or 18th-century sages. Entrepreneurship  is a part of an overarching mega-financial Dutch Blitz game.

People are passionately attached to the factors of happiness in this game. Yet, like any Dutch Blitz game, when players start to cheat to a substantial degree for more significant “happiness factors,” the happiness for the other player(s) is usually at risk.

Endeavor to be a savvy contributor to your Dutch-Blitz game(s) to bridge the game’s “happiness factor” to all those observing. After-all that is the purpose of the fun.

Preface: With the baton of democracy peacefully transferred on January 20th, the Biden Administration now will be ideally positioned to introduce tax policy changes that should not be discounted nor unheeded with the deal making successes and cohesive union among current lawmakers. 

Looking Ahead: 2021 Tax Planning for A Biden Administrations Tentative Tax Policy Revisions

Credit: Donald J. Sauder, CPA | CVA

The good news on possible tax reforms? Any proposed sweeping tax legislation from the Biden Administration for tax reform likely will only be concerning for high-income taxpayers. The bad news? A curbing of high-income earner financial appetites will result in projected shifts to economic activity and require the government to have an increasingly crucial role in replacing recent decades’ economic stimulus measures from the marketplace.

What Biden’s Tax Plan Could Change?

With the House and Senate’s passage of the Tax Cut and Jobs Act of 2017, top tax rates were reduced. A new tax reform proposal from the Biden Administration may increase the maximum rate back to near 40%, with a lower threshold applicable to an adjusted gross income of $400,000 and above.

The 199A Qualified Business Income deduction of up to 20% could perhaps be eliminated with tax reform leading to immediate increases to tax costs for Main Street business owners. This would be in addition to any possible income tax rate changes and threshold adjustments outlined above. A business that qualified under the Tax Cut and Jobs Act of 2017 for the 199A tax deduction experienced more than ideal business tax conditions—introducing new tax reforms would somewhat likely phase-out this tax-saving attribute for Main Street business owners.

Of note, while present tax reform guidance is silent on the accelerated depreciation features from the Tax Cut and Jobs Act of 2017 that were almost too good to be true for business owners, including 100% bonus deductions on both new and used capital expenditures and a substantial increase in the long-standing Section 179 tax deduction. Any proposed tax reforms may change these features of accelerated deductions on capital expenditures, and therefore, lower permissible and beneficial tax deferments, leading to high immediate tax costs.

Current information on possible reform to itemized deductions, while unknown, the possibility is likely. This would be most applicable and focused on high-income earnings, say above the $400,00 adjusted gross income threshold.

Revisions to social security taxes are also under discussion, and current proposals apply only to high-income taxpayers above the $400,000 adjusted gross income threshold.

For estate planners and high-net-worth individuals, a Biden tax reform may propose an estate exemption reduction from $11.5M to say $3.5M, resulting in increased restrictions on wealth transfers among generations with a tax-free pass. Additionally, the step-up basis of inherited assets could be eliminated. This is a tax feature whereby the cost basis of appreciated assets is increased to the fair market value in an estate transfer that therefore reduces the amount of the investment subject to capital gain or ordinary taxes on the future sale of the asset(s).

Finally, capital gains on capital asset transactions are also subject to revisions with any proposed tax reforms. Firstly, an increase in long-term capital gains from 20% to an ordinary rate of 39.6% again for high-income earnings above, say $1.0M in adjusted gross income, or when harvesting such levels of gains. Secondly, 1031 tax exchanges may be eliminated with a Biden tax reform plan. This would disallow the deferment of tax gains on the sale of a property when proceeds are invested in like-kind property and a widely used tax defer tool for real estate investments.

For business budgeting, keep foremost in mind that the higher levels of cash flow required for amortized debt payments (debt is paid with after-tax cash-flows, leverages with higher tax rates and earnings threshold) will be subject to coverage of additional tax costs. Bottom-Line of these tax reform implications? Higher tax rates from possible tax reform will lead to reduced cash flow for debt payment. Management that planned debt-financed capital expenditure payments under the Tax Cut and Jobs Act of 2017 rates in recent years, aligned with tight payments margins on cash flow, should heed this caution immediately. Prudent planning could include appropriate cash flow management plan revisions and perhaps discussions with lenders.

Trump’s tax reform for businesses with the Tax Cut and Jobs Act of 2017 may be the lowest tax rates Main Street business may see for the next decade(s). We are advising clients to defer as little taxable income as possible and capitalized on the low tax rates for the 2020 year to build equity and balance sheet strength, pay down debts, and prepare for what may be likely reforms with tax planning that will require additional diligence in cash flow management.

With the baton of democracy successful transferred on January 20th, the Biden Administration now will be ideally positioned to introduce tax policy changes that should not be discounted nor unheeded with the deal making successes and miracles of the cohesive union among current lawmakers. Please begin to plan appropriately and discussing the tax and cash flow implications with your tax advisor.