While many summer vacationers continue to make reservations at traditional resorts and hotels, many others seeking the “comforts of home” or looking to “live like a local” are booking short-term rentals through online marketplaces like VRBO and Airbnb. The trend is making short-term rental properties an increasingly attractive investment.

Owning a short-term rental can be a great way to generate passive income, as well as benefit from the appreciation in value common to many types of real estate investments. However, with the extra income comes the need to consider the potential tax reporting requirements, and the rules governing the taxation of rental income and determination of allowable expenses can be difficult to navigate.

Many vacation-home owners seeking to rent their property use third parties, like the online marketplaces, to manage their listings. Those companies will list your rental on their websites and collect the rental income from your tenants for a percentage of the rent, then pay you the net rental income. Effective January 1, 2022, the IRS requires those U.S. third parties to report gross earnings for U.S. hosts earning more than $600 in a calendar year. If your rental income exceeds the threshold you will receive a Form 1099-K from the listing company showing the income you earned for that year. These forms are useful in reporting income from a rental property to the IRS; still, you should track and maintain detailed records of all rental income earned for the year.

Keeping expense records

In addition to tracking and reporting income, there are many expenses that may qualify for a deduction on your tax return. These expenses, along with your rental income, are generally reported on Schedule E of Form 1040. In general, expenses are allowed to be deducted when they are ordinary and necessary for managing, conserving, or maintaining the property. Ordinary and necessary expenses are those that are common and would be expected when maintaining a rental property. A few examples of items that are listed on Schedule E include cleaning and maintenance, management fees, repairs, and utilities.

You should maintain detailed records, including invoices and receipts, that demonstrate the type of expenses and when they were incurred. Keeping adequate records is important in case your return is audited by the IRS. If you report deductions on your return but do not have records to back them up, those expenses could be disallowed; you also could be subject to penalties and interest.

IRS rules for reporting

Whether your piece of paradise is in the mountains or at the shore, there are special rules for reporting expenses for rental properties, which are based on how the property is used and classified by the IRS. If an owner does not personally use the property, the reporting is fairly straightforward. It is treated as a rental property and all income and expenses are reported on Schedule E. But when there is both personal and rental use, the property will fall into one of the following categories:

• Personal residence: If personal use is more than 14 days or 10 percent of the rental days, whichever is greater, and the property is rented less than 15 days, you generally are not required to report rental income and expenses on your return. You might be able to deduct mortgage interest and real estate taxes as an itemized deduction on Schedule A.
• Rental property with personal use: If personal use is less than 14 days or 10 percent of the rental days, whichever is greater, and the property was rented, or held out for rent, during the year, all rental income is reported on Schedule E, and expenses are prorated between personal and rental use. The personal portion of any real estate taxes can be included on Schedule A as an itemized deduction. Because the property is considered a rental property, mortgage interest allocable to personal use is considered personal interest and is not deductible.
• Dwelling unit used as a home: If personal use is more than 14 days or 10 percent of the rental days, whichever is greater, and the property is rented for more than 15 days, all rental income is reported on Schedule E and expenses are prorated between personal and rental use. However, certain rental deductions are limited to the gross income from the property. The personal portion of mortgage interest and real estate taxes may be deductible on Schedule A as an itemized deduction.

Ordering rules – Dwelling unit used as a home

Not only are expenses for rental property classified as a dwelling unit used as a home limited in terms of being tax deductible, they are also subject to ordering rules. The rental portion of mortgage interest, real estate taxes, and casualty and theft losses—items that would be deductible on Schedule A if the property had not been rented—are deducted first. If these expenses do not offset all of the income, the remaining operating expenses can be deducted up to the amount of income. As well, depreciation can be deducted if income still is in excess of operating expenses. Operating expenses and depreciation cannot produce a loss, but any expenses not allowed in the current year can be carried forward to future years until there is sufficient income to use them as deductions.

Conclusion

These and other IRS rules can make reporting income related to the rental of a vacation home challenging. There are many factors to consider if you are purchasing a vacation home or using an existing vacation home for rental income. The team of professionals at HBK CPAs & Consultants is experienced in planning for these issues and can guide you through the process.

For questions regarding tracking and reporting income and expenses, please contact your HBK representative.

The COVID pandemic forced many of us home for at least part of the year, resulting in our homes functioning as schools, day care facilities, and, yes, offices. With this shift – whether it is temporary or it will become the new norm – you may be wondering if you are entitled to a nice tax break in the form of the Home Office Deduction. If you are an employee, the short answer is No. The Tax Cuts and Jobs Act (TCJA) of 2017 suspended the Home Office Deduction for employees for tax years 2018 through 2025. Therefore, the remainder of this article will focus on self-employed individuals.

In general, expenses associated with a “dwelling unit” used by a taxpayer as a residence are disallowed unless a specific exception applies. As one exception to the general rule, a taxpayer is permitted to deduct expenses for the business use of a home. Now, you may be wondering if “working from home” is akin to “business use of a home.” The answer – maybe.

If you are self-employed, we need to look at the specific requirements in the Code to determine whether you qualify for the deduction. Expenses may be deductible if the home is used regularly and exclusively (1) as the principal place of business, (2) as a place for meeting or dealing with patients, clients, or customers for business purposes, or (3) in connection with a business if the office is a separate structure that is not attached to the home. These three rules require regular and exclusive use for the space to qualify as a “home office,” so some definitions are in order.

Regular Use

To qualify as regular use, the specific area must be used for business purposes on a regular basis (I know – thank you Captain Obvious). The proposed regulations are not very helpful with this determination – they provide that whether the taxpayer’s use is “regular” depends on “all the facts and circumstances.” If we look to case law, regular use is probably achieved with frequent and repetitive use, and occasional or incidental business use likely does not meet the standard.

Exclusive Use

To qualify as exclusive use, a specific area in your home must be used only for your business. It does not qualify if used for both personal and business purposes. The area does not need to be a specific room (i.e., marked off by a permanent partition); it can be a specifically identifiable space within a room (e.g., a desk in the corner of a room).

Principal Place of Business

Okay, so your use is regular and exclusive, but is your home office the “principal place of business?” If you have no other business location, the answer is easy, but what if you have multiple business locations (i.e., you have a separate office and you work out of your home)? Under the rules, two alternative standards are available to determine which location is the principal place of business.

First, if the home office is used regularly and exclusively for administrative or management activities, and there is no other location where such activities are conducted, it qualifies as the principal place of business. The Service has identified the following as examples of administrative or management activities: billing customers, clients, or patients; keeping books and records; ordering supplies; setting up appointments; and forwarding orders or writing reports. This is huge – even if you have a business location outside the home, you may qualify for the Home Office Deduction if the business is managed from the home.

Alternatively, the principal place of business determination may be made based on the relative importance of the activities performed at each location and the time spent at each location. In evaluating the relative importance of the activities performed, the location at which services are rendered or goods are delivered is a principal consideration. If comparing the activities performed at each location does not yield a definitive conclusion, the time spent at each location may be used. In 2020, the relative importance of activities performed and time spent at home may have drastically increased, thus making your home the principal place of business this year when it may have not been in the past.

Place for Meeting or Dealing with Patients, Clients, or Customers

If your home office does not qualify as the principal place of business, you may still be able to claim the Home Office Deduction under the “meeting or dealing” exception. Again, the business use of your home office must be regular and exclusive, and if your meetings or dealings with patients, clients, or customers in your home office are more than occasional and are substantial and integral to the conduct of your business, you may qualify for the Home Office Deduction. Importantly, this exception only applies if your patients, clients, and customers physically visit your home – phone calls and video conferences do not qualify.

Separate Structure Not Attached to Dwelling Unit

If all else fails, you may still be able to claim the Home Office Deduction if the office is a separate structure from, and not attached to, your home and you use it regularly and exclusively for business purposes. Examples include a free-standing studio, garage, or barn.

Limitations and Eligible Expenses

If, based on the rules articulated above, you have a qualifying home office, you may be able to deduct expenses for the business use of your home, subject to certain limitations (there are ALWAYS limitations). The Home Office Deduction is subject to a gross income limitation, meaning that the deductions for the home expenses cannot be used to create a net loss for the business activity. There are two methods available to calculate the Home Office Deduction – the Regular Method and the Simplified Option. The Simplified Option involves simply multiplying the allowable square footage of the home office (up to a maximum of 300 square feet) by a prescribed rate ($5.00) to determine the deduction (capped at $1,500). Under the Regular Method, actual expenses must be allocated between the personal use portion of the home and the business use portion of the home. Common methods of allocation include square footage or number of rooms. Allocable expenses include real estate taxes, home mortgage interest, depreciation, insurance, utilities, repairs, and rent paid in the case that you do not own the home.

Conclusion

Due to the COVID pandemic, we are using our homes for business purposes more than ever before. If you think you may now qualify for the Home Office Deduction, or have questions regarding your personal tax situation, please contact your HBK representative or a member of our Tax Advisory Group to discuss further.

The Office of Workforce Transformation in Ohio will open a new round of TechCred applications from January 4 through January 29, 2021 at 3:00 PM.

Since the program’s inception, TechCred has completed six rounds of funding. In the most recent funding round, which ended in October, 246 Ohio employers were approved, which allows funding for 3,000 credentials.

TechCred provides employers with the opportunity to support employees through the advancement of their technological skills. Employees can earn credentials in subject matter including manufacturing technology, construction technology, business technology, cybersecurity, robotics, and information technology fields. A list of eligible credentials is available at https://techcred.ohio.gov/wps/portal/gov/techcred/about/credential-list/.

Employers may also request approval for credentials not included on this list. Eligible credentials must meet the following criteria:

• Industry-recognized
• Short-term (the program must be able to be completed in less than one calendar year and consist of fewer than 900 clock hours or 30 credit hours)
• Technology focused
• Includes certificates, which are earned by successfully completing training or courses, or certifications, which are earned by passing a standardized test recognizing an individual’s competency in a particular field.

Due to the ongoing status of the COVID-19 pandemic, online and distance-learning programs are encouraged.

Interested employers should visit https://techcred.ohio.gov/wps/portal/gov/techcred/apply to apply for the TechCred program. The Ohio Development Services Agency reviews applications and awards funding. Businesses can be awarded up to $2,000 per credential and $30,000 per funding round, which is reimbursed to the employer when the employee obtains the approved credential or completes the approved program.

To learn more about Ohio’s TechCred program, visit techcred.ohio.gov. For questions about this program or other support for manufacturers, contact a member of HBK Manufacturing Solutions by calling 330-758-8613 or emailing manufacturing@hbkcpa.com.

The first of a multi-part series on overhead cost allocations and rates

Manufacturing businesses often use cost allocations to value their cost of goods sold and inventory. In particular, allocations are commonly used to determine manufacturing overhead, which is critical to understanding the true cost (and profitability) of the products they manufacture and sell.

However, some manufacturers do not update their overhead allocations regularly. The outdated, inaccurate information then works its way into their financial statements resulting in misunderstanding the profitability of certain products and poor business decisions based on that misinformation. For instance, if a manager believes that a product is not profitable based on inaccurate data, they may increase the price. That price increase could render the company uncompetitive; they could lose business that was actually profitable before the price change.

As the end of the year approaches, it is an ideal time for managers to review the rates used in overhead allocations. Depending on the costing system, rates can be based on department, machine, or another cost driver. Consider the following questions when deciding when to review your overhead rates and allocations:

1. When is the last time you reviewed your overhead allocations or rates? The best practice is for managers to evaluate these factors regularly. Depending on your industry and the nature of your business, “regularly” could be once every one to three years.


2. Has your business added or eliminated any operations or processes? Manufacturers that have recently added a machine shop or an additional production line might want to revisit their overhead allocations to ensure they are accurate, given their expanded capabilities.


3. Similarly, manufacturers working to improve operational efficiencies may experience changes in their cost structures that could affect their overhead rates. If specific product lines or processes are benefiting from artificial intelligence, automation, or robotics that improve output, overhead cost allocations may need to be adjusted to account for the new technology as well as the adjusted throughput rates.


4. Have your costs changed in other ways? Are your rent, property taxes, or general liability insurance premiums rising? Has the tight labor market-led you to increase salaries and other employee benefit program costs? Have new customer requirements regarding quality assurance or continuous improvement caused you to make operational changes? Significant cost changes require you to revisit overhead rates and allocations.


5. Finally, do the overhead costs attributed to production reflect your overall costs? If production is absorbing too much or too little overhead, analyze your allocations. While, at times, there are legitimate reasons for variances between reported costs and actual costs, frequent or significant differences may indicate you need to reallocate costs.

To discuss your overhead allocations or rates, contact a member of HBK Manufacturing Solutions, a group of dedicated professionals focused on the manufacturing industry. We can be reached at 330-758-8613 or manufacturing@hbkcpa.com.

Many companies choose to pay stipends to employees as a method of compensating them for incurred business expenses. This is especially true in construction companies, where it is widely viewed as a common industry practice. While the approach of using stipends in this manner is widespread, many construction companies fail to properly plan for and/or execute them, which can result in additional taxes owed by both the company and the employee.

In the simplest terms, a stipend is a monetary advance to an employee that allows an him or her to pay for various business expenses. Depending on how the stipend is structured, it can either be taxable income to the employee, or a non-taxable reimbursement. In order to keep the stipend non-taxable, a company must implement an accountable reimbursement plan, whereby employees complete expense reports proving that all business-related expenses are being reimbursed through the payment of the stipend. If a company does not have an accountable plan, or it is not followed (e.g. expense reports are not submitted or do not provide the appropriate documentation to support the expenses claimed), then the stipend paid to the employee may be re-characterized as taxable income.

One area where companies may run into difficulties with employee reimbursement stipends is in the area use of a personal vehicle for business purposes. The easiest method to use is to base the reimbursement on the number of business miles driven multiplied by the IRS standard mileage rate, which is currently 57.5 cents per mile. If a company provides a stipend to an employee prior to the business usage of the car, the company will need to take great care in reconciling the expense report provided by the employee. If business usage is less than the stipend provided, the employee should reimburse the company for the excess funds received.

It’s clear that establishing an accountable reimbursement plan is essential for any company providing stipends to employees for business expenses. For more information, please contact Richard P. Mishock at RMishock@hbkcpa.com or reach out to your HBK advisor.

*This is the first in a series of articles addressing the impact of the TCJA on the Manufacturing industry.

TCJA: A Recap

The Tax Cuts and Jobs Act (TCJA) that was signed into law in December 2017 introduced changes to the Internal Revenue Code (IRC) the likes of which have not been seen since the Tax Reform Act of 1986. Many of these new or altered provisions directly affect manufacturers, and in this and subsequent articles of a series of articles, Monitoring Manufacturing: Effects of the New Tax Code, I’ll address those likely to have the most impact on our industry.

Pros & Cons of Cash Basis Accounting

One of the most beneficial additions to the IRC resulting from the TCJA is the opportunity for some manufacturers to switch to a cash basis method of accounting. Under prior law, businesses with inventories were typically required to use the accrual method, which generally requires income to be recognized when it is earned and expenses to be recognized when they are incurred.

The major pitfall to the accrual method of accounting is that it often accelerates the recognition of income and the related tax payments. That can create a cash flow problem. Under the cash basis of accounting, income is recognized when the money is received and expenses are deducted when they are paid. Improved cash flow is just one benefit associated with cash accounting; for example, the business can accelerate tax deductions by paying expenses prior to the end of its tax year.

Who is eligible?

The TCJA allows businesses with average annual gross receipts of less than $25 million – based on their previous three tax years – to adopt a cash accounting method and thereby potentially defer the recognition of income to future tax years. In addition, businesses under that $25 million threshold are no longer required to account for their cost of goods sold using inventories.

Instead, they can use a method of accounting that treats inventories as non-incidental materials and supplies or that mimics their financial accounting treatment of inventories. As such, the business can expense inventory as it is actually paid for, rather than being required to capitalize it – that is, not expense it. It is a very favorable change in that it will add to the business’s deduction for cost of goods sold. Treating inventories as non-incidental materials and supplies also exempts the business from applying Section 263A, which requires certain costs ordinarily expensed to be capitalized as part of inventory for tax purposes. Combining these opportunities could yield considerable benefits.

The TCJA expands the pool of businesses that are eligible to use the cash method of accounting. It is likely that many manufacturers previously prohibited from using the cash basis method of accounting will now be eligible. Nonetheless, it is imperative to conduct a thorough analysis of your specific circumstances.

For questions or to arrange a study of the potential opportunities for your company, contact a member of the HBK CPAs & Consultants’ Manufacturing team at (330) 758-8613.