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By Zinner & Co.
Tax Services Department 

By the Tax Services Department

You’ve finally made the decision to become one of “those people.”  You know, the person who, as was drawing closer to retirement (and coincidently, during one of the never-ending sub-zero days of winter), decided that living somewhere south of the Mason-Dixon line  just made sense. You meticulously planned to move south to retire. But, before you settle back in the lounge chair twirling the paper umbrella as it shades your Pina Colada, you may want to ensure you have all of your assets in order.

By Tax Services Department

I once had a wealthy client who was a private business owner that wanted to gift a vacation home to his children.  Based on prior gifting, to transfer the property outright, he would have incurred a 40% gift tax rate on a portion of the value of the home because the fair market value was in excess of their remaining gift tax exemption. 

As his advisor, we had discussed his long-term financial goals and created an Ohio limited liability company so the vacation home could be deeded into the LLC.  Since the home was now an LLC asset, he had a qualified professional perform a valuation of the LLC. 

Assigning several “discounts” for the value of the LLC , when he transferred the LLC ownership to the children, he was able to reduce the fair market value of the vacation home by using a 30% discount per the valuation.  This simple planning allowed him to transfer the vacation home to his children without incurring any gift tax.

Needless to say, valuation discounts are a very important and significant component of estate planning.  The two main discounts are lack of control and lack of marketability.

Lack of Control
Typically, when ownership of a family business is gifted to family members of a lower generation, the control stays with the older generation by the use of voting and non-voting stock.  While the IRS originally maintained that valuation discounts for minority interests (lack of control) were not available, the IRS changed its position in 1993, in Revenue Ruling 93-12. 

Lack of Marketability
In addition, a discount for a lack of marketability has been allowed because the Family Limited Partnership (FLP) units are not sold in the stock or other open market and are not easily valued.  The lack of marketability discount is available because of the difficulty of selling “hard to value” assets. This opened the door for FLPs and family limited liability companies (FLLCs) to become very useful estate planning tools. 

The countdown clock has begun for the opening of the Republican National Convention. It is estimated that 50,000 people will descend upon Cleveland in July of 2016, spending an estimated $200 Million on everything from political paraphernalia  to Parma pierogis.  With so many people coming to the city, hotels will be hard-pressed to accommodate such a large influx of visitors over a short period of time.  However, this may present an opportunity for you to be an Airbnb host. 

What is Airbnb?  Airbnb is a relatively new online marketplace that enables people to rent out lodging for periods ranging from just a few days to up to a month.  With the advent of this marketplace, travelers now have more travel accommodation options available to them than ever before.  Accommodations available on the site have included apartments, houses, castles, treehouses, and boats.  If you plan to take advantage of this opportunity to become an Airbnb site, it’s important to understand the tax reporting requirements related to that activity.

• If you rent out all or part of your home or apartment for less than 15 days during the year, all of the rental income you receive is tax-free and does not need to be reported on your tax return.  To qualify for this treatment, the home or apartment must be used personally for more than 14 days or 10% of the total days the home is rented to others at a fair rental price.  It should be noted that the 10% calculation does not take days the property was vacant into account, including days the owner spends principally on repairs and maintenance. 
• In addition, there are strict limitations in place to ensure that you don’t deduct any personal expenses.   You are allowed to deduct 100% of your direct rental expenses, subject to the limitation mentioned above.  These are expenses that apply only to renting the property, such as fees or commissions you pay to the rental agency (such as Airbnb), advertising, credit checks, insurance (for the rental period only), cleaning costs, repairs (solely for the rental portion of your home), and depreciation (limited to the rental portion of the home).   You may also deduct a portion of your general expenses to own and operate your entire home, such as mortgage interest and real estate taxes, utilities, insurance, cleaning expenses, repairs, landscaping, and other home maintenance expenses.  You must allocate the deduction for these general expenses based on the amount of time the property served as a rental, compared to the total time it was used during the year.  
• If you continue to occupy the home or apartment while you rent out a room, you won’t have an issue with meeting the personal use requirement.  Personal use includes all days the property was used by the owner, certain family members, and any party that was charged less than fair market rental rates.  If you rent out the entire space, you’ll have to make sure to keep track of the number of days the home is rented and how many days you utilize the home personally.  This tax break is often referred to as the “Masters exemption” because of its popularity in Augusta, Georgia, where it is utilized heavily for the golf tournament of the same name.  If you fall under this exemption, you may exclude the rental income you collect and include 100% of the qualified residence interest expense and real property taxes as deductions on Schedule A.  However, you will not be able to take any other deductions resulting from operating expenses related to the rental period. With the increase in use of this exemption and the popularity of services such as Airbnb, there has also been an increase in the number of computer-generated tax notices due to conflicting tax reporting.  This generally results from the issuance of 1099 tax forms by the service companies who facilitate the rental being sent to the taxpayer/landlord, and the taxpayer/landlord not reporting the rental income on their tax return.  The IRS has yet to address this issue, and Airbnb is standing by its conservative approach of filing 1099’s regardless of the term of the rental.  You may attach a statement claiming the exemption to your tax return, but this may not always prevent a tax assessment notice from being sent by the IRS.  The best practice is to maintain detailed records in the event you must respond to such a notice, should you meet the tax-free rental treatment.
• If you rent your main residence, house, or apartment for more than 14 days during the year, and live in it 15 days or more, you won’t qualify for tax-free treatment.  In this case, you’ll fall under Section 280A of the Internal Revenue Code (IRC), the code section covering the rental of vacation homes.  You’ll have to report and pay income tax on your net rental income by filing Schedule E with your individual tax return.  You will be permitted to offset the rental income received by the expenses associated with renting your home, not to exceed the rental income reported for the year.  Thus, in this case, you will be able to bring your net rental income down to zero, but you won’t be permitted to deduct a net loss from the rental activity.

• If instead of renting your entire home, you rent out only a room or several rooms, you can only deduct these general expenses in proportion to the portion of the home rented.  For example, assume you rent out your property for 37 days during the year.  The property would be considered a rental for 10% (37 ÷ 365 = 10%) of the year.  Therefore, you would be able to deduct 10% of your general expenses and all of your direct expenses, up to the amount of rental income earned during the year.