Internal Revenue Code Section 1031 exchanges have been very popular with taxpayers for many years. This Code section allows taxpayers to defer recognition of gain on the disposition of assets by participating in a like-kind exchange (“LKE”) transaction. There are several rules that a transaction must meet in order to qualify as an LKE. This article covers the basic requirements that must be met in order to defer recognition of gain on disposal of assets until a later date. 

The Basics of Section 1031 Exchanges

The first hurdle for an exchange of property to qualify as an LKE is that it must involve qualifying property. Qualifying property includes property used in a trade or business and property held for investment. Property used for personal purposes, stocks, bonds, notes, inventories , and partnership interests do not qualify for a Section 1031 exchange.

In addition to the requirement that the transaction must involve qualifying property, it must also involve like-kind property. Like-kind properties are of the same nature or character, even if they differ in grade or quality. Exchanging real property for real property would qualify as an exchange of like-kind properties; however, exchanging real property for tangible personal property would not qualify as an exchange of like-kind properties. Depreciable tangible personal property needs to be either like-kind or like-class to qualify for LKE treatment. To be considered like-class properties, the assets must be within the same General Asset Class or Product Class.

The basis of the property received in an LKE transaction is generally the same as the adjusted basis of the property given up, however, see the discussion below for partially nontaxable transactions.

Deferred Exchanges

A deferred exchange involves an exchange of like-kind assets that is completed over a period of time. Deferred exchanges are more complex, and additional requirements apply. There are time limits to meet in order for a deferred exchange to qualify as a Section 1031 exchange. The first time limit provides a taxpayer 45 days from the date the relinquished property is sold to identify potential replacement properties. The identification must be in writing, signed by the seller, and delivered to a person involved in the exchange (for example, the seller of the replacement property or a qualified intermediary). The second time limit requires that the replacement property must be received and the exchange completed no later than 180 days after the sale of the relinquished property or the due date (with extensions) of the income tax return for the year in which the relinquished property was sold, whichever is earlier. It is important to note that the replacement property will not be treated as like-kind property unless these identification and the receipt requirements are met.

Additionally, if the transferor actually or constructively receives money or unlike property in full consideration for the property transferred prior to the receipt of replacement property, the transaction is treated as a sale rather than a deferred exchange. Using a qualified intermediary (“QI”) can serve as a safe harbor against actual or constructive receipt.

A qualified intermediary is a party who enters into a written exchange agreement with the taxpayer. The written exchange agreement requires that the QI:

1. Acquires the relinquished property from the taxpayer,

2. Transfers the relinquished property,

3. Acquires the replacement property, and

4. Transfers the replacement property to the taxpayer.

The written exchange agreement must expressly limit the taxpayer’s rights to receive, pledge, borrow, or otherwise obtain the benefits of money or unlike property held by the QI before the end of the exchange period.

Beware: Some Exchanges are Only Partially Nontaxable

If money or unlike property, referred to as boot, is received in addition to the like-kind property and a gain is realized on the transaction, the exchange will be considered only partially nontaxable. Gain must be recognized equal to the lesser of the boot received or realized gain. If a loss is realized on the transaction, no loss can be recognized.

In calculating the realized gain, any liabilities assumed by the other party must be added to the amount realized. Any liabilities of the other party assumed by the taxpayer should be subtracted from the amount realized.

Example: A taxpayer exchanges business property with an adjusted basis of $32,000 for like-kind property. The property was subject to a $4,000 mortgage. The fair market value (“FMV”) of like-kind property received was $36,000. In addition, the taxpayer received $1,500 in cash and paid $500 in exchange expenses. The other party agreed to pay off the mortgage. How much gain should be recognized on the transaction?

The recognized gain on the transaction is $5,000.

The basis of the property that a taxpayer receives (other than money) in a partially nontaxable exchange is the total adjusted basis of the property given up, with some adjustments. Add to the basis any additional costs incurred and any gain recognized on the exchange. Subtract from the basis any money received and any loss recognized on the exchange. The basis is allocated first to the unlike property, other than money, up to its FMV on the date of the exchange. The remainder is the basis of the like-kind property.

LKE Transactions Involving Related Parties

There are special rules for LKE transactions between related persons. Under the rules, if either party disposes of the property within two years after the exchange, the exchange is disqualified from LKE treatment. In that event, the gain or loss on the original exchange must be recognized as of the date of the later disposition.

Related persons include members of the taxpayer’s family, a corporation owned greater than 50% by the taxpayer, and a partnership owned greater than 50% by the taxpayer. The two-year holding period begins on the date of last transfer of property that was part of the LKE transaction.

Conclusion

As discussed in this article, it is difficult to comply with the rules of Section 1031 related to a like-kind exchange transaction. Although there are many restrictions in place to meet the requirements of a like-kind exchange transaction, the benefits of deferring gain on an exchange can be great for taxpayers. For that reason, these transactions have been very popular for a number of years.

In December of 2014, Congress approved the Achieving a Better Life Experience (ABLE) Act that allows for tax-advantaged savings for persons with disabilities. Known as ABLE accounts, these new accounts allow earnings to grow tax-free and distributions to be tax-free for qualified disability expenses. Under the provisions of the new law the accounts cannot reduce certain Medicaid or supplemental security income (SSI). The accounts are designed to encourage savings to maintain health, independence and quality of life and secure funding that will supplement other benefits individuals with disabilities receive through Medicaid, SSI, or employment without disqualifying them from those benefits.

The beneficiary of the account can withdraw contributions and earnings at any time for qualified disability expenses. These include:

• Education
• Housing
• Transportation
• Employment training and support
• Assistive technology and personal support services
• Health, prevention and wellness
• Financial management and administrative services
• Legal fees
• Expenses for oversight and monitoring
• Funeral and burial expense
• Other expenses consistent with the purpose of this provision

In our desire to provide you with the timely instructions to comply with existing IRS guidance on the tangible property regulations, we asked you on Friday, February 13, 2015 to mail in provided Form(s)  3115 to the IRS. Ironically, later on the same day, the IRS provided long-awaited guidance and relief.

Under this new guidance taxpayers are still required to file Form(s) 3115 if they have at least $10M in average gross receipts over the last three years and at least $10M of total assets in 2014. 

However, for anyone not meeting the $10M threshold, there is no longer a Form 3115 filing requirement. 

If you received a Form 3115  from us and have not yet mailed it to the IRS, we ask that you not file the form in light of this new guidance and wait until your tax preparer reaches out to you directly. If, however, you already mailed in a Form 3115 that is no longer required, do not worry – there is no harm in this. 

If you are a taxpayer that is still required to file a Form 3115 under the new guidance and have not received the form from us, know that we will still prepare the form and either send it to you in advance of or with your tax return. 

Thank you for your cooperation  and PATIENCE in this process and please let us know if you have any questions.

One of the most common inquiries clients have for their accountants is “What documents do I need to save, and for how long?” Retaining, organizing, and filing old records can become a burden, both at the business and individual levels. As we all strive to achieve a more "paperless" process, how do we determine what warrants taking up valuable office and storage space and what does not?

Records should be preserved only as long as they serve a useful purpose or until all legal requirements are met. To keep files manageable, it is a good idea to develop a schedule so that at the end of a specified retention period, certain records are destroyed.

At Stockman Kast Ryan + Co., we have developed a Records Retention Schedule we think you will find helpful. Although it doesn't cover every possible record, it does cover the most common ones. As always, please feel free to ask us should you have specific questions or concerns.

Tax time is becoming a more and more lucrative time for those wanting to steal your identity or scam you out of money. Identity theft has topped the Internal Revenue Service’s “Dirty Dozen” annual list of scams for the last 3 years. 

The IRS will never do any of the following:

1. Call to demand immediate payment
2. Demand that you pay taxes without giving you the opportunity to question or appeal the amount they say you owe
3. Require you to use a specific payment method for your taxes, such as a pre-paid debit card or wire transfer
4. Ask for credit or debit card numbers over the phone
5. Threaten to bring in local police or other law-enforcement to have you arrested for not paying

If you receive a phishing email:

Don't open any attachments or click any links and don't reply to the message or give out any personal or financial information. Forward the email to phishing@irs.gov and then delete it.

To help minimize your risk:

Our goal, this year as in every year, is to complete our clients’ tax returns as early and accurately as possible. Using the month of February to enter tax information you provide to us, rather than waiting until March or later once you have received ALL of your tax information, will help us to meet this goal.

There are several ways you can help us better serve you and meet your desired timelines for the completion of tax returns:

• As early as January, send in the tax information you have that is not generated by or dependent on third parties. For business returns or individuals with Schedule C, this could include items such as financial statements, fixed asset purchases/dispositions, bank statements, etc. In the case of individuals, information such as W-2s, itemized deductions, rental activity income and expenses, non-brokerage account income sources, etc. could be provided.

• Once you have received the awaited forms, such as 1099s, Schedule K-1, etc., send them in promptly.

• Sign and return electronic filing authorization forms promptly. We will greatly increase the use of e-signatures for getting tax returns processed and e-filed more quickly than in years past.

• If your tax information is late in arriving and an extension would be acceptable to you, we would appreciate your consideration of that alternative. If you have questions or concerns regarding this option, we are more than happy to discuss the process of extending with you.

We enjoy serving our clients, and we will do everything possible to meet your needs and provide first-class service. If you would like to discuss your situation for this upcoming tax season, please do not hesitate to contact us via phone or email. 

With contributions from Penny Sayre, CPA, Tax Manager

Substantiation requirements must be met for charitable donations to be allowed

The federal government encourages your generosity by allowing you to deduct your gifts to charities on your income tax return if you itemize deductions. However, you must follow the IRS’s reporting and substantiation rules to assure your charitable deduction is allowed. While all contributions must be substantiated, there are numerous and overlapping requirements.

General Rules

For a contribution of cash, check, or other monetary gift, regardless of amount, you must maintain a bank record or a written communication from the donee organization showing its name, plus the date and amount of the contribution. Any other type of written record, such as a log of contributions, is insufficient.

For a contribution of property other than money, you generally must maintain a receipt from the donee organization that shows the organization's name, the date and location of the contribution, and a detailed description (but not the value) of the property. If circumstances make obtaining a receipt impracticable, you must maintain a reliable written record of the contribution. The information required in such a record depends on factors such as the type and value of property contributed.

Contributions Over $250

If the contribution is worth $250 or more, stricter substantiation requirements apply. No charitable deduction is allowed for any contribution of $250 or more unless you substantiate the contribution with a written receipt from the donee organization. You must have the receipt in hand when you file your return (or by the due date, if earlier) or you won't be able to claim the deduction. If you make separate contributions of less than $250, you won't be subject to the written receipt requirement, even if the sum of the contributions to the same charity total $250 or more in a year.

The receipt must set forth the amount of cash and a description (but not the value) of any property other than cash contributed. It must also state whether the donee provided any goods or services in return for the contribution, and if so, must give a good faith estimate of the value of the goods or services. If you received only “intangible religious benefits,” such as attending religious services, in return for your contribution, the receipt must say so. This type of benefit is considered to have no commercial value and so doesn't reduce the charitable deduction available.

Contributions Over $500

In general, if the total charitable deduction you claim for non-cash property is more than $500, you must attach a completed Form 8283 (Noncash Charitable Contributions) to your return or the deduction is not allowed. In general, you are required to obtain a qualified appraisal for donated property with a value of more than $5,000, and to attach an appraisal summary to the tax return. However, a qualified appraisal isn't required for publicly-traded securities for which market quotations are readily available. A partially completed appraisal summary and the maintenance of certain records are required for (1) nonpublicly-traded stock for which the claimed deduction is greater than $5,000 and no more than $10,000, and (2) certain publicly-traded securities for which market quotations are not readily available. A qualified appraisal is required for gifts of art valued at $20,000 or more. IRS may also request that you provide a photograph.

Recent Case Provides a Note of Caution to Taxpayers Related to Documentation of Noncash Charitable Contributions

As we begin the new tax year of 2015, a review of a 2014 Tax Court Memorandum Decision (TC Memo 2014-203, Thad D. Smith v. Commissioner) provides a reminder that the IRS and the courts take the charitable contribution rules seriously and that good tax documentation is required to support a deduction for noncash charitable contributions. Here’s a summary of the take-away lessons from the Smith case regarding documentation of noncash charitable contributions:

• Taxpayers must obtain a written acknowledgement from the charity that indicates what was donated, the date of the donation and a statement that no goods or services were provided in return for the donation or a description of what was provided by the charity in return for the donation. The written documentation from the charity must be received by the due date of the tax return or the date of filing, whichever is earliest.
• Taxpayers must maintain the following documentation for items donated (including groups of similar items) that exceed $500 in value: (1) date of acquisition of each item, (2) detailed description of the property and its current condition, (3) estimated cost of each item, (4) estimated current fair market value of each item, and (5) an explanation of how current value was determined.
• For noncash items (including groups of non-cash items) that exceed $5,000 included in the donation, an appraisal by a qualified appraiser must be obtained.

Recordkeeping for Contributions for which You Receive Goods or Services

If you receive goods or services, such as a dinner or theater tickets, in return for your contribution, your deduction is limited to the excess of what you gave over the value of what you received. For example, if you gave $100 and in return received a dinner worth $30, you can deduct $70. But your contribution is fully deductible if:

• you received free, unordered items from the charity that cost no more than $10.20 in 2014 ($9.90 in 2013) in total;
• you gave at least $51 in 2014 ($49 in 2013) and received only token items (bookmarks, key chains, calendars, etc.) that bear the charity's name or logo and cost no more than $10.20 in 2014 ($9.90 in 2013) in total; or
• the benefits that you received are worth no more than 2% of your contribution and no more than $102 in 2014 ($99 in 2013).

If you made a contribution of more than $75 for which you received goods or services, the charity must give you a written statement, either when it asks for the donation or when it receives it, that tells you the value of those goods or services. Be sure to keep these statements.

Cash Contribution Made through Payroll Deductions

You can substantiate a contribution that you make by withholding from your wages with a pay stub, Form W-2, or other document from your employer that shows the amount withheld for payment to the charity. You can substantiate a single contribution of $250 or more with a pledge card or other document prepared by the charity that includes a statement that it doesn't provide goods or services in return for contributions made by payroll deduction.

The deduction from each wage payment is treated as a separate contribution for purposes of the $250 threshold.

Substantiating Contributions of Services

Although you can't deduct the value of services you perform for a charitable organization, some deductions are permitted for out-of-pocket costs you incur while performing the services. You should keep track of your expenses, the services you performed and when you performed them, and the organization for which you performed the services. Keep receipts, canceled checks, and other reliable written records relating to the services and expenses.

As discussed earlier, a written receipt is required for contributions of $250 or more. This presents a problem for out-of-pocket expenses incurred in the course of providing charitable services, since the charity doesn't know how much those expenses were. However, you can satisfy the written receipt requirement if you have adequate records to substantiate the amount of your expenditures, and get a statement from the charity that contains a description of the services you provided, the date the services were provided, a statement of whether the organization provided any goods or services in return, and a description and good-faith estimate of the value of those goods or services.

Please call us if you have any questions about these rules. Together we can make sure that you'll get all the deductions to which you are entitled when we prepare your 2014 tax returns.

Contributions from Bernie Benyak, CPA, CFP, Tax Director

On Oct. 30, the IRS issued its cost-of-living adjustments for 2015. In a nutshell, with inflation remaining in check, many amounts increased only slightly, and some stayed at 2014 levels. As you implement 2014 year end tax planning strategies, be sure to take these 2015 adjustments into account in your planning.

Individual income taxes

Tax brackets will widen and personal exemptions will increase slightly for 2015.

Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $150 to $300, depending on filing status, but the top of the 35% bracket increases by $3,625 to $7,250, again depending on filing status.

The personal and dependency exemption increases by only $50, to $4,000 for 2015. The exemption is subject to a phaseout, which reduces exemptions by 2% for each $2,500 (or portion thereof) by which a taxpayer’s adjusted gross income (AGI) exceeds the applicable threshold (2% of each $1,250 for separate filers).

For 2015, the phaseout starting points increase by $2,425 to $4,850, to AGI of $258,250 (singles), $284,050 (heads of households), $309,900 (joint filers), and $154,950 (separate filers). The exemption phases out completely at $380,750 (singles), $406,550 (heads of households), $432,400 (joint filers), and $216,200 (separate filers).

Your AGI also may affect some of your itemized deductions. An AGI-based limit reduces certain otherwise allowable deductions by 3% of the amount by which a taxpayer’s AGI exceeds the applicable threshold (not to exceed 80% of otherwise allowable deductions). For 2015, the thresholds are $309,900 (up from $305,050) for joint filers, $284,050 (up from $279,650) for heads of households, $258,250 (up from $254,200) for singles and $154,950 (up from $152,525) for separate filers.

AMT

The alternative minimum tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.

Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2015, the threshold for the 28% bracket increased by $2,900 for all filing statuses except married filing separately, which increased by half that amount.

The AMT exemptions and exemption phaseouts are also indexed. The exemption amounts for 2015 are $53,600 for singles and heads of households and $83,400 for joint filers, increasing by $800 and $1,300, respectively, over 2014 amounts. The inflation-adjusted phaseout ranges for 2015 are $119,200–$333,600 (singles and heads of households) and $158,900–$492,500 (joint filers). (Amounts for separate filers are half of those for joint filers.)

Education- and child-related breaks

The maximum benefits of various education- and child-related breaks generally remain the same for 2015. But most of these breaks are also limited based on the taxpayer’s modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within the applicable phaseout range are eligible for a partial break — breaks are eliminated for those whose MAGIs exceed the top of the range.

The MAGI phaseout ranges generally remain the same or increase modestly for 2015, depending on the break. For example:

The American Opportunity credit. The MAGI phaseout ranges for this education credit (maximum $2,500 per eligible student) remain the same for 2015: $160,000–$180,000 for joint filers and $80,000–$90,000 for other filers.

The Lifetime Learning credit. The MAGI phaseout ranges for this education credit (maximum $2,000 per tax return) increase for 2015; they’re $110,000–$130,000 for joint filers and $55,000–$65,000 for other filers — up $2,000 for joint filers and $1,000 for others.

The adoption credit. The MAGI phaseout ranges for this credit also increase for 2015 — by $3,130, to $201,010–$241,010 for joint, head-of-household and single filers. The maximum credit increases by $210, to $13,400 for 2015.

(Note: Married couples filing separately generally aren’t eligible for these credits.)

These are only some of the education- and child-related breaks that may benefit you. Keep in mind that, if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible.

Retirement plans

Many retirement-plan-related limits increase slightly in 2015; thus, you may have opportunities to increase your retirement savings:

Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2015:

Traditional IRAs. MAGI phaseout ranges apply to the deductibility of contributions if the taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:

• For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
• For a spouse who participates, the 2015 phaseout range limits increase by $2,000, to $98,000–$118,000.
• For a spouse who doesn’t participate, the 2015 phaseout range limits also increase by $2,000, to $183,000–$193,000.
  • For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2015 phaseout range limits increase by $1,000, to $61,000–$71,000.

Taxpayers with MAGIs within the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

But a taxpayer whose deduction is reduced or eliminated can make nondeductible traditional IRA contributions. The $5,500 contribution limit (plus $1,000 catch-up if applicable and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.

Roth IRAs. Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute:

• For married taxpayers filing jointly, the 2015 phaseout range limits increase by $2,000, to $183,000–$193,000.
• For single and head-of-household taxpayers, the 2015 phaseout range limits also increase by $2,000, to $116,000–$131,000.

You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.

(Note: Married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.)

Gift and estate taxes

The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2015 the amount is $5.43 million (up from $5.34 million for 2014).

The annual gift tax exclusion remains at $14,000 for 2015. It’s adjusted only in $1,000 increments, so it typically increases only every few years. It increased to $14,000 in 2013, so it might go up again for 2016.

Is tax relief on your horizon?

With the 2015 cost-of-living adjustment amounts trending slightly higher, you have an opportunity to realize a little bit of tax relief next year. In addition, with many retirement-plan-related limits also increasing, you may have the chance to boost your retirement savings. If you have questions on the best tax-saving strategies to implement based on the 2015 numbers, please give us a call. We’d be happy to help.

Provisions affecting businesses

Provisions affecting individuals

An ongoing battle