2020 COVID-19 Tax Credits for the Workplace

Tax credits for paid sick and family leave

The Families First Coronavirus Response Act (FFCRA) provides two self-employed tax credits to help cover the cost of taking time off due to COVID-19. While most of the text in these laws apply to businesses with employees, it also applies to self-employed individuals.

The tax credit for paid sick leave applies to eligible self-employed taxpayers who are unable to work (including telework or working remotely) due to:

  • Being subject to a federal, state, or local quarantine or isolation order due to COVID-19.
  • Being advised by a health care provider to self-quarantine due to COVID-19. Experiencing COVID-19-related symptoms and seeking a medical diagnosis. If you meet all the requirements, you would be eligible for qualified sick leave for each day during the year that you were unable to work for the above reasons (up to 10 days). The tax credit is worth the lesser of $511 per day or 100% of your average daily self-employment income for the year per day.
  • The only days that may be considered in determining the qualified sick leave equivalent amount are days occurring during the period beginning on April 1, 2020 and ending on December 31, 2020.

Under the expanded Family and Medical Leave Act (FMLA) provision of the FFCRA, you would be eligible for qualified family leave for each day that you were unable to work because you were caring for someone else impacted by COVID-19 (up to 10 days), or your child’s school or childcare provider was closed or unavailable due to COVID-19 (up to 50 days). You can claim a tax credit for the lesser of $200 per day or 67% of your average daily self-employment income for the year per day.

 How do I calculate and claim these tax credits?

The “average daily self-employment income” is calculated as your net earnings from self-employment during the tax year, divided by 260. An individual can claim a credit for both qualified sick leave and qualified family leave, but not both for the same time periods. You can claim both the tax credit for paid sick leave and the tax credit for paid family leave on your 2020 Form 1040 tax return. However, you do not have to wait until the next tax-filing season to benefit from these credits

 Employee Retention Credit

 If you have employees, the Employee Retention Credit (ERC) can help you cover the cost of keeping idle workers on your payroll during the pandemic. The tax credit is worth half of what you spent on wages and employee health plan costs after March 12, 2020, and before January 1, 2021, up to $10,000 per worker.

To qualify, your business must have one of the following:

  • A full or partial suspension of its operations due to governmental orders limiting commerce, travel, or group meetings due to COVID-19.
  • A sufficient decline in gross receipts compared to 2019. The decline begins when there is a 50% drop in a calendar quarter compared to the same quarter in the prior year. The decline does not end until a calendar quarter reaches 80% of the same prior-year quarter. This means that if a quarter drops to less than 50% and the following quarter is at 70%, there is still a decline.

You can claim this credit by reducing your payroll tax deposits. If your employment tax deposits are not enough to cover the full credit, you can get an advance from the IRS by filing Form 7200.

If you received a Paycheck Protection Program loan, you cannot also claim the ERC. You can claim both the paid leave credits and the ERC but not on the same wages.

For more information, contact your tax advisor and/or visit the U.S. Department of Labor website: https://www.dol.gov/agencies/whd/pandemic/ffcra-employer-paid-leave

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

The 12-Month Rule – Determining the Deductibility of Prepaid Expenses

Taxpayers seeking additional business deductions before the end of the year might consider adopting the 12-month rule by prepaying some business expenditures before year-end. Certain expenses such as insurance, rebates, and licenses can be prepaid before year-end without needing to be capitalized for tax purposes, thus allowing a tax deduction for the current tax year. The 12-month rule must satisfy the requirements of economic performance in order to be utilized. The recurring item exception may provide some relief if the economic performance standard isn’t met.

Basics of the 12-Month Rule

Under normal circumstances, IRS regulations require taxpayers to capitalize (i.e., not deduct) amounts paid for certain prepaid assets. In other words, let’s say you spend $1,000 of your hard-earned money in October on a license that lasts one year. This doesn’t necessarily mean the entire amount is deductible in the tax year the payment is made. Cash-out = tax deduction. Those more familiar with accounting principles will argue that the matching principle needs to be applied, meaning that the deduction should be applied to the period in which it provides a benefit. Meaning, you would deduct 3/12 of the expense in the year the payment is made and 9/12 in the following year. This would be the IRS’ approach (See Reg. Sec. 1.162-3(d)). Taxpayers may be allowed to deduct the full $1,000 amount in the year in which it was paid by applying the 12-month rule. To apply this rule, we must look to Reg. Sec. 1.263(a)-4(f) which states that:

Except as otherwise provided in this paragraph, a taxpayer is not required to capitalize amounts paid to create any right or benefit for the taxpayer that does not extend beyond the earlier of:

  • 12 months after the first date on which the taxpayer realizes the right or benefit; or
  • The end of the taxable year following the taxable year in which the payment is made.

Let’s apply this to our license example. A license that lasts one year was purchased in October of the current year and it is set to expire in September of the following year. The payment creates a right that does not extend 12 months after it is initially created, thus satisfying the first condition. Also, it does not extend past the following taxable year since it ends in September, which satisfies the second condition. If the right had extended beyond September of the following year, the 12-month rule would no longer be satisfied, and the license would need to be deducted ratably over the life of the license.

Exception to the Exception: Understanding Economic Performance

The 12-month rule cannot be universally applied in all situations. If another regulation or code section specifically states that a certain type of prepaid asset is disallowed, the 12-month rule will not apply. Cash basis taxpayers will have slightly different results from accrual basis taxpayers. The rules for cash-basis taxpayers are relatively straight-forward: make the payment, and as long as the conditions above for the 12-month rule are satisfied, the taxpayer is eligible for the deduction. However, in order for this to always be true, economic performance must be satisfied. This is also true for accrual-basis taxpayers, but unlike cash basis taxpayers, accrual basis taxpayers will accrue certain expenses at year-end that a cash basis taxpayer will not.

In basic terms, economic performance is the timing of when a liability owed by a taxpayer is truly treated as being incurred. All of the necessary events need to have happened to determine that a) a liability is fixed, b) the amount can be determined with reasonable accuracy, and c) a specific action or event has taken place. For example, economic performance occurs for the following liabilities:

  • Rent Expense – generally, ratably over the period the taxpayer is entitled to use the property
  • Services – occurs as services are provided
  • Insurance – occurs when payment is made

This means that for prepaid services and prepaid rent, economic performance isn’t satisfied until the property is used or until the service is provided to the taxpayer, respectively. As such, merely paying the liability doesn’t mean the payment can be deducted. However, payment for an insurance premium in the event that needs to take place for economic performance. Assuming the 12-month rule is satisfied, prepaid insurance will be deductible upon payment. A more comprehensive list of prepaid assets and their respective economic performance traits can be found at the end of the article.

Exception to the Exception to the Exception: The Recurring Item Exception

What happens if economic performance hasn’t occurred, but you really want that tax deduction? It’s at the top of your wish list and you’ve been good all year. Surely Santa will step in on your behalf. Well, congratulations! The recurring item exception exists! Reg. Sec. 1.461-5 states that economic performance will be treated as having occurred with respect to liability if:

  1.  The liability is recurring in nature and is either not material, or provides for better matching of income and expense,
  2.  And economic performance will occur before the earlier of 8 1/2 months after year-end, or the filing of the tax return.

For example, a taxpayer accrues an expense for an insurance premium year-end. The premium covers October of the current year to September of the following year. The taxpayer makes the payment on January 15th of the following year. Even though this satisfies the 12-month rule, economic performance has not occurred before year-end since payment has not been made. However, under the recurring item exception, the deduction may be taken since insurance premiums are recurring in nature. It is not material, and payment was made within 8 ½ months of year-end.

Note: The recurring item exception cannot be applied to interest, rents, worker’s compensation, tort, breach of contract, and violation of law.

Bringing It All Together

To see how all of these concepts work together, let’s go through two examples:

Example 1:  Prepaid Advertising

On December 15th, a taxpayer pays a marketing firm $10,000 for advertising services that the taxpayer believes will be performed over the next 3 months. The marketing firm completes the advertising service by February 28th of the following year.

  • 12-Month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For services, economic performance is satisfied as services are provided. The amount of the liability is fixed and determinable at year-end. However, the services were not provided by the end of the year so economic performance is not satisfied. Economic performance rules trump the 12-month rule, so it’s not looking good for the taxpayer thus far.
  • Recurring Item Exception – The taxpayer argues that they regularly engage marketing firms and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return.
  • Conclusion – The recurring item exception allows the taxpayer to apply the 12-month rule and the taxpayer is able to take the deduction. Note that for prepaid services, services must be provided within 3 ½ months of the payment being made. Other prepaids, such as prepaid interest, can be paid within 8 ½ months of year-end and still be deductible.

Example 2:  Prepaid Interest

On December 15th, a taxpayer pays an interest obligation of $10,000 related to business debt covering the second half of December and the first half of January of the following year.

  • 12-month Rule – The conditions for the 12-month rule are satisfied because the benefit to the taxpayer is realized within 12 months of the payment.
  • Economic Performance – For interest, economic performance is satisfied as the borrower has use of the money. The amount of the liability is fixed and determinable at year-end. However, the taxpayer cannot “use” the money for January in December, so economic performance is not satisfied. Again, economic performance rules trump the 12-month rule; so, it is still nondeductible.
  • Recurring Item Exception – The taxpayer argues that they regularly pay interest and the amount paid is not material to their financial statements. Also, the payment was made before filing the tax return. However, prepaid interest is one of the exclusively carved out items that cannot be applied by the recurring item exception.
  • Conclusion – Even though the 12-month rule is satisfied, economic performance and the inability to apply the recurring item exception prevent the taxpayer from deducting the prepaid January interest.

As you can see, these concepts work together to provide some relief to taxpayers while still trying to prevent abuse by others who would seek to make large prepayments before year-end for the sole purpose of lowering their tax liability. When determining the deductibility of prepayments for tax purposes, every situation is unique and requires a fair bit of analysis and understanding to make sure the taxpayer takes a defensible position. One should always consult with their tax advisor on their own circumstances to determine best practices.

Prepaid Expenses and Economic Performance

Prepaid Expense Economic Performance
Prepaid Insurance Payment


Prepaid Warranty and Service Contracts Payment


Prepaid License or Permit Fees Payment


Prepaid Taxes Payment


Prepaid Dues and Fees Payment


Prepaid Rebates Payment


Prepaid Rent Ratably over the period of time the taxpayer is entitled to use the property


Prepaid Services As services are performed


Prepaid Interest Ratably as the taxpayer has use of the money being borrowed


Prepaid Goods As the goods are provided to the taxpayer


Author, Jonathan Smith, Senior Tax Manager, Spiegel Accountancy Corp

Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Paycheck Protection Program Tax Treatment

More than 500 like-minded stakeholders are calling on Congress to overturn an Internal Revenue Service rule and allow Paycheck Protection Program (PPP) loan forgiveness to be fully tax-free.

In a December 3, 2020 letter to leaders of the House and Senate, the groups, led by the Associated General Contractors of America, urged lawmakers to enact legislation before the end of the year to correct the tax treatment of loan forgiveness under PPP.

IRS Notice 2020-32 states that “normally deductible business expenses will not be deductible if the business pays the expense with a Paycheck Protection Program loan that is subsequently forgiven,” which the coalition believes is a misinterpretation of the Coronavirus Aid, Relief and Economic Security Act. Section 1106(i) of the CARES Act states business expenses are “includible in gross income of the eligible recipient by reason of forgiveness” and “shall be excluded from gross income,” for purposes of the Internal Revenue Code of 1986. The coalition wants Congress to clarify this contradiction.

“At the onset of the COVID-19 pandemic, Congress responded with speed, cooperation, and an eye to preventing the worst potential economic outcomes. We ask that you bring that same spirit of urgency and cooperation before the end of this session to prevent an avoidable catastrophe for millions of small businesses that, without Congressional action, will face a surprising, and, in many cases, insurmountable tax bill next year,” the groups wrote. Spiegel Accountancy Corp Founding Principal, Jeff Spiegel, says, “Congress needs to act to get this resolved to allow expenses to be deducted.”

“The terms of the PPP are simple: if qualifying small businesses use a federally-guaranteed loan to pay their employees and cover certain non-payroll expenses, the loan will be forgiven,” the letter continued. “From April 3rd, when the program launched, through August 8th, when its authorization expired, the Small Business Administration guaranteed $525 billion in PPP loans to 5.2 million qualifying small businesses nationwide, preserving tens of millions of paychecks for their employees as the pandemic spread throughout the country.”

The coalition noted that if unchanged, the IRS ruling could increase small businesses’ taxes up to 37%.

“Since the IRS issued Notice 2020-32, Congress has signaled that it intends to reverse the ruling,” the letter said. “The Democratic and Republican Chairs of the House Ways and Means and Senate Finance Committees issued public statements saying that the IRS Notice, and, more recently, the IRS Revenue Ruling, is flawed and contrary to Congressional intent.”

The coalition added that the “most recent IRS revenue ruling” has created a renewed sense of urgency for Congress to address the issue before the end of the year.

“Allowing the IRS position to remain unchallenged will result in a significant tax increase on small business owners already suffering from the effects of COVID-19 shutdowns,” the groups wrote. “This tax will hit small business owners after their PPP loan has already been spent, and just as many states are re-imposing mandatory closures of thousands of businesses in the face of spiking numbers of COVID-19 cases. Many PPP loan recipients retained employees on their payrolls, even when there was little to no work to perform, in compliance with the intent of the program to keep people employed and off the unemployment rolls. The IRS changed the rules after businesses took out PPP loans, and business owners are now being asked to pay what amounts to a surtax on their workforce.

“Without Congressional action, businesses will face an unexpected tax bill when they file their taxes for 2020, as they continue to struggle with government-mandated shutdowns or slowdowns. Many of those businesses will close and never re-open. This senseless tax policy stands both the letter and spirit of the PPP on its head,” the letter concluded.


Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Time to Apply for PPP Loan Forgiveness?

The 24-week period for many of the original Paycheck Protection Program (PPP) loans ended during the month of November. Those who elected for an 8-week program, or have exhausted their funds, may have begun the process of applying for forgiveness even though there is plenty of time left. Fortunately, the application process for loan forgiveness has operated much more smoothly than the original loan application period.

PPP loans were created to incentivize small businesses to retain employees by helping cover payroll costs as many businesses were forced to shutter during the COVID-19 lockdown. These loans also covered mortgage interest payments or rent, along with utilities to help businesses stay afloat. Treasury Secretary Steve Mnuchin stated, “The PPP has provided 5.2 million loans worth $525 billion to American small businesses, providing critical economic relief and supporting more than 51 million jobs.

PPP Loan Forgiveness Application Deadlines

 While borrowers who received their loan prior to June 5, 2020 could have elected for an 8-week or 24-week covered period, loans funded on or after June 5th meant waiting until November (or later) to apply for forgiveness. Keep in mind that loan payments may be deferred for up to 10 months following the end of the established loan period. It is also important to note the covered period begins the day the loan was funded.

In October, the Small Business Administration (SBA) released a new loan forgiveness application, making it easier for those with PPP loans of $50,000 or less. Banks have begun the initial phase of accepting these PPP applications from borrowers even though the time to apply depends on the bank and when the PPP covered period ends. For example, Bank of America will not take submissions until the covered period ends, while other banks will accept applications after the PPP funds have been exhausted. Most banks encourage borrowers to prepare the application for loan forgiveness immediately following the end of the loan period and collect the necessary documentation in preparation. The SBA has provided a fillable questionnaire to assist the application process.

According to the SBA, there are an estimated 3.57 million outstanding PPP loans of $50,000 or less, totaling approximately $62 billion of the $525 billion in PPP loans. The SBA suggests borrowers contact their PPP lender to obtain the correct form. They will provide either the SBA Form 3508, SBA Form 3508EZ, SBA Form 3508S, or a lender equivalent. The expiration date listed on the application forms has created some confusion. Essentially, it is a temporary date required by the SBA’s Paperwork Reduction Act, and each month a new expiration date is placed on the forms.

Borrowers may apply for forgiveness any time before the maturity date of the loan, which may be two to five years from loan origination. However, applying after the 10-month deferment means a borrower must begin making payments on the loan. While the SBA has 90 days to review and approve the applications, lenders have seen a much faster turnaround time.

PPP Loan Integrity

Businesses holding loans that exceed the $50,000 threshold require additional documentation to apply. Borrowers are encouraged to maintain close contact with their lenders as each may have developed its own evaluation and process procedures in addition to those required by the SBA. Businesses that received $2 million or more in PPP loans must complete one of two required loan necessity questionnaires, SBA Form 3509 and SBA Form 3510. The SBA recently offered additional guidance on these sizable loans. (See Rev. Rul. 2020-27 on PPP Loans and Taxes)

The U.S. Treasury maintains that all loans above the $2 million mark will be subjected to additional scrutiny under the current audit plan. Additionally, the Department of Justice established a fraud team as soon as PPP loan applications became available. Any amount of fraud has been strongly discouraged. It is important for borrowers to consult with their tax accountant, in addition to their lender, to ensure the application process completed accurately.

For more information on the Paycheck Protection Program, visit the SBA website.


Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Rev. Rul. 2020-27 on PPP Loans and Taxes

On November 18, 2020, the U.S. Treasury Department and the Small Business Association (SBA) released Rev. Rul. 2020-27 that offers additional guidance on the tax treatment of expenses paid using Paycheck Protection Program (PPP) funds in the event the loan is not forgiven by the end of 2020. The IRS ruling concerning deductions for eligible PPP loan expenses is as follows:

(1) deny a deduction if the taxpayer has not yet applied for PPP loan forgiveness, but expects the loan to be forgiven; and

(2) provide a safe harbor for deducting expenses if PPP loan forgiveness is denied or the taxpayer does not apply for forgiveness.

The Treasury press release stated, “Since businesses are not taxed on the proceeds of a forgiven PPP loan, the expenses are not deductible. This results in neither a tax benefit nor tax harm since the taxpayer has not paid anything out of pocket.” Secretary Steve Mnuchin said, “These provisions ensure that all small businesses receiving PPP loans are treated fairly, and we continue to encourage borrowers to file for loan forgiveness as quickly as possible.”

While debt cancellation is ordinarily considered to be income, the PPP loan amount is nontaxable income. Borrowers may not deduct expenses paid with PPP funds (i.e. rent, mortgage interest, utilities) as that would be double-dipping. One of the most common questions is what if a borrower does not deduct expenses that ultimately end up not approved through loan forgiveness. Answer: It is possible to file an extension on 2020 taxes or file an amended income tax return once loan approval (or partial) has been authorized.

Additionally, the Treasury and IRS released Rev. Proc. 2020-51 this same day. This ruling provides a safe harbor for certain PPP loan participants, whose loan forgiveness has been partially or fully denied, or who decide to relinquish loan forgiveness, to claim a deduction for certain otherwise deductible eligible payments during the 2020 tax year.

Safe Harbor rules allow borrowers who decline loan forgiveness to claim a deduction for the otherwise deductible eligible payments on an original income tax return or information return, as applicable, for the taxable year in which the taxpayer decides to forego requesting forgiveness.

Mnuchin added, “Today’s guidance provides taxpayers with greater clarity and flexibility.”


Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

PPP Loan Forgiveness Form

The SBA has issued a Loan Necessity Questionnaire for Paycheck Protection Plan borrowers with an original principal amount of $2 million or more. This form is to facilitate the collection of supplemental information that the SBA loan reviewers will use to evaluate the good-faith certification that borrowers made on the initial application for the loan that economic uncertainty made the loan necessary.

The borrower is required to complete the questionnaire and return to the lender within 10 days of receipt, along with supporting documents. While the form will be distributed by the lender, you may also download a copy of the fillable form here.

Department of Business Oversight’s New Name

The California Department of Business Oversight has officially changed its name to the Department of Financial Protection and Innovation (DFPI). The department name change became effective September 30, 2020.

While the DFPI has yet to set a firm deadline for updates to loan documents, business cards, or websites, licensees should complete this legally required transition as soon as possible.

During the transition period, the DFPI will continue to recognize existing materials with the “Department of Business Oversight.” The department recognizes it may take time to incorporate any/all legally required disclosures, documents, printed materials, and website information provided to consumers, other regulators, or to the public.

Additionally, please note that the department’s Sacramento headquarters address has changed to 2101 Arena Boulevard, Sacramento, CA 95834. Please contact California Financing Law Special Administrators with any specific challenges.

For questions, please contact the appropriate department program or email Ask.DBO@dbo.ca.gov

Tax Relief for Victims of California and Iowa Disasters

The California wildfires and the Iowa derecho that occurred this summer have wreaked havoc on area residents. While federal disaster relief is available, the IRS recently released information on assistance it may offer. According to the IRS, victims of the latest California wildfires and the August 10th Iowa derecho now have until December 15, 2020 to file individual and business tax returns and make payments. It is not necessary for taxpayers to indicate on the return they are in a disaster zone. The IRS will automatically provide filing and penalty relief to any taxpayer within these disaster areas.

FEMA designated the following areas for disaster relief: Linn County in Iowa and Lake, Monterey, Napa, San Mateo, Santa Cruz, Solano, Sonoma, and Yolo counties in California. Any additional areas added to disaster relief status will automatically be provided the same relief. An updated list of affected localities can be found on the disaster relief page at IRS.gov. In the event an affected taxpayer does receive a penalty notice, the IRS recommends calling the number on the notice to have the penalty abated.

Taxpayers with a valid extension to file their return by October 15, 2020 will now have until December 15, 2020 to file their tax returns and make payments due during this time period. The IRS noted that tax payments related to 2019 returns that were due on July 15, 2020 are not eligible for this relief.

The December 15, 2020 deadline also applies to quarterly estimated income tax payments due on September 15, 2020, and the quarterly payroll and excise tax returns normally due on October 31, 2020. It also applies to tax-exempt organizations, operating on a calendar-year basis, that had a valid extension due to run out on November 15, 2020. Businesses with extensions also have the additional time including, among others, calendar-year corporations whose 2019 extensions run out on October 15, 2020.

Individuals and businesses in a federally declared disaster area who suffered uninsured or unreimbursed disaster-related losses can choose to claim them in the year the loss occurred (2020) or in the prior year tax return (2019). These returns must have the FEMA declaration number on any return claiming the loss: 4558 for California or 4557 for Iowa. See Publication 547 for details.

For information on disaster recovery, visit disasterassistance.gov.


Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

Reminders for REITs on Prohibited Transactions

Reminders for REITs on Prohibited Transactions was originally published in AAPL’s Summer Edition 2020 Private Lender Magazine.

The passage of the Tax Cuts and Jobs Act led to an increase in the number of private lending funds converting to mortgage REITs over the past two years. Fund managers made the conversion decision by carefully weighing whether the tax benefits of the Section 199A 20% Qualifying Business Income Deduction outweighed the increased compliance costs associated with operating a REIT.

Due to the current pandemic, it is important to be circumspect when administering your REIT.

Loan payment delays or forbearances may be indicative of upcoming loan modifications or foreclosures, which could disqualify the private lending entity’s REIT status. To maintain REIT status, the REIT may need to make investment decisions that might reduce stockholders’ overall return and alter investment objectives but would keep the REIT election safe. Loss of REIT status would lead to the mortgage REIT reverting to a C corporation, resulting in unfavorable tax treatment. The C corporation would pay tax at a 21% tax rate, and the dividend payments issued to investors would be taxed a second time at the investors’ income tax rates, resulting in double taxation.

Loan Modifications
Loan modifications or foreclosures could result in REITs failing to meet the required income or asset tests. If loan modifications or foreclosures within a REIT do not meet safe harbor guidelines, they may result in prohibited transactions. Loss of REIT status may occur if IRS regulations are not met. There are workable solutions around these matters if the manager is proactive and plans to avoid problems.

Prohibited Transactions for REITs and Safe Harbor Rules
REITs are required to pay a 100% tax on net income generated from prohibited transactions. These transactions may arise when a loan is foreclosed on and leads to the sale of a real estate owned asset if that property is considered to be held as inventory or primary sale to customers. Exceptions may be made when the fair market value (FMV) of the property sold in a year does not exceed 10% of the aggregate tax basis or aggregate FMV of REIT assets at the beginning of the year.

Fund managers with mortgage REITS and borrowers in default need to be more diligent during our current economic state. IRS safe harbor rules provide relief in situations where a REIT might engage in a prohibited transaction if REIT compliance is not met.

To ensure these rules are satisfied:

  1. The property held to produce rental income must remain in the REIT for at least two years.
  2. Any accumulated expenditures made through the REIT, during the two-year duration, may not exceed 30% percent of the property’s net sale price.
  3. The REIT: (a) made no more than seven property sales during the year; (b) during the tax year, the aggregated adjusted bases of the property does not exceed 10% of the aggregate adjusted basis of all assets held by the REIT as of the beginning of the year; (c) the FMV of property sold does not exceed 10% of the FVM of the total REIT assets as of the beginning of the year.
  4. If the property consists of land or improvements not acquired through foreclosure or lease termination, the REIT has held the property for at least two years for the production of rental income.
  5. If the seven-sales property rule related to Sec.(b)(C)(iii)(I) (item 3(a) above) is not met, substantially all of the marketing and development expenditures relating to the property sold were met through an independent contractor or taxable REIT subsidiary from whom the REIT receives no income.

Dealer Versus Inventory
To distinguish between inventory and investment property, a REIT may take the position that the property sold was not inventory and the REIT is not a dealer of property assets. If it were determined that a REIT sold dealer property, that would be considered a prohibited transaction. Essentially, property or inventory held primarily for sale as part of its business model is not considered a capital asset.

Income from a Foreclosure Property
If the REIT does not follow IRS guidelines, income from a foreclosure property will be taxed at the highest rate by multiplying the net income from the sale of the foreclosed property by the highest rate specified per tax code. Tax will be imposed for each taxable year on the net income from a REIT liquidating a foreclosure property asset.

Sales of assets of a REIT that do follow a liquidation plan would not be considered prohibited transactions under tax code Section 857(b)(6). The IRS ruled that if the taxpayer previously expressed that he or she intended to hold the assets or properties for a minimum number of years, yet now sees a long decline in asset value and has explored alternatives to hold on to the properties, the REIT may pursue a complete liquidation.

REIT Qualifications
To qualify as a REIT, an entity must meet two annual income tests (among other requirements). The REIT must:

  1. Invest at least 75% of the assets in real estate related income.
  2. Derive at least 75% of taxable income from rents or mortgage interest.
  3. Disperse a minimum of 90% of gross taxable income to shareholders each year in the form of dividends.
  4. Maintain a minimum of 100% of its shareholders after the first year of existence.
  5. Ensure no more than 50% of its shares may be held by five or fewer individuals during the last half of each taxable year.
  6. Have no more than 20% of its assets consist of stocks in taxable REIT subsidiaries.

Make sure to consult your tax adviser, as a REIT may be subject to some federal, state and local taxes on property, even if the REIT qualifies as a REIT under federal tax guidelines. If the mortgage REIT has a loan in default, which the fund manager feels will result in a loan modification or foreclosure, carefully review the REIT qualifications and safe harbor rules to mitigate any risk of loss of REIT status or of engaging in a prohibited transaction.


Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

CARES Act Rules for IRAs, RMDs & the August 31 Deadline

Retirees over the age of 70 ½ might be struggling to make sense of the new regulations with the passage of the SECURE Act at the end of 2019 and the current CARES Act. These new regulations may be confusing for retirees in regard to required minimum distribution (RMD) rules.

The SECURE Act passed last December is permanent and essentially raises the age for RMDs to 72; however, it went into effect January 2020. Therefore, if an individual turned 70 ½ in 2019, RMDs must still be taken in 2019 and 2020, since the age of 72 would not be reached until 2021.

So, how does the CARES Act come into play? Some say it’s like an RMD holiday. The CARES Act legislation essentially suspended RMDs from IRAs, inherited IRAs, 401(k)s, and inherited 401(k)s during 2020 and gave everyone the chance to put it back into their account within 60 days without taxation.

If an individual has already taken some or all RMDs and has gone past the 60-day mark, these funds may still be rolled over. The recently issued Notice 2020-51 allows an account holder to rollover all RMDs funds, distributed January 2020 to now, provided the rollover is made by August 31, 2020. Additionally, this move will not count as the one-per-year rollover allowed, so you may still enact a rollover for another purpose.

Another new benefit for retirement accounts is the ability to make a withdrawal from a qualified retirement plan or IRA due to a COVID-19 related issue. An individual can “self-certify” they have been financially impacted due to coronavirus-related circumstances. Plus, individuals under 59 ½ will be exempt from the 10% penalty tax for early withdrawal. Congress realized the need for hardship withdrawals, which meant individuals could access funds in their accounts without penalty. The maximum withdrawal amount is capped at $100,000.00. Participants may be permitted to recontribute the amount over a 3-year period, following the date of distribution, without affecting normal contribution limits. Repayment may be spread over the years 2020, 2021, and 2022 equally, as opposed to the entire amount being taxable the year the distribution was taken.

IRS waives requirements.


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