Red Spot Design2, Author at The CJ Group

Consider Taxes before Converting Your Home to a Rental Property

Posted on July 10, 2017 by Red Spot Design2

Have you ever thought about becoming a landlord? This option may be tempting if your local real estate market is surging and rental rates are strong, especially if you’re already planning to relocate or downsize to a smaller home.

Ideally, you’ll be able to shelter most or all of the rental income with tax deductions and eventually sell the property for a higher price than you originally paid. In the meantime, however, it’s important to understand the confusing tax rules that apply when a personal residence is converted into a rental.

Special Basis Rule

Once you become a landlord, you can depreciate the tax basis of the building part of a residential rental property (not the basis of the land) over 27.5 years. In plain English, this means you can deduct from your taxable income a portion of the building’s value every year for the next 27.5 years. However, a special basis rule applies to a rental property that was formerly a personal residence.

Under the special rule, the initial tax basis of the building portion of the property for purposes of calculating your postconversion depreciation write-offs equals the lower of:

The building’s fair market value (FMV) on the conversion date, or
The building’s regular basis on the conversion date.

Regular basis usually equals original cost plus the cost of any improvements (excluding any normal repairs and maintenance).

When You Sell

The rules become really confusing when you sell the property. To determine if you have a deductible loss, a similar special basis rule applies. That is, you must use the lower of:

The property’s FMV on the conversion date, or
The property’s regular basis on the conversion date.

Additionally, you must reduce the initial basis by depreciation deductions taken during the rental period. The special basis rule and the depreciation deductions greatly reduce the odds of having a deductible loss on a sale, especially when property values are below historical levels. With property values recovering in many areas, however, the chances of reporting a taxable gain have increased.

Your tax basis for purposes of calculating whether you have a taxable gain on a sale is simply the property’s regular basis on the sale date. Regular basis generally equals the original cost of the land and building, plus the cost of any improvements minus depreciation deductions claimed during the rental period.

Sellers in Limbo

When a converted property is sold, you must use the special basis rule to determine if you have a deductible loss on the sale, but you must use the regular basis rule to determine if you have a taxable gain. Following two different basis rules can sometimes cause sellers to have neither a taxable gain nor a deductible loss. This happens whenever the sale price falls between the two basis numbers.

Confused? Here are some examples of how to calculate gains and loss to help clarify.

Example 1: No tax gain or loss on sale

To illustrate how this works, suppose you convert your home to a rental while the market is recovering — but it hasn’t returned to its previous peak by the time you sell. Here’s how the numbers might shake out:

Regular basis on conversion date	$300,000
Postconversion depreciation deductions	($13,000)

Regular basis for tax gain	$287,000

FMV on conversion date	$235,000
Postconversion depreciation deductions	($13,000)

Special basis for tax loss	$222,000

If the net sale price is between $222,000 and $287,000, you have no tax gain or loss, because the sale price falls between the two basis numbers.

Example 2: Modest gain on sale

Alternatively, suppose you convert a property in a market that’s still in the early stages of recovery, and you intend to hang onto it for a while before selling.

Regular basis on conversion date	$300,000
Postconversion depreciation deductions	($32,000)

Regular basis for tax gain	$268,000

FMV on conversion date	$285,000
Postconversion depreciation deductions	($32,000)

Special basis for tax loss	$253,000

If the net sales price is above $268,000, you have a taxable gain. For example, with a net sale price of $345,000, you must report a taxable gain of $77,000 ($345,000 – $268,000). That is because, in this example, the postconversion depreciation deductions reduced the regular basis and the value of the property jumped. As a result, the sale price exceeds the regular basis, which produces a modest taxable gain on the sale.

Example 3: Big gain on sale

Now, let’s suppose you convert a property in a strong market. You’ve owned it for years and its FMV never fell below what you paid for it. In this case, the special basis rule for determining if you have a tax loss does not apply.

Regular basis on conversion date	$235,000
Postconversion depreciation deductions	($26,000)

Regular basis for tax gain	$209,000

FMV on conversion date	$285,000

Assuming the property is sold for $360,000, your taxable gain would be a whopping $151,000 ($360,000 – $209,000). In this example, the postconversion depreciation deductions reduced the property’s basis and the value jumped after the conversion. So the sales price substantially exceeds the basis, generating a significant taxable gain on the sale.

Principal Residence Gain Exclusion

Fortunately, some landlords may be able to shelter their gain on the sale of a recently converted property with the principal residence gain exclusion. When allowed, the gain exclusion really helps: Unmarried property owners can potentially exclude gains of up to $250,000, and married joint-filing couples can potentially exclude up to $500,000.

Important note: If you qualify for the gain exclusion, you can’t use it to shelter the part of a gain that’s attributable to depreciation deductions. In the previous example, if the gain exclusion applied, the taxpayer must still report a taxable gain of $26,000, which equals the amount of the postconversion depreciation deductions. But that’s much less than the total gain of $151,000.

To qualify for this exclusion, the tax rules require that you use the property as your principal residence for at least two years during the five-year period ending on the sale date. So, it’s impossible to meet the two-year usage requirement once you’ve rented the property for more than three years during that five-year period.

So, this tax break is allowed only if you’ve rented the property for no more than three years after the conversion date at the time you sell.

Ready to Convert?

Home-to-rental conversions can be a lucrative financial proposition for some property owners. But the tax rules can be confusing. To help understand the rules and evaluate whether you should become a landlord, contact your tax advisor. He or she can help decide what’s best for your situation. Beyond taxes, your tax pro will help you factor other considerations into your decision.

Sharing Tax Issues in the Sharing Economy

Posted on July 8, 2017 by Red Spot Design2

Do you provide car rides through a mobile app, rent out your spare room using an online platform or repair computers for local businesses on demand? If so, you may be considered part of the “sharing economy” (also known as the Gig or on-demand economy).

Participation in this emerging method of distributing services can be a good way to earn money in your down time, pursue a more flexible lifestyle and provide cash to offset the expenses associated with owning a vehicle or a home. The IRS recently offered some guidance for this rising trend. Here’s a summary of the key points.

Employee vs. Independent Contractor

First and foremost, there’s no free tax ride. Uncle Sam wants his cut of your earnings from any sharing economy activity — and your state tax agency may be eyeing it, too. The good news is that some of your tax liability could be offset by deductible business expenses.

When providing on-demand services, you’ll generally be classified as an independent contractor, rather than an employee. Certain exceptions apply — for example, if you’re a corporate officer of the firm providing the service.

Employees receive W-2 forms from their employers. But contractors will usually receive 1099 forms for participating in the sharing economy jobs, which must be reported on Schedule C on the individual’s federal tax return. The type of 1099 form depends on the volume of your activities. The company will issue:

Form 1099-MISC if you only occasionally provide services, or
Form 1099-K if you had more than 200 transactions and received at least $20,000 in payments for the year.

Instead of having taxes regularly withheld from their paychecks, self-employed contractors must make quarterly estimated tax payments to the IRS. Otherwise, they could be assessed tax penalties and interest on the amounts that weren’t paid, as well as any regular tax that’s owed. These adverse consequences could happen even if a contractor is ultimately entitled to a tax refund at the end of the year.

Taxes are a “pay-as-you-go” proposition. Self-employed taxpayers often rely on estimated tax payments to pay both their income tax liability and self-employment tax (the equivalent of FICA tax for employees). Payments must be made quarterly according to the IRS schedule:

First estimated payment is due on April 15,
Second estimated payment is due on June 15,
Third estimated payment is due on September 15, and
Fourth estimated payment is due on January 15 of the following tax year.

These deadlines move to the next business day if the due date falls on a weekend or a holiday. For example, the estimated payment for the fourth quarter of 2017 is due on Tuesday, January 16, 2018, because Monday, January 15, 2018, is Martin Luther King Day.

Some taxpayers participating in the sharing economy may have another option: The requisite amount of tax can be paid through any combination of estimated tax payments and regular income tax withholding. Therefore, if you’re employed at another job, you could increase your withholding to compensate for the extra tax you’ll owe from your sharing economy job. Simply fill out a revised Form W-4 and submit it to your employer. Your tax advisor can help you figure out the right amount of incremental withholdings.

Deductible Expenses

Depending on your circumstances, you may be able to claim deductions for expenses incurred to provide on-demand services. What costs qualify? In general, a business expense must be “ordinary and necessary” or the IRS won’t allow you to deduct it. Consider the following examples.

Drivers. Typically, the biggest expense for drivers on Uber, Lyft and other ride-sharing apps is vehicle depreciation. Subject to the annual limits for luxury cars, you may be able to write off at least some of the vehicle’s cost over time, based on the percentage of business use. In addition, you may deduct other operating expenses, such as gas, oil, insurance, car washes and repairs.

There’s a simplified alternative to keeping detailed records that are required for deducting actual expenses (including depreciation): You may use the IRS flat rate of 53.5 cents per business mile in 2017. Under this alternative, you can also deduct related tolls and parking fees.

Landlords. If you will take an extended vacation this year, have an unused spare room or own a second home, you might rent the unoccupied property to a tenant through an online platform, such as Airbnb, HomeAway or VRBO.

Deductions for rentals are limited to the amount of rental income if your personal use of the residence exceeds the greater of 14 days or 10% of the time the place is rented out. But, if you rent out a place for 14 days or less, there are no tax consequences: You don’t have to report the income, but you can’t claim deductions either.

When renting out property, beware of the rules for hotels and bed-and-breakfast properties. If you provide substantial services primarily for the guest’s convenience, such as regular cleaning, changing linen or maid service, you may be classified as running a hotel business. This classification could increase your tax liability, but your tax pro may have suggestions to avoid that pitfall. For example, you might consider charging a separate cleaning fee at the end of the rental, rather than providing complementary daily maid service.

Office space. To save overhead expenses, some small business owners opt to share office space, especially in high-priced business districts, through sharing platforms like WeWork. Essentially, the company rents out space in an office building and finds tenants to sublet smaller units. Each tenant maintains a desk, a computer and other essentials. But tenants collectively share common amenities, including a kitchen, lobby and general receptionist. As an added benefit, professionals who share office space can network with other like-minded professionals, which may lead to joint ventures and other forms of collaboration and revenue-sharing.

For tax purposes, you can deduct 100% of your shared office expenses. This option may be easier and subject to fewer limitations than home office deductions.

Professionals. The sharing economy isn’t just for people who own hard assets, such as vehicles or real estate, or who perform manual labor, such as the services of a housekeeper or handyman. Increasingly, professionals — including attorneys, physicians and computer programmers — are participating in the Gig.

A major expense for these professionals is the vehicle used to travel to and from freelance assignments. Additionally, they may be able to deduct at least some of the costs of electronic devices — such as tablets and smartphones — based on the percentage of business use.

Bottom Line

The tax rules that govern sharing economy activities are still evolving. Contact your tax pro for additional guidance. Although the standard principles for self-employed individuals generally apply to people with sharing economy jobs, there are some exceptions and subtle nuances. Your advisor can help ensure that you’re in compliance with the latest rules.

MOR Questions Your Audit May Not Catch

Posted on July 6, 2017July 23, 2024 by Red Spot Design2

Although a regular audit of financial statements and disclosures can help property managers prepare for a HUD-sanctioned management and operating review (MOR), there are some differences between HUD Audit Guidelines and the questions covered in a management review through HUD 9834.

There are rather obvious differences on HUD 9834, like lead-based paint compliance, vacancy monitoring, or receipts — by unit — of appliance purchases. Those questions aren’t included in HUD audit guidelines. However, items like documentation of outside contractors and the reconciliation of accounts payable seem like they should be similar for an audit or MOR. They aren’t exactly.

We have highlighted a few of the grey areas here that property managers of HUD-funded properties should be aware of when reviewing HUD 9834. Did your recent audit cover all the obvious and not so obvious questions you may be asked during an on-site review, or do you have some work to do?

1. Condition of the Property

Lead-based paint compliance – inspection, maintenance, abatement and protection of tenants and their belongings?
Repairs – paid consistently from right operating expense account and eligible items reimbursed by reserve?
Tools – satisfactory inventory system to account for them (and keys?)
Appliances – secured to prevent theft?
Maintenance backlogs – backlog of work orders?
Unit Readiness – assess occupancy readiness of vacant units?
Signage – clear and adequate for tenants and visitors?

2. Financial Health

Project operating costs – reasonable compared to a similar property?
Principals and Board – received HUD 2530 approval and meet regularly?
Mortgage – any past restructuring?
Owner – eligible for incentives?
Reserve and General Operating accounts – adequate to meet future needs?
Operating expenses – regularly reviewed to make sure property is paying best possible rates, including taxes and utilities?
Bad debts – procedure for write-offs reasonable?
Centralized accounting – approved by HUD?

3. Rent Increases

Requests – submitted promptly to HUD?
Reserve for Replacement analysis – performed before submitting budget-based rent increase?
Rent adjustments – documented last adjustments?
Special rent increases – previously approved?

4. Vacacy Rates

Vacancy activity – documented for the last 12 months and how many each month?
Rates – vacancy rates on the date of the MOR on-site visit?

5. Staffing

Vacancy – staffing issues impacting vacancy rates?
Vendors – maintain a list of outside contractors and bills paid in time to maximize discounts?
Enterprise Income Verification (EIV) – proper controls with regard to staffing access to sensitive tenant data in the EIV system?
Management – can staff adequately perform management and maintenance functions, and do they receive regular training?
After Hours – after hours and emergency phone numbers posted?
Supervision – process for field supervision of staff?
Tenant employment – efforts to employ tenants under Section 3?

6. Tenants

Sex offender status – does application ask if applicant or any member of applicant’s household is subject to a lifetime of state sex offender registration?
Previous residence – does application ask about list of previous residences?
HUD 92006 – attached to application?
Application denial – different appeals reviewer than the person who denies the application?
Wait list – number of applicants listed for each type of unit?
Fees and charges – other charges assessed besides security deposits?
Tenant Rental Assistance Certification System (TRACS) – data secure and up to date?
Private information – tenant personal information stored according to HUD document retention guidelines and access limited to only certain personnel?
Unit size – unit sizes adequate for household composition?
Eligibility exceptions – exceptions granted to ineligible households?
Pets – pet deposits in acceptable range and payments allowed?
EIV – income discrepancies documented and resolved?
Utilities – certifications reflecting the correct utility allowances, and reimbursements distributed within five days of receipt of housing assistance payments?
Intent to Vacate – notices received in writing?
Rejections – rejection letters inform applicants of the right to appeal and appeals documented and handled properly?

By paying attention to these particular questions at your properties — in addition to conducting a regular HUD audit — your ability to answer questions during a MOR desk review or on-site review will be stronger. For additional questions or concerns, talk to the Audit team at Cornwell Jackson.

Download a copy of the HUD 9834 or view the source list on the whitepaper for additional HUD forms and guides.

Download the whitepaper: Are You Ready for MOR? Affordable Housing Audit Tips to Meet HUD Standards

Scott Bates, CPA, is a partner in Cornwell Jackson’s audit practice. He provides consulting to clients in real estate, including HUD-funded properties. Contact Scott at scott.bates@cornwelljackson.com or 972-202-8000.

Take Care to Meet Terms of Contracts at Risk of Default

Posted on July 1, 2017 by Red Spot Design2

It is one thing to disagree about certain aspects of a construction project. It’s quite another when disagreements justify the termination of a contract due to default.

Prime example: In a recent case, a contractor doing work at a federal government facility faced termination for default where he repeatedly insisted on changing designs, failed to submit required documents and didn’t submit a safety plan. (Appeals of Industrial Consultants, Inc. d/b/a W. Fortune & Co., ASBCA No. 59622, 3/10/17)

Background

When construction projects end up in legal disputes, the terms of the contract generally control the outcome. And sometimes a breach of the contract results in a termination due to default.

Of course, not every breach is a deal-breaker. Only a material breach warrants termination. Courts have characterized a material breach as a substantial failure to perform or a violation of terms that is substantial enough to invalidate a contract’s intent. Essentially, a material breach is so fundamental to the terms of the contract that it defeats its main purpose.

One instance that can result in termination is a failure to follow design documents. In a classic case, the Appellate Court of Connecticut held that the construction of a kidney-shaped pool was a substantial deviation from the peanut-shape listed in the contract and that it constituted a material breach. The pool contractor’s refusal to comply with the contract’s specifications justified termination. (Strouth v. Pools By Murphy & Sons, Inc., 829 A.2d 102, 8/26/03)

Another basis for contract termination is a delay in completing the work by the date specified in the contract or where circumstances make timeliness critical. In some cases, a combination of failure to follow design and lack of timeliness can combine for a justified termination.

Facts of the Recent Case

A federal research and engineering facility in Hanover, NH, put out a contract to upgrade its heating, ventilation and air conditioning (HVAC) equipment. Although the scope of work was limited by budget constraints, the job was designed to include replacement of the air handling and condensing units, the variable air volume terminal units and the existing louvers, as well as ductwork modifications.

Prospective bidders were “urged and expected” to attend a pre-bid site visit conducted by the U.S. Army Corps of Engineers and told the work would have to meet certain Army Corps specifications. The contractor in question declined to visit the site before making the bid. The firm’s bid price was the lowest bid by a 35% margin.

The parties entered into a contract that allowed more than a year to complete the work. Work on site could only be performed on no more than four consecutive weekends after electrical work was completed by a third party. And that work couldn’t be finished until two months before the contract’s specified completion date.

Safety Plan and Product Data

One of the contract issues relating to the dispute was a standard government requirement that the contractor had to submit for approval by the contracting officer 1) an accident prevention plan and 2) product data for the air handling unit and other equipment.

The contractor visited the site for the first time a little over a month before work was scheduled for completion. After this walk-through, the contractor concluded that the government’s design had significant defects. He then began a campaign to redesign the work, which he refused to drop even though the Army Corps repeatedly told him to build as designed.

In the course of this process, the contractor submitted numerous Requests for Information to which the government promptly responded. Subsequently, the contractor either delayed in providing government-requested submittals or never provided requested submittals at all.

“Lack of Response”

Eventually, the officer in charge of the work sent three notices to the contractor, demanding that deficiencies be fixed. Numerous communications went back and forth between the parties. According to the officer in charge, the contractor was accusatory, combative and unwilling to cooperate. Two days after the scheduled completion date, the officer in charge issued a termination for default, citing the firm’s “lack of response regarding (the) request for required submittals, and to complete the contract as written.”

The outcome: The case went to an administrative judge for the Armed Services Board, who ruled that the contractor failed to:

Complete the work in a timely fashion,
Proceed with the work after the Amy Corps rejected its proposed changes to the project,
Furnish some of the requested submittals, and
Gain approval of other submittals.

Because the contractor was unable to demonstrate that the defaults were excusable, termination for default was granted.

Stick to Basics

Although you may have some leeway on construction projects, you must adhere to the basic contract. If it states that you must build in a certain way, follow the specified design or run the risk that your firm will be terminated for default.

4 Tips on Government Bids

When work in the private sector slows, you might be able to tap into another source of revenue: federal and local government authorities.

But winning a government bid is hardly a slam dunk, and your firm may find the process to be tedious and sometimes overwhelming. Here are four basic tips to help you get started.

Start small and end big. Most government agencies place a value on past success. Win a few small contracts and then you can move on to a bigger piece. Once you get your foot in the door, keep it there until you’re ready for the next step.
Do the legwork. Fortunately, you can find most of the resources you need online. First, sign up with the Central Contractor Registration (CCR) database, creating a profile so government procurement officers can find you. Then sign up for the pre-approved bidder list for the General Services Administration (GSA).
Keep your nose to the grindstone. This is a marathon, not a sprint. It may take a couple of years or even longer to win your first bid. Those who throw in the towel early aren’t around to finish the race.
Foster relationships. As it is in the private sector, developing relationships with government procurement officers is essential to continued business. In addition, partnering with other entities may lead to future payoffs.

A Look at Accounting Methods of Developers

Posted on June 27, 2017July 23, 2024 by Red Spot Design2

When considering publicly traded O&G stocks or Master Limited Partnerships (MLPs), investors should spend some time with the audited financial statements. Companies that are involved in exploration and development may either account for their oil and gas activities under the successful efforts method or the full cost method. This choice has a material impact on the balance sheet, net income, and how cash flows are presented on the financial statements.

With the Successful Efforts accounting method, the oil company:

Capitalizes costs only when the costs are associated with successfully finding or developing oil and gas reserves
Expenses dry holes and any other costs associated with failed efforts at finding or developing oil and gas reserves
Expenses production costs
Recovers any capitalized costs through depletion

With the Full Cost accounting method, the oil company:

Acknowledges that unsuccessful efforts are a necessary and unavoidable part of the business of exploration
Capitalizes all costs related to acquiring, exploring, and developing reserves
Expenses all production costs
Recovers capitalized costs through depletion
Performs the annual ceiling test: the capitalized amount carried on the balance sheet cannot exceed the present value of future cash flows (revenue net of future development and production costs) discounted at 10%. To the extent capitalized costs exceed the full cost ceiling, an expense is incurred to write off the excess.

Generally, in times of rising or high O&G commodity prices, the full cost accounting method will report higher net income because costs incurred in unsuccessful projects are capitalized. Consequently, the assets reported on the balance sheet will be higher assets. In times of falling or lower O&G commodity prices, however, the full cost method will report a lower net income and can have significant write downs because of the ceiling test. There are good arguments on both sides for choosing either the Successful Efforts method or the Full Cost accounting method. The key takeaway here is that during times of falling or lower commodity prices, companies that use the successful efforts accounting method may look artificially more successful than companies using the full cost accounting method. Be aware that you may not be comparing apples to apples when looking at the financial statements of companies that use different accounting methods.

Read the Footnote With Regard to Reserves

Another important disclosure, included with the annual financial statements, is the footnote discussing mineral reserves. This unaudited footnote is included with financial statements filed with the SEC, and it is generally the last footnote to the financial statements. It should outline (at least at a high level) how successful the developer has been at building reserves.

By carefully reading the footnote discussing the reserves and the management discussion and analysis section of the annual report, investors can learn where the drilling is happening, the biggest blocks of drillable acres, plans to complete or explore those areas and trends with regard to adding reserves. Understanding the plans of a developer to continue future exploration — such as where and to what extent — can support decisions on investment.

Continue Reading: Tax Benefits for Investing in Oil & Gas

Scott Allen, CPA, joined Cornwell Jackson as a Tax Partner in 2016, bringing his expertise in the Construction and Oil and Gas industries and 25 years of experience in the accounting field. As the Partner in Charge of the Tax practice at Cornwell Jackson, Scott provides proactive tax planning and tax compliance to all Cornwell Jackson tax clients.

Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

Prepare for a Management & Occupancy Review (MOR)

Posted on June 22, 2017July 23, 2024 by Red Spot Design2

decorative background with tiny houses arranged in rows

Over the past eight years and now into the era of the new Republican White House, scrutiny on affordable housing developers, owners and management companies has increased. Whether the reasons are to root out abuses of Section 8 funding or to justify cutting the US Housing and Urban Development budget, politics have put pressure on HUD inspectors to increase their review of funding recipients. Based on a recent presentation we attended on the return of the HUD Management & Occupancy Review (MOR), we outline ways that owners and managers of HUD-funded properties can prepare for a potential MOR.

Based on our experience with audits of HUD-funded properties and organizations, preparation and elements of a MOR are fairly similar. Let’s walk through the key areas of risk and review.

In the course of preparation, we recommend setting up a separate paper filing system and an online file to organize and store information relevant to a MOR, including a complete HUD 9834 form, your most recent REAC filing, audit of financial statements and disclosures, documentation on resolving any previous audit or MOR issues and general management documents such as leasing renewals (as requested in HUD 9834).

The top 10 risks that the MOR desk review will emphasize include:

PASS Score (physical property conditions)
FASS Score (financial condition)
Loan Payment Status (late payments, etc.)
Management Review Score (tenant complaints, staffing practices)
SOA (sex offender audit issues)
Overdue AFS (audit of financial statements)
OHAP watch list (program restructuring notifications)
FASS Referrals (financial restructuring)
EH&S (health and safety violations)
Management Condition (discrimination, falsification)

Any previous red flags, notifications or issues should be resolved — or documented as in process of being resolved —prior to another MOR. Findings that earlier issues have not been resolved can put a project/program/property on HUD’s radar as a bad partner. That puts future funding at risk.

After the desk review comes the on-site review. This review can include questions about transactions that occurred since the last MOR. If your project’s last MOR was in 2011, that’s a lot of ground to cover.

Even the best, well-run properties can experience grey areas that may be flagged. Items we have found during our financial statement audits include improper verification of income or handling of surplus cash. We have also noted contract issues in which an individual property or management company does not have its own separate HUD contract. Even wait lists can be scrutinized for possible discrimination.

The goal of any property should be to receive a “Superior” or “Above Average” MOR performance rating. This means the property/program is adhering to HUD policies and is operating a safe, fair and financially sound operation for providing affordable housing to the community. A “Satisfactory” rating means that there are some minor corrections to make. Anything below a rating of 70 is below average or unacceptable.

There are many good property management companies in the Dallas/Fort Worth area — whether for-profit or nonprofit — that run tight ships and schedule regular audits or reviews. Our recommendation to them is third-party validation. Have a CPA firm with knowledge and experience with HUD-funded properties walk staff through HUD 9834 documentation or at the least review their answers and addendums.

Continue Reading: MOR Questions Your Audit May Not Catch

Tax Benefits for Investing in Oil & Gas

Posted on June 15, 2017July 23, 2024 by Red Spot Design2

Business diagram shows change of the prices for oil

O&G exploration is still highly speculative, even with the advanced technologies available today. The unique tax benefits to this industry — designed as incentives for O&G development — can include a large direct deduction of all costs associated with development in the year they occurred. No other industry allows that timing of cost recovery. MLPs, for example, can deduct 70-80 percent of their costs to develop a drilling site, regardless of how successful it is. If it ends up being a dry hole, they can deduct 100 percent of the costs, but of course they’ve lost a lot of money on the investment.

The other unique tax benefit for O&G investment derives from the statutory concept of depletion. Every time you take oil or gas reserves out of the ground, you deplete the value of the asset.

When it comes to tax benefits for oil and gas investing, benefits vary by investment type. The most significant benefits apply mainly to direct working interest investments and to certain drilling partnerships. Direct investments in royalty interests receive a more limited benefit, as do Master Limited Partnerships (MLPs). Investors in O&G publicly traded stocks don’t receive a tax benefit directly, but may receive income taxed at long term capital gain rates via dividends or stock buy backs.

The following are the primary tax benefits that apply to direct working interest investments and partnerships (to a degree). CPAs like myself who are knowledgeable about tax compliance and reporting of O&G investment income can determine if your particular investments are eligible for these deductions.

Intangible drilling and completion costs (“IDC”)

IDCs include all the expenses incurred by the operator of the well related to the drilling and preparing the well for production. Such expenses may include the cost of the drilling contractor, wages paid to employees to oversee the project, survey work, site preparation, fuel, etc. IDC also includes the cost of casing and tubing in addition to certain other tangible items, so the term “intangible” can be a bit misleading. The costs of pumping equipment, flow lines, storage tanks, separators, salt water disposal equipment, and other production facilities or equipment is not classified as IDC and is required to be capitalized and depreciated.

With the exception of integrated oil companies and drilling projects situated outside of the United States, IDC can be fully deducted in the year in which they occurred. You must make the election to deduct IDC on the first return in which IDC is incurred by either deducting or affirmatively electing.

For cash basis taxpayers, if the contract with the operator requires the costs to be prepaid, IDC is fully deductible when paid, even if the actual costs are incurred by the operator in the following year.
Taxpayers can elect to capitalize and amortize over 60 months straight line (if IDC incurred on non-domestic oil and gas properties, it must be capitalized and amortized over 10 years – not eligible to be expensed).

In assessing the potential tax benefits available from a potential oil and gas investment, the investor should consider their alternative minimum tax (“AMT”) position. IDC is partially deductible for AMT purposes. Excess IDC (difference between IDC deducted and the amount that would have been amortized during the tax year had the election to capitalize and amortize been made) is added to AMT income and multiplied by 40 percent. All excess IDC above the product is considered preference IDC and is not deductible for AMT. For example:

Assume AMT income before any IDC preference add back is $500,000 and Excess IDC is $400,000; AMTI including Excess IDC = $900,000 x 40% = $360,000 amount deductible from AMT
$40,000 is the preference IDC add back, thus, taxable AMT is $540,000

The IDC deduction applies to working interests, either owned through drilling partnerships or direct working interests. It also applies to MLPs, but passive activity and publicly traded partnership tax rules limit its utility.

Depletion

Investors compute cost depletion and statutory depletion (also known as percentage depletion), then deduct the larger of the two amounts. Depletion is calculated on a property-by-property basis.

Cost depletion is computed by the units of production method (total volume produced during the year / total expected remaining volumes to be ultimately produced at the beginning of the tax year multiplied by leasehold cost.
- No income limitations apply
- Once all leasehold costs are fully recovered through depletion, cost depletion is zero
Percentage depletion is calculated by multiplying gross sales for the property for the year by 15%
- Allowable depletion is limited to taxable income for the property, thus, percentage depletion can reduce taxable income on a property to zero, but may not create a tax loss for the property.
- Overall income limit – 65% of taxable income; any allowable percentage depletion above the overall limit is carried over to future years
- Not limited to leasehold cost – thus may continue to deduct percentage depletion after all leasehold costs are fully recovered

This is the 100,000-foot view of O&G investing for the potential investor looking to diversify a portfolio while prices are low. To explore if these opportunities may be right for you, consult with your investment advisor. Cornwell Jackson can assist potential investors with analyzing the potential tax impacts of oil and gas investments and with the complexity of tax filing each year. Contact us with any questions.

Download the Whitepaper: Oil & Gas 101: Investing Basics

Contact him at Scott.Allen@cornwelljackson.com or 972-202-8032.

How Does Terrorism Affect Manufacturing?

Posted on June 14, 2017 by Red Spot Design2

It seems that a day doesn’t go by without a terrorist attack taking place somewhere in the world.The violence recently perpetrated in Manchester, UK, and on London Bridge and close by Borough Market are still fresh in our minds. Unfortunately, one or more other events will have likely happened before you read this article or shortly after.

These attacks are eroding public confidence in security and will gradually affect the global economy, if it hasn’t already. In particular, tremors are being felt throughout our domestic manufacturing sector. Where will it all lead? This article will examine some of the main repercussions for manufacturers on both the global stage and in their own plants and warehouses.

View of the Global Economy

This list is not all-inclusive, but the following are four significant ways that terrorism can affect the global economy:

1. Market uncertainty. You don’t have to be anywhere near a terrorist attack to experience a financial downturn. Cataclysmic events and uncertainty caused by terrorism are known to roil the world’s economic markets. One dramatic example is the immediate and sustained decline following 9/11.

However, as such events become increasingly frequent, they seem to have less of a long-term impact. In the face of recent attacks, the stock markets both abroad and in the U.S. have shown some resiliency. Nevertheless, when there is a belief that there is no longer a safe place to do business, terrorist events affect the broader picture and will likely have a cumulative effect.

2. Destruction of property. While other effects of terrorism are difficult to measure, physical destruction can often be quantified. Manufacturing plants, transportation systems and physical property are destroyed at an enormous cost. The infrastructure in the surrounding area will be strained as businesses struggle to cope with the aftermath.

Notably, resources that normally would be focused on producing goods and services are diverted and allocated for other purposes, such as spending on the military and improving security. Overall, the impact is almost certainly negative, although some observers suggest that military spending leads to an economic boost.

3. Governmental reactions. A bunker mentality among governments and citizens usually sets in after a particularly destructive attack or series of attacks. This could create a domino effect of expanded budget deficits, additional taxes and increasing inflation. In extreme circumstances, government controls may have to be initiated and nationalization of industries may even have to be implemented.

Loss of personal freedoms is often a byproduct. In addition, during militarization the private economy may suffer and recovery can take a long time.

4. International divisiveness. Typically, terrorist attacks both here and abroad encourage increased nationalism and skepticism about foreign involvement. At the same time, they tend to discourage tourism and trade in ways that hinder the global economy. This trend toward a populist movement is exemplified by political events such as Britain’s plans to leave the European Union and erodes some of the positive results of foreign cooperation that have been built up the last few decades.

View of the U.S. Manufacturing Sector

Manufacturing is critical to the U.S. economy and the economies of many other nations. Accordingly, the manufacturing supply chain could be damaged by terrorist attacks taking place in far-flung locations. The supply chain encompasses vendors supplying raw materials, warehouses and distribution centers, and retailers who deliver the goods to consumers. Without an uninterrupted flow, the entire system could crumble. The chain is only as strong as its weakest link.

If manufacturing firms in the U.S. aren’t yet attuned to the dangers being posed by terrorist acts around the world, they need to wake up to the new reality, and fast.

Following are some of the issues to address.

1. Adopt access security. Targets of terrorist attacks are often located in high-profile areas with a heavy concentration of people. The terrorists usually want to make a dramatic statement and inflict the most damage possible. Therefore, not only are transportation systems likely targets, but so are office buildings, factories and corporate headquarters. Manufacturing warehouses and plants can’t be ruled out. For these reasons, your firm must adopt security measures for accessing the premises, even if it doesn’t produce goods historically tied to political or governmental functions.

2. Find alternative delivery sources. Direct threats to a designated property aren’t the only concern. If an airport is threatened and delays ensue, deliveries may be delayed. The same possibilities arise for shipments by rail or sea. With delays lasting weeks, the interruptions can irreparably harm the business, especially if property is damaged.

3. Develop contingency plans. Because this situation is akin to the developments following a natural disaster, such as a hurricane or flood, similar preparations should be made. If the firm is not located in a region prone to such natural disasters, or exposure is limited, it may not have adequate emergency and contingency plans in place. The threat of terrorist acts should change this thinking.

4. Perform risk analysis. If your firm hasn’t done so already, consult with security experts to conduct a risk analysis for terrorism, especially if your firm is in a densely populated area. Include provisions for finding secondary and tertiary suppliers, emergency procedures for factory production and other methods for thwarting disruptions to the supply chain (for example, backup storage sites). Make sure that workers are properly trained in emergency procedures should an attack take place.

Keep in mind, you will need to be prepared to act swiftly and decisively. The sooner you move, the less your workflow will be affected. For instance, if you rely on deliveries to a nearby airport, rail hub or port, continue to monitor activities. Be among the first to move cargo through alternative means — not the last.

To gain more attention to their activities, terrorists often target transportation systems, physical property and infrastructure. As a result, terrorist acts affect exports and imports with a direct connection to the manufacturing sector. You can’t run and hide from the potential problems or ignore them either. Coordinate your security measures accordingly.

The Cyber Threat

Not all terrorism attacks involve bricks and mortar.

The risk of a cyberattack is just as prevalent and may be even more lethal. Take for example, the recent cyberattacks in London against the British Parliament and in Ukraine, Russia, and other countries against banks, energy companies and an aircraft manufacturer.

Cyberterrorism knows no political or geographical boundaries. A strike can come from anywhere and pierce and bring down defense systems of corporations, transportation systems and even an entire country.

In particular, manufacturing firms store data essential to their operations and their supply chain. If that data is wiped out, it could take months to get the operation up-and-running again. Make sure that your firm is protected by the latest technology and continue to install updates as necessary.

Prepare: E-Verify May Soon Become Mandatory

Posted on June 8, 2017 by Red Spot Design2

With so much focus in Washington on stemming illegal immigration and the erosion of job opportunities for U.S. citizens, chances appear better than ever that the E-Verify system will become mandatory. President Trump’s 2018 budget proposal includes funds to upgrade the system so that it can handle greater capacity, that is, if Congress authorizes requiring businesses to use it.

California’s View of E-Verify

Often following the beat of a different drummer, the state of California has passed its own laws limiting the use of the federal immigration status verification system known as E-Verify.

In 2011, California passed the Employment Acceleration Act, which prohibits state agencies, cities, and counties from requiring private employers to use the federal system in most cases. Exceptions include where the use of E-Verify is mandatory by federal law, or when using the system is a condition necessary to receive federal funds. Previously, in some areas of California, city contractors and businesses within city limits were also required to use E-Verify. Voluntary use for private employers is permitted.

Effective January 1, 2016, Assembly Bill 622 set forth stiff civil penalties of up to $10,000 for each separate occurrence of misuse of the E-Verify system. Violations include actions such as:

Using the system to verify the status of existing employees,
Using the system to verify the status of job applicants before an offer of employment has been made, and
Failing to give an individual a Tentative Nonconformation notice, as soon as reasonably possible, when such notice has been received after attempting to verify status.

Given the fact that violations can quickly result in significant penalties, California employers using the E-Verify system should review their practices to ensure compliance.

Background: E-Verify is currently a voluntary federally administered electronic system designed to help employers verify the work eligibility and citizenship status of job applicants and employees. Its purpose is to alert users when the Social Security number supplied by an individual is already in use by someone else. After an initial pilot phase that began in 1996, it became available to employers in all states in 2001.

Where Verification is Mandatory

Today, nine states — Alabama, Arizona, Georgia, Louisiana, Mississippi, North Carolina, South Carolina, Tennessee, and Utah — require that most employers use E-Verify. Federal contractors also must use the system. A handful of other states require that public employers or contractors doing business with state or local governments use E-Verify.

Even so, only about 10% of employers use the system. Of those, 60% do so because they are required to by law. Yet about 90% of employers recently polled by the Society for Human Resource Management (SHRM) said they would support a mandate to use E-Verify or a similar system, subject to certain changes in the existing program.

What Employers Want

High on employers’ wish list of possible changes to the E-Verify system is that using it would take the place of the Form I-9, “Employment Eligibility Verification,” the paper-based system created for the same purpose. Current users of E-Verify are still required to collect I-9s from employees, just like everyone else.

Additional changes sought by employers point to issues they would face now if E-Verify were made mandatory in its current form, including:

A strong “safe harbor” protecting employers from accusations of wrongdoing if they use the system in good faith,
Removal of any potential liability for employment-based discrimination charges in conjunction with its administration of E-Verify, and
Provision of a set time period for resolving work authorization disputes.

Another concern with E-Verify in its present form is that its usefulness is limited. That is, it determines whether information entered into the system — such as name, date of birth and Social Security number — already exists in the government’s database and corresponds to someone who is eligible to work. “What it can’t do is give employers certainty that the people standing before HR are who they say they are,” according to SHRM.

Instead, SHRM proposes the use of a network of “identity verification centers.” These centers are similar to the ones companies use when individuals need to request a new password to gain access to their online accounts. The requester must provide personally identifiable information to prove who they are (such as answers to preset security questions). In an employment setting, employers would be told whether an employee or job applicant has cleared that hurdle.

Also, currently employers that use E-Verify must later verify that the person they just checked out is indeed employed by the company. One reform being proposed is that the system be streamlined by dropping this requirement.

Pending Legislation

The latest version of the “Accountability Through Electronic Verification Act,” was proposed by Senator Charles Grassley (R-Iowa and chairman of the Senate Judiciary Committee) and co-sponsored by nine other senators in January. If passed, it would make E-Verify permanent (though under current law, it must be reauthorized by Congress every two years). It would also address several of the concerns of groups like SHRM.

Here are several of the key provisions of the proposed measure, as described on Congress’ website.

Employers must: (1) use E-Verify to check the identity and employment eligibility of any individual who hasn’t been previously vetted through E-Verify not later than three years after enactment of this Act (2) re-verify the work authorization of individuals not later than three days after their employment authorization is due to expire, and (3) terminate an employee following receipt of a final E-Verify nonconfirmation. The information provided by the employee must then be submitted to DHS, to assist in enforcing or administering U.S. immigration law.
The system may be used to verify the identity of individuals before they are hired, recruited or referred if the individual so consents.
The bill eliminates the Form I-9 process and sets forth the design and operation requirements of the E-Verify system.
U.S. employers must begin to participate in E-Verify within one year of enactment of this Act; and employers using a contract, subcontract or exchange to obtain labor to certify that they use E-Verify.
The failure of an employer to use E-Verify shall be treated as a violation of the Immigration and Naturalization Act requirement to verify employment eligibility. It also creates a rebuttable presumption that the employer knowingly hired, recruited or referred an illegal alien.
The bill increases civil and criminal penalties for specified hiring-related violations, and establishes a good faith civil penalty exemption/reduction for certain hiring-related violations.
State and local governments may not prohibit employers from using E-Verify to determine the employment eligibility of new hires or current employees.

There’s no guarantee that E-Verify will become the law of the land, and if it does, chances are there will be a lag time before it takes effect. Still, it’s a good idea for companies to review their work-status vetting procedures, as well as the possible implications of what a more foolproof E-Verify system might have for your workforce.

Underperforming Employees May Be Salvageable

Posted on June 7, 2017 by Red Spot Design2

7It’s easy to spot underperformance, but correcting it is a different matter. The fact is, effectively managing your workforce, especially problem employees, just doesn’t come naturally to most people. Here’s some guidance to potentially help turn around an employee who is missing the performance mark.

Tackling the Problem

When an employee is underperforming, begin the performance management process with these two steps:

Clearly define the nature and degree of the underperformance.
Determine whether you’ve done the best job possible in helping the employee to be successful. For example, is the employee aware that you consider his or her work subpar? Have you put it in writing as well as had discussions with the employee?

Staff members who aren’t sure whether they’re on the right track often wait for feedback, rather than proactively seeking guidance. That means you need to act at the first sign an employee isn’t meeting expectations, rather than hoping the situation will remedy itself.

If the individual has worked under other supervisors in previous jobs within the company, a quick meeting could be productive, before talking with the employee. Describe the issues you’re having, and ask the previous supervisor whether the same type of problems were present in the past. If the answer is “no,” that may help set the agenda for your discussion with the worker. The conversation might proceed along these lines:

Clearly and specifically state your performance concerns. For example, in a manufacturing plant, you may need to advise an employee that he or she is habitually falling below the daily production goal.
Let the employee know that your objective is to work together to find a solution.
After discussing the specific performance issues, ask how you can help the employee turn around the situation, with some possible suggestions in mind. There may be issues you aren’t aware of, such as tools that are in disrepair or missing, or poor lighting in the employee’s workspace. So be open to his or her input.
Provide the employee with any written materials you may have — or can put together — about the employee’s tasks and expectations. For example, are there manuals, guides and checklists about how to do the job properly?

If the employee attributes the performance concerns to lack of clarity about expectations, or an inability to prioritize tasks, the remedy might be as simple as regular monthly, weekly or even more frequent meetings to go over what needs to be accomplished before the next meeting.

The discussion could also reveal that the employee, while generally qualified for the position, needs some training to fulfill all the requirements of the job.

Accepting Criticism

How well the worker responds to the initial part of the performance discussion will influence how you wrap it up. If he or she is concerned, cooperative and motivated to improve, you can end with the remedial plan you devise. If, instead, the employee is defensive and unrepentant, giving no indication of a willingness to change, it may be time to describe the consequences of a lack of improvement.

The outcome of the meeting needs to be a concrete and detailed performance improvement plan with milestones. The plan itself may be as simple as a schedule for check-ins and progress assessment meetings.

Job Descriptions

To determine the milestones, go back to the written job description to see if it’s clear enough. Depending on the job, measuring progress may be easy, such as by seeking a higher output rate for a standard unit of product or service. Of course, it’s not always that easy, and it may require some serious thought. Whatever you decide, don’t leave this unaddressed. It’s not enough to say “I’ll know good performance when I see it.”

The clearer the job description, the easier it is to hold employees accountable for specific performance metrics. Take a look to see if it provides a framework you can use for measuring progress. If it doesn’t, it should be revised. An example of a metric for progress that’s harder to measure — let’s say, for an office assistant –— might be something like this: Within the first 90 days of employment, complete cross-training with the receptionist so you can efficiently fill that position as needed.

Follow-up discussions to look at performance improvement should be just that — discussions, not lectures. Before offering your assessments, seek the employee’s own opinion of his or her progress. You may see more improvement than the employee does, and that can give you an opportunity to encourage him or her with a little praise.

The worst mistake you can make in an employee turnaround effort is to lay out a detailed remediation plan, then neglect to follow up and review progress with the employee. That’s especially true if you promise adverse consequences for a lack of improvement and then nothing happens. Failing to follow up wastes everyone’s time, and the employee may either conclude you weren’t serious to begin with, or that he or she has improved enough.

When Your Best Efforts Fail

Doing all the right things to try to turn an underperforming employee into a valued worker is no guarantee of success, of course. After you’ve given it your best shot, you may decide the employee just isn’t right for his or her current role. Is there another area in the company that seems like a better fit? If so, explore the possibilities with other managers and then with the worker.

If the employee simply isn’t salvageable to work for your company at all, act promptly. The former employee will probably be better off finding a job that’s more suitable to his or her skills and interests. And in the end, your workforce will likely benefit by higher production and improved morale. Be sure to document all of the steps you took to try and turn the situation around, and consider consulting legal counsel to ensure you’re in compliance with all applicable laws.

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