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Pamela Avraham

Still Time to Save on 2018 Estate and Trust Income Taxes

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  Distribute by March 6, 2019 to Reduce High Estate & Trust Income Taxes 

Tax Savings for Estates and Trusts

If you are the executor of an estate or the trustee of a trust, you should know that egregiously high income tax rates apply to estates and trusts at very low levels of income.  Despite the new tax act, in 2018, for estates and trusts, a 37% income tax rate as well as the 3.8% Net Investment Income (NII) tax kicks in at $12,500 of income. That’s not very high.   For example, let’s say an estate has income of $212,500. The tax on the $200,000 (income in excess of the $12,500 threshold), at 40% equals a tax of $80,000. Ouch! 

Help! Is there any hope?

Yes, the estate and trust only pays tax on what’s not distributed. Distributions lower the income tax for the trust and at the same time increase the recipient’s personal income tax. However, individuals do not pay the highest rates unless they are wealthy. In our example, if there are four beneficiaries and each receives $50,000 (one-fourth of the $200,000) many individuals will only pay 10% – 24% on that $50,000 instead of 40%.  Potential tax saving could range from $32,000 to $60,000 depending on the individual tax bracket of each beneficiary.

Is there anything I can do?

It’s not too late. There’s a rule allowing distributions made in the first 65 days of the next year to be treated as if made in the preceding year. A special election must be made on the Fiduciary Income Tax Return.  This year’s deadline is          March 6, 2019. Executors and trustees should act soon to take advantage of this opportunity for substantial tax savings.

Please contact us for assistance with making distributions or any other tax related questions about managing a trust or estate.

 

Tax Ramifications of Investing in Real Estate

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Investing in residential rental properties    raises various tax issues that can be somewhat confusing, especially if you are not a real estate professional. Some of the more important issues rental property investors will want to be aware of are discussed below.

Jersey Shore Home

Rental Losses

Currently, the owner of a residential rental property may depreciate the building over a 27½-year period. For example, a property acquired for $200,000 could generate a depreciation deduction of as much as $7,273 per year. Additional depreciation deductions may be available for furnishings provided with the rental property. When large depreciation deductions are added to other rental expenses, it’s not uncommon for a rental activity to generate a tax loss. The question then becomes whether that loss is deductible.

$25,000 Loss Limitation

The tax law generally treats real estate rental losses as “passive” and therefore available only for offsetting any passive income an individual taxpayer may have. However, a limited exception is available where an individual holds at least a 10% ownership interest in the property and “actively participates” in the rental activity. In this situation, up to $25,000 of passive rental losses may be used to offset nonpassive income, such as wages from a job. (The $25,000 loss allowance phases out with modified adjusted gross income between $100,000 and $150,000.) Passive activity losses that are not currently deductible are carried forward to future tax years.

What constitutes active participation? The IRS describes it as “participating in making management decisions or arranging for others to provide services (such as repairs) in a significant and bona fide sense.” Examples of such management decisions provided by the IRS include approving tenants and deciding on rental terms.

Selling the Property

A gain realized on the sale of residential rental property held for investment is generally taxed as a capital gain. If the gain is long term, it is taxed at a favorable capital gains rate. However, the IRS requires that any allowable depreciation be “recaptured” and taxed at a 25% maximum rate rather than the 15% (or 20%) long-term capital gains rate that generally applies.

Exclusion of Gain

The tax law has a generous exclusion for gain from the sale of a principal residence. Generally, taxpayers may exclude up to $250,000 ($500,000 for certain joint filers) of their gain, provided they have owned and used the property as a principal residence for two out of the five years preceding the sale.

After the exclusion was enacted, some landlords moved into their properties and established the properties as their principal residences to make use of the home sale exclusion. However, Congress subsequently changed the rules for sales completed after 2008. Under the current rules, gain will be taxable to the extent the property was not used as the taxpayer’s principal residence after 2008.

This rule can be a trap for the unwary. For example, a couple might buy a vacation home and rent the property out to help finance the purchase. Later, upon retirement, the couple may turn the vacation home into their principal residence. If the home is subsequently sold, all or part of any gain on the sale could be taxable under the above-described rule.

2018 Tax Changes

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The Tax Cuts and Jobs Act (TCJA) raises many questions for taxpayers looking to plan for the coming year. Below are answers to some of them.

Tax Savings

Can I take advantage of the new deduction for pass-through business income?

The new rules for owners of pass-through entities — partnerships, limited liability companies, S corporations, and sole proprietorships — allow them to deduct 20% of their business pass-through income. The 20% deduction is available to owners of almost any type of trade or business whose taxable income does not exceed $315,000 (joint return) or $157,500 (other returns). Above those amounts, the deduction is subject to certain limitations based on business assets and wages. Different deduction restrictions apply to individuals in specified service businesses (e.g., law, medicine, and accounting).

Can I still deduct mortgage interest and real estate taxes paid on a second home?

Yes, but the new rules limit these deductions. The deduction for total mortgage interest is limited to the amount paid on underlying debt of up to $750,000 ($375,000 for married individuals filing separately). Previously, the limit was $1 million. Note that the new restriction will not apply to taxpayers with home acquisition debt incurred on or before December 15, 2017. Additionally, the deduction for interest on home equity loans (new and existing) is suspended and will not be available for tax years 2018-2025.

Note that the law also establishes a $10,000 limit on the combined total deduction for state and local income (or sales) taxes, real estate taxes, and personal property taxes. As a result, your ability to deduct real estate taxes may be limited.

Are there any changes to capital gains rates and rules that I should know about?

The rules concerning how capital gains are determined and taxed remain essentially unchanged. But since short-term gains (for assets held one year or less) are taxed as ordinary income, they will be taxed at the new ordinary income rates and brackets. Net long-term gains will still be taxed at rates of 0%, 15%, or 20%, depending on your taxable income. And the 3.8% net investment income tax that applies to certain high earners will still apply for both types of capital gains.

Can I still deduct my student loan interest?

Yes. Although some earlier versions of the tax bill disallowed the deduction, the final law left it intact. That means that student loan borrowers will still be able to deduct up to $2,500 of the interest they paid during the year on a qualified student loan. The deduction is gradually reduced and eventually eliminated when modified adjusted gross income reaches $80,000 for those whose filing status is single or head of household, and over $165,000 for those filing a joint return.

I have a large family and formerly got to take an exemption for each member. Is there anything in the new law that compensates for the loss of these exemptions?

The new law suspends exemptions for you, your spouse, and dependents. In 2017, each full exemption translated into a $4,050 deduction from taxable income which, for large families, added up. Compensating for this loss, the new law almost doubles the standard deduction to $12,000 for single filers and $24,000 for joint filers. Additionally, the child tax credit is doubled to $2,000 per child, and the income levels at which the credit phases out are significantly increased. Depending on your situation, these new provisions could potentially offset the suspension of personal exemptions.

I have been gifting friends and relatives $14,000 per year to reduce my taxable estate. Can I still do this?

Yes, you may still make an annual gift of up to $15,000 in 2018 (increased from $14,000 in 2017) to as many people as you want without triggering gift tax reporting or using any of your federal estate and gift tax exemption. But TCJA also doubles the exemption to an estimated $11.2 million ($22.4 million for married couples) in 2018. So anyone who anticipates having a taxable estate lower than these thresholds may be able to gift above the annual $15,000 per-recipient limit and ultimately not incur any federal estate or gift tax. Note, however, that the higher exemption amount and many of TCJA’s other changes to personal taxes are scheduled to expire after 2025, unless Congress acts to extend them.

NJ Tax Amnesty Program -Running Now!

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The Clock is Ticking…NJ Tax Amnesty Program Runs Through Jan. 15, 2019  

Gift from State of NJ

Businesses and individuals with unpaid NJ tax liabilities may be able to get a break on penalties under the Amnesty Program  which is in effect from November 15, 2018 through  January 15, 2019.  The measure applies to all state taxes including  gross income,   corporate business tax and sales and use tax.  However, it does not apply to unemployment  type taxes administered by the Department of Labor.   

 Why should I do this now? Because under this limited-time offer the Division of Taxation will forgive all penalties, and one-half of the accrued interest due at Nov. 1, 2018. 

 Here are some of the details 

  • NJ Amnesty will provide relief for 2008 – 2016 delinquent individual or business tax return filers. 
  • Requests for amnesty must be filed electronically 
  • The Division of Taxation recently mailed a letter to all taxpayers who are known to have amnesty-eligible deficient and/or delinquent accounts 
  • If you didn’t receive a letter and you want to participate, you will need to register or self-report through the Non-Outreach Portal 
  • Federal tax liabilities are not included under the program 

 Is there a hitch? Sort of. The bad news is that if a taxpayer is eligible for amnesty and does not take advantage of it, an additional 5% penalty will be added to the already imposed penalties and interest on the original tax liability.   

To see if this program might be right for you, please contact our Tax Manager, Steven Citron.