The timing of taxable income and deductions for federal income tax purposes is relatively straightforward. Generally, income is taxable in the year it is earned and received. Likewise, deductible expenses incurred and paid this year can offset taxable income on this year’s return. The Internal Revenue Code is riddled with exceptions, but these basic rules usually apply, especially for calendar-year taxpayers.
The tax law also includes several provisions commonly referred to as “carrybacks” and “carryforwards” (or “carryovers”). As their names imply, the tax item can be carried back to a prior year or carried forward to a succeeding year.
Two items that are often carried forward by individuals are capital losses and excess charitable deductions. For instance, capital losses realized in 2012 offset capital gains plus up to $3,000 of ordinary income for the year. If you have an excess capital loss of $10,000, you can carry forward $7,000 to 2013 after offsetting $3,000 of ordinary income in 2012.
Similarly, your current deduction for charitable donations may be limited by one or more percentage thresholds in the law. For example, donations of appreciated property are generally limited to 30% of your adjusted gross income (AGI). If you exceed the 30%-of-AGI limit this year, you may carry over the excess for up to five years.
Carrybacks aren’t as common, but may also be available in certain situations. Take a “net operating loss” (NOL) sustained by your small business. If you have an NOL in 2012, you can carry back the loss for two years. Thus, you’re effectively able to reduce your tax liability for one or two of the previous years for a refund of taxes already paid. Then you can carry forward any remaining NOL for up to 20 years. If it suits your purposes, you can elect to waive the NOL carryback. For more information on carrybacks and carryforwards, give us a call. We can help you make the best tax return choices for your situation.
With the recent economic downturn experienced by many taxpayers, there is a tax concept that is very important: cancellation of debt. You would think that the cancellation of debt by a credit card company or mortgage company would be a good thing for the taxpayer. And it can be, but it can also be considered taxable income by the IRS. Here is a quick review of various debt cancellation situations.
Consumer debt. If you have gone through some type of credit “workout” program on consumer debt, it’s likely that some of your debt has been cancelled. If that is the case, be prepared to receive IRS Form 1099-C representing the amount of debt cancelled. The IRS considers that amount taxable income to you, and they expect to see it reported on your tax return. The exception is if you file for bankruptcy. With bankruptcy, generally the debt cancelled is not taxable.
Even if you are not legally bankrupt, you might be technically insolvent (where your liabilities exceed your assets). If this is the case, you can exclude your debt cancellation income by reporting your financial condition and filing IRS Form 982 with your tax return.
Primary home. If your home is “short” sold or foreclosed and the lender receives less than the total amount of the outstanding loan, you can also expect that amount of debt cancellation to be reported to you and the IRS. But special rules allow you to exclude up to $2 million in cancellation income in many circumstances. You will again need to complete IRS Form 982, but the exclusion from taxable income brought about by the debt cancellation on your primary residence is incredibly liberal. So make sure to take advantage of these rules should they apply to you.
Second home, rental property, investment property, business property. The rules for debt cancellation on second homes, rental property, and investment or business property can be extremely complicated. Generally speaking, the new laws that cover debt cancellation don’t apply to these properties, and the IRS considers any debt cancellation income taxable. Nevertheless, given your cost of these properties, your financial condition, and the amount of debt cancelled, it’s still possible to have this debt cancellation income taxed at a preferred capital gains rate, or even considered not taxable at all.
Be aware that many of the special debt cancellation provisions are set to expire at the end of 2012. If you’re unsure as to how debt cancellation affects you, contact our office to review your situation and determine how much, if any, cancelled debt will be taxable income to you.
Planning to rent out your vacation getaway? When it comes to taking advantage of the tax benefits, timing is an important factor.
Here are two points to remember.
* The fourteen-day-or-ten-percent test.
The IRS applies this test to determine if you use your vacation home as a personal residence. If you stay in the home more than 14 days or 10% of the total days it's rented in a calendar year (whichever is greater), the general rule is you're using it as your home.
Why does it matter? Because treating a vacation home as your personal residence affects your rental deductions. You'd include all the rent you receive as income on your tax return. But related expenses are generally limited to the amount of that income, meaning you can't offset other income with a loss. Note that time spent in your vacation home by family members and certain others can count as personal use.
* The less-than-fifteen exception.
Rent out your vacation home for less than 15 days during the taxable year, and the income is yours, tax-free. You don't even have to report it on your return. Just be aware that any expenses related to the rental are nondeductible. If you itemize, you can still deduct qualified mortgage interest and real estate taxes on your vacation home.
Other tax rules, such as passive activity and capital gains reporting, can also impact the decision to rent out your vacation home. Give us a call before you put up that "For Rent" sign. We'll be happy to review your options under the tax rules.