Tax Update Fall 2017
Congress and the White House have yet to agree on legislation which addresses the issues of the Affordable Care Act (aka Obamacare) and what tax law changes will be taking place this year.
One of the main issues concerns the treatment of debt forgiveness for your primary residence—whether it be an abandonment of the property or partial loan modification. Since 2007 this income has been exempt from tax under the Mortgage Debt Forgiveness Act, which expired at the end of 2016.
We are tracking what is happening with any potential tax legislation that may affect your tax liability for 2017.
In this newsletter we address how the forgiven debt is treated on your tax return in the event the Mortgage Debt Forgiveness Act is not reinstated.
We are also addressing some questions on tax provisions that we have received from you here in the office.
If you have any questions regarding the following topics or any other tax issues please be sure to contact our office.
Cancellation Of Debt-Insolvency
The Mortgage Debt Forgiveness Act, which treated the debt forgiven on your primary residence as nontaxable income, expired on December 31, 2016 and has not yet been reinstated by Congress—and may not be. If you had debt forgiveness from your mortgage company or had a loan modification that reduced the amount of the indebtedness then you may receive a notice for cancellation of debt.
Taxpayers with cancelled debt can often exclude the cancellation of debt income to the extent they were insolvent immediately before the cancellation. If a cancelled debt is excluded from income, it is nontaxable. Generally, cancelled debt that is excludable from income is debt that is discharged in a bankruptcy.
Cancellation of Debt
Cancellation of debt (COD) is settlement of a debt for less than the amount owed. A debt may be cancelled by a lender voluntarily or through bankruptcy or other legal proceedings and may result in ordinary income, income from the sale of assets (capital gain), or both.
Form 1099-A, Acquisition or Abandonment of Secured Property
If your lender foreclosed on your mortgage or repossessed property as a result of a defaulted loan then each borrower will receive Form 1099-A if, in full or partial satisfaction of the debt, they acquire an interest in the property. You need not be in the business of lending money to be subject to this reporting requirement.
Form 1099-C, Cancellation of Debt
If your lender cancels or forgives a debt of $600 or more, it must provide the borrower with Form 1099-C, showing the amount of cancelled debt to be reported as income. Generally, individual taxpayers must include all cancelled amounts, even if less than $600, as Other Income on line 21, Form 1040.
Coordination Form 1099-A with Form 1099-C
If, in the same calendar year, a debt is canceled of $600 or more in connection with a foreclosure or abandonment of secured property, you may not receive both Form 1099-A and Form 1099-C, Cancellation of Debt, for the same debtor. You may receive Form 1099-C only.
Examples of COD Income
Nonbusiness credit card debt cancellation: if non-business credit card debt is cancelled, the taxpayer may be able to exclude the cancelled debt from income up to the extent he or she is insolvent.
Personal vehicle repossession: if the taxpayer had a personal vehicle repossessed during the year, the transaction is treated as a sale, and gain or loss on the repossession must be computed. If the lender also cancels all or part of the remaining debt, the taxpayer may be able to exclude the cancelled debt from income to the extent he or she is insolvent.
A taxpayer is insolvent to the extent that the total of all their liabilities exceeds the fair market value (FMV) of all their assets immediately before the cancellation of debt.
For purposes of determining insolvency, assets include the value of everything the taxpayer owns (including assets that serve as collateral for debt and exempt assets which are beyond the reach of creditors, such as the value of a retirement account). Liabilities include the following items.
Example #1 – Amount of Insolvency More Than Cancelled Debt
Jill was released from her obligation to pay her personal credit card debt in the amount of $5,000. Jill received a Form 1099-C from her credit card lender showing cancelled debt of $5,000. Jill uses the insolvency worksheet to determine that her total liabilities immediately before the cancellation were $15,000 and the FMV of her total assets immediately before the cancellation were $7,000 which means that immediately before the cancellation, Jill was insolvent to the extent of $8,000 ($15,000 total liabilities minus $7,000 FMV of her total assets). Because the amount by which Jill was insolvent immediately before the cancellation was more than the amount of her debt cancelled, Jill can exclude the entire $5,000 cancelled debt from income.
Example #2 – Amount of Insolvency Less Than Cancelled Debt
Assume the same facts as Example #1, except that Jill’s total liabilities immediately before the cancellation were
$10,000 and the FMV of her total assets immediately before cancellation were $7,000. In this case, Jill is insolvent
to the extent of $3,000 ($10,000 total liabilities minus $7,000 FMV of her total assets) immediately before the cancellation. Because the amount of the cancelled debt was more than the amount by which Jill was insolvent immediately before the cancellation, Jill can exclude only $3,000 of the $5,000 cancelled debt from income under the insolvency exception. Jill must include $2,000 of cancelled debt as an addition to her income, unless another exclusion applies.
Business Use of Home
We have addressed business expenses and substantiation issues in past newsletters. One of the more popular business expenses for home-based businesses is the home office deduction. The IRS code states that the space used for the home office must be used exclusively and regularly for the operation of the business. No other activity can be conducted in the home office to qualify for the tax deduction. If the taxpayer uses the room for any other purpose (such as a guest bedroom or place for students to prepare their homework) then the home office deduction is not allowed.
Some expenses are deductible whether or not a taxpayer uses his or her home for business. Others are deductible only if the home is used for business.
Expenses that benefit only the area exclusively used for business, such as painting or repairs in the home office, are direct expenses that are fully deductible.
Expenses for keeping up and running the entire home, such as insurance, utilities, and general repairs, are indirect expenses that are deductible based on the percentage of the home used for business.
Expenses for the part of the home not used for business, such as lawn care or painting a room not used for business, are unrelated expenses that are not deductible.
The basic local telephone service for the first telephone line is nondeductible even if it is used for business. Any additional charges for long distance or a second line into the home used for business are deductible. Any deductible telephone costs are not included as business use of home cost.
A qualified home office is considered non-residential real property depreciable over 39 years. For home office depreciation, the basis in the home is the smaller of:
Permanent improvements prior to using the home for business are added to the basis of the home and depreciated as part of the adjusted basis of the home. The cost of improvements made after using the home for business that affect the area of the home used for business are depreciated separately.
EXAMPLE: Rita had a new roof put on her home in 2000. She first used her home for business in 2004. She also replaced her furnace in 2017. The cost of the new roof from 2000 is added to the basis of her home, and the business portion is depreciated starting in 2004. The business portion of the cost of the furnace is depreciated as a separate asset starting in 2017.
Calculating Business Use of Home Deduction
The business percentage equals the area of the part of the home used for business divided by the area of the whole house. Any reasonable method may be used to determine the business percentage.
The following are two common methods.
Do not include home expenses in the business use equation for any period during the year where the home was not used for business.
Day Care Facility
The business percentage of an area exclusively used for business in a day care facility is calculated under the business percentage method above. For the portion of the home regularly used, but not exclusively used for the day care business, multiply that portion by the business percentage of time.
EXAMPLE: Jane uses her 1,600 square foot basement for day care. The total area of her home is 3,200 square feet. Her day care uses the basement an average of 12 hours per day, five days a week, 50 weeks per year. The basement is used by her family at night and on weekends. The business percentage of her home is calculated as follows: 1,600 ÷ 3,200 = 50%. 12 x 5 x 50 = 3,000 day care hours per year. 24 x 365 = 8,760 total hours per year. 3,000 ÷ 8,760 = 34.25% day care time percentage. Any direct expenses, such as repainting the basement, are multiplied by 34.25% to determine the deductible business portion of the expense. Any indirect expenses, such as utilities, are multiplied by 17.13% (50% x 34.25% = 17.13%) to determine the deductible business portion of the expense.
DID YOU KNOW? In many cases, the basement and garage may be included in the total square footage of a day care provider’s home when calculating the business use percentage. In addition to used rooms, area can include:
Calculating Time Spent on Day Care
The provider should keep a log reflecting time spent conducting the day care busi-ness, including dates and hours each person was in the provider’s care, and additional time spent organizing, prepar-ing meals, and cleaning up.
The business use of home deduction is limited to net income from the business.
Carryover of Unallowed Expenses
Deductions not allowed due to the net income limitation are carried over to the following year. They are added to current expenses from each category and subject to the deduction limit for that year for that category, whether or not the taxpayer lives in the same home during that year.
Simpliﬁed Option for Home Ofﬁce Deduction
The simplified option for the home office deduction may be calculated as follows:
NOTE: Although record keeping is simplified, this option does not change the criteria for who may claim a home office deduction.
Dependent Support Worksheet
We regularly receive questions from clients about the ability to claim a family member or friend as a dependent on their tax return. The IRS has issued guidance of how to determine whether the person living in your household is eligible to be claimed as a dependent on your individual income tax return.
The support test is one of the factors used to determine eligibility for the dependency exemption for another person. This person may be your qualifying child or qualifying relative.
What is considered support?
Total support includes amounts spent to provide food, lodging, clothing, education, medical and dental care, health insurance, recreation, transportation, and similar necessities.
When Should You Include Support Items?
A qualifying item is included in total support in the year it is paid. This is true even if you paid for the item with borrowed money that you repay in a later year.
If someone new has been added to your household, contact our office if you need help in determining whether they can be included on your tax return and the documentation that will be needed at tax time.
For more information, please contact me.
Contact the office if you have any questions regarding these issues or any changes in your household that may have an impact on your tax filing requirements.
As your tax professional, I assure you that I will be keeping a watchful eye on Congress and on IRS actions which may affect your business and your tax filings in the New Year. I will be happy to address any concerns and answer questions you have about any of the issues covered in this newsletter. Thank you for the opportunity and privilege of allowing me to serve as your tax professional this past year.
Stephen W. McKown
Did you ever notice that when you put
the words “The” and “IRS” together, it spells
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