Keeping Wealth in Your Family's Future

According to a new study by Merrill Lynch’s Private Banking and Investment Group, family wealth fails to outlive the generation following the one that created that wealth in more than two out of three instances; 90% of the time, “assets are exhausted before the end of the third generation.” 

This report focuses on investors with more than $5 million, but the principles apply just as well to those with $500,000 or even $50,000 to invest. If you are concerned about the financial security of your children and grandchildren, you should set a good example and discuss money matters regularly with your descendants.

Savvy spending

One reason that family wealth may not last very long is simple: people spend too much. 

In the Merrill Lynch study, more than half of the respondents either expressed confidence that a 6% distribution rate could sustain an investment portfolio indefinitely or did not have any idea of how much could be withdrawn prudently. 
To put this in perspective, research indicates that a sustainable distribution rate might be as low as 2% of portfolio value a year.

           
 Obviously, the less you spend the more that can pass to a surviving spouse and to your descendants. Spending moderately will signal to your loved ones that this is how one builds and maintains net worth. In addition, you can make sure that your heirs know that your spending habits are designed to minimize the chance of depleting the family’s coffers.

Continuing the conversation

Indeed, perhaps the most important thing you can do to preserve wealth in your family is to regularly talk to your children about finances. Remember to keep the discussions age appropriate. With very young children, you might talk about how money is earned by working, how some money goes to taxes to pay for schools and other services, and how what’s left might be either saved or spent. Avoid getting into too much detail with youngsters, who probably will be overwhelmed and, therefore, intimidated rather than educated.

           
 Once your children are ready for college, you can have practical conversations about their choice of study and eventual career path. A student who knows a substantial inheritance lies in the future, or who can play a possible role in a thriving family business, might be inclined to consider a course of study that relates to a personal passion; another student, one who understands that his or her lifestyle will depend on his or her earnings, could go in another direction.

            
Similar conversations might take place when children are about to become parents or are shopping for a home. The more they know about your finances, and about their own prospects for an inheritance, the greater the likelihood they’ll make informed decisions.

            
On the flip side, holding these ongoing conversations with your children can educate you, too. You might discover a need for gifts or loans that you hadn’t known about. Conversely, you might realize that your children are uninterested in financial matters and may make poor decisions if they inherit money outright. If so, you may have the opportunity to build safeguards into your estate plan, such as giving or leaving money to a trust for a child’s benefit.

Hitting the highlights

Of course, some parents will not want to reveal all the details of their financial affairs to their children. In truth, that’s not really necessary. You might give your children an overview, with enough information to impart what you are willing and able to provide during your life and a general idea of what they might inherit someday. In addition, you can tell your children where to find key documents and also provide contact information for your professional advisors.

           
 Once you bring your advisors into the inheritance conversation, keep in mind that some studies show that both parents and children may be more comfortable discussing their circumstances with a financial professional (CPA, attorney, financial planner) than with each other. If that’s the case in your situation, you might ask a professional with whom you work to suggest and even host a meeting of the generations. Our office would be pleased to help you get the conversation started.

Ask us for our Personal Cash Flow spreadsheet to help keep track of your expenses!

"Reasonbable Compensation" for S Corp Owners

For regular C corporations, “reasonable compensation” can be a troublesome tax issue. The IRS doesn't want shareholder executives to inflate their deductible salaries while minimizing the corporation’s nondeductible dividend payouts.

            
For S corporation owners, the opposite is true. If owner employees take what the IRS considers “unreasonably low” compensation, the IRS may recast the earnings to reflect higher payroll taxes, along with interest and penalties.

One pocket to pick

Eligible corporations that elect S status avoid corporate income taxes. Instead, all income flows through to the shareholders’ personal tax returns.

            
Example 1: 
Ivan Nelson owns a plumbing supply firm structured as an S corporation. Ivan’s salary is $250,000 a year while the company’s profits are $400,000. The $650,000 total is reported on Ivan’s personal tax return.

            
In 2014, Ivan pays 12.4% as the employer and employee shares of Social Security tax on $117,000 of earnings. He also pays 2.9% Medicare tax on his $250,000 of salary. As a result of recent tax legislation, Ivan—who is not married—owes an additional 0.9% Medicare tax on $50,000, the amount over the $200,000 earnings threshold (the threshold is $250,000 on a joint tax return). Altogether, Ivan pays well over $20,000 in these payroll taxes.

Going low

Often, S corporation owners have a great deal of leeway in determining their salary and any bonus. Holding down these earnings may reduce payroll taxes.

 Example 2: 
Jenny Maxwell owns an electrical supply firm across the street from Ivan’s business. Jenny’s company also is an S corporation. She reports the same $650,000 of income from the business but Jenny classes only $75,000 as salary and $575,000 as profits from the business. Thus, she pays thousands of dollars less than Ivan pays for Social Security and Medicare taxes.

Proving your payout

As mentioned, the IRS might target S corporation owners suspected of lowballing earned income. Therefore, all S corporation shareholders should take steps to justify the reasonableness of their compensation.

If you own an S corporation, consider spelling out your salary level in your corporate minutes. Where possible, give examples and quote industry statistics that show your compensation is in line with the amounts paid to executives at similar firms. Other explanations also might help.

            

• Depending on the situation, you might say that business is slow, in the current economy, so the minutes will report that you are keeping your salary low to provide working capital for the company. 
• If your business is young, the minutes could explain that you’re holding fixed costs down, so the company can grow, but you expect to earn more in the future. 
• In still another scenario, you might say that you are nearing retirement and making an effort to rely more on valued employees, so a modest level of earnings reflects the actual work you’re now contributing.

As illustrated above, holding down S corporation compensation can result in sizable payroll tax savings. (Our office can help you establish a reasonable, tax-efficient plan for your salary and bonus.)

Calculating coverage

Beyond compensation, health insurance also may affect the payroll tax paid by an S corporation owner. Special rules apply to anyone owning more than 2% of the company’s stock.

            
If the company has a health plan and pays some or all of the costs for coverage of such a so-called “2% shareholder,” the payments will be reported to the IRS as taxable income. However, that amount will not be subject to payroll taxes, including those for Medicare and Social Security. 
The company can take a deduction for these payments, effectively reducing corporate profits passed through as taxable income for the shareholder.

            
In addition, the S corporation shareholder may be able to deduct the premiums paid by the company—this deduction can be taken on page 1 of his or her personal tax return, which may provide other tax benefits. However, such an “above-the-line” deduction cannot be taken in any month when the shareholder or spouse is eligible to participate in another employer-sponsored health plan. Also, this deduction can’t exceed the amount of the shareholder’s earned income for the year.

            
This can be a complicated issue, especially if your state law prevents a corporation from buying group health insurance for a single employee. If you own an S corporation, our office can help you decide the best way to hold down payroll tax as well as income tax from your health plan.

             

5 Ways to Use Us More Effectively

We meet with new entrepreneurs on a regular basis, and I had the pleasure of speaking with three new business owners recently who had never worked with a CPA before.  

One of the owners said, "What do you do? I mean, I know you do taxes and stuff, but what else do you do?" 

After our meeting ended, I began to wonder how our clients view us through the lens of their daily challenges as business owners. When a financial decision is about to be made, does our client think, "You know, I should run this by Jonathan to see what he thinks?"
I wasn't sure.

We are knowledge workers, and our most valuable asset is the knowledge and experience that we draw upon and share as part of our small business engagements.  When clients engage us to work with them, depending on how involved we are, that knowledge is theirs when they need it....via email, phone or face-to-face.  No by-the-hour billing; no invoices with 7 lines on them showing you what we did last month.  A flat fee and BAM!  Our knowledge is theirs.  In that situation, why in the world would you not call?

Here are five scenarios in which we feel our clients could better utilize our talents to their advantage:

1.  I'm About to Spend a Lot of Money:

If the decision involves spending a large amount of money, you should probably discuss it with us before you commit to it.  I'm not saying that we need to be involved in the smaller decisions, like where you buy your paper clips and how much you spend on them, but I wouldn't decide to change my investment strategy or invest a large sum of money in the market without speaking to my financial planner first.  Why would you, as a small business owner and the one responsible for the financial health of your business, decide to commit a large sum of money to these things without running it by us first?

A new employee

A new piece of equipment

A new rental property or commercial building

A new business opportunity

Emptying your IRA to buy a new house or investment property....

I have a client to whom we provide outsourced CFO services.  He won't take on a new customer without first calling me and allowing me to run a margin analysis, to make sure he's obtaining the margins that his company needs to produce profit and grow.  So, with each new proposal, he contacts me and we run the numbers.  He knows that if he takes on a new customer, he has costs involved:  a new employee, technology costs, maybe travel expenses.  We have built a model for determining whether each new customer is profitable, so he knows with certainty what's going to happen when he makes a decision.

2. I'm About to Receive Money:

I'm not talking about revenue you receive in the normal course of business.  I'm talking about something extraordinary....a life insurance settlement, a loan from your mother, or (heaven forbid) an early distribution from a retirement account.  These are not run-of-the-mill occurrences.  I have been in meetings that went something like this:

"So, is there anything out of the ordinary that I need to know about?"

"Not really....no, wait.  I did take $50,000 out of my IRA in September to help me fund the business and didn't have any withholding taken out."

"OK, how old are you again?"

"I'm 49."

"OK, are you prepared to pay the $16,000 in federal and SC taxes that come along with that?"

Silence.

Lesson to be learned here:  if you are about to receive money that you don't normally receive, it helps to contact your CPA and ask questions regarding how your financial picture will be impacted.

3.  I've Formed an LLC.  Hooray!

I hear this statement about once every, um, 36 seconds.  While the states have made it SO EASY to set up an LLC, there is hardly any guidance that the average person can find that addresses the tax issues surrounding such a decision.  This is how the conversation usually goes:

"So, you said in your email that you have set up an LLC?"

"Yes, I did.  I knew it was something I needed to do."

"Who told you that?"

"LegalZoom."

"OK, how is your LLC taxed?"

"Um, as an LLC."

"You know that an LLC can be taxed four different ways, right?"

"No, I guess LegalZoom didn't tell me that."

And we're off!  I love tax planning, so I don't have any problem whatsoever having this conversation with a client.  It never fails that they leave the office knowing way more than when they came in, because LLC's are the most used and least understood entity choice around.  But, before you form one, you really should come in and discuss it with us.  Fixing a mistake down the road because you weren't informed can cost you more in time and heartache, I promise you.

4.  I'm Worried About My Business' Cash Flow: (Why don't I have any money?)

My biggest point of frustration with my career is that people consider a CPA to be the bean-counter or the tax guy.  I only like to eat beans, and while I like the world of tax, I don't live and die with each scintillating tax return I prepare.

When we decided to price our business engagements differently about four years ago, I make purposeful statements like "It doesn't have to involve taxes for you to call me" or "Anything to do with your business' cash flow is important, and we need to talk about it."  Here is a snippet from a recent meeting:

"So, how are things going?"

"Well, cash has been tight lately and I've been really stressed out about it."

"Really?  When did you notice the slowdown in your cash flow?"

"About six months ago."

" Six months! Why didn't you call me?"

"I don't know.  It didn't really have anything to do with taxes, so I didn't want to bother you. I just figured things would right themselves."

Bother me?  What is it you think you pay for?

When you work with Godwin & Associates, you never have to worry about "bothering" us.  If you were a bother, we wouldn't be working with you.  Life is too short.  So, assuming you're not a bother, we have an open knowledge policy.  If there is a concern about your business' cash flow, we need to know about it.  Because guess what?  We've all been there. I might know of a way to help that you haven't yet thought of.

A man is walking down the street and falls into a hole.

He sits there for hours, calling out to people for help.

A priest walks by and throws in a prayer written on a sticky note.

A doctor walks by and throws down a prescription.

A friend walks by, then jumps in the hole with the man.

The man asks "What are you doing?  Now we're both stuck in here."

The friend says "Yes, but I've been in here before and I know the way out."

5.  I'm Frustrated and I Don't Know What To Do: (Nothing is happening.)

Sometimes I'm a cheerleader; sometimes I'm a counselor; sometimes I serve as a sounding board; sometimes I am the good angel to your bad angel.  

I'm always a truth-teller, however.  I won't sugarcoat the truth no matter how much you want me to, and I'm going to ask the hard questions.

Sometimes, a sole proprietor or the sole owner of a corporation just needs someone to talk with. Things happen that throw us off our game.  The biggest problem with being a solo owner is the risk of isolation, and making too many decisions in a vacuum.

If you always have your head down, doing work and just getting by, it's easy to just make decisions on the go and not consider the far-reaching effect of what you're about to do. You've been trained to look down and keep moving, but decisions have consequences that serve as dominos for your life.

I've had meetings where a sole owner comes by, and just sits there....silent....for a few minutes.  The consternation is obvious, but they've been sitting by themselves for so long they don't know how to tell me what's wrong.  I consider myself a good listener, so I just wait until the right time and start asking questions to coax the issue out of my client.  As painful as it might have seemed in the beginning, some wonderful things come out of those meetings.  Insight....a new way to think about the problem....a laugh or two....and the comfort of knowing that as a small business owner myself and fellow entrepreneur, I am right there with you.

 Our goal is to help you prosper, so when the phone rings or the email pops up and you need us, we want to help.  To help your business grow, to help your employees continue to make money so they can support their families, and to help you provide the wonderful service or product to our community and the world.  If we don't do our job, other people (not just you) suffer.  

So, the next time you wonder whether or not the question of the day is something we can help you with, drop us a line.

How can we help you today?

Why you aren't using your accountant

Deductions for Dining Out

Champagne and caviar on the IRS? Typically, the answer is no. Nevertheless, there are times when you can go out to eat—perhaps to the best restaurant in town—and recoup some of your costs through tax savings.

Business as usual 

Perhaps the most obvious way to deduct dining costs is to buy a meal for someone with whom you do business or would like to do business. The good news is that everything counts: food, drinks, tax, and tip. The bad news? Meal costs typically are considered entertainment expenses, which generally have a 50% cap on deductions.

 Example 1: Nora Peters has dinner with a potential client for her landscaping business. They both have full-course meals with wine, and the tab comes to $100 with tax and tip. If Nora pays the bill, she can take a $50 tax deduction.
The IRS explicitly frowns on so-called “taking turns” deductions. Thus, if the potential client is Nora’s neighbor and they dine together every month, alternating as to who pays the bill, the IRS won’t allow either party to take tax deductions.
However, that may not always be the case.

Example 2: Nora and her neighbor dine together throughout the year, discussing possible ideas for the latter’s garden, and Nora picks up the tab every other time, paying a total of $600. Eventually, the neighbor hires Nora to landscape her garden; Nora ultimately earns $2,000 from that job, reported as taxable income. Can Nora take a $300 (50% of $600) tax deduction, despite the alternate bill paying? Our office can help you determine the answer to such difficult questions.

Beyond reasonable doubt

The IRS also asserts that meal outlays that are “lavish or extravagant” won’t qualify for a tax deduction. Unfortunately, the agency doesn’t provide a dollar limit or any tangible guideline, only that the cost must be “reasonable,” considering the “facts and circumstances.” 

Merely dining at a deluxe restaurant or a pricey resort won’t automatically rule out a 50% deduction.

 One way to approach this issue is to put things into perspective. In a major city with a steep cost of living, spending $100 on a dinner for two may not be considered lavish, if there’s a valid business purpose for the excursion. Conversely, spending hundreds of dollars on a meal with someone who has only a peripheral connection to your company and little chance of providing meaningful revenues in the future, might not pass muster.

One U.S. Commerce Department website provides an example of spending $200 for a business-related meal. If $110 of that amount is not allowable because it is lavish and extravagant, the remaining $90 is subject to the 50% limit. Thus, the tax deduction could be $45 (50% of $90).

Going solo

You should be aware that the 50% limit also applies to business meals away from home, not just to meals where you’re entertaining someone.

Example 3: Ron Sawyer travels from his Dallas home to Tucson on a sales trip. He does no entertaining but spends $140 eating his meals in restaurants. Ron’s meal deduction is $70 (50% of $140).

Filling out a foursome

Generally, you can’t claim a 50% deduction for buying your spouse a meal. There are exceptions, though, if including your spouse at the table serves a business purpose, rather than one that’s personal or social.

 Example 4: Tim Walker invites a customer to dinner. The customer is visiting from out of town, so the customer’s spouse is also invited because it is impractical to entertain the customer without the spouse. Tim can deduct 50% of the cost of the meal for the customer's spouse. What’s more, if Tim’s wife joins the group because the customer's spouse is present, the cost of the meal for Tim’s wife is also deductible.

Taking the deduction

For self-employed individuals and business owners, taking 50% deductions for business meals may be straightforward. For employees, though, those deductions might be harder to obtain. Unreimbursed expenses are included in miscellaneous itemized deductions, which are deductible only to the extent they exceed 2% of adjusted gross income (AGI).

Example 5: Lynn Knox, who is an employee, spends $500 on business meals in 2014 and is not reimbursed. When she prepares her tax return for the year, she includes $250 as a miscellaneous itemized deduction. Her AGI is $100,000, so her 2% threshold is $2,000. If Lynn’s miscellaneous deductions add up to $2,400, she is entitled to deduct the $400 excess. Without her business meals, Lynn’s miscellaneous deductions would have been only $2,150, generating a $150 deduction, so Lynn effectively gets a $250 deduction for her $500 of business meal expenses. If Lynn’s miscellaneous deductions were under $2,000, she would have no tax benefit from her business meals.

Meal Plans

·       In order to support a deduction for buying someone a meal, you must be present.

·       The purpose of the meal must be the active conduct of business, you must engage in business during the meal, and you must have more than a general expectation of getting income or some specific business benefit in the future; or the meal must be associated with the active conduct of business and come directly before or after a substantial business discussion.

·       You should keep a record of all these meal expenses. Note the “who, where, when, and how much” details along with an explanation of the business purpose of your mealtime conversation.

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Inherited Assets vs. Gifts

When someone gives you cash or other valuable assets, do you owe income tax? No. The same is true if you receive an inheritance. The giver may owe gift tax and the decedent’s estate may owe estate tax but you, as the recipient, won’t owe income tax.

           
 The situation will change, however, if you receive a non-cash asset as a gift or inheritance and subsequently sell that asset. You’ll incur tax consequences, which will depend on your so-called “basis” in the asset. In this context, your basis can be considered your cost for tax purposes.

Carryover basis

When you receive an appreciated asset as a gift, you also receive the giver’s basis in that gift. In tax parlance, the former owner’s basis “carries over” to you.

            
Example 1: Mike Owens invested $10,000 in ABC Corp. stock many years ago. Mike always receives the dividends from ABC, rather than reinvesting them. When the shares are worth $19,000, Mike gives those shares to his niece Pam. In this scenario, Pam retains Mike’s $10,000 basis in the shares. If she sells the shares for $22,000, Pam will owe tax on a $12,000 gain, because of the carryover basis, rather than owing tax on the $3,000 gain since the gift.

            
For gifts of appreciated assets, the donor’s holding period also carries over. Here, Pam will have a favorably taxed long-term gain because Mike held the shares for many years. In another situation, where Pam’s sale takes place one year or less since Mike’s purchase, her $12,000 gain would be taxed at higher ordinary income rates.

(The carryover basis rules on gifts of depreciated property are more complex. If you have received such a gift, our office can explain the tax consequences of a future sale.)

Stepped-up basis

Different rules apply to inherited assets. Here, the heir’s basis typically is the asset’s value on the date of death.
Example 2: Rebecca Smith dies and leaves $200,000 worth of XYZ Corp. shares to her nephew Tom. Even if Rebecca’s basis in the shares was only, say, $90,000, Tom’s basis in the shares is $200,000, their value when Rebecca died. Tom will have no taxable gain on a subsequent sale for $200,000, a $10,000 gain on a sale for $210,000, and a $5,000 capital loss on a sale for $195,000. Depreciated assets are stepped down: if Rebecca had bought the shares for $200,000, but they were worth $90,000 when she died, Tom’s basis would be $90,000.
After an inheritance, sales generally are taxed as a long-term gain or loss, regardless of the heir’s or the decedent’s holding period.
In some cases, special rules apply to the basis of inherited assets. For property held jointly with right of survivorship (JTWROS), the survivor generally gets a basis step up for half of the asset value.

Example 3: Victor and Wendy Young hold shares of DEF Corp. in a brokerage account. The account is titled as JTWROS, so the surviving co-owner will be the sole owner. Victor dies first, when the couple’s basis in the shares is $60,000 and the current value is $88,000.       

Going forward, Wendy owns those DEF shares. Her basis is stepped up to $74,000: $30,000 for her half of the previous $60,000 basis plus $44,000 for Victor’s half of the current $88,000 value, which is stepped up at his death. If Wendy sells the DEF shares a week later for $89,000, she will have a $15,000 long-term capital gain, considering the basis increase to $74,000 at Victor’s death. (Different rules may apply to property held by married couples living in community property states.)

Basis backup

As you can see, documenting your basis in gifted or inherited assets is vital. When you get a gift, find out the giver’s basis in that asset; after an inheritance, document the date of death value (or the value on the alternative valuation date, as explained in the “Second Look” Trusted Advice column herein).
 Putting a value on listed securities or other assets held in an investment account may be relatively easy. Such information should be available online or from the financial firm holding the assets. If you receive a gift of stock from Uncle Joe, who dimly recalls buying the shares “in the 1980s,” make every effort to find a number that can be justified by hard evidence.

Liquid assets present more of a challenge. Again, try to get a valuation you can support for the basis of assets you receive as a gift. For inherited assets, hire a reputable professional as soon as possible to appraise assets, such as real estate, collectibles and shares of a closely held company.

 Second Look

·       The basis of inherited assets may be affected by the so-called “alternative valuation date.”

·       An estate’s executor can choose to have all the estate assets valued as of six months after death, rather than the date of death, if that will reduce estate tax or the generation-skipping transfer tax.

·       In that case, the valuation six months after death will be the basis of all inherited assets, on future sales by the heirs.

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Lug Nuts and Tax Returns?

The characters in today's episode:Your business is being played by a 2011 Toyota PriusYour business' financial function is being played by a flat Yokonowa 15" tireYour accounting talent is being played by a tire jack kit that came with the 2011 Toyota Prius

I walked into my garage the other day and saw that my front passenger side tire was flat.  I mean, flat....with a huge nail stuck in the top of it.  Being a two car household, I didn't skip a beat as I grabbed the other keys and went about my day.  But, I had the unpleasant task of changing that tire in the back of my mind all day.
It occurred to me that I didn't really understand the function of my tires until they couldn't function.  it didn't matter that I had been driving for 20 years or that I had the car regularly serviced.  When the tire is flat, I'm not going anywhere.

A new start-up or an already-on-fire small business faces a challenge when it comes to the financial functions within the company.  Your internal financial function is like the tires on a car.  If your financials are flat that car is going to have a hard time getting anywhere, reliably.But the nice thing about flat tires, is that there are plenty of people who can fix them... including, perhaps, you.

"I'm a pretty savvy guy, how hard can this really be?  It doesn't cost me anything to change these tires myself, but it costs me $662 to get four new tires from the tire shop and have them put the tires on my car.  I've got YouTube, right?  I can figure this out and save myself some money.  I can take this jack that came with the car and change these tires myself!"

I used the less-than-steller jack and tire iron to remove one flat tire and tighten up the lug nuts on the spare. There were no instructions.  I had no idea if I was doing this correctly. It was in the middle of this, confidence shoot, I realized all the things I didn't know about changing a tire. Once changed, I stared at the spare tire incredulously. I had a vision that I would be driving along to find myself stopped on the road somewhere with a spare tire rolling down the highway and lug nuts on the asphalt...    In the end, I decided to only replace the one flat tire on my Prius with the spare until I could get the car to the shop. I knew that I wasn't the best person to change the tire, so I hired someone else to do it.  What did I purchase?  Four new tires and some labor?
No.  I purchased peace of mind. I purchased experience.  I purchased safe travels in my 2011 Toyota Prius with my family by allowing an expert to put those tires on.

The challenge in your business is understanding how critical the financial function really is. It's so critical that it deserves much more attention than being ignored until the end of the month, or placed into the hands of a receptionist (who is great at that job but has no experience in accounting), or handed to a spouse at the dinner table one night over meat loaf.

  
What does a business pay our firm for when they ask us financial assistance?  Debits and credits? A tax return?No.  They purchase the peace of mind that comes with having accurate financial records and the unlimited expert knowledge that we have gained over years of working with other clients.

So, yeah, I paid $662 for some tires and a pro to put them on.  But more importantly, I paid $662 to guarantee those lug nuts would stay on the tire, the tire on the car, and me on the road.

Tax Free Income From Renting Your Home

From Canton, Ohio, where the Pro Football Hall of Fame Weekend takes place in August, to Los Angeles, which has Haunted Hayrides to celebrate Halloween throughout October, cities small and large host special events throughout the year. 

Moreover, oceanfront communities attract millions of tourists in the summer while mountain regions offer winter sports each winter.

            

What is the common denominator? If you live in an area popular with tourists, for a season or a month or even a day, you can rent your home for a sizable amount. According to some reports, homes in the Augusta, Georgia area rent for as much as $20,000 for the week of the Masters Golf Tournament in April.

Income from such rental activity is legitimately tax-free: you don’t have to report it on your tax return. You can’t deduct any expenses incurred for the rental, but you still can take applicable mortgage interest and property tax deductions for your home with no reduction for the profitable rental period.

Fortune’s fortnight

As you might expect, you have to clear some hurdles to qualify for this tax-free income. Perhaps most important, you must rent the home for no more than 14 days during the year. If you go over by even one day, tax-free taxation will vanish. In that case, you will have to report your rental income, and you may take appropriate deductions, but the process can become very complicated.

In addition to the 14-day limit, the IRS says that you must use the “dwelling unit as a home.” This means that you must use the property for personal purposes more than (a) 14 days or (b) 10% of the days it is rented to others at a fair price, whichever is greater.

Example 1: Jan Harrison lives in Charlotte, North Carolina, throughout the year but rents her home for a week when the Bank of America 500 race is in town. She moves in with her sister and then goes home after the weeklong rental ends. Jan lives in her home well over 300 days in the year, so claiming the tax-free rental income won’t be a problem.

You also can claim this tax break for a vacation home as long as there are at least 15 days of personal use and you keep rentals under 15 days a year. With either a primary residence or a second home, keep careful records to show that you observed the 14-day rental limit.

Proceed prudently

Tax-free income is certainly welcome, but it shouldn’t be your only concern. Keep in mind that you are letting other people occupy your home, perhaps during a time when parties may occur. Make sure you have a formal rental agreement in place and that you collect the rent upfront, along with a deposit for possible property damage. Check with your homeowners insurance agent to see if you need special coverage, and check with local officials to find out if you need a permit for a short-term rental.

            If you decide to use a service to handle the rental and save you some aggravation, ask what fees you’ll owe. In addition, ask if the rental income will be reported to the IRS. Such reports may complicate what can be a straightforward tax benefit; our office can explain the possible problems and solutions.

SC Rental Home?  Check this out.