Richard A. Lindsey, CPA

Lindsey & Waldo, LLC – Certified Public Accountants

  • Feb 25

    Not reporting or under reporting rental income contributes to the tax gap. Landlords need to be aware of everything that counts as income and what expenses are deductible.

    What is the Tax Gap?

    In its simplest terms the Tax Gap is the difference between what the Internal Revenue Service estimates it should collect and what it actually collects in a given tax year through voluntary compliance. In 2005, the IRS estimated this tax gap to be approximately $345 billion. Individual income tax accounts for over 71 percent of the tax gap, due in large part to the fact that individual income tax is the largest source of federal receipts. It is also estimated that rental and royalty income is being underreported by over 51 percent. These estimates, which remain the most recent estimates available, were compiled using data collected in tax year 2001 and before.

    As a direct result of the IRS’ mandate to close the Tax Gap, audits of individual income tax returns increased by 77 percent between 2001 and 2006, when they conducted nearly 1.3 million audits.

    What Do I Have to Include as Rental Income?

    In the simplest terms, rental income is any payment received for the use or occupation of property. In addition to normal rental income there are other forms of income that may need to be included in your rental income.

    An advance rental payment is one you receive before the period it covers. For example, you sign a 10-year lease to rent your property.

    When the lease is signed you receive $5,000 for the first year’s rent and $5,000 as rent for the last year of the lease. You must include $10,000 in your income in the first year.

    Security deposits are considered advance rent if used as a final payment of rent and should be included in your income when received. However, if you plan to return the security deposit to your tenant at the end of the lease, do not include it in your income. But if you keep any part of the security deposit because your tenant does not live up to the terms of lease, include the amount you keep in your income in that year.

    Payment for cancelling a lease occurs if your tenant pays you to cancel a lease. Report the payment as rental income in the year you receive it.

    If your tenant pays any of your expenses, the amount must be included in rental income. You may also be able to deduct the expenses. For example, your tenant pays the property taxes and deducts that amount from the normal rent payment because the lease does not require them to pay it. Include the amount the tenant paid as rental income and deduct the property taxes as a rental expense.

    Property or services received in lieu of money must be included in your rental income based on the fair market value of the property or services. For example, your tenant is a painter and you agree to let her paint your property in exchange for two months rent. Include in your rental income the amount the tenant would have paid for two months rent.

    Lease with an option to buy payments are usually counted as rental income. If the tenant buys the property, payments received after the sale date are generally counted as part of the selling price.

    What Deductions Can I Take as Rental Expenses?

    You can deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as mortgage interest, property taxes, advertising, maintenance, utilities and insurance. This includes expenses incurred from the time the property is made available to rent and is actually rented.

    The cost of repairs to your rental property is also deductible. This includes the cost of labor and materials. However, you cannot deduct the cost of your own labor. A repair keeps your property in good operating condition and does not materially add value to the property. Examples include painting, fixing leaks and replacing broken windows.

    An improvement, such as a new deck or fence, is something that adds value to your property, prolongs its useful life, or adapts it to new uses. The cost of improvements cannot be deducted and must be recovered through depreciation.

    What Records Should I Keep?

    Good records are the best defense in the event of an audit. You must be able to document your income and expenses. Good records will also help you prepare your tax return.

    Keep track of any travel expenses, such as mileage, you incur for your rental properties. A mileage log detailing your trips for showing the property and for repairs is the best documentation for travel expenses. Separate your receipts for minor repairs from those for capital improvements.

    You must be able to substantiate certain expenses in order to deduct them. Generally you must have documentary evidence, such as receipts and cancelled checks, to support your expenses.

    In the event of an audit, items on your tax return that you cannot support will be disallowed by the IRS and you may be subject to additional tax, penalties and interest. Good records will support the income and expenses on your tax return and help you avoid costly errors.

  • Feb 18

    When I recently asked a group of small business owners, managers and salespeople this question most of the answers I got related to that person’s particular product or service. But is that what people really buy? Your product or service?

    Great customers are everywhere! People need and want to be safer, richer, more successful, healthier, and happier. The list of human desires is endless! And that means that opportunities to serve others and increase your business are also endless. Are you taking advantage of that fact?

    People buy benefits! They buy things that make their lives better. They buy solutions. They buy comfort, safety, health, and happiness. Very few people buy nutrition – they buy health. Very few people buy transportation – they buy economy, safety, or sex appeal. What benefits are you selling?

    “Customers are best heard through many ears.”

    Describe the benefits of your product or service from the customer’s perspective. Emphasize its selling points. Successful business owners know or at least have an idea of what their customers want or expect from them. This type of anticipation can be helpful in building customer satisfaction and loyalty. The description of your product should include decisions about package design, brand, trademarks, warranties, guarantees, product life cycles, and new product development.

    Clients respond to and buy what your product or service will do for them. This has often been called “selling the sizzle…not the steak!”

    So when you’re marketing your product or service, when you’re selling your company or yourself tell people what you’re selling in terms of what the results will be and you’ll be abundantly more successful.

  • Feb 14

    You may have heard or seen the ads by American Tax Relief and others. The companies brag about their ability to settle your overdue taxes for a fraction of what you owe. You may have seen actors on television portray themselves as wealthy clients who owed the government thousands, hundreds of thousands or even millions of dollars and were able to settle for pennies on the dollar with the help of the advertiser. The implication is always that the individuals were able to continue their previous lifestyles while escaping their tax debts and you can too.

    What you may not have heard is that federal authorities say the owners of American Tax Relief were living the high life behind the wheels of a Ferrari, Rolls Royce, Bentley and two Porsches while bilking their customers out of more than $60 million because few customers ever saw the promised tax relief.

    In early October the company, which had its California business license suspended last year for failing to pay its own income taxes, was shut down by the Federal Trade Commission.

    According to an October 6, 2010 article on WebCPA, American Tax Relief charged up-front fees ranging from about $3,200 to $25,000 for the purported tax relief services. The company’s ads included a toll-free number for consumers to call for a “free consultation.” After speaking briefly with a commission-based sales person who was supposedly a tax consultant, virtually all consumers were told that they qualified for a tax relief program and that American Tax Relief could help them significantly reduce their tax debts.

    In reality few of the company’s customers qualified for the promised tax relief programs, which are available only in very limited circumstances. According to the FTC, most people who hired the company would, at most, qualify for an installment agreement which still requires that the amount of the debt be paid in full.

    The tax debt relief program is referred to by the IRS as an offer-in-compromise. If you don’t know, an offer-in-compromise is an agreement between a taxpayer and the IRS where the government accepts less than the full amount owed in exchange for the taxpayer’s promise to abide by the tax laws for at least five years.

    The idea of an offer-in-compromise is sound – when it is utterly hopeless for a taxpayer to be expected to pay off his or her tax liability, then the amount to be paid is discounted to a manageable amount and the taxpayer starts over. The uncollectible tax is written off of the IRS’ books.

    The most common reason for the government’s acceptance of an offer-in-compromise is doubt as to collectability. That is, doubt exists, on the part of the IRS, that the taxpayer could pay the full amount of the liability within the remaining statutory period for collection.

    In making its determination about your ability to pay, the IRS says you should be able to use the full fair market value of the equity in all your assets –home, cars, stocks and bonds, retirement accounts,– plus four, five or more years’ worth of future income to pay toward your tax debt.

    Despite the IRS’ claims that it would be more considerate of taxpayer’s financial difficulties in these particular economic times, from 2001 to 2009, offers-in-compromise accepted by the IRS declined 72 percent. Conversely, the number of offers submitted increased 18 percent from 2008 to 2009 alone.

    My advice is to approach an offer-in-compromise with care. Expectations should not be too high for a favorable outcome, no matter what representations are made by actors on television.