Choose Tenants Wisely: The Case of Reid v. Mutual of Omaha Insurance Company

Rental Property Real Estate Tax
Rental Property

It is well known that acquiring property for the purpose of renting to tenants is a potentially highly lucrative endeavor. Rental property can yield enormous financial benefits to property owners, and these benefits can be even greater when owners are equipped with adequate tax knowledge. Huddleston Tax CPAs encourages rental property owners (and future owners) to peruse our material on this topic. If obtaining rental property is within your contemplation, however, it is important to consider that owning such property frequently presents complications. Things do not always go smoothly, and there are snags which can be a severe drain on your supply of mental and physical energy. The case of Reid v. Mutual of Omaha Insurance Company (1989) is a telling example of the sort of headache which can result from owning rental property.

Of course, this case is not intended to discourage rental property ownership. But future owners should certainly be aware that hassles such as the kind in Reid v. Mutual of Omaha Insurance Company are fairly common. Rental property ownership can be extremely rewarding, but it involves a great deal more than just collecting rent checks!

Facts

Reid (the plaintiff) contracted with Mutual (the defendant) to rent out a piece of office space for a period of five years. Mutual was supposed to pay Reid a monthly rent of $1100. Approximately two years after the five year lease was signed, another company, Intermountain Marketing, moved into the adjacent space. Mutual made a formal complaint to Reid about the behavior of Intermountain. Mutual claimed that Intermountain was too noisy and that Intermountain employees were using up all of Mutual’s allotted parking spots. Reid failed to adequately address Mutual’s complaint and as a consequence Mutual moved out of the office space and ceased paying rent. Soon after Mutual’s departure, Intermountain expanded into Mutual’s former space and effectively took over Mutual’s lease. However, Intermountain soon went bankrupt and then exited the space.

Reid sued Mutual and argued that Mutual’s failure to pay rent constituted a breach of contract. Mutual argued that Reid’s failure to address Intermountain’s troublesome behavior constituted a “constructive eviction” and therefore Mutual’s contractual obligation was released. Mutual also claimed that Reid had a duty to mitigate any resulting losses from the alleged breach and that Mutual was only liable for a portion of the losses as a consequence.

Law

When a contract has been breached, the breaching party is not necessarily liable for all losses which follow from the breach. The other party of the contract has a duty to mitigate, and the damages which are recoverable are limited to those which were unavoidable despite reasonable effort to mitigate.

Ruling

The court (Supreme Court of Utah) ruled in favor of the plaintiff, but determined that the plaintiff was not entitled to the full value of the lease because the breach triggered a duty to mitigate. The plaintiff could only recover a sum which represented losses which were deemed unavoidable even after reasonable attempts to mitigate.

Reid v. Mutual of Omaha Insurance Company offers a very important lesson for future rental property owners: even with a long-term lease, unpaid rent is not always recoverable. Cases such as this one emphasize the importance of choosing tenants with extreme care!

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View the following video to learn more about the tax benefits of real estate ownership

Conklin v. Davi: Adverse Possession and Marketable Titles

Real Estate Adverse Possession Title
Real Estate

Huddleston Tax Weekly will continue to examine legal cases which involve real estate because such cases can be of substantial value to our readers who are either current or future property owners. When engaging in real estate transactions, it is always best to draw up a contract which captures every conceivable detail of the exchange. Developing a thoroughly detailed contract will help to avoid the possibility of any legal disputes. The case of Conklin v. Davi (1978) is an interesting example of a dispute which could have been avoided if the parties had created a more detailed contract.

Facts

Conklin (the plaintiff) sold real estate to Davi (the defendant). A section of the property was acquired through adverse possession. Adverse possession is the process through which real property may be obtained without a monetary transaction; adverse possession occurs when an individual actively and openly “possesses” land for a specified period of time. The contract between the parties omitted reference to the fact that a portion of the land was acquired through adverse possession. Davi wished to obtain a title which was wholly “marketable” so that the land could be sold again in the future without complication. Davi believed that a marketable title could not be gained through the transaction due to the fact that a piece of the land had been acquired through adverse possession. Based on this belief, Davi refused to conclude the transaction. Conklin sued for specific performance and Davi counterclaimed for rescission of the contract.

Law

The critical issue before the court was whether land acquired through adverse possession can have a marketable title when transferred via sale. The answer is yes: provided that the seller shows proof that the land was acquired legally through adverse possession, the buyer is capable of obtaining a title which is wholly marketable.

Ruling

The court (the Supreme Court of New Jersey) ruled in favor of the plaintiff (Conklin). The defendant could have procured a marketable title to the entire land as long as the plaintiff provided proof of ownership through adverse possession. The court ordered the plaintiff to provide such proof before suing the defendant for specific performance.

As Conklin v. Davi shows, land acquired through adverse possession can yield a wholly marketable title. The issue was that the plaintiff did not provide proof of ownership when the contract was formed; another issue was that the parties were unaware that adverse possession could produce a marketable title. The lesson is clear: before selling or buying real estate, be sure to conduct research and develop a sufficiently detailed contract!

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To learn more about the tax benefits of real estate ownership view the following webcast

Vancouver’s Latest Tax May Impact Seattle Real Estate Market

Seattle Real Estate Market Prices
Seattle Real Estate Market

Though the Seattle real estate market is attractive on its own merits, a recent tax issued in Vancouver, Canada may create even more demand in the Seattle housing market. In recent years, foreign buyers have caused housing prices in the Vancouver market to rise substantially. In response, the city (of Vancouver) implemented a tax to help stabilize the market. Some observers speculate that new tax will push foreign home buyers south toward Seattle. Let’s take a look at the facts and develop an informed view of the matter.

Foreign Buyer Transfer Tax

The new tax – which is known as the Foreign Buyer Transfer Tax – applies specifically to foreign buyers in the Vancouver housing market. Whenever a foreigner purchases a piece of Vancouver real estate they must pay an additional 15 percent on top of the home price. The tax took effect on August 2nd of this year.

Because little time has passed since the implementation of the tax, predicting its long-term impact is not an easy task. However, it seems likely that foreign real estate buyers – who are predominantly Chinese – will look toward Seattle simply because of the large disparities in home prices between the two markets. In August, the benchmark home price in Vancouver rose to $1.57 million; in Seattle the median home price is $625,000. It seems reasonable to predict that the new Vancouver tax will create an additional incentive to migrate south on top of other incentives which already exist.

Since August, investment in the luxury real estate market of Vancouver has declined by approximately 20 percent. Whether this decline is attributable specifically to the new tax is not fully clear. Along with Seattle, foreign buyers will probably also look toward Toronto.

Possible Impact on Seattle Market

As of right now, there is relatively little hard evidence to support the idea that the Vancouver tax will lead to a stampede of foreign investment in the Seattle real estate market. In fact, there are some data which may suggest a decline in foreign investment. As a general matter, tracking foreign investment is a difficult task, but one way to obtain an imperfect sense of foreign investment trends is to look at cash sales. Cash sales may reflect foreign investment trends to a degree because many (though not all) foreign buyers pay in cash because they are unable to obtain financing in the U.S. But, as it turns out, cash sales have actually declined in Seattle in the past several years. Though this is not conclusive evidence, it tends to throw doubt on the migration hypothesis.

Even without a pile of solid evidence surrounding it, the Vancouver tax has still managed to catch the attention of the Seattle political establishment. Seattle officials are very concerned about keeping housing prices affordable and the potential impact of the Vancouver tax has already sparked discussion about policy considerations. However, it seems certain that no measures will be adopted until there is more firm data on the effect of the tax.

The new Vancouver tax is an interesting example of a city taking action to stabilize its housing market. But at this point it appears that the idea of this tax creating a veritable avalanche of foreign investment in Seattle is almost pure speculation.

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If you’re curious about various tax strategies which can help you save money as a property owner you should view the following presentation by our CPA Jessica Chisholm

Basic Facts of Cost Segregation

Cost Segregation Study Tax Reporting
Cost Segregation

Cost segregation is a process which involves separating personal property assets from real property assets for the purpose of shortening the time of depreciation and reducing tax liability. In a cost segregation study, assets are classed together according to their depreciation period. Cost segregation has the potential to save building owners large sums of money because it enables certain costs to be depreciated over a much shorter period of time (5, 7 or 15 years) than they normally would be (27.5 or 39 years).

Personal Property Assets

Certain elements of a building may be categorized as the “personal property” of the owner as opposed to real property for tax purposes. For instance, non-structural elements – such as wall covering, carpet, lighting, certain parts of the electrical system and others – may be categorized as personal property in most instances. Certain types of land improvements – such as landscaping and sidewalk improvements – may also be categorized in this manner. When categorized in this fashion, these elements will have relatively shorter “useful lives” than they otherwise would have, and consequently owners may have a reduced tax burden and may take advantage of depreciation deductions.

Typically, cost segregation studies are financially prudent for buildings which have been bought or remodeled for over $200,000. Cost segregation studies can be performed on any building which has been bought, constructed, expanded or remodeled since 1987. Hence, studies can be performed “retroactively” on buildings which are not newly completed.

Cost segregation can be a tremendous positive force for business owners as it can give them access to cash much more quickly than would otherwise be possible. In the world of business, timing is of immense importance, and so taking earlier deductions can literally alter the whole direction of a company’s long-term future.

Cost Segregation Studies

The IRS scrutinizes cost segregation studies very thoroughly. This is because such studies can – and frequently do – translate into many thousands of dollars in tax savings. When hiring someone to perform a cost segregation study, it is important that your hire be well-informed not only on the relevant architectural and engineering specifications but also on the applicable law. Simply hiring a construction engineer or architect with no prior experience with cost segregation analysis is unadvisable. There are heavy penalties imposed by the IRS when cost segregation is used improperly and so it imperative to hire a qualified specialist to perform the analysis.

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As we’ve seen, cost segregation has the potential to save business owners lots of money. To learn more about cost segregation, curious readers should view the following presentation by Huddleston Tax CPAs principal and founder, John Huddleston

The Tax Benefits of Real Estate Ownership

Real Estate Property Owners Tax
Real Estate

Most people — even those among the so-called millennial generation — would like to own property at some point in their lives. Since it relates to both our drive for prosperity as well as our abundance of space, there is something about real estate ownership which gives off a thoroughly American impression. As Americans, material success has always been among our primary concerns, and home ownership is a clear indication of such success. What’s more, home ownership also has symbolic value as it represents stability. And in a land of such frenzied activity having a sense of stability can be a source of great pleasure.

What not all Americans realize, however, is that real estate ownership offers a number of important tax benefits which are unavailable to renters. And among those who have some sense of the benefits of home ownership very few are aware of exactly how advantageous these benefits can be. As it turns out, there is a whole range of perks available to those who own property. Property owners who take advantage of these perks can save a great deal of money.

For instance, property owners are able to deduct a number of items on Schedule A of their personal 1040. Individuals are able to deduct mortgage interest (on the first $1 million of home acquisition debt and the first $100,000 of home improvement debt), qualified mortgage insurance, real estate taxes, and the points paid when purchasing or refinancing. Individuals who sell their home may be able to exclude up to $250,000 ($500,000 if married and filing jointly) provided they meet the requirements of the Principal Residence Exclusion.

People who own rental property are able to take deductions for a variety of expenses which they may incur throughout the course of ownership. Advertising, cleaning bills, utilities (when the rental property does not have a tenant or when utilities are included in rental price), mortgage interest, homeowners insurance and property taxes are all deductible. Repairs to rental property are deductible as well, while improvements to rental subject must be capitalized and then depreciated over their useful life.

There are many other benefits which may be derived from real estate ownership. For more information, view the resources from our webcast here.

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Check out this video to learn more

Reasons Why Your Property Taxes May Have Increased

If you own a home or commercial property, you will notice that your property tax amount changes from year to year. No matter where you are located, there exists always a possibility that your property tax will increase. Here are some reasons why your property taxes may vary annually.RealEstateForSale

Increase in Neighborhood Value

If the neighborhood has seen marked improvements, this can send your property taxes skyrocketing. If large, nice homes are being built or if renovations are taking place in many homes, there will be an increase in taxes. If there are more amenities, such as nice stores, better roads, and nice, green parks being added to the neighborhood, this will trigger higher home values and higher property taxes.

Government and School Funding

If the local government and local schools are in need of more money, property taxes for everyone in the local area will go up. Property taxes are used to fund public schools for students and they are also used for local budgets. If there have been budget issues, it is likely that you will owe more money in taxes. If a new school is being built in your area, this will also inflate tax needs and your tax assessment.

A New Golf Course

One thing that will definitely increase your taxes is being located near a golf course. Golf course communities are often considered luxury by definition, and this consideration translates into skyrocketing taxes. If a golf course is built near your home or community, you can expect that you will find yourself having the same type of property taxes as a planned golf course community.

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Tax Deductible Rental Property Expenses, Part 4: Landscaping, Hired Help, HOA Fees

In order for your rental property to be attractive to prospective renters, it should be found in good and presentable order. These expenses can be deducted against the income received from this property provided they meet the business use requirements. Let’s look at landscaping, hired help, and HOA fees.

For more information, please review IRS Publication 527 for current regulations.

Landscaping

The seasonal maintenance of the property such as grass trimming, floral arrangements, and other weather related tasks can be applied to the rental income for the property. In some of these services you may be required to pay for the cost of the plants, shrubs, etc. Most of these types of services are performed similar to your main home landscaping, however these costs are limited to only the portion of time in which the property is not personally used.

Hired Help

This type of cost is usually for such services as property security review, greeting new renters, and even a concierge type of service such as a tour guide for the local area. This service should be set forth in an agreement between yourself and the parties involved, and can be expensed against the revenue of the property during allowed rental days. Please note that these services should not be used in return for rental use otherwise it would be classified as personal use days since you had a material benefit from this. It is important to note that these payments may need to be reported under a 1099 if they exceed the $600 threshold. Because of this when using hired help, it is usually best to use a service organization which would handle some of these requirements.

HOA (Home Owners Association)

Since these types of dues assessments are usually periodic, they can be used to offset the income from the rental property. Many of these associations perform services use as property maintenance, administration services, etc. It is important to note that these services along with others related to them can only be deducted if they are not personally used. Also note that some services which are offered by these HOA’s should not be duplicated in other areas such as landscaping and hired help. Using an HOA can be a benefit since most of the services needed to maintain and run your property can be managed by them as a bundled service assessment fee.


Redmond CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Tax Deductible Rental Loss

One thing we learned about investing in real estate over the last few years is that it can be quite volatile at times and requires sufficient capital and planning to be successful. Rental properties are traditionally long term investments and losses may occur during the holding period. Investors should make an effort to become familiar with the issues related to the deductibility of such losses.

IRS passive loss rules dictate that passive losses from real estate can only be offset by passive income and can only be carried forward not back. Generally, losses from real estate rental activities are considered passive losses unless you are a real estate professional. Even if you actively or materially participate in the management of the rental property any resulting losses would still be passive losses if you are not a real estate professional. Active participation and material participation are not the same. Active participation is a less stringent standard and requires that you be involved in significant and bonafide management decisions including tenant approval, rental terms and expenditures. To meet the material participation standard your management efforts must be on a substantial, continuous and regular basis and meet additional IRS requirements beginning with a minimum of 500 hours spent on rental activities.

There are exceptions to this rule. If you own at least 10% of a rental property and actively participate in its management then you may be able to deduct up to $25,000 of passive losses even if you don’t have any passive income. Under this rule you can offset passive income from the rental property with your non-passive income such as wages, interest and dividends etc. Since this is intended to be a break for smaller landlords the deduction amount gets reduced after your modified AGI exceeds $100,000. You lose $1 of offset for every $2 over MAGI which reduces the offset to $0 when MAGI reaches $150,000. See Passive Loss Rules for Rental Property.

Real estate professionals are able to treat losses as non-passive and offset other income if they materially participate in the real estate management activities. This requirement applies to each rental property individually so some properties owned by a real estate professional could qualify while others do not. To be considered a real estate professional you would need to spend more than 50 percent of your time and more than 750 hours annually on real estate activities. This standard must be met every year so one year you may qualify as a real estate professional and the next you don’t. See Professional Real Estate Rules for Rental Property.

Passive losses that cannot be offset because of a lack of passive income and don’t meet other deductibility requirements become deferred or “suspended” and are carried forward indefinitely until passive income becomes available or the entire rental property investment is sold.

Given the complexity of the rules regarding real estate rental properties and the usual long term holding periods you must maintain good records over the life of the investment and possibly long after it is sold if carry-forwards are involved. Obviously, this can get pretty onerous when you have multiple properties and your own personal involvement in each one can change from year to year which changes the tax treatment. Aside from purchase cost information you need to keep receipts for all expenses related to your properties and keep track of rents received. Depreciation schedules should be kept for the property structures and any capital improvements. Be sure and keep a logbook to document your time spent on rental property to show active or material participation or that you are a real estate professional.


Redmond CPA+John Huddleston has written extensively on tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington School of Law.

Tax Deductible Rental Property Expenses, Part 3: Supplies, Taxes, Utilities

As a Landlord, you may incur certain expenses during the course of business that have some significant impact on your profitability. Among these are supplies, taxes, and utilities, which are generated from the property from which you are receiving income. As with other business expenses, you must remove any personal use items as well as determine any periods of time in which the property was used for personal reasons. This is the case even if you are using 1040 Schedule C or Schedule E. Let’s start with supplies.

Supplies

These expense can be very tricky and sometimes difficult to maintain, however if set up properly then there should be very few problems at tax time.
Let’s determine what items would fall into this category. Most items in this account are using day to day consumable goods purchased solely to maintain the rental place. First let’s look at the difference between “supplies” and “expenses.” Expenses are usually items that are used when consumed. An example would be a trash can, certain small appliances, food, etc. Supplies are items that you would purchase sometimes in bulk for the same purpose; however, these items can be held in inventory storage until consumed. Examples of this are bulk paper (copy, toilet, etc.), pens, pencils, bulk cleaning items, trash bags, etc. It is very important to note that these items should be inventoried periodically to monitor costs as well as quantities on hand. Postage stamps are another item which you may buy in bulk, but only use a fraction leaving the rest in inventory until used. Keeping a supplies and expenses chart of accounts is the best way to handle this.

Taxes

During the course of business there are many taxes that you might have to pay directly related to the property. As with most jurisdictions, you may receive a separate bill for your property, business, and income taxes. If you operated a rental property in which this is not the case, then as we mentioned earlier you must allocate the percentage of personal use to business use. This is common with a house in which a homeowner may have “residents” living in empty bedrooms and other spaces. This is a very important area since a miscalculation can cause large interest and penalties when discovered after a tax audit review. It is recommended that on each tax bill make a copy of the original bill and on the copy write down the calculated amounts as back up for your records. This can be somewhat complicated if you are using a Schedule E and have multiple properties and you receive a tax bill with no separation of address. Real Estate taxes are deducted as applicable to the property assessed and should not include the owner’s basis.

Utilities

This is somewhat the same as with taxes since most utilities such as electricity, water, gas, communications, and security may be paid by the landlord on a single bill. If you have multiple properties, sometimes separate bills are issued. However, if there is any personal use, you must allocate the portions which are business from the personal and report them on the appropriate tax schedules.


Shoreline CPA+John Huddleston has written extensively on tax issues for small business owners. Since 2002, he has owned his own small business, Huddleston Tax CPAs. He holds a law degree and a masters in tax law, both from the University of Washington School of Law.

Tax Credits for Landlords

This particular article of the Landlord’s Tax Guide focuses on the different types of tax credits available to landlords who rent out their property. A tax credit is better than a deduction because it is a one-for-one reduction of tax owed, while a deduction simply reduces the total amount of income that is taxable. This article will focus on two particular credits: the Rehabilitation Tax Credit and the Low Income Housing Tax Credit.

Note: None of the tax credits associated with installing energy efficient appliances or products are applicable to rental homes.

Low Income Housing Credit

The IRS allocates housing tax credits to state agencies each year. Those state agencies then award the credits to developers of qualified projects in a competitive bidding process. To be eligible, a proposed project must commit to one of two occupancy threshold requirements:

1.) Restricted rents, including utilities, in low-income units.

2.) Operate under these restrictions for 30 years or longer.

The occupancy threshold requirement must be either:

1) Twenty percent of units must be rent restricted and occupied by households with incomes at or below 50% percent of the area median income as determined by the Department of Housing and Urban Development.

2) At least 40% percent of the units must be rent restricted and occupied by households with incomes at or below 60% percent of the area median income.

The limits on tenant-paid rent are based on a percentage of area median income and adjusted for household size. This program may be combined with a program like Section 8 in order to allow the landlord to collect full market rent with the tenant only paying the maximum rent allowable to continue tax credit eligibility.

Rehabilitation Tax Credit

This credit is a bit obscure but can be very useful in certain situations. It is available at 10% of qualified rehabilitation expenditures if the building is not a certified historic structure. If the building is an historical building, then it is good for 20%  of expenditures. (In order to be considered a certified historic structure, the building must either be listed in the National Register or located in a registered historic district certified by the Secretary of the Interior as being of historic significance to the district.)

Another option when the 10% credit is available is if the building has been “substantially rehabilitated.” For this to apply, the building must have been placed in service before  1936, and the rehabilitation process must have left intact a certain percentage of the original structural framework of the building.  Finally, “substantially rehabilitated means the expense of rehabilitation exceeds the greater of your adjusted basis in the building or at least $5,000.

Note: Given the complex nature of landlord tax credits, please consult a tax attorney or CPA before proceeding.


Redmond CPA+John Huddleston has written extensively on tax issues for small business owners. Since 2002, he has owned his own small business, Huddleston Tax CPAs. He holds a law degree and a masters in tax law, both from the University of Washington School of Law.