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MONTHLY TAX NEWSLETTERMay 2016
This past tax season we definitely noticed an uptick in the number of clients who rented out their homes through websites such as airbnb and VRBO. Moreover, we saw a larger jump in the number of clients asking us how they would be taxed if they were to rent out their home on a short-term basis a few times each year through one of these websites.
Believe it or not, if you rent the home for 14 days or less during a calendar year, the IRS allows 100% of the rental income received to be tax-free.
Here are the rules as spelled out in IRS Publication 527:
Used as a home but rented less than 15 days. If you use a dwelling unit as a home and you rent it less than 15 days during the year, its primary function is not considered to be rental and it should not be reported on Schedule E (Form 1040). You are not required to report the rental income and rental expenses from this activity.
Let's say you can rent your home for $10k per week, and you rent the home out for only 2 weeks each year. In this example, you would put $20k of rental income into your pocket each year without owing a dime in federal income taxes. Now that's great tax planning!
The IRS details the rules for homeowners who rent out their homes in Chapter 5 of IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes.)
The rules divide rental properties into three buckets based on the number of days rented versus the number of days used personally as follows:
Reporting Tax-Free Income Reported to the IRS:
What should you do if you rent your home for 14 days or less during the calendar year and then receive a 1099-Misc during the following January reporting the rental income you received to the IRS? Even though this income is not taxable to you, the IRS is now expecting you to report the rental income as reported in Box 1 of the 1099-Misc somewhere on your personal tax return.
To keep this income tax-free, simply complete a Schedule E as follows:
By following those two simple steps, the IRS will be happy since they will find the income reported to them on the 1099-Misc on your personal tax return. And you'll be happy since you will not pay any federal income taxes on income that is not taxable to you.
In other words, the IRS won't send you a notice incorrectly assessing taxes on the tax-free rental income reported to them on the 1099-Misc. And the rental income remains tax-free to you. You save the IRS a stamp while also saving yourself hundreds or thousands of dollars in federal income taxes.
When renting out your home for just a few weeks a year, please plan ahead to not rent out that home for more than 14 days. Once you hit 15 rental days, you'll need to report that income on your tax return and also prorate your mortgage interest and real estate taxes between your rental activity and your personal use days; causing you to lose out on a portion of these valuable tax breaks.
Your tax return will also become much more complicated for the current year as well as future years due to how the mixed-use rental losses are carried over to subsequent years.
Stopping at 14 days, therefore, is probably more valuable than getting that 15th day of rental income.
The numbers are in. President Obama recently released his 2015 Tax Return back in April. Initially I was going to critique his tax return. Instead, I am going to present my three-step solution to tax simplification.
1. Require All Politicians to Self-Prepare Their Tax Returns Each Year
For starters, let's require that all politicians, including the President of the United States, to manually self-prepare their tax returns each year - without the help of a tax professional and without using any tax prep software.
Let's also not allow our country's legislators to prepare their tax returns during working hours, Doing so will cause the President and each member of Congress to spend countless hours during their nights and weekends in February and March working on their taxes just as many American taxpayers do each year.
It wouldn't take more than a few years of manually preparing their own tax returns for the politicians to realize how overly complex the tax rules have become.
2. Have the IRS send The President and each Politician a notice questioning an item on their return that was reported correctly.
When the IRS has trouble agreeing information received from third parties to what taxpayer reports on their returns, their computers automatically generate a confusing 10-page notice to the taxpayer. Instead of asking for clarification for the item in question, the notice instructs the taxpayer to either pay additional federal income taxes on that item or, if they don't agree wit the assessment, to send in documentation supporting the position claimed on their tax returns. Sadly, with these intimidating and confusing notices, taxpayers are guilty until they prove their innocence.
I understand that the IRS needs to send notices demanding a balance due to get taxpayers to respond, but to be honest, it's quite unnerving for most people get a confusing 10-page notice form the IRS assessing additional taxes.
As part of my three-step plan, I would like to see the IRS send the President and every politician one of these notices each year assessing additional taxes, even if their tax returns were completed correctly and they don't owe any additional taxes.
The politicians, without the help of a tax professional, can then try to get through to the IRS' "customer service" number, and after being on hold for an hour or more, try to reason with the IRS agent. Or, they can compose and mail in a letter supporting their position, and hope that the person who ultimately processes the response does so correctly on the first try. In my experience, it often takes more than one submission of documentation to resolve an issue with the IRS in the taxpayer's favor, even when the taxpayer's tax return is 100% correct.
3. Make Sure Each Politician Gets Audited Each Year
The third step of my three-step plan is frankly brilliant. Every year, have the IRS audit the tax returns submitted by the President and each politician. Let the politician defend his or her deductions in front of the IRS agent without any professional help.
If you have ever gotten audited, it's really an uncomfortable process, even if you have nothing to hide and all of your documentation is available and in perfect order. I think it would be a great annual exercise for the people who actually draft and vote on the tax laws to sit through an IRS audit each year.
Three Steps to Success
How long do you think it would take for Congress to vote for tax simplification, and for the President sign the bill into law, if every politician, including the President, would be required to:
1. Independently prepare his or her own tax return without the help of a tax professional or any tax software,
2. Then, respond to a random IRS notice each year on an issue where they correctly reported that item on their tax returns,
3. And finally defend their tax deductions during an annual IRS Audit.
My guess is less than 2 years. Trust me, I know that there is no easy solution to tax simplification., But starting with the massive Tax Reform Act of 1986, the tax laws have gotten significantly more complicated during these past three decades. Drastic times require drastic measures, and I feel my three-step plan is the perfect drastic measure.
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