Oh it is that time of year again.  Boy does that sneak up on me.  I can’t believe we are already past the holidays and into 2011.  If you are new to the game, each year in January we as landlords need to fill out what is called a Certificate of Rent Paid or a CRP.  Some tenants will call it a tax rebate (which it is not), but whatever.

Here is the link to the MN CRP 2010.  This form doesn’t change from year to year so if you did it last year, you are in luck.  Otherwise here are some quick tips:

• When figuring out the totals, do not include any damage deposits, late fees, or other non-rent payments in the total amount.  Also, only include actual rent paid, not rent billed (or accounts receivable).
• Any rental subsidy amounts (including section 8 and other non-profit agencies) should not be included in the total line on the CRP. Only include rent paid by the tenant(s).  In your accounting system remember to mark each subsidy payment in the memo field to make this easier at the end of the year.
• When calculating the total amount, you must divide the total rent paid by the total number of adults in the unit, regardless of how much rent each paid.  Married renters are considered one person, again regardless of how they paid.  You should then send a form to each adult.  This may cause some frustration among roommates, but just tell them you are simply following the instructions.
• If you have many 2009 Certificate of Rent Paid forms to send, I recommend that you fill in a copy of the form with your business information and make copies of that original CRP to save yourself time. With almost 30 rental units, you can imagine how much time this saves me!
• Alternatively, the Certificate of Rent Paid form comes in a PDF format, so I purchased a copy of Adobe Acrobat and opened the PDF in edit mode.  I then entered my business info once and then simply changed the property and tenant info and printed them out (I am faster at typing than writing!).
• Often you will have tenants that have moved out during the year.  Personally, I just wait for past tenants to call me and request the CRP.
• Lastly, make a copy of all of the Minnesota CRPs for yourself.  I will always get a least 2-3 calls in August (when the tenants turn these in for their taxes) from someone looking for a new copy.  It will save you having to recreate the wheel when they lose their copy.

Remember that this form must be mailed to your tenants by January 31, 2011.  I have had the question over the years about what happens if the landlord doesn’t send it.  It could be a $100 fine if a tenant can prove you neglected to send it.  Not sure how they prove that, but you gotta do it, so get it done.

In years past, I have stayed away from any automated software to generate the Minnesota Certificate of Rent form.  The companies usually wanted a couple hundred dollars for their software.  Well I guess they rethought their business model.  CRP Gen now has a pricing model that costs only $1 per CPR (but you must spend at least $25).  Despite the $25 minimum, I may consider that this year.  If you have more than 10 rental units, I would use it to save time.  Check it out here.

You have 3 weeks to fill these out.  If you have many to do, just do it like I do…Turn the music up, get a beer and do 5-10 per night until you are finished.  Makes them go by faster!

Maybe I am a creature of habit or maybe it is just that I stay with something unless it is broken.  I have been using QuickBooks to manage my business (both rental properties and real estate) for many years now.  I was recently asked if I had tried some of the other “rental property” software packages that are custom built for rentals.

I have looked at the other options, but a couple thoughts:

• Most of these apps were overkill for what I needed.  They track the tenant application info, repair history, and long term history of which units of yours this person lived in.  None of that is important to me as I have it in my brain or on paper.
• I just need accounts receivable for each tenant.  All other info (move-in date, phone numbers, tenant names, etc) is on lease or tenant app.  I move contact info to my phone.
• My accountant can take the QuickBooks file and upload it and then pull all the reports he needs to do my taxes.  Doubt he could use the others.
• The Quicken Property manager software (last I checked) is not compatible with regular quicken or QuickBooks.
• QuickBooks is an industry standard small business accounting software that is widely recognized and the IRS would be hard to argue with you about how it does the work.
• Lastly, many of these other software packages are as or more expensive than QuickBooks.

Alternatively, I know several investors that have 5-10 properties and still use spreadsheets.  While this may work well for someone that is highly versed in Excel, there are a few draw backs:

• I don’t know about you, but a couple times in my past when using Excel, I have copied the wrong formula and ended up with a result that was close, but not perfect.  I didn’t realize to much later that it was wrong.  Quickbooks can’t have that issue.
• While you can create reports using Excel, I can simply open Quickbooks and call up a couple dozen financial reports to show me or my mortgage guy how things are looking.
• At the first of each month, my QuickBooks automatically enters all the rents as well as any continuous bills.  Not easily done with Excel.
• It is much harder to show an auditable trail in Excel than in Quickbooks.  See this post for why you need to be set up for auditing.

It is almost the first of the year.  While the learning curve on QuickBooks is pretty steep, think about buying it and making a New Years resolution to get on board.

In a recent court case, Thomas F. Hale v. Commissioner, TC Memo 2010-229 the IRS determined that the taxpayer was not entitled to deductions for his rental properties because of the lack of substantiation.

The taxpayer introduced into evidence approximately 317 pages of uncategorized photocopies of receipts, canceled checks, invoices, and similar documents. He made no attempt to tie that evidence to the IRS’s expenses in question. The taxpayer basically handed the IRS a “shoebox”.

RESULT:

Although the court case addresses other items in the taxpayer tax return, the net result was that the taxpayer owed taxes AND accuracy related penalties of:

Year      Deficiency           Penalty

2003        $17,994             $3,599

2004         19,240              3,848

2005         23,216              3,568

TAKEAWAY:

Part of a taxpayer’s responsibility in running a business is having a set of books and records in a form that is traceable back to the origin of the receipt. Whether it is using an accounting software package such as Quickbooks or cross referencing your receipts to cancelled checks- there needs to be an auditable path to the expense in question.

Circular 230 Notice: IRS regulations require us to advise you that, unless otherwise specifically noted, any federal tax advice in this communication (including any attachments, enclosures, or other accompanying materials) was not intended or written to be used, by any taxpayer for the purpose of avoiding tax-related penalties imposed under the U.S. Internal Revenue Code or any other applicable state or local tax law provision; furthermore, this communication was not intended or written to support the promoting, marketing or recommending of any of the transactions or matters it addresses.

Greg Nelson, CPA, MBT

Olsen Thielen CPAs

www.otcpas.com/blog

Tax Court Case favors the IRS-Taxpayer did not meet real estate professional 750-hour requirement

If you are claiming to be a Real Estate Professional here is another case that points out that taxpayers needs to be documenting their time when performing real estate activities. A recent tax court case held against the taxpayer claiming that he did not qualify as a real estate professional. The Tax Court held that being “on-call” does not count towards the 750 hour requirement (Moss, 135 TC No 18).

SITUATION: The taxpayer was employed full time. The taxpayer and his wife owned a number of rental properties, including four apartments and three single-family homes. The taxpayer was directly involved in the rental properties performing rent collection, repairs/maintenance, and screening/evicting the tenants. For record keeping purposes the taxpayer kept a log detailing the dates he spent performing these activities. The taxpayer neglected to include the time spent but later was allowed to go back and prepare a time summary. The taxpayer’s total hours were 646 and did not meet the 750 hour test (as required to be a real estate professional). NOTE: Not to mention the fact that over 50% of his service must be in the real estate profession.

The taxpayer also argued that he was on-call during his employee time to handle rental issues. The Tax Court took the position that service time must be actual performance of such service. The tax court also rejected the taxpayer’s claim that his calendar reflected only 75% to 85% of his time- failure to provide proof.

CONCLUSION: The Tax Court ruled in favor the IRS and the taxpayer was subject to additional income taxes and accuracy-related penalties.

TAKE AWAY: Taxpayers claiming to be real estate professional need to keep detailed records of their time and services when working on their properties.

Greg Nelson, CPA, MBT

Olsen Thielen CPAs

www.otcpas.com/blog

I attended a landlord seminar today that was hosted by an attorney that represents tenants.  It was a fascinating look at landlord issues, but with a tenant advocate teaching it.  He spoke about many of the loopholes and other places that landlords have a tendency to not follow the law or the letter of their leases and how the tenants can win lawsuits or defend against evictions.

There was quite a discussion about security deposits and I thought it made sense to lay out some of the gotchas and give you some reminders on how the process is supposed to work.

• If possible, take pictures of the unit prior to the tenant moving in and store them on your computer.  The attorney explained that often the “move-in” form is simply filled in with OK and a line through the entire column for each room.  He stated it was easy to defeat this in court as meaningless.  Pictures before the move-in will give you considerable ammunition if you get pulled into court by the tenant for the amount withheld from the security deposit.
• A landlord has 3 weeks from the date that the tenant moves out or the receipt of the tenant’s new address, whichever is later, to get the security deposit or security deposit disposition letter in the mail.  That is the law, but the attorney recommended that even if you do not know the new address of the tenant, you should still put the letter in the mail to the old address.  If that letter forwards to the new address, great.  If it is returned, put that in your file so you can show you tried.
• Even if at the end of the lease or tenant’s occupancy, there is nothing left of the security deposit, you must still send a written disposition letter.  Even if the tenant owes you 3 months of rent, do not neglect this.
• If you fail to send the letter or security deposit within 21 days, the tenant can take you to court.  If they win, you owe them double the entire security deposit, plus interest (without any deductions for missed rent or damages), plus $500 as  a penalty.  For example, if the damage deposit was $1000 and the tenant lived there 1 year, the amount would be $1000 + $5 + $1000 + $5 + $500 = $2510.  That is a lot of money!
• You can only deduct for physical damages beyond “ordinary wear and tear”.  So what is wear and tear?  Although that is somewhat subjective, repainting and cleaning carpets is NOT considered excessive, normally.  If they are really worn or dirty, you could make a case that it is excessive damage (and I have seen excessive).  Make sure to document this fully.
• When you put amounts on the security deposit disposition letter, make sure to use real numbers.  A friend of mine was sued by a tenant for the damage deposit money withheld.  The tenant won the case.  The judge said that if my friend would have had receipts he would have easily won.  Do not put round numbers for supplies and repairs.  Did you really spend $20 on cleaning supplies?  Was the carpet cleaner really $60?  Use the exact figure.  It may help convince the tenant that you have receipts and you may not end up in court.  Use a time sheet if possible to account for your time if you do the work.  Do not round the hours.
• Before you start any work or cleaning, take pictures of all the problems.  Then you can use those pictures to compare to the before photos if you get to court.  As a side note, if your tenant leaves the property a mess and they are on rental subsidies, like Section 8, send the after pictures to their case worker.  It may help the next guy (and you can get some secret pleasure out of getting the tenant in trouble).
• Do not always assume you are keeping the security deposit.  I know some landlords that are keeping the deposit despite having a good tenant.  They find anything they can not to give it back.  Be honest and fair.  Otherwise you may end up in court.
• Effective August 1, 2010, the time you as a landlord are required to store your tenant’s left over stuff has been reduced to 28 days.

Following the letter of the state law and the details in your lease is the proper way to keep yourself out of court fighting over the disposition of security deposits.

Many of us purchased townhouses as the market was going bust and home builders were dumping their excess inventory of townhouses.  I know of developments were more than 50% investors.  The deals were good and we all felt like the market could not drop as far as it has.

While a home in an association has less maintenance because a lot of it is taken care of by the association, renting a home in an association takes a little more work that you may expect.  Unlike a regular single family home or even a multi-family building, you have the association watching over your property for things.

Some associations are great and they function and as long as nothing is out of control, they leave everyone alone.  I had the misfortune to be involved with one association where the president made her personal crusade to be the mother hen of this 60 unit townhouse development.  She literally watched secretly out her window as people walked their dogs and would take pictures of anyone that did not pick up after their dog or let the dog walk on the grass.  She would then send the pictures to the management company and the offender would get a warning or a fine.

This happened constantly and was not limited to dog cleanup.  She called the police on her neighbor for loud music or loud voices over 15 times.  Only 3 of those were documented by the police as a nuisance.  If you forgot to bring in your garbage can within 24 hours after garbage pick up, she would get you fined.

She seemed to especially hate tenants.  This project had about 15% of the units rented.  My tenants had 2 dogs, which was the association limit.  One day I get an email from the association management company with a picture attached of 3 dogs playing in the yard with my tenant another woman.  They were giving me a warning saying my tenant had 3 dogs and that I was in violation of the association rules.  I immediately called my tenant who explained that the 3rd dog was her sister’s who stopped over for a couple minutes (this explains the 2nd woman in the picture).

The reason I am telling you all this is that if you own a property in an association, you need to be sure that your lease states something to the effect of:  “tenant has read the association rules and bylaws and will obey both.  Failure to comply with the rules can be grounds for eviction.  This lease is subordinate to the association rules.”  This will help you in the situation where your tenant decides to do something outside the rules.  For example, if my tenant decided to keep a 3rd dog, without this provision, I would have no legal ground to do anything about it.  And the association would have kept fining me indefinitely.

If you own a property in an association, make sure to have your leases include the above language and consider having an attorney review it prior to executing it with a tenant.  This will save headaches later.