Archive for October, 2011

Expenditures – Part 3 – Local Travel

October, 2011

Expenditures – Part 3 – Local Travel

In a recent newsletter (Expenditures – Part 2) we discussed some basic principles regarding expenditures including “travel expenses related to the property or management thereof.” In this newsletter we will discuss further a few aspects of this particular expenditure.

As stated in Expenditures – Part 1, to be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your industry. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.

As also stated in Part 1, you can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip was to collect rental income or to manage, conserve, or maintain your rental property. This will usually include educational costs related to managing your income properties. You must properly allocate your expenses between rental and non-rental activities. You cannot deduct the cost of traveling away from home if the primary purpose of the trip was related to the acquisition of a new property or the improvement of your existing property. These costs would be recovered by taking depreciation.

In this article, we will discuss only local transportation expenses in the normal course of managing rental property, leaving the significantly more complex issues related to other categories of travel (e.g., cruise ship seminars) for future discussions. Very few landlords utilize public transportation for travel related to management of properties reasonably close to their place of residence, so local transportation almost always means use of a private motor vehicle of some kind. This usually means a car, SUV, van, pickup truck, or panel truck. In most cases this vehicle is owned rather than being leased.

All landlords utilize one or more motor vehicles in managing their income properties. However, few landlords fully comply with the IRS requirements regarding the deductibility of vehicle use and many do not even come close.

You can deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property. Generally, if you use your personal vehicle for rental management activities, you can deduct the expenses using one of two methods: (1) actual expenses allocated to business use according to the percentage of miles driven for business compared to total miles driven for the year or (2) the standard mileage rate for the business miles.

Actual expenses can include essentially everything related to operation of the vehicle, including repairs and maintenance, insurance, and fuel. Depreciation or, with certain restrictions, Section 179 are also applicable to the business share of usage. For 2011, the standard mileage rate for a car, SUV, van, pickup, or panel truck is 51 cents a mile for all business miles. Changing from one method to the other is restricted by the IRS.

The IRS says that to take a business deduction for the use of your vehicle, you must determine whether the use was business or personal. If the answer is personal, no deduction is allowed.

Travel between home and an office where business is conducted is considered commuting and commuting miles are not deductible. However, for any business, travel is not considered commuting when your home is your principal place of business and the travel is to another work location in the same trade or business, regardless of whether that location is regular or temporary and regardless of distance. However, if you have an office where you perform a substantial part of the work related to the business, with this office being located other than at home, travel between home and that office will usually be considered non-deductible commuting even though you also maintain a home office.

To deduct vehicle expenses under either method, you must keep records that follow the rules in chapter 5 of IRS Publication 463. In order to determine the percentage of vehicle expenses or mileage that are business related and support the percentage in an audit, it is important that a log be kept. The log should include beginning and ending odometer mileage for each business related trip.

The IRS expects all business use of vehicles to be documented and your documentation may be required in an audit. Most tax experts interpret IRS requirements to be a written detailed log showing dates, times, purpose, and beginning and ending odometer readings for each trip driven. Whether or not such detail is really necessary, we mention the fact that one IRS publication states:

“….. to claim the deduction, keep adequate records, such as a written travel log with complete and accurate mileage records for each business use of your car. If you are unable to produce a clear and accurate business mileage record, the IRS may disallow the deduction.”

Does the language “such as” mean that there are other options? Whether a log is the only option or not, in order to be certain of the mileage deduction surviving an IRS audit, one who takes a deduction for business use of vehicles will be on firmer ground if able to produce a mileage log. While some may be able to reconstruct a log if needed from receipts and day-planner records, a contemporaneous log is best and is what the IRS means by a log. That is, writing down each trip including the date, time, destination, and the starting and ending mileage.

Although simply the miles for each leg or a round trip may be adequate in some cases, it is best to log starting and ending mileage. Although the trip meters available in most modern vehicles may seem a simpler way to keep track of a trip distance, recording only the trip meter results will not be nearly as convincing to an auditor as recording starting and ending mileages.

Logging in the day’s travels in the evening is doable if odometer mileage notes are kept throughout the day, but trying to recreate your travels at the end of each week (or longer) is next to impossible to do while remaining consistent with personal trips and fuel fill-up mileages so as to avoid discrepancies that might be discovered in an audit.

It is almost certain that the majority of self-employed individuals fail to keep a contemporaneous log with odometer readings for each stop, as the IRS would like to see, and it is likely that the percentage keeping any type of log at all is relatively low. Many simply roughly estimate their business mileage each year when doing their returns, some simply using a number that significantly reduces their taxable income.

Most know that only 1 to 2 percent of small business owners are audited and, even then, certain types of businesses are targeted whereas others are essentially ignored. For example, cash businesses are more likely to be audited than businesses where there is a bank record for most items of revenue. Furthermore, all audits won’t touch on the auto mileage issue anyway.

Therefore, in practice, the chance of being caught without a needed log is extremely low. For various reasons, all of the deduction taken is unlikely to be disallowed to begin with because there are ways to prove certain usage. For example, the mileage for driving to a landlord seminar in a distant city can be proven and various receipts would show that one made the trip, including those for buying gas along the way.

Most understand these facts and also know that the worst that will happen is that they will have to pay the taxes (plus some penalties) on a non-allowed portion of the deduction for one year in question. Many probably figure that they earned many, many times that amount for the hours that would have been spent on maintaining proper mileage logs during the 20 years that they were never audited.

However, considering the relatively little time and energy required for maintaining an adequate log, there is really no excuse for not doing so. As with other items related to a possible audit, having detailed records regarding a particular item being looked at by the audit can reduce the chance that the auditor will look at other items. Having inadequate records regarding your business auto deduction may encourage the auditor to look more closely at your records for other items, both income and expenses.

This article summarizes certain issues related to business use of a motor vehicle. For more detailed information regarding significantly more issues, see the appropriate IRS publications. For tax advice consult a competent tax advisor.

Carbon Monoxide Devices

October, 2011

Some Questions & Answers

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Q1

Do you have information about the location where the mandatory “carbon monoxide devices” are supposed to be installed in the CA single-family home rentals per the new SB183 that is effective July 1, 2011? Some people recommend installing them on the ceilings while others say to install them on the lower half of the walls. My rental property is located in San Jose, CA.

A1

The text of the subject SB 183 can be found on the Web. Although I will provide some discussion regarding my understanding of the law, you should read and understand the law yourself, at least those portions that are relevant to your particular properties.

In brief summary, effective July 1st, 2011:

1)   All existing single family dwellings that contain a fossil fuel burning heater or appliance, fireplace, or an attached garage must install carbon monoxide alarms. In other words, unless you live in an all-electric home not having a fireplace with a detached garage and you don’t use a hibachi, you are covered by this law.

2)   All other existing dwellings (multi-family) shall comply by January 1, 2013.

3)   CO alarms must be either battery powered or plug-in with battery backup.

4)   CO alarms must be installed outside of sleeping areas and on every level of a dwelling, including the basement.

5)   If the device is a combined smoke detector and CO detector, the combined device must comply with the law for each type detector and the combined device must emit an alarm or voice warning that clearly differentiates between a carbon monoxide warning and a smoke warning.

6)   The devices must be ones that have been certified by the State Fire Marshall. It will be illegal to sell detectors that have not met the Fire Marshall’s certification requirements.

7)   With respect to the number and placement of carbon monoxide devices, the devices must be installed in a manner consistent with building standards applicable to new construction for the relevant type of occupancy or with the manufacturer’s instructions. Manufacturers must have their instructions approved by the state.

8)   The law creates disclosure requirements with respect to carbon monoxide detectors upon sale of a property.

As you are aware, there have in the past been differences in opinions and instructions among manufacturers and “experts” regarding which living spaces should have CO detectors and where they should be installed within a particular room, with opinions regarding the where to install them varying from “on the wall close to the floor” or “on the ceiling.” This has always been an important issue regarding combination smoke and CO detectors because some experts have considered that the two types have different optimum locations.

As seen in item 7 above, SB 183 does not itself provide installation instructions, but basically leaves it up to the State Fire Marshal. In general, past recommendations have been that CO alarms be installed on every level of a dwelling, including basements, and outside each sleeping area in the immediate vicinity of the bedroom(s). However, it is important that you obtain correct information for both the new state law and for any more restrictive local ordinance.

In my opinion, your best choice for obtaining correct information on this aspect of the subject is to inquire of governmental entities which are responsible for enforcing the state law and any local ordinance for San Jose with the issue and/or are responsible for enforcing the law. I would further suggest that you consult more than one agency that might provide such information in hope that the same answer from all or at least a majority of those consulted provide you with the same information, giving some confidence that you have the correct information. You should include the city (or county) building department, a couple of fire stations in the area, and any local rental housing agency. You might also see what kind of information you can obtain from your local landlord association(s) or any property management companies who are willing to respond to your request. I would also suggest that you attempt to obtain for your files printed materials regarding the subject from anyone providing information.

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Q2

I have a tenant who is a foreign born US citizen. Since he moved in, he married a young lady for whom he is trying to acquire citizenship. She has a social security number, but the credit reporting company could not find her. Is there any documentation I should ask for prior to signing her up on a lease amendment?

A2

The fact that a person has a social security number does not mean the person has a credit history with TransUnion, Experian, or Equifax. Reasons why a person will not have a credit record include:

  • They have never obtained credit from a merchant or lender who reports to credit bureaus. Even if a credit event is reported to one credit bureau, it may take time before all credit bureaus have the information.
  • A person may have always utilized cash or checks and never borrowed money (at least from a lender who reports to credit bureaus), obtained a credit card, or rented from a landlord who reports to credit bureaus (few landlords do) and, hence, may never have a record with any credit bureau.
  • It may take months for a first credit event to appear at any credit bureau for someone who has only just recently obtained credit.

One may need to obtain a Social Security Number or Individual Taxpayer Identification Number for employment or tax reporting reason, but may never obtain credit. For example, someone who has significant interest income in the U.S. would need either a SSN or ITIN.

The above being said, “no record found” reports sometimes results from the fact that the SSN or ITIN and name that were provided were not correctly entered. It’s even possible that an applicant mistakenly provided an incorrect number. However, incorrect SSNs will often result in a report that indicates the number and name do not match.

Regarding documentation that should be required, all applicants (all co-tenants of legal age,  including spouses) should be screened using the same procedures; including verifying identity (potentially the most important item) and screening reports – e.g., credit reports, eviction records, criminal record reports, employment or business history, and previous landlord checks. When there is no information from one or more of the reports, landlords must evaluate the applicant from information received.

Finally, you should not hesitate to ask applicants why they have no credit record.

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Q3

As a landlord in the state of Washington, can I restrict my rental properties to be no smoking?

 A3

I cannot state that a particular rental property location is not subject to some unusual local ordinance related to prohibition of non-smoking rules, but I’d probably bet a lot of money against there being one. Nationwide, the trend has for years been to limit smoking. Many states have passed laws and many local governments have passed even more restrictive ordinances against smoking in public places. Some jurisdictions even prohibit smoking in bars.

Most basically, there is no law that prevents landlords and property managers from regulating smoking on the premises, whether inside individual units or outside in common and private use areas. This is because (1) there is no constitutional right to smoke and (2) smoking is not protected by federal Fair Housing laws and is very unlikely to be protected by any state or local laws. HUD does not prohibit non-smoking policies in affordable housing. In fact, in 2009 HUD released a memo that encourages public housing authorities (PHAs) to implement non-smoking policies.

In Washington State a number of PHAs have adopted non-smoking policies including those in King County Housing Authority, Wall Walla Housing Authority, and Clallam Housing Authority.

There is now increasing action against smoking by owners and managers of properties. Tens of thousands of apartments and condos have gone smoke-free in the past five years, including those managed by the owner and those managed by management companies. Some municipalities are passing ordinances related to smoking prohibitions, not only in public places, but also in multi-unit housing.

Many landlords prohibit smoking in their units rather than discriminate against smokers per se because it is the act of smoking in the unit rather than the fact that a tenant is a smoker that is important. Most, perhaps all experts feel that owners have the right to protect their properties against damages from smoking and to protect other occupants from secondhand smoke. However, now the problem becomes one of detecting violators without running afoul of privacy rights. The solution is to both prohibit smoking inside of units, as well as on associated patios and balconies, and to make tenants responsible for damages resulting from failing to adhere to the prohibition.

This requires that applicants first be made aware that the unit is a non-smoking one in order to avoid wasted time and money in processing applications for those who might be unwilling to sign a lease that includes non-smoking provisions. Upfront notice can be accomplished in advertising, in an information sheet attached to the application form, or within the application form itself.

The lease agreement should, of course, contain very specific clauses related to the non-smoking issue. In addition to a clear statement of the prohibition, acknowledged by the tenant upon signing the agreement, the lease should also set out in some detail a list of damages resulting from smoking for which a violator will be responsible. The list would include items such as burns or stains on any component of the unit, odors, smoke residue on any surface, and potential other liabilities such as damages resulting from smoking-related fires.

The lease agreement should clearly make the tenant responsible for the cost of repairing, cleaning, painting, or replacing any items so damaged. Of course, the tenant must be initially provided with a unit that has no evidence of previous smoking-related damage or such previous damage must be noted in the move-in checklist.

For multi-unit properties, prohibiting smoking inside units and in common area hallways and within some distance of residents’ patios, balconies, doors, etc, can actually reduce the risk of problems

Because second hand tobacco smoke is often considered a nuisance in the same way that loud noise would be considered a nuisance, if tenants are complaining about drifting tobacco smoke, landlords must take action to protect them. Landlords and property managers who fail to accommodate non-smoking tenants who complain about secondhand smoke may be exposing themselves to lawsuits. If a resident or prospective resident has a disability or chronic illness which is made worse by exposure to tobacco smoke, Fair Housing Laws will require a ”reasonable accommodation.”

Holding Deposits

October, 2011

Holding Deposits

Sometimes, when the rental market is tight, applicants may offer a holding deposit to take the rental unit off the market until the applicant’s screening and verification is complete. Other times, a holding deposit may seem appropriate when an applicant appears committed to the rental, but must make arrangements for the move-in funds. The holding deposit is not a security deposit, but is to compensate the landlord for damages suffered for holding a unit off the market in the event that the applicant fails to meet screening qualifications or rescinds his/her agreement to rent the unit.

It is best to avoid the use of holding deposits, particularly now that most verifications of qualification can usually be done within a relatively short time utilizing today’s technology. Although holding deposits may be legal in your state, they often lead to misunderstandings or even legal hassles. A major problem is that most states do not cover the subject adequately, if at all, and it is often unclear regarding how much of the deposit may be retained by the landlord in the event screening results are unsatisfactory or the applicant cannot come up with the necessary funds or simply changes his mind about wanting the unit.

Some states that cover holding deposits by statute specifically allow a landlord to retain an amount related to the landlord’s cost of holding the unit. This might include the costs of additional advertising, prorated rent for the holding period and perhaps a reasonable charge for the time related to paper work and inconvenience to the landlord, but holding a larger amount puts the landlord at risk for a lawsuit. Some states specifically require that there be a written contract that states the terms and provides a receipt for the amount.

Although holding deposits are best avoided, sometimes they are helpful because of market conditions. If allowed by your state, it might be better to utilize a holding deposit rather than lower qualifying standards or reduce the rent. For the landlord’s protection, holding deposits should always be in cash, cashier’s check, or money order and for the protection of both parties there should always be a written agreement detailing the conditions related to the deposit even if not required by law.

When the landlord holds the rental unit for an applicant, it should be considered off the market and unavailable to other qualified prospective tenants who may have to be turned away. If the applicant later changes his/her mind, the landlord may have suffered financial harm. In such a case, the landlord is justified in retaining all or part of the holding deposit within the limits allowed by state law. However, be sure that this scenario is discussed in a signed agreement.

The amount of the holding deposit should be reasonably related to the rent of the unit and should take into account the potential inability of some applicants to immediately put up significant deposit funds in addition to application and/or screening fees.

The written holding deposit agreement should be in accordance with any applicable state law and unambiguously cover the following issues:

  • The address of the rental unit,
  • The names of landlord and applicant,
  • The amount of the deposit,
  • The length of time (including exact ending date) the landlord is willing to hold the rental, taking into account the size of the deposit and other qualifying information,
  • The basic terms of the lease agreement,
  • The conditions under which the landlord will rent the unit to the applicant – e.g., verification of identity, a fully completed application form, satisfactory results on all applicable screening reports, verification of employment, and full payment of the security deposit and first month’s rent by the end of the holding period,
  • What will happen to the deposit if the applicant signs a lease agreement – usually, that the full holding deposit will be credited to the security deposit,
  • What will happen if the applicant decides not to rent the unit before being notified whether or not his/her application has been approved,
  • What will happen to the holding deposit if the applicant fails to pass screening – usually the full deposit should be returned if the failure is evident within a couple of days after the landlord has accepted the holding deposit, and
  • What will happen to the holding deposit if the applicant defaults on the holding agreement – specifically, how much the landlord will retain, this being in accordance with any applicable state law, and when and how the portion not being retained by the landlord will be returned to the applicant.

Possible clauses in the agreement might be written as follows:

  • After the applicant has been notified that he/she has been approved to rent the unit and the applicant fails to complete the rental transaction for whatever reason, then the amount of damages to be deducted from his/her holding deposit shall be $____­____ per day from the date he/she agreed to rent the unit (the day the unit was taken off the market) until the day he/she gives notice of his/her rescission plus an equal number of additional days to compensate for lost marketing time and additional advertising expenses incurred.
  • If the landlord’s damages exceed the amount of the holding deposit, then applicant agrees to pay the difference, to a maximum amount of $________, within _____ calendar days of request.
  • In the event the landlord re-rents the unit within the time frame for which deductions have been made from the holding deposit, then the applicant should be credited an amount equal to the daily rent stated above for each day that rent was collected for the unit, with when and how the portion not being retained by the landlord will be returned to the applicant.

In summary, landlords and agents must follow any laws of their states and they should use good judgment and be fair in their holding deposit policy. An applicant whose holding deposit is retained without adequate justification may well have a cause of action for damages against the landlord which can result in more time and expense than the deposit was worth.

I Have a Tenent Whose Dogs Destroyed The Carpet…

October, 2011

Some Questions & Answers

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Q1

Is there any legal reason why a landlord would not be able to take a copy of a prospective tenant’s SS card and driver license?

A1

The shortest answer is No! A longer short answer follows.

A landlord can request and make copies of any documents considered material to making an informed business decision. I considered the two items you mentioned to be at the top of the list and the minimum of what should be required. That being said, however, there are at least a few caveats.

First, as with most issues related to landlording, it is important that the same procedures be followed with all applicants, at least for a particular vacancy. Better yet, the procedures should not be changed every time there is a vacancy, but should be followed for a significantly long period, with changes being justified by changing business conditions such as supply/demand in the rental market. The policies and reasons for change should be documented and retained for at least the statutes of limitations of relevant statutes, ordinances, and regulations related to fair housing and other discrimination issues.

Second, a landlord will be safer to ask for two (or more) ID items out of a possible list of four or more items. It is important however to choose items that are relevant and material to identity verification and any other misrepresentation or fraudulent activity against the landlord or others. There are potential legitimate reasons why an applicant cannot come up with a requested document.

Third, landlords must be concerned about security of any such documentation – both computer and paper records – to avoid potential liabilities related to identity theft.

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Q2

I have a tenant whose dogs destroyed the carpet….it was so bad I had to seal the floors and a portion of the walls because the odor was horrific. What can I legally charge her? The carpet was 2 years old when she moved in and her tenancy was almost 6 years. It was expensive carpet as I had previously lived in the house [like 20 year carpet].

The new carpet I put in is 10 year at the cost of $1750 plus $250 to tear it out. Can she be charged the full $2000 or a pro-rata amount? It looks like I will be going to small claims on this one…appreciate your advice.

A2

Technically, charging a tenant the full replacement cost for any major building component would be unfair because the landlord had some period of benefit for the component – in your case, 8 years as I understand the facts. Most states do not have a specific statute regarding the issue, but many tenants are aware of the issue and many judges would not allow charging full replacement cost if the matter went to court. Probably few, if any, judges would allow it if the issue were raised by the tenant or an attorney for the tenant.

You are correct that the charge must be prorated. The tenant can be charged only for the expected remaining life of the carpet had it not been damaged by the tenant. The tenant should be charged for the fraction of replacement cost calculated by dividing the expected remaining life by the expected useful life of the particular carpet being replaced. However, when replacing any component with one of lesser or greater quality, there are potential issues that can be raised, the most basic issue being charging the tenant for something of higher quality than what the tenant damaged.

For a 20-year expected useful life and 8 years of use, the tenant would be charged for 12/20 of the replacement cost. For a 10-year expected useful life, the tenant would be charged for 2/10 of the replacement cost. Hence, the manner of calculation is quite important.

However, in view of the fact that a 10-year life carpet is replacing a 20-year life carpet, the tenant or her attorney could raise some issues. First, one could reasonably question if the 12/20 fraction can be applied to the 10-year replacement carpet cost. One might argue that the 12/20 needs to be applied to the cost of the original carpet. One would almost certainly insist that using the 20-year life requires proof that it really had an expected life of 20 years. One might also argue that the useful life of a normal rental grade carpet is 10 years and that the tenant should not be penalized for the fact that a higher quality carpet was used because it was your personal residence at the time of installation. Accordingly, a judge might agree that the 2/10 fraction must be used. Finally, the tenant might claim that the carpet looked like it had a lot more than 2 years use at the beginning of her occupancy and you may need proof of condition such as the move-in checklist, photos, and/or a witness.

Since 2/10 of $2,000 is $400, whereas 12/20 of $2,000 is $1,200, there is a significant difference in the charge. The tenant is more likely to argue the issue for the greater amount compared to the lesser amount and the risk of you losing in court probably increases with the amount involved.

It is possible that you would get away with using the 12/20 fraction because the tenant does not contest the matter or, if she does, isn’t represented by an attorney, doesn’t herself come up with good arguments, and you’re before a judge who doesn’t care. You will need to decide whether to use the smaller fraction (that you can likely successfully defend in court) or go for the maximum, assuming that the worst will be the lower of the two fractions (not necessarily true if the judge decided you were trying to cheat the tenant).

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Q3 (continuance of previous Q2)

This one will go to small claims court. What can I charge for my time? I have spent approx 40 hours cleaning. All tile grout had urine stains and needed to be hand-scrubbed….couldn’t hire anyone to hand-scrub. Can this be reasonably accounted for?

 A3

What would be considered reasonable – assuming anyone raises the issue – will depend on the type of work (including skill level & physical requirements), the local economy, and the particular judge. I think $20 to $30 per hour would be considered reasonable in most jurisdictions, with CA being on the high side compared to MS. You could consider using a number in the high twenties, as it will not seem as high as $30. There’s a reason why most merchants price something at $29.99 rather than $30.00. You could use $27 or $28 so as not to appear too cute. You will also want to have a written log detailing your work, logging time in tenth-hour or 10-minute increments. The hourly rate is probably more debatable than the number of hours because data can be found supporting lower levels of pay than you would want to work for, whereas, it’s harder to prove the hours required for such work, particularly as cleaning time depends on a number of issues including the type of dirt/stains, the item and type of material that is dirty/stained, and the worker’s knowledge of cleaning products. Accordingly, a judge might look more favorably on billing for more hours at a lower hourly rate, particularly when you can show a realistic looking detailed log.