Gotta Get Away: Timeshares, Hotels and the Sharing Economy

By Kevin Riley

It’s a familiar tale: An entrepreneurial business model enters the real estate market, disrupting traditional players. Even now-ubiquitous chain hotels were once a disruptor and, in the 1970s, timeshare executives were the ones shaking up the hospitality market. Timeshares became such a competitive presence that every major hotel conglomerate entered the market and acquired existing, successful companies. Now, in the past few years, timeshare businesses have adapted to the digital age and rapidly diversified their offerings to appeal to a changing consumer base. Perhaps because of its entrepreneurial roots, the timeshare industry may be well-positioned to adapt and weather the market’s newest disruption: the sharing economy and the growth of online rental platforms offering an alternative—and in many cases, more affordable—hospitality experience.

The power is in the hands of the consumer. With an expanding pool of options available for consumers, vacation rental providers are jockeying for travelers’ dollars. Online platforms, such as HomeAway, and its subsidiary VRBO, offer consumers a different travel experience, with accommodations available at their fingertips. The flexibility these platforms provide has particularly resonated with millennials and anyone traveling on a budget.

Because the traditional timeshare model offers an alternative to purchasing a second home, rental platforms have impacted timeshares differently than hotels. Timeshare buyers have long had access to a variety of travel destinations without the hassle of upkeep and maintenance. Destination choices, however, have evolved. For the past 15 years, some timeshare operators have prioritized expanding into urban areas, including major hubs like New York City and Miami, as well as secondary urban markets gaining popularity as cultural destinations, like Boston, San Diego, Vancouver and New Orleans. And competition could get fiercer in those markets, particularly because many customers are swayed by the authentic travel experience online rental platforms can offer via homestays and other non-traditional arrangements.

In addition to providing greater exposure for smaller competitors, the secure automated payment processing capabilities of online rental platforms also removed a barrier to entry into the market for these smaller players. Companies with a modest supply of vacation rentals, for example, may not have had the ability to obtain a merchant account to enable online transactions. While online rental platforms charge a host service fee for each transaction, that fee is a much cheaper alternative to a merchant account and allows small players to offer a convenience on par with larger hotels and timeshare companies.

As a testament to its financial adaptability, the timeshare industry has seen prominent deal activity in 2016. In June, private equity investment firm Apollo Global acquired Diamond Resorts International Inc. Following suit of other major hotel conglomerates, this December, Hilton Worldwide Holdings’ board of directors approved the spinoff of its timeshare business, Hilton Grand Vacations, which represented 12 percent of their top line, and Park Hotels & Resorts, Inc. The spinoffs are expected to be finalized in early January 2017. Starwood Hotels and Resorts also completed the spinoff and sale of its timeshare business, Vistana Signature Experiences this year, before finalizing its merger with Marriott, in September. Because the hotel industry is an entirely different business than timeshares, with different multiples and earnings, spinning off timeshares into a separate public entity is a common strategy.

All signs point to sustained growth of the sharing economy in the coming years. Hotel owners and timeshare operators alike would be wise to develop agile service offerings and adaptable marketing strategies to prepare for disruptions on the horizon and secure their share of the market.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Winter 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

 

2016 Year in Review: Top Tax Issues Impacting the Real Estate Industry, Part One

By Tanya Thomas and Jeff Bilsky

The next tax filing season may seem far away, but as 2016 ends, taxpayers will begin the task of year-end tax planning. While 2016 was not a year for major tax reform or legislative action, there have been some notable regulatory changes. 2016 saw several pieces of regulatory guidance that could have an impact on acquisition and disposition transactions, entity structuring activities, taxable income calculations and tax accounting method options. As real estate owners and operators, construction companies, developers and REITs embark on analyzing their tax situation for 2016 and beyond, it’s critical to be aware of these new developments.

Though many tax changes proposed or finalized in 2016 could impact the real estate industry, in this article we highlight two areas that should be top of mind for leaders in the real estate industry at the start of the new year, including IRC Section 385 regulations, and a series of final, temporary and proposed regulations under IRC Sections 704, 707 and 752.

IRC Section 385 Regulations

Debt equity regulations under IRC Section 385 were finalized in October. The proposed regulations, issued in April, were set to re-characterize certain intercompany debt instruments as equity, most likely preferred equity. If finalized as they were proposed, these regulations could have adversely impacted REITs and caused qualification issues with the REIT testing provisions. The finalized regulations significantly altered parts of the proposed regulations and, in general, give the IRS authority to re-characterize certain intercompany debt instruments as stock. The new IRC Section 385 regulations are intended to curb certain earnings stripping situations often used as domestic and international tax planning strategies. The regulations were specifically directed at curtailing inversion transactions, or those involving the movement of a multinational U.S. group’s tax residence outside of the United States.

While the new regulations do not appear to adversely impact SEC-registered REITs and their interaction with Taxable REIT Subsidiary (TRS) entities and subsidiary REITs, there is some impact to Foreign Investment in Real Property Tax Act (FIRPTA) “blocker” structures involving a C corporation owning controlling interests in subsidiary REITs. The final regulations exempt “non-controlled” REITs from all aspects of the regulations. As a result, unless controlled by 80 percent or more of vote or value by an includible member of an expanded group, such as a non-REIT C corporation, a REIT will not be part of a member of an expanded group. Based on this change, there will not be any requirement of additional documentation or re-characterization of debt for the following:

(1) Lower-tier REITs of non-controlled REITs; or
(2) Taxable REIT subsidiaries of non-controlled REITs.

However, a non-REIT C corporation and its 80 percent-or-more-owned REIT would be within the scope of the final regulations. Because of the new IRC Section 385 regulations, it is critical for taxpayers with “blocker” REIT structures to analyze the new regulations and consider their potential impact and requirements. For more in-depth details of the regulations and the various provisions, refer to our comprehensive alert on Section 385 issued in October.

Final, Temporary and Proposed Regulations under IRC Sections 704, 707 and 752

In October, the U.S. Treasury and the IRS released long-awaited guidance on liability allocations under IRC Section 752, disguised sales under IRC Section 707 and deficit restoration obligations under IRC Section 704. IRC Sections 704, 707 and 752 apply to entities that operate as partnerships, and given that many taxpayers in the real estate industry utilize partnerships in their structures, it is critical to evaluate these new rules. The regulations represent significant changes in partnership taxation and will have a critical impact on planning for partnership formation and restructuring transactions, as well as ongoing operations.

When the IRS proposed these regulations in January 2014, it was widely perceived that the regulations could change whether certain obligations resulted in a partner having economic risk of loss for a partnership liability under IRC Section 752. This, in turn, could impact a partner’s ability to deduct losses and receive tax-deferred cash distributions from the partnership. Additionally, the originally proposed disguised sale regulations and clarified certain aspects of existing exceptions. The final regulations take a multifaceted approach and address some of the provisions that were accepted when proposed, while withdrawing and re-proposing some of the aspects that tax advisors were concerned about.

• Final and temporary regulations under IRC Sections 707 and 752 provide guidance around disguised sales of property to or by a partnership and impact existing regulatory exceptions. The regulations severely limit the effectiveness of the debt-financed distribution exception. This is accomplished by changing the way liabilities must be allocated under IRC Section 752 for purposes of the debt-financed distribution exception. Further, the regulations clarify that the preformation expenditure exception generally applies on an asset-by-asset basis with limited opportunity to aggregate assets. The regulations also eliminate the ability to apply the preformation expenditure exception to expenditures funded with qualified liabilities.

• Final and temporary regulations under IRC Section 752 provide rules around when certain obligations are recognized for the purpose of determining whether a liability is a recourse partnership liability. The regulations effectively eliminate a taxpayer’s ability to use “bottom-dollar guarantees” to create economic risk of loss. Without economic risk of loss, partners may be allocated fewer partnership liabilities, resulting in a lower overall tax basis. A lower tax basis may limit the ability of the partner to deduct allocated losses. Further, partners with negative tax capital accounts may be required to recognize taxable income to the extent at which they are allocated fewer partnership liabilities.

• Proposed regulations withdraw and re-propose regulations under IRC Sections 752 and 704. These proposed regulations strengthen anti-abuse rules in determining whether a partner bears economic risk of loss for partnership liabilities under IRC Section 752, and would create similar anti-abuse rules relating to certain obligations to restore a deficit in a partner’s capital account under IRC Section 704.
The new regulations are important because real estate taxpayers often operate in a partnership format or use partnerships in their organizational structures. Within the REIT industry, these new provisions could significantly impact the operating partnership under REITs or UPREITs, including the formation of UPREITs.

In October, BDO’s National Tax Office issued three alerts related to the new partnership regulations. For an in-depth discussion of these regulations and their applicability, refer to our alert addressing disguised sales under IRCS Section 707 and Section 752, our alert relating to the determination of recourse liabilities under Section 752, and our alert discussing the re-proposed regulations.

Conclusion

As we barrel toward the start of another year and a new president prepares to take office and potentially institute more significant tax reform, the time to review regulatory tax changes is now. Real estate owners and operators, construction companies, developers and REITs face an array of opportunities and challenges in the new year. With forthcoming uncertainty due to market fluctuations and a potential increase in interest rates, getting into compliance with new tax provisions now could establish a sturdier foundation for real estate companies to weather potential disruptions ahead.
Stay tuned for more of this series in future issues of the Real Estate & Construction Monitor, where we’ll continue this discussion, focusing on other key tax developments impacting the real estate industry and developments specifically applicable to REITs. In part two, we’ll examine several recent court decisions and rulings that could have an impact on the real estate industry with respect to acquisitions and dispositions and tax accounting methods.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Winter 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Big Data: How Big An Impact for REITs?

By Stuart Eisenberg

Big Data is big-time ubiquitous in headlines across industries, but the real estate industry has been slow to take advantage. That’s all changing. Commercial real estate companies and REITs are embracing new technologies to harness the power of Big Data to elevate their investment and management strategies and optimize their operations.

When we talk about Big Data, we mean the exponential growth in volume, variety and velocity of structured and unstructured data. That data, however, is only as useful as our ability to interpret it—an ongoing challenge for every organization. But in recent years, advanced analytics and powerful business intelligence technologies have enabled us to extract real value from Big Data. And it’s about time, because Big Data is only getting bigger. Embedded sensor technology and wireless connectivity have opened up a whole new world of information—the so-called “Internet of Things.” In real estate, as in most industries, knowledge is power; those who not only have the information but know how to use it are empowered to make smarter decisions, faster.

Of course, all investment decisions ultimately hinge on investors’ future predictions. But there are several significant ways real estate developers and owners, REITs included, can gain an edge by turning Big Data into actionable insights.

On the investment front, property owners have access to unprecedented information and intelligence around demographics, supply and demand trends and economic nuances—and better algorithms to analyze that intelligence. At a time when REITs are wise to exercise restraint in their investment decisions and deploy capital sensibly, this could be a valuable tool to help them better understand and target certain markets. At the property level, many variables impact an asset’s value, and with the rise of Big Data, REITs are able to analyze demand for specific features within a property, including amenities, as well as LEED status and energy efficiency. This intelligence can help enhance value by better aligning with tenants’ demands.

From a management perspective, greater access to demographic and real-time local trend data can help landlords, including REITs, make decisions at the individual property level. When setting rents, for example, REITs might analyze traditional population data along with new, non-traditional data sources to determine if a certain property is a candidate for a rent increase, or if they’ll need to invest in upgrades or other perks to attract and keep tenants. Similarly, activity trackers and smart watches and phones mean more data is available than ever before at the individual level. If data indicates people in a certain population center are walking or biking more instead of driving, REITs might forecast increased demand for properties in their portfolios that are near walkable retail centers, entertainment and other amenities.

From an operational perspective, the application of the Internet of Things within properties themselves allows owners to capture and analyze data from physical objects. Many owners are upgrading their buildings and automating certain decision-making processes to build efficiencies. For example, many have installed smart sensors and devices that can track temperature, air quality and other metrics that proactively alert owners to maintenance or repair needs within their properties. Many are also automating back-office processes. As more new technologies come into the market, REITs and other property owners will be better able to monitor properties, trim costs and make their overall operations processes smarter.

It’s clear that Big Data affords real estate owners and REITs a big dose of opportunity to better predict, monitor and measure their investments, and could ultimately unlock more value for shareholders.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Winter 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

Fast Takes: Uncertainty Lingers After Historic Brexit Vote

By Anthony La Malfa

Uncertainty was the prevailing sentiment in the months leading up to the Brexit vote, and continues to characterize the ripple effects now being felt across the globe. The quintessential British phrase, “keep calm and carry on,” has become a motto for many sectors, and real estate is no different. A court battle continues over the legality of invoking Article 50 without Parliament’s approval. Once invoked, the clock would start on a minimum of two years’ worth of “leave” negotiations. The U.S. real estate industry is just beginning to feel the initial aftershocks, but a few trends are taking shape.

Business as usual at home, but with caution

Despite rising property values, currency and market volatility are still dark clouds. Landlords are working against slowing sales and rising vacancy rates in office and multifamily units across the United States. As the Brexit negotiations continue, we can expect to see markets worldwide mirroring the hesitation and political pressure the EU and UK will likely experience.

Adding fuel to the fire, conditions in the U.S. commercial real estate debt market indicate the sector may be heading toward a slowdown. Moody’s Investors Service reported that more than 5.9 percent of the $390 billion in commercial property mortgages that had been packaged into securities were more than 60 days overdue in payments in September. The Wall Street Journal asserted that the default rate is a result of borrowers being unable to pay off 10-year loans that were issued before the 2008 financial crisis.

Introducing another layer of uncertainty to the U.S. markets, risk-retention rules will go into effect on Dec. 24 as part of a larger overhaul of the Dodd-Frank Act. These rules will require CMBS issuers (or a third party) to retain a minimum of 5 percent of the securities they create through securitization for 10 years, which could make borrowing a costlier undertaking.

Markets crowd, fueling exploration

Nervousness in the markets, combined with new rules ramping up requirements for security and identification for foreign buyers, has slowed sales in U.S. gateway markets, including New York, Boston and Los Angeles. In particular, high-end condo sales have slowed down in the New York City market. On the other hand, sovereign wealth funds are continuing to eye the U.S.

Prices had already reached high, perhaps even unsustainable, levels prior to the Brexit vote. More owners, landlords and investors are getting crowded out of gateway cities, and scooping up opportunities in secondary markets like Dallas, Austin, Chicago and the Carolinas. This trend usually starts with residential properties, then extends to other assets as well—currently we’re seeing a lot of deals for hotels, healthcare facilities and industrial assets. This situation could change if interest rates rise, as most predict they will in the short term.

Capital could migrate more amid U.S. election aftermath

While the presidential election is still freshly inked, assets could shift in the short term in the wake of President-elect Trump’s victory. We could see a dip in investment from the Middle East, and those investors could be looking to sell existing assets. If that does happen, it will be interesting to see where those funds are re-deployed. Potential targets include major metropolitan and business centers like Hong Kong and Singapore in the Asia-Pacific region.

This article originally appeared in BDO USA, LLP’s “Construction Monitor Newsletter (Winter 2017). Copyright © 2017 BDO USA, LLP. All rights reserved. www.bdo.com

 

Tax Development Highlights

The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Developments concerning the Affordable Care Act (ACA). 

In the lead-up to the roll out of the health insurance exchanges on Oct. 1, 2013, the IRS issued the following guidance on the ACA:

Individuals:

  • The IRS released Questions and Answers (Q&As) on the health insurance premium tax credit on its website. This credit is designed to make health insurance affordable to individuals with modest incomes (i.e., between 100% and 400% of the federal poverty level, or FPL) who are not eligible for other qualifying coverage, such as Medicare, or “affordable” employer-sponsored health insurance plans that provide “minimum value.” To qualify for the credit, individuals must purchase insurance on a health exchange. The Q&As note that individuals can choose to have the credit paid in advance to their insurance company to lower what they pay for their monthly premiums, and then reconcile the amount paid in advance with the actual credit computed when they file their tax return. Alternately, individuals can claim all of the credit when they file their tax return for the year. The Q&As explain exactly who is eligible for the credit and address other important aspects of it.
  • The IRS issued final regulations on the “shared responsibility” payment under the ACA, which is the enforcement mechanism for the ACA’s mandate that most individuals maintain health insurance coverage. Starting in 2014, the individual shared responsibility provision calls for each individual to have basic health insurance coverage (known as minimum essential coverage), qualify for an exemption, or make a shared responsibility payment when filing a federal income tax return. Individuals will not have to make a payment if coverage is unaffordable, if they spend less than three consecutive months without coverage, or if they qualify for an exemption under one of several other reasons, including hardship and religious beliefs. The final regulations address these and other aspects of the shared responsibility payment.

Small Businesses:

  • The IRS issued proposed regulations on the tax credit available to certain small employers that offer health insurance coverage to their employees. This credit is available to an employer with no more than 25 full-time equivalent employees (FTEs) employed during its tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000. However, the full credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of not more than $25,000. The proposed regulations would become effective when they are formally adopted as final regulations. However, employers may rely on the proposed regulations for tax years beginning after Dec. 31, 2013, and before Dec. 31, 2014.

Tax treatment of same-sex spouses. 

The IRS and other Federal agencies issued guidance on the treatment of same-sex spouses and couples for tax and other purposes in light of the Supreme Court’s landmark Windsor  decision striking down section 3 of the Defense of Marriage Act (DOMA), which had required same-sex spouses to be treated as unmarried for purposes of federal law. The key developments are as follows:

  • Effective as of Sept. 16, 2013, the IRS adopted a “state of celebration” rule in recognizing same-sex marriages. This means that same-sex couples who were legally married in jurisdictions that recognize their marriages (i.e., “state of celebration”) will be treated as married for federal tax purposes, regardless of whether their state of residence recognizes same-sex marriage. Spouse may retroactively apply this rule to open years.
  • Same-sex spouses who were legally married in a state that recognizes same-sex marriages must file their 2013 federal income tax return using either “married filing jointly” or “married filing separately” status, even if they now reside in a state that does not recognize same-sex marriage. Same-sex spouses who file an original 2012 tax return on or after Sept. 16, 2013 also generally must file using a married filing separately or joint filing status. Same-sex spouses may file original or amended returns choosing to be treated as married for federal tax purposes for one or more prior tax years still open under the statute of limitations on refunds.

The IRS provided optional special administrative procedures for employers to use to correct overpayments of employment taxes for 2013 and prior years for certain benefits provided and remuneration paid to same-sex spouses.

The Department of Labor’s (DOL)’s Employee Benefits Security Administration (EBSA) announced that it is following the IRS in recognizing “spouses” and “marriages” based on the validity of the marriage in the state of celebration, rather than based on the married couple’s state of domicile, for purposes of interpreting the meaning of “spouse” and “marriage” as these terms appear in the provisions of the Employee Retirement Income Security Act of 1974 (ERISA) and in Internal Revenue Code provisions that EBSA interprets.

  • In Frequently Asked Questions (FAQs) posted on the IRS’s website, the IRS made clear that same-sex and opposite-sex individuals who are in registered domestic partnerships, civil unions, or other similar formal relationships that aren’t marriages under state law aren’t considered as married or spouses for federal tax purposes.

New rules for deducting or capitalizing tangible property costs. 

The IRS issued new regulations for determining whether amounts paid to acquire, produce, or improve tangible property may be currently deducted as business expenses or must be capitalized. Among other things, they provide detailed definitions of “materials and supplies” and “rotable and temporary spare parts” and prescribe rules and elective de minimis and optional methods for handling their cost. They also have rules for differentiating between deductible repairs and capitalizable improvements, among many other items. The regulations generally are effective for tax years beginning on or after Jan. 1, 2014, but taxpayers can elect to apply them to certain pre-2014 years.

New rules for dispositions of certain depreciable property. 

The IRS issued proposed regulations that change several of the rules for dispositions of Modified Accelerated Cost Recovery System (MACRS) property. While the regulations are not final but merely proposed, taxpayers may rely on them. Included among the changes are rules that no longer treat structural components of a building as separate from the building and rules providing that partial dispositions generally are treated as dispositions.

New simplified relief for late elections pertaining to S corporations. 

The IRS provided simplified methods for taxpayers to request relief for late elections pertaining to S corporations. The relief covers the S corporation election itself, the electing small business trust (ESBT) election, the qualified Subchapter S trust (QSST) election, the qualified Subchapter S subsidiary (QSub) election, and late corporate classification elections which the taxpayer intended to take effect on the same date that the taxpayer intended that an S corporation election for the entity should take effect.

Simplified per-diem increase for post-Sept. 30, 2013 travel.

An employer may pay a per-diem amount to an employee on business-travel status instead of reimbursing actual substantiated expenses for away-from-home lodging, meal and incidental expenses (M&IE). If the rate paid doesn’t exceed IRS-approved maximums, and the employee provides simplified substantiation, the reimbursement isn’t subject to income- or payroll-tax withholding and isn’t reported on the employee’s Form W-2. In general, the IRS-approved per-diem maximum is the GSA per-diem rate paid by the federal government to its workers on travel status. This rate varies from locality to locality. Instead of using actual per-diems, employers may use a simplified “high-low” per-diem, under which there is one uniform per-diem rate for all “high-cost” areas within the continental U.S. (CONUS), and another per-diem rate for all other areas within CONUS. The IRS released the “high-low” simplified per-diem rates for post-Sept. 30, 2013 travel. The high-cost area per-diem increases $9 to $251, and the low-cost area per-diem increases $7 to $170.

Supreme Court to decide FICA tax treatment of severance pay. 

The Supreme Court agreed to review a decision of the Court of Appeals for the Sixth Circuit which held that severance payments aren’t wages for purposes of Federal Insurance Contributions Act (FICA) tax. Thus, the Supreme Court will resolve a circuit split that currently exists between the Sixth and Federal Circuit Courts on the issue.

Please don’t hesitate to contact us at info@templetonco.com or 561-798-9988 to begin discussing options specific to your tax situation.

Rental Activities and the 3.8% Surtax on Passive Activities

The health care reform legislation enacted in 2010 significantly broadens the Medicare tax base for higher-income taxpayers by enacting two new taxes. Beginning in 2013 higher-income taxpayers will be subject to an additional 0.9% tax on earned income and a new 3.8% tax on investment income.  As a result, business income from an activity that is passive is now subject to the 3.8% tax as it is now considered investment income.

I. Planning for those taxpayers that have net passive income from rental activities:

Two areas of the tax law that provide planning opportunities are as follows:

1. Self-rental regulations
2. Status as a real estate professional

1. When looking at the self-rental regulations, if one or more activities are treated as a single activity, then they can be  constitute an appropriate economic unit for the measurement of gain or loss under IRC Sec. 469 [Reg. 1.469-4(c)(1).  This provides that rental and trade or business activities can be combined and considered an appropriate economic-unit, if it meets the following two tests:

(a) one activity is insubstantial in relation to the other, or

(b) each owner of the trade or business activity has the same proportionate ownership interest in the rental activity.

Although no definition of insubstantial is provided in the regulations, under prior Temp. Reg. 1.469-4T, an 80/20 rule applied to determine if an activity was insubstantial. According to this rule, a rental activity could be combined with a trade or business activity if either the rental activity provided less than 20% of the gross income for the combined operation or vice versa.

A facts and circumstances test may also be used to identify activities constituting an appropriate economic unit for the measurement of gain or loss.  Any reasonable method may be used to apply the relevant facts and circumstances. The most important factors are [Reg. 1.469-4(c)(2)]:

a. Similarities and differences in types of business.

b. The extent of common control.

c. The extent of common ownership.

d. Geographical location.

e. Interdependencies between the activities.

2. The second concept which should be considered when planning for 2013 relate to the ability of a taxpayer to qualify as a real estate professional.  Here the taxpayer must meet two criteria:

1. Qualify as a real estate professional.
2. Materially participate in the real estate rental activity.

A taxpayer qualifies for the special relief provision for real estate professionals in any tax year if

(a)  more than 50% of personal services performed by the taxpayer in all trades or businesses during the tax year are performed in real property trades or businesses in which he or she materially participates, and

(b) the taxpayer performs more than 750 hours of service during the tax year in real property trades or businesses in which he or she materially participates. Regulations provide seven tests for determining material participation.

The material participation standard plays a role in two distinct aspects of the real estate professional rules. First, when determining whether a taxpayer qualifies as a real estate professional, only real property trades or businesses in which he or she materially participates are counted.  Second, once it is determined that a taxpayer qualifies as a real estate professional, non-passive treatment is available only for rental real estate activities in which he or she materially participates.

II. Summary and Final Thoughts:

The health care reform legislation has created some excellent planning opportunities for higher-income taxpayers.  Adequate planning with respect to the self-rental regulations and classification as a real estate professional are two instances where the taxpayer can eliminate the new 3.8% tax on passive income by converting those activities into non-passive.

Furthermore, upon the disposition of the activity, the gain would also not be subject to the additional tax.

Please don’t hesitate to contact us at info@templetonco.com or 561-798-9988 to begin discussing options specific to your tax situation.

What you need to know about the tax provisions in the 2012 American Taxpayer Relief Act

The 2012 American Taxpayer Relief Act, signed into law on Jan. 2, 2013 by President Obama, is a sweeping tax package that addresses the permanent extension of the Bush-era tax cuts for most taxpayers, revises the tax rates on ordinary and capital gain income for high-income individuals, modifies the estate tax, offers permanent relief from the Alternative Minimum Tax [AMT] for individual taxpayers, limits the deductions and exemptions of high-income individuals, and provides a host of retroactively resuscitated and extended tax breaks for individual and businesses. Here’s a rundown of the package:

  • Tax rates. For tax years beginning after 2012, the 10%, 15%, 25%, 28%, 33% and 35% tax brackets from the Bush tax cuts will remain in place and are made permanent. This means that, for most Americans, the tax rates will stay the same. However, there will be a new 39.6% rate, which will begin at the following thresholds: $400,000 (single), $425,000 (head of household), $450,000 (joint filers and qualifying widow(er)s), and $225,000 (married filing separately). These dollar amounts will be inflation-adjusted for tax years after 2013.
  • Estate tax. The new law prevents steep increases in estate, gift and generation-skipping transfer (GST) tax that were slated to occur for dying individuals and gifts made after 2012 by permanently keeping the exemption level at $5,000,000 (as indexed for inflation). The new law, however, permanently increases the top estate, gift, and GST rate from 35% to 40% It also continues the portability feature that allows the estate of the first spouse to die to transfer his or her unused exclusion to the surviving spouse. All changes are effective fore individuals dying and gifts made after 2012.
  • Capital gains and qualified dividends rates. The top rate for capital gains and dividends beginning in 2013 will be 23.8% if income falls in the 39.6% tax bracket. For lower income levels, the tax will be 0%, 15%, or 18.8%.
  • Personal exemption phase-out. Beginning in 2013, personal exemptions will be phased out (i.e., reduced) for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers). Taxpayers claim exemptions for themselves, their spouses and their dependents. Last year, each exemption was worth $3,800.
  • Itemized deduction limitation. Beginning in 2013, itemized deductions will be limited for adjusted gross income over $250,000 (single), $275,000 (head of household) and $300,000 (joint filers).
  • AMT relief. The new law provides permanent AMT relief. Prior to the Act, the individual AMT exemption amounts for 2012 were to have been $33,750 for unmarried taxpayers, $45,000 for joint filers, and $22,500 for married persons filing separately. Retroactively effective for tax years beginning after 2011, the new law permanently increases these exemption amounts to $50,600 for unmarried taxpayers, $78,750 for joint filers and $39,375 for married persons filing separately. In addition, for tax years beginning after 2012, it indexes these exemption amounts for inflation.
  • Tax credits for low to middle wage earners. The new law extends for five years the following items that were originally enacted as part of the 2009 stimulus package and were slated to expire at the end of 2012: (1) the American Opportunity tax credit, which provides up to $2,500 in refundable tax credits for undergraduate college education; (2) eased rules for qualifying for the refundable child credit; and (3) various earned income tax credit (EITC) changes.
  • Cost recovery. The new law extends increased expensing limitations and treatment of certain real property as Code Section 179 property. It also extends and modifies the bonus depreciation provisions with respect to property placed in service after Dec. 31, 2012, in tax years ending after that date.
  • Tax break extenders. Many of the “traditional” tax extenders are extended for two years, retroactively to 2012 and through the end of 2013. Among many others, the extended provisions include the election to take an itemized deduction for state and local general sales taxes in lieu of the itemized deduction for state and local income taxes, the $250 above-the-line deduction for certain expenses of elementary and secondary school teachers, and the research credit.
  • Pension provision. For transfers after Dec. 31, 2012, in tax years ending after that date, plan provision in an applicable retirement plan (which includes a qualified Roth contribution program) can allow participants to elect to transfer amounts to designated Roth accounts with the transfer being treated as a taxable qualified rollover contribution.
  • Payroll tax cut is no more. The 2% payroll tax cut was allowed to expire at the end of 2012.

Tax breaks for businesses from the 2012 American Taxpayer Relief Act

In addition to the lofty package of tax relief for individuals, the recently enacted 2012 American Taxpayer Relief Act extends a host of important tax breaks for businesses. We’ve put together a list to give you an overview of its impact. For more detailed information and to determine how it will affect your business, give us a call at 561-798-9988.

The following depreciation provisions are retroactively extended by the Act:

  • Fifteen-year straight line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.
  • Seven-year recovery period for motor sports entertainment complexes.
  • Accelerated depreciation for business property on an Indian reservation.
  • Increased expensing limitations and treatment of certain real property as Section 179 property;
  • Special expensing rules for certain film and television productions; and
  • The election to expense mine safety equipment.

The new law also extends and modifies the bonus depreciation provisions with respect to property placed in service after Dec. 31, 2012, in tax years ending after that date.

The following business credits and special rules are also extended:

  • The research credit is modified and retroactively extended for two years through 2013.
  • The temporary minimum low-income tax credit rate for nonfederally subsidized new buildings is extended to apply to housing credit dollar amount allocations made before Jan. 1, 2014.
  • The housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds is extended two years.
  • The Indian employment tax credit is retroactively extended for two years through 2013.
  • The new markets tax credit is retroactively extended for two years through 2013.
  • The railroad track maintenance credit is retroactively extended for two years through 2013.
  • The mine rescue team training credit is retroactively extended for two years through 2013.
  • The employer wage credit for employees who are active duty members of the uniformed services is retroactively extended for two years through 2013.
  • The work opportunity tax credit is retroactively extended for two years through 2013.
  • Qualified zone academy bonds are retroactively extended for two years through 2013.
  • The enhanced charitable deduction for contributions of food inventory is retroactively extended for two years through 2013.
  • Allowance of the domestic production activities deduction for activities in Puerto Rico applies for the first eight tax years of the taxpayer beginning after Dec. 31, 2005, and before Jan. 1, 2014.
  • Exclusion from a tax-exempt organization’s unrelated business taxable income (UBTI) of interest, rent, royalties, and annuities paid to it from a controlled entity is extended through Dec. 31, 2013.
  • Treatment of certain dividends of regulated investment companies (RICs) as “interest-related dividends” is extended through Dec. 31, 2013.
  • Inclusion of RICs in the definition of a “qualified investment entity” is extended through Dec. 31, 2013.
  • The exception under subpart F for active financing income (i.e., certain income from the active conduct of a banking, financing, insurance or similar business) for tax years of a foreign corporation beginning after Dec. 31, 1998, and before Jan. 1, 2014, for tax years of foreign corporations beginning after Dec. 31, 2005, and before Jan. 1, 2014.
  • Look-through treatment for payments between related controlled foreign corporations (CFCs) under the foreign personal holding company rules is extended through Jan. 1, 2014.
  • Exclusion of 100% of gain on certain small business stock acquired before Jan. 1, 2014.
  • Basis adjustment to stock of S corporations making charitable contributions of property in tax years beginning before Dec. 31, 2013.
  • The reduction in S corporation recognition period for built-in gains tax is extended through 2013, with a 10-year period instead of a 5-year period.
  • Various empowerment zone tax incentive, including the designation of an empowerment zone and of additional empowerment zones (extended through Dec. 31, 2013) and the period for which the percentage exclusion for qualified small business stock (of a corporation which is a qualified business entity) is 60% (extended through Dec. 31, 2018).
  • Tax-exempt financing for New York Liberty Zone is extended for bonds issued before Jan. 1 2014.
  • Temporary increase in limit on cover over rum excise taxes to Puerto Rico and the Virgin Islands is extended for spirits brought into the U.S. before Jan. 1, 2014.
  • American Samoa economic development credit, as modified, is extended through Jan. 1, 2014.

For additional information, contact either Steve Leone, CPA, sleone@templetonco.com or Emma Pfister, CPA,epfister@templetonco.com.

2013 Tax Planning

People get ready.

More individuals will be snared by the alternative minimum tax (AMT), and various deductions. Other tax breaks will be unavailable. As a result of expiring Bush-era tax cuts, individuals will face higher tax rates next year on their income, including capital gains and dividends, and estate tax rates will also be higher. AMT became problematic this year because exemptions have dropped and fewer personal credits can be used to offset them.

Additionally, a number of tax provisions expired at the end of 2011 or will expire at the end of 2012. For example, rules that expired at the end of 2011 include:

  • Research credit for businesses.
  • Election to take an itemized deduction for state and local general sales taxes instead of the itemized deduction permitted for state and local income taxes.
  • Above-the-line deduction for qualified tuition expenses.
  • Rules that expire at the end of 2012 include:
  • Generous bonus depreciation allowances and expensing allowances for business.
  • Expanded tax credits for higher education costs.


Remember, these adverse tax consequences are by no means a certainty as Congress and President Obama could extend the Bush-era tax cuts for some or all taxpayers and retroactively “patch” the AMT for 2012. This would increase exemptions and availability of credits, revive some favorable expired tax rules and extend those that are slated to expire at the end of this year. 

But – this is not the time for inaction. The prospect of higher taxes next year makes it even more important to engage in year-end planning now.

We’ve put together a list of considerations for individuals and businesses that will guide you through these challenges. While not all actions will apply to your particular situation, many of these moves may benefit you. For further explanation or clarification, please call us at 561-798-9988.

Year-End Tax Planning Moves for Individuals

• Increase your FSA. Set aside more for next year in your employer’s health flexible spending account (FSA). Next year, the maximum contribution to a health FSA is $2,500. Remember – you will no longer be able to set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids. 
• Make HSA contributions. If you became eligible to make health savings account (HSA) contributions late this year (even in December), you can make a full year’s worth of deductible HSA contributions even if you were not eligible to make HSA contributions for the entire year. 
• Realize losses on stock while preserving your investments. There are several ways this can be done. For example, you can sell the original holding then buy back the same securities at least 31 days later. It would be advisable for us to meet to discuss year-end trades you should consider making. 
• Sell assets before year-end. If you are thinking of selling assets that are likely to yield large gains, such as inherited, valuable stock, or a vacation home in a desirable resort area, make the sale before year-end while still paying attention to the market. 
• Sell and repurchase stock. You may own appreciated-in-value stock and want to lock in a 15% tax rate on the gain, but you think the stock still has plenty of room to grow. In this situation, consider selling the stock and then repurchasing it. You’ll pay a maximum tax of 15% on long-term gain from the stock you sell. You also will wind up with a higher basis (cost, for tax purposes) in the repurchased stock. 
• Make contributions to Roth IRAs. Roth IRA payouts are tax-free and immune from the threat of higher tax rates, as long as they are made after a five-year period, and on or attaining age 59-½, after death or disability, or for a first-time home purchase. 
• Convert traditional IRAs to Roth IRAs. This will help you avoid a possible hike in tax rates next year. Also, although a 2013 conversion won’t be hit by the 3.8% tax on unearned income, it could trigger that tax on your non-IRA gains, interest, and dividends. Conversions, however, should be approached with caution because they will increase your adjusted gross income [AGI] for 2012. 
• Take required minimum distributions from retirement plans. This is applicable if you have reached age 70-½. Failure to take a required withdrawal can result in a penalty equal to 50% of the amount of the RMD not withdrawn. If you turn age 70-½ this year, you can delay the first required distribution to 2013, but if you do, you will have to take a double distribution in 2013—the amount required for 2012 plus the amount required for 2013. Think twice before doing this. 
• Deduct your medical expenses. This year, unreimbursed medical expenses are deductible to the extent they exceed 7.5% of your AGI, but in 2013, for individuals under age 65, these expenses will be deductible only to the extent they exceed 10% of AGI. 
• Shelter gifts. Make gifts sheltered by the annual gift tax exclusion before the end of the year to save gift and estate taxes. You can give $13,000 in 2012 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. 

Year-End Tax Planning Moves for Business Owners

• Consider stock redemption. If your business is incorporated, consider taking money out of the business through a stock redemption. The buy-back of the stock may yield long-term capital gain or a dividend, depending on a variety of factors. But either way, you’ll be taxed at a maximum rate of only 15% if you act this year. Wait until next year and your long-term gains or dividends may be taxed at a higher rate if reform plans are instituted or the Bush-era tax cuts expire. Contact us for help on executing an effective pre-2013 corporate distribution. • Hire a veteran. If you are thinking of adding to payroll, consider hiring a qualifying veteran before year-end to qualify for a work opportunity tax credit (WOTC). Under current law, the WOTC for qualifying veterans won’t be available for post-2012 hires. The WOTC for hiring veterans ranges from $2,400 to $9,600, depending on a variety of factors (such as the veteran’s period of unemployment and whether he or she has a service-connected disability). 
• Put new business equipment and machinery in service. This will allow you to qualify for the 50% bonus first-year depreciation allowance. Unless Congress acts, this bonus depreciation allowance generally won’t be available for property placed in service after 2012. (Certain specialized assets may, however, be placed in service in 2013.) 
• Make expenses qualifying for the business property expensing option. The maximum amount you can expense for a tax year beginning in 2012 is $139,000 of the cost of qualifying property placed in service for that tax year. The $139,000 amount is reduced by which the cost of qualifying property placed in service during 2012 exceeds $560,000 (the investment ceiling). For tax years beginning in 2013, unless Congress makes a change, the expensing limit will be $25,000 and the investment ceiling will be $200,000. 
• Buy a SUV. If you are in the market for a business car, and your taste runs to large, consider buying heavy SUVs (those built on a truck chassis and rated at more than 6,000 pounds gross (loaded) vehicle weight). Due to a combination of favorable depreciation and expensing rules, you may be able to write off most of the cost this year. Next year, the write off rules may not be as generous. 

These considerations are just the beginning to creating a plan that will work for you. Whether you are planning for your family or business, contact us to discuss these options further.

Health care

Health care continues to be one of the more contemptuous issues our country faces. And no wonder, in 2011 alone, the U.S. spent $8,400 per person compared to the next highest-spending country, Norway at $5,352.

Since 2002, family premiums for employer-sponsored health care have increased by a whopping 97 percent placing the cost burdens on employers and workers.

The drivers of these cost increases include an aging Baby Boomer generation that is creating more patients and more treatments, a need for long term care for chronic illnesses, more sophisticated treatments and technology, and increasing inefficiencies, malpractice and administrative costs.

On March 23, 2010 President Obama signed the Patient Protection and Affordable Care Act (otherwise known as ObamaCare) into law. This law, while intending to offer more affordable health care to individuals and families, requires much employer compliance and action.

Overall the Act requires most U.S. citizens and legal residents to have health insurance by creating state-based American Health Benefit Exchanges through which individuals can purchase coverage, with premium and cost-sharing credits. These credits are available to individuals and families with income between 133-400 percent of the federal poverty level.

Separate Exchanges will also be created that will allow small businesses to purchase coverage. Employers will be required to pay for penalties for employees who receive tax credits for health insurance through an Exchange, with exceptions for small employers. New regulations on the health plans in these Exchanges will also be imposed in the individual and small group markets. Medicaid will also be expanded to 133 percent of the federal poverty level.

As this law moves into action and even if it is repealed, one thing is certain – change. It’s clear that quality, price and service are often sacrificed in the current health care model. So the change will have to come from employers, providers, physicians, payers and insurers. This is how:

• Employer driven change – 60 percent of the under 65 population have insurance through their employers and all are negatively impacted by escalating costs and inadequate quality. As a result, educating those employees is a must as well as focusing more on wellness and prevention.

• Provider/Physician change – Health care providers will go from a fee-based model to a newer value-based model and focus on being more accountable in their care. There will be consolidation and newer business models that require increased use of data analytics and clinical intelligence.

• Payer/Insurer change – By moving the focus away from claims processing to more collaboration in an effort to improve care and manage costs. There will also be a shift from administrator to supplier of data analytics/clinical intelligence.

So the question becomes for employers – are you going to pay or play ObamaCare?

Play means employers offer minimum essential coverage to all of your full-time employees.

Pay is an excise tax if you do not offer minimum essential coverage (or any coverage) and at least one of your full-time employees is certified as having enrolled in coverage through a state health exchange for which he or she received a premium tax credit or cost sharing reduction. This tax is applicable to employers with 50 or more full-time employees on average per business day. The monthly penalty (non deductible) is $166.67 (1/12 of $2,000) times the total number of full-time employees for the month minus 30.

What to do?

Look at your workforce Employers need to evaluate their workforce and look at their employees (both full-time and part-time) and see if any could be reclassified as employees for purposes of the mandate.

Business structure Employers also need to understand if their current business structure or model could cause the company to be subject to the employer mandate – and see if there are circumstances under which they could restructure to avoid the mandate.

Learn about Health Insurance Exchanges Examine the relationship between the employer mandate and the individual mandate and how the health insurance Exchanges that will be put in place in 2014 will provide opportunities for some employers and many individuals to acquire such coverage.

Florida recently returned $1 million planning grant to the federal government and has set up a non-ACA compliant health care initiative. However, if the state doesn’t set up an ACA compliant exchange, the federal government will.

Employers need to act now and consider an overall benefit redesign with an emphasis on better employee health. They should also set up and access information systems and reporting for compliance and start discussions with payers and providers that consider risk sharing.

Though overturning ObamaCare would mean relief from this compliance burden and potential penalties, it doesn’t necessarily change the need for an employer’s strategic evaluation of their workforce, business structure, overall plan design and employee communications.

This work upfront can save you a lot of heartache and expense down the road.

 For more information, please e-mail info@templetonco.com.