June 2000

IN THIS ISSUE

Tax Rules on Renting Your Vacation Home 

How to Save on Office Equipment 

The Lighter Side . . . Courtroom Moments 

Tax Calendar 

Do You Know . . .

Who said, "Men occasionally stumble over the truth, but most of them pick themselves up and hurry off as if nothing had happened"?

Answer on page 4.

Tax Rules on Renting Your Vacation Home

If you own a vacation home that you sometimes use and sometimes rent to others, special rules apply to the income you receive from renting the home and to the expenses you incur from maintaining the home. Generally, the rules require you to determine the percentage of personal vs. rental use and divide your expenses between the two. If you qualify, those expenses considered rental expenses will be deductible. However, the rules also require you to determine if you used the home as a residence; if so, then special rules will determine the deductibility of any expenses.

Amount of personal use determines tax treatment

Under the IRS rules, the extent to which you use your vacation home for personal reasons affects its tax treatment. Generally, if you only rent out your vacation home, and do not use it for personal reasons, you include all of the income and can deduct all of the expenses associated with the home. If you sometimes use the home for personal reasons, but don't meet the diminium personal use test (defined below), all the income is taxable, and you must allocate expenses between personal and rental. Either way, your deductible rental expenses can be more than your gross rental income. However, your losses may be limited under the passive activity rules.

But if your personal use meets the diminium test, i.e., your personal use is considered significant, then a special rule applies; if you have a net loss, you may not be able to deduct all of the rental expenses.

Dominium personal use test. A dwelling unit is considered a residence during the tax year if you use it for personal purposes more than the greater of: 1) 14 days or 2) 10% of the total days it is rented to others at a fair rental price. (A fair rental price for your property generally is an amount that a person who is not related to you would be willing to pay; it's not a fair rental price if it is substantially less than the rents charged for other properties that are similar to your property.)

The definition of a dwelling unit includes a house, apartment, condominium, mobile home, boat, or similar property. It has basic living accommodations, such as sleeping areas and cooking facilities. A dwelling unit doesn't include property used solely as a hotel, motel, inn, or similar type of establishment that is regularly available for rental and is not used by the owner as a home.

Diminium rental use test. Just as there is a diminium rule for personal use, the IRS also requires that the home be rented out a minimum number of days in order for rental expenses to be deducted. If you use the dwelling unit as a home and you rent it for fewer than 15 days during the year, you can't include any of the rent in your income and can't deduct any of the rental expenses.

Rental vs. personal use

Before you can determine which expenses are deductible, you first need to determine the number of days used for personal and rental purposes based on the following rules:

1) Any day that the unit is rented at a fair rental price is a day of rental use even if you used the unit for personal purposes that day. This rule does not apply when determining whether you used the unit as a residence.

2) Any day that the unit is available for rent but not actually rented is not a day of rental use.

3) Any day that you spend working on and repairing the property is not counted as a personal use day. The work for that day, however, must be substantially full-time.

Example: Your beach house was available for rent from June 1 through August 31 (92 days). Your family uses the house during the last two weeks in May (14 days). You were unable to find a renter for the first week in August (7 days). The person who rented the house in July allowed you to use it over a weekend (2 days) without any reduction or refund of rent. The house wasn't used at all before May 17 or after August 31.

1) The house was used as a rental for 85 days (92–7). Therefore, it meets the minimal rental use test. The days it was available for rent but not rented (7 days) are not days of rental use. For the July weekend (2 days), your use is considered rental use because you received a fair rental price for the weekend.

2) The house was used for personal purposes for 14 days, the last two weeks in May.

3) The total use of the house was 99 days (14 days personal use + 85 days rental use).

4) The rental expenses are 85 days of rental/99 days of total use, or 86% of the beach house expenses.

5) When determining whether you used the beach house as a residence (diminimus personal use test), the July weekend (2 days) you used it was personal use even though you received a fair rental price for the weekend. Therefore, there were 16 days of personal use and 83 days of rental use for this purpose. Because you used the house for personal purposes more than 14 days and more than 10% of the days of rental use, you used it as a residence. Therefore, if you have a net loss, you may not be able to deduct all of the rental expenses.

Rule for vacation home used as residence

If you use a dwelling unit as a residence and rent it for 15 days or more during the year, you include all your rental income in your gross income. If you had a net profit from the rental property for the year (that is, if your rental income is more than the total of your rental expenses, including depreciation), deduct all of your rental expenses. However, if you had a net loss, your deduction for certain rental expenses is limited.

Limit on deductions. If your rental expenses are more than your rental income, you cannot use the excess expenses to offset income from other sources. Any excess expenses can be carried forward to next year and will be subject to any limits that apply next year. You can deduct the expenses carried over to another year only up to the amount of your rental income for that year, even if you do not use the property as your residence for that year.

Rental income

Whether you used the home as a residence is the first step in determining how you will be able to treat your expenses. Next, you need to calculate what your actual income and expenses from renting are for the year, and whether you have a net gain or loss. Below is a list of what forms of payment should be included when determining rental income.

Canceling lease payments. Any payments you receive from a tenant for canceling a lease.

Any property or services received. If you receive property or services in lieu of rent, include the fair market value of the property or services in your rental income. If the services are provided at an agreed-upon or specified price, that price is the fair market value, unless there is evidence to the contrary. For example, you have a tenant who is a painter and offers to paint the rental home, instead of paying two months' rent. You include in your rental income the amount the tenant would have paid for two months' rent. You can also include that same amount as a rental expense for painting your property.

Lease with option to buy. If the rental agreement gives the tenant the right to buy your rental property, the payments you receive under the agreement are generally rental income. If, however, your tenant exercises the right to buy the property, the payments you receive for the period after the date of sale are part of the selling price.

Rental expenses

You can deduct your rental expenses in the year you pay or incur them, and include the following.

Repairs and improvements. You can deduct the cost of repairs that you make to your rental property, but not the cost of improvements. Improvement costs can be recovered through depreciation.

The difference between a repair and improvement is that a repair keeps your property in good operating condition. It does not materially add to the value of your property or substantially prolong its life. Repairs include painting your property inside or out, fixing gutters or floors, or plastering. If you make repairs as part of an extensive remodeling or restoration of your property, the entire job is considered an improvement.

An improvement, on the other hand, adds to the value of your property, prolongs the property's useful life, or adapts it to new uses. If you make an improvement, the cost must be capitalized, and generally can be depreciated as if the improvement were separate property.

Insurance premiums. You can deduct insurance premiums you pay for rental property. If you pay a premium for more than one year in advance, you cannot deduct the total payment in the year you paid it. You can deduct only the part of the premium payment that applies to that first year.

Interest expense. The mortgage interest you pay on your rental property is deductible.

Charges for services. You can deduct charges you pay for services provided for your rental property, such as water, sewer, and trash collection.

Travel and local transportation expenses. You can deduct the ordinary and necessary costs of traveling away from home or local transportation expenses if the primary purpose of incurring the costs was to collect rental income or to manage, conserve, or maintain your rental property. For travel costs, you must allocate your expenses between rental and non-rental activities. For local transportation, you can deduct the expenses using the actual expenses or the standard mileage rate.

Condominium costs. If you rent your condominium, you can deduct depreciation, repairs, upkeep, dues, interest, taxes, and assessments for the care of the common parts of the structure. You cannot deduct special assessments you pay for improvements, but these costs may be recoverable through depreciation.

Cooperative fees. If you rent your co-op, you can usually deduct all the maintenance fees you pay to the co-op. You can't deduct a payment ear-marked for a capital asset or improvement, or a cost charged to the corporation's capital account, such as a new roof.

Conclusion

Vacation homes that you use and sometimes rent, have special rules that apply to the tax treatment of income and expenses related to the home. The deductibility of the rental expenses will depend on whether you used the dwelling unit as a "residence," and whether you had a loss. If you used the vacation home as a "residence" for part of the time and also had a net profit from renting it during the year, you can deduct all of your rental expenses. However, if you had a net loss, your deduction for rental expenses is limited to the amount of rental income for that year.


The Lighter Side . . . Courtroom moments

The National Association of Forensic Economics publishes two journals with articles of interest to economists, accountants, and finance and business professionals. On its Web site, it has included some less­than-stellar courtroom questions and answers in its resources section entitled "Great Moments in Courtroom Testimony."

Q: Could you see him from where you were standing?

A: I could see his head.

Q: And where was his head?

A: Just above his shoulders.

* * *

Q: . . .and what did he do then?

A: He came home, and the next morning he was dead.

Q: So when he woke up the next morning he was dead?

* * *

Q: Mrs. Jones, is your appearance this morning pursuant to a deposition notice which I sent to your attorney?

A: No. This is how I dress when I go to work. I was doing an autopsy!

* * *

Q: . . .any suggestions as to what prevented this from being a murder trial instead of an attempted murder trial?

A: The victim lived.

* * *

Q: What is your relationship with the plaintiff?

A: She is my daughter.

Q: Was she your daughter on February 13, 1979?

* * *

Q: Now, you have investigated other murders, have you not, where there was a victim?

* * *

Q: Are you qualified to give a urine sample?

A: Yes. I have been since early childhood.


How to Save on Office Equipment

Many businesses, large and small, make mistakes when it comes to spending money on office furniture or equipment. These businesses may be spending money unnecessarily, when they could be saving substantial amounts by taking a few simple steps.

Take inventory. Prior to making any purchases, a business should determine what its needs are, take inventory of what is on hand, and determine whether any current equipment meets those needs. Often, a current piece of equipment may suffice, but it just needs repair or minor upgrading.

Ask around. When shopping, a business often asks a salesperson what piece of equipment, software, etc. would work best for its needs. This can be a good starting point if the businessperson has no previous experience with the piece of equipment and needs information. On the other hand, don't just take the salesperson's word. Ask employees who use or will be using the equipment what model they prefer and/or features they think are necessary.

Look to the future. Also consider what features you may need, not only today, but perhaps down the road as well. You don't want to spend money on equipment that may become quickly obsolete. On the other hand, don't fall for the "just a few more dollars" temptation by spending additional money on features and extras that you are not likely to use.

Consider the whole package. Price should not be a business' only focus. Service and support for the equipment should be considered as important a factor.

Weigh leasing vs. buying. Buying and leasing office equipment each has its advantages. Buying is less expensive, but leasing generally includes a service agreement that is better than the one that comes with a purchase. Leasing may also be a better option for equipment that is based on fast-changing technology it may be easier to upgrade. And leasing may be better for a large or cumbersome piece of equipment, since the business won't be saddled with the problem of disposing of the equipment when it becomes obsolete.

Whether you consider buying or leasing, ask several vendors for quotes and ask each of them the following: 1) what are the maintenance and performance statistics for the model you are considering (for example, copier "z" is in operating condition 95% of regular office hours); 2) what is the response time for a service call; 3) what is the price to upgrade the equipment if a new model becomes available.

If you are thinking of leasing, also ask for a breakdown of the monthly lease cost. The monthly lease fee should allocate a portion for the equipment portion of the lease, another for service, etc. Pay close attention to the equipment portion, and calculate what the list price is, based on this lease price. It may be higher than the average street price. You can then choose to purchase or ask for a lower monthly payment for the equipment portion of the lease.


Tax Calendar

June 12

Employees who work for tips. If you received $20 or more in tips during May, report them to your employer.

June 15

Individuals. Make a payment of your 2000 estimated tax if you are not paying your income tax for the year through withholding (or will not pay in enough tax that way). Use Form 1040-ES. This is the second installment date for estimated tax in 2000.

Corporations. Deposit the second installment of estimated income tax for 2000.

Employers. For Social Security, Medicare, withheld income tax, and non-payroll withholding, deposit the tax for payments in May if the monthly rule applies.

July 10

Employees who work for tips. If you received $20 or more in tips during June, report them to your employer.

July 17

Partnerships. File a 1999 calendar-year return (Form 1065).This due date applies only if you were given an automatic three-month extension.

Employers. For Social Security, Medicare, withheld income tax, and non-payroll withholding, deposit the tax for payments in June if the monthly rule applies.

July 31

Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for the second quarter of 2000. Deposit any un-deposited tax. (If the total is less than $1,000 and not a shortfall, you can pay it with the return.) If you deposited the tax for the quarter in full and on time, you have until August 10 to file the return.

For federal unemployment tax, deposit the tax owed through June if more than $100.

Answer from page 1: Winston Churchill



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