Short Sales and Tax Implications

Last week we gave you some tips and facts about short selling a property.  This week we would like to continue with the topic of short sales, but this time we are going to go over some of the tax implications involved when you short sale a property.

Photo provided by Wesley Fryer via flickr.com

First of all, you should know that often a short sale results in a cancellation of debt.  That means that the lender reports the difference between what you owed on the property and what you sold it for as income to the IRS, and you are subject to income taxes on that amount.  That can amount to a lot of money in some cases.  However, the IRS has provided for 2 exceptions to paying tax on this amount.  One exception is for those who short sale their primary residence. If you owned the home and lived in it for 2 years, you don’t have to pay taxes on the difference.  You will have to report it on your income taxes and fill out a form to tell the IRS that it was your primary residence.

Second, is for those who have investment (rental) property. If you can be considered “insolvent” the day before the Cancellation of Debit is issued, you don’t have to pay taxes on the difference.  Insolvent means that your debt (what you owe others) is larger than your assets (the value what you own).   Again it must be reported on your tax return.

If the property is not your primary residence or you are not insolvent, you will be required to pay on the amount that is reported to the IRS.  You will receive a Form 1099-C which will tell you the amount and the date of the cancellation of debt.  However, if it is a rental property and you lost money on the sale, sometimes the loss will offset the cancellation of debt.

Short Sales can be very complicated.  We recommend that you contact a real estate professional that is experienced and then contact your tax advisor to find out what the tax implications will be before your complete the short sale process.  It may not change your mind about going through with it, but at least you will be prepared at tax time.

Remember, it is important to have  a basic knowledge of the tax system-not just when you are dealing with short sales, but with all your financial decisions.  We have a great tool to help you gain the essential knowledge of the tax system. Check out avoidbeingaudited.com to learn more.

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It’s our 50th Post! Let’s Talk About Short Sales

Today we are posting our 50th post! This is exciting for us, and we hope you have found the information on this blog very useful.  We hope to continue that helpfulness today by sharing some information about Short Sales.

Photo provided by Casey Serin via Flickr.com

The current economic condition has caused a flood of short sales in the real estate industry.  A short sale occurs when what is owed on a property is more than its value.  So, in order to sell the property, you have to negotiate with the lender and settle for a lesser payoff amount.  Even though this has become a common way to sell a property, how it works has remained confusing to many.  So, in an effort to clarify this practice we will give you some of the key facts about short sales.

Short Sales Facts

  1. When considering a short sale, lenders generally look for two things:  a verifiable hardship such as a job loss, pay cut, illness, etc and lack of liquid assets that could be sold that would allow you to pay down the mortgage.
  2. About 85% of short sales applied for go through.  However, they take a long time, anywhere from 30 days to 2 years.
  3. For the most part, banks would rather approve a short sale than foreclose.  They lose less money on a short sale and they avoid the hassle and liability of vacant properties.
  4. Even though it takes time to negotiate a short sale, there are times when starting a short sale process can postpone or even stop the auction sale of a property.
  5. It is best to make one short sale offer at a time to avoid clogging the system.
  6. Negotiating a short sale can be tricky.  It is wise to hire someone who has experience in short sales to make sure you are protected.
  7. Short sales are not as financially damaging as a foreclosure. They don’t present problems with employment or security clearances.  Home owners who go through foreclosure are not eligible for a Fannie Mae backed mortgage for 5 years.  Those who go through a short sale are eligible for a Fannie Mae backed Mortgage in 2 years.

We hope you find these facts helpful.  We will continue this discussion next week by explaining the tax implications involved with Short Sales.  If you want to learn more about tax implications for short sales and other tax deductions, click here.

Gambling Winnings: How to Record them Correctly

Many people find gambling enjoyable and relaxing. It can be a nice break to go to a casino and spend time at the slots or tables.  A big problem we see as accountants is that most people don’t understand how the winnings affect their tax return.  Here are a couple of examples.

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About 25 years ago a good friend of mine called me and told me her elderly parents had gone to Wendover, NV and won $50,000 playing a quarter slot machine.  They lived on their Social Security and had not been required to file a tax return in several years.  They wanted to use the money to buy a house, you could do that 25 years ago, but were scared about how much taxes they would have to pay.  It turned out they were able to pay the tax and buy a house, but because of the added income, they had to pay taxes on their social security income, which they normally would not have had to do.

Another couple I know lived in a town with several casinos.  One of their past times was going to the casino after work.  Over the course of a year, they had won $250,000.  However, they had actually spent more than their winnings.  They both had good jobs and only one dependent.  When we figured their taxes they owed a lot of money.  They couldn’t understand why they owed so much when they spent more than they won.

It wasn’t an accounting error; gambling winnings and expenses are taxed differently than other income and expenses. Let me explain.  Your winnings are included in your adjusted gross income, but what you spend is deducted on a Schedule A.  Now, if your adjusted gross income is too high, the IRS places limits on what you can deduct on your Schedule A and other places including medical expenses, college tuition credits, child tax credits, exemptions and employee business expenses.  These deductions are limited before your gambling losses are deducted.  This means that even if you break even with your gambling winnings you are going to loose valuable tax deductions, which will cost you even more money.

There are some things you can do to minimize your tax liability from gambling winnings. You should also be very careful with how you record your winnings because the IRS watches this deduction, and it can be a huge red flag for the IRS. To learn more about how to plan for gambling winnings on your taxes and record them correctly to avoid being audited by the IRS, click here.

Tax Deductions for Paying your Children

Owning and running a business can be rewarding and challenging. Over the years we have noticed that many business owners utilize their spouses and children. If you have children old enough to perform a task, you know what we mean.  Not only is it cost effective to have your children help but many times it is a way to spend quality time together and to teach your children values like hard work and helping one another.

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What many people don’t realize is that while you are spending time with your children and teaching them, you can also create a legitimate tax deduction.  This means that you are allowed to pay each child a certain amount each year for helping you in your business.  There are some specific guidelines such as paying them according to their age and the task performed.  You can’t pay the 5 year old $2000 for emptying the trash in the office one time.  There are also specific rules on how to keep track of what each child does and how you can pay them.

Although there are specific guidelines to follow, there is a wide range of what you can pay your children to do.  We have seen construction workers take their children to help with clean up.  We have seen realtors have their children help deliver flyers.  We have seen day care providers have their children help with cleaning and preparation.  We have even had a vet pay his daughter to come in and help feed and care for the animals.

This is another way of deducting money you are already going to pay out.  How many times have you told your children that if they help you with a task you will buy them that pair of designer jeans or pay for Little League?  Of course you will pay your children to help you. Why not put in a little more effort and make it tax deductible?

At Soulence Tax and Accounting, we encourage business owners to take advantage of all the available tax deductions. For more information about how to properly pay your children and other tax deductions you may qualify for, visit avoidbeingaudited.com.

Information for this post provided by Matthew Anderson of Soulence Tax and Accounting.

Watch Out! Fees for Filing Late are on the Rise

There is a lot of controversy about the current spending habits of our Federal Administration.  Because of the many bailouts and several other reasons, our national debit is at a record high and getting bigger every minute.  This has caused the IRS to start looking for ways that they can collect money, and they are changing their practices to bring in revenue. One major change we are seeing is that the IRS is looking at all the laws that they haven’t been as “strict” on over the past few years and finding ways to cash in on them.

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One of the ways that the IRS is changing its practices is with late penalties for filing information returns. An information return is one that is filed with the IRS but doesn’t have a tax attached to it.  Income tax returns for S Corporations, LLC’s, and Partnerships are all information returns because they are flow through entities and the taxes are paid by the owners of the entities on their personal tax returns.  So these returns simply report to or inform the IRS about the income and expenses of the entity. Also included with information returns are the IRS’s copy of 1099 forms and W-2 forms.  So if you do not file these on time the IRS will fine you.

In the past if you filed an information return late, you may or may not have received a penalty. The enforcement of the late penalty was pretty inconsistent even though the IRS rules provide for a penalty for late filing, and until now, it hasn’t been strictly enforced.  Most of the time, we could simply write a letter and get the penalty waived.  The IRS has noticed that this penalty has the potential to bring in millions of dollars of revenue so, they are not only sending more letters  for penalties for filing late, but they have upped the penalty from $400 a month per owner to $1000 a month per owner, and they are not waiving the penalties.

So what does this mean to you if you file a late entity return?  Let’s say you have a LLC with 3 members and you file your return 3 months late.  You will now receive a penalty of $9000. ($1000 x 3 Owners x 3 Months = $9000 Late Penalty) Kind of makes you want to file on time – doesn’t it?

Remember that Corporation tax returns are due March 15th and LLC and Partnership returns are due April 18th this year. If you need help in filing an extension let us or your accountant know one week ahead of the due date so that we can get confirmation that the extension was filed and accepted.  With the IRS growing more strict, we need to have this documented proof of extensions and filings.