Tax Break for Commercial Real Estate Investors

COVID-19 impacted the economy dramatically and commercial real estate was no exception in terms of decreased values. Often, the real property could no longer service the debt used to finance it. This debt restructuring and resulting debt forgiveness can result in taxable income.

Taxable Income and Debt Cancellation

If you have a $80,000 loan and the bank reduced the amount you owe down to $50,000, then you have an economic benefit of $30,000, which should be treated as taxable income. This is indeed how cancellation of debt is treated, but there are exceptions such as in the case of bankruptcy or insolvency. There is another unique scenario that applies only to commercial real estate.

Assuming that the taxpayer is not a C-corporation, debt cancellation is excludable from taxable income if it results from qualified real property business indebtedness (QRPBI). QRPBI is debt taken on to buy real property used for commercial purposes. Starting in 1993, debt used for building or improving a property also qualify.

As we all know, there is no such thing as a free lunch. In order for debt cancellation to not be considered current taxable income, the taxpayer must reduce their basis in the real property by this same amount. This does not cancel the income; instead, it defers its recognition and helps cash flow as a result. Below, we look at an example of how this works.

Illustrative Example

Assume David bought a property in 2017 and he uses it for business purposes. In 2022, the property has a first mortgage of $200,000 and a second mortgage of $100,000 (both with the same bank), with a fair market value (FMV) of $240,000. He negotiates with the bank to reduce the second mortgage down to $20,000, resulting in income from the cancellation of debt of $80,000.

The amount of debt cancellation that can be deferred is equal to the amount of the second mortgage before the debt cancellation, less the FMV minus the first mortgage. In David’s case, before debt cancellation, the FMV ($240k) minus the first mortgage ($200k) was $40,000. The balance of the second mortgage ($100k) exceeded this by $60,000. Out of the total debt cancellation of $80,000, this $60k is subject to deferral, with only the remaining $20,000 reported as immediate taxable income.

The $60,000 is not considered as taxable income only to the extent that David has sufficient adjusted tax basis in the depreciable real property to absorb this as a reduction in basis. Assuming this is the case, the reduction in basis applies the first day of the tax year after the debt cancellation (unless the property is sold before year-end – then it applies immediately).

In the example above, David would include the $10,000 of cancellation of debt income on his 2022 tax return and adjust his basis in the real property by $60,000 as of Jan. 1, 2023.

Filing Mechanics

For real estate held via partnerships instead of by individuals, determining if debt is QRPBI qualified happens at the entity level, although reductions of basis are done at the individual level for each partner, allowing individual planning. The election to defer cancellation of debt income is recorded on Form 982.

Conclusion

The COVID pandemic caused many real estate investors to restructure their debts. The option to defer debt income cancellation offers a great tax planning opportunity by delaying taxable income and improving cash flows.

How to Calculate the Cash Conversion Cycle

The Cash Conversion Cycle, also known as the Net Operating Cycle, answers the question, “How many days does it take a company to pay for and generate cash from the sales of its inventory?” However, before an analysis like this can take place, it’s important to consider the company’s primary line of business.

If the company sells software, it’s more challenging to measure performance if it generates revenue primarily on intellectual property – by developing computer code and licensing its use to clients. For online marketplaces, especially those that make the majority of their profits from third-party sellers that manage product sourcing, listing their inventory and shipping products on their own won’t measure the online marketplace’s own inventory. Since these types of businesses don’t act like a manufacturer that produces and sells products to other businesses or the general public, this type of analysis will be less helpful.

To start with the formula for the Cash Conversion Cycle (CCC), it’s calculated as follows:

CCC = Days of Sales Outstanding (DSO) + Days of Inventory Outstanding (DIO) – Days of Payables Outstanding (DPO)

Days of Sales Outstanding, Defined

DSO is the average number of days it takes a company to collect payment once a sale has completed. The beginning and ending Accounts Receivable figures from a fiscal year are added together and divided by 2. Then revenue from the income statement for the entire fiscal year must be divided by 365 days to get a daily average.

DSO = Beginning Accounts Receivable + Ending Accounts Receivable / 2 = Revenue / 365 days

The fewer the days, the better; however, it can’t be so fast that such tight payment terms push customers away.

Days of Inventory Outstanding, Defined

DIO is the average number of days a business keeps its inventory before it’s purchased.

The beginning and ending inventories of a fiscal year are added together and divided by 2 to find an average. The resulting figure is then divided by the daily average of the cost of goods sold over a fiscal year, which is often 365 days.

DIO = Beginning Inventory + Ending Inventory / 2 = Cost of Goods Sold / 365 days

The lower the number, the faster inventory is sold. While there’s nothing wrong with moving it fast, there is the danger that orders might not be able to be fulfilled.

Defining the Operating Cycle

As the CFA Institute explains, putting DIO and DSO together constitutes the Operating Cycle. This is defined as the period of days that it takes a business to transform basic materials and/or goods into stock and obtain money from the completed transaction. When this number is small, it means product is moving and customers have no issue making prompt payments.

Days of Payable Outstanding, Defined

Days of Payable Outstanding determines the number of days a business takes to fulfill its debts to suppliers.

DPO = Beginning Accounts Payable + Ending Accounts Payable / 2 = Cost of Goods Sold / 365 days

Considerations for DPO include finding a balance between how long a business can take to pay their suppliers, but also not missing out on pre-payment discounts or being penalized with late fees, financing charges, etc.

Going Beyond the Results

When analyzing the Cash Conversion Cycle for the right type of company, it can provide great insight into a company’s efficiency in collecting billings; how long inventory is up for sale; and the time it takes to become current with its own suppliers. Depending on the results of the CCC analysis, performing financial analyses can provide insight into not only how the company is performing financially, but why the company is performing financially.

Sources

https://blogs.cfainstitute.org/insideinvesting/2013/05/21/a-look-at-the-cash-conversion-cycle/

Have the Markets Bottomed or is it a Bear Market Rally?

With the S&P down nearly 20 percent and the Nasdaq index down nearly 4,000 points since the beginning of 2022, one could say the indices are in a bear market. While we can’t predict the future, economic indicators can offer some insight into the likelihood of the market’s future performance.

There are many ways to determine how the market might act the next day, week or longer into the future. Looking at sectors and how they’ve performed against the entire market is a good way to see if it’s bottomed out or if it’s time to look at other sectors. Volatility and the near-term expectations are other ways to see how professional investors gauge the market’s future moves. Reviewing the current and expected path of monetary policy and evolving economic indicators are still other ways to determine how markets will likely perform going forward.

The VIX and Market Capitulation

The Chicago Board Options Exchange’s (CBOE) Volatility Index (VIX) or “fear gauge” is one indicator of a market bottom. When investors attempt to hedge their investments, especially when volatility is expected, long options on the VIX can provide an “insurance policy” against falling equity prices. While there have been many levels on the VIX in the mid-30s, it often reaches levels in the 40s, 50s or even potentially higher to see a true bottom or market capitulation. Looking back to the 2008/2009 financial crisis, the VIX spiked to 79.13 on Oct. 20, 2008. Similarly, the VIX spiked to 82.69 on March 16, 2020, during the lows of the COVID-19 crash.

Measuring the Put/Call Ratio

Another indicator to gauge if the market has bottomed is when there’s a large consensus of bearishness. Using the put/call ratio, investors can see the current and past ratios of puts to calls presently held in the market. As the number of puts increase relative to call options, or the number of contracts betting stocks will increase in price over time, it indicates the market movers are expecting a down-turn in the markets. As the put/call ratio rises, it implies investors are feeling more and more bearish about the markets. When the ratio hits an extreme, higher implying a market bottom and lower implying a market top, investors are signaling they are nearing a turn in the markets.

Analyzing Moving Averages

When it comes to moving averages (a 50-, 100- or 200-day, for example), it can help establish trends for stock price action. Depending on the moving average used, the lower the number of stocks above or below a particular moving day average, the sector’s or index’s strength and direction can be measured. When it comes to measuring an index or a sector with a moving average, if a trend is showing more stocks are declining and staying below a moving average, it gives investors a sign of bearishness. If a big percentage, such as 70 percent or 80 percent of an index or sector, is below a particular moving average, this can indicate it may be forming a bottom or oversold conditions.

The Federal Reserve and Managing Inflation

According to the Federal Reserve Bank of San Francisco, the historic range for the federal funds rate grew from 11 1/3 percent to 11 3/4 percent based on decisions from the September 1979 Federal Open Market Committee (FOMC) meeting. The Oct. 6, 1979, FOMC meeting created a four percent range for the federal funds rate (11.5 percent to 15.5 percent). By the end of 1979, the federal funds rate was nearly 14 percent, reaching 17.60 percent during 1980. Then January 1989 saw a recession due to the Fed changing reserve requirements, adding on additional fees for loans directly from the Fed, and promoting the economy to be more judicious in obtaining new loans. These changes led to interest rates rising toward the end of 1980, creating another recession in July 1980. While unemployment increased, inflation fell to four percent as 1982 closed out, compared to inflation running 14.6 percent annually between May 1979 and April 1980.

Immediately before the Oct. 6, 1979, FOMC meeting, the S&P 500 index hit a peak of 111.27 at closing the day before. Following a trend that began the Monday after the FOMC meeting, it eventually hit a “double-bottom”: 100 on Oct. 25, 1979, and then 99.87 on Nov. 7, 1979. It eventually reached a high of 118.44 on Feb. 13, 1980, before falling back to its last lows on March 27, 1980, to 98.22, and then eventually seeing an upturn.

While there are many economic, technical and fundamental indicators to gauge the direction of the stock market, taking a comprehensive approach to analyze the markets is not foolproof and risk can be mitigated only to a certain degree.

How Social Security Benefits Are Affected by Earned Income

Thanks to the Great Resignation trend over the past year, there is a high availability of jobs. Therefore, now is a good time for retirees who would like to go back to work to ease into the job market. However, if you’ve already begun drawing Social Security benefits, you should understand how earning income will affect those payouts.

First of all, you have two options if you’d like to stop receiving Social Security. One option is available only if you’ve been drawing benefits for a year or less. In this case, you may cancel your application; but be aware that you must repay all the benefits that you and your family have received to date. That includes spousal benefits and even Medicare premiums that were deducted from your payout. You will still be able to reapply for Social Security later.

The second option is available only if you have reached full retirement age but have not yet turned 70 years old. In this case, you may request to have your Social Security payouts suspended.

There are two benefits associated with these strategies: 1) foregoing Social Security income will likely reduce your tax bill; and 2) your Social Security benefits will start accruing again based on the delay and calculations that include your new wages.

However, you may continue receiving Social Security while you work, which could be important if your spouse is receiving benefits based on your earnings record. Under this scenario, a portion of your benefit may be withheld or even subject to higher taxes. It all depends on how much you earn. If your annual income is $19,560 or less (2022), it won’t impact your Social Security benefits.

Note that only wages from a job or self-employment count toward your Social Security income limit for withholding purposes. Distributions you receive from pensions, annuities, investment income, interest, veterans benefits or other government or military retirement benefits are not considered earned income.

Once your income totals more than $19,560, the impact depends on your age. If you have not yet reached “full retirement age,” Social Security will withhold $1 in benefits for every $2 you earn over the limit.

During the year you reach full retirement age, your annual total earnings limit increases to $51,960 (2022), and the subsequent benefit reduction drops to $1 for every $3 you earn over that amount. In fact, they count only how much you’ve earned up to the month before your birthday – not what you end up earning in a whole year. Once you’ve reached full retirement age, it doesn’t matter much how you earn, there will no longer be any withholding of benefits.

Better yet, starting in January of the year after you turn full retirement age, regardless of whether you continue working or not, your Social Security benefit will increase to reflect any previously withheld benefits due to your income exceeding the limit. And if the years you subsequently worked rank among your 35 highest earning years, your payout will increase even more to reflect a higher benefit calculation (since you paid FICA taxes on that income).

Tax Considerations

In the case of all beneficiaries, at least 15 percent of Social Security income is exempt from federal income taxes. Be aware though, that for tax purposes, your reportable income includes half of your Social Security benefit plus all other forms of income, such as a job, pension or investment income. If your total annual income is between $25,000 and $34,000, then as much as 50 percent of your Social Security benefit is taxable. If you earn more than $34,000 in a year, then up to 85 percent of your Social Security benefit is subject to taxes.

This is a general overview of what happens to your Social Security benefits when mixed with earned income. There are additional details, so it’s a good idea to work with a Social Security expert to decide if you should cancel or suspend payouts, and to understand how your income and tax situation may be impacted by going back to work.

With that said, if your portfolio has taken a beating this year, you might want to stop investment distributions for now and give it time to grow. Fortunately, the United States is currently enjoying a robust job market in which highly experienced candidates can negotiate a flexible work schedule, job site and higher salary, so it may be worth it to go back to work for another year or two to help secure your long-term retirement plans.

Tips to Save on A/C This Summer

You love summer, don’t you? School’s out and BBQs are on. But what you probably don’t love are those higher air conditioning bills. Here are some tried-and-true ways to help lower the cost of keeping cool.

Change Air Filters

Make sure you switch out your filters before those sizzling summer temps arrive, then once a month after that. When filters are dirty, they block the airflow, which causes your air conditioner to work harder when cooling your home. You’ll not only lower your bills by five to 15 percent, but you will also extend the life of your entire A/C system. If you don’t change those clogged filters, it could create a malfunction and you’ll have to get your unit repaired.

Turn Up Your Thermostat

Set it to 78 degrees and shed a few layers. Yes, this might not be preferable to your icy 72 degrees, but you know what will feel good? Seeing your electricity bill go down 18 percent.

Run the Ceiling Fan

This works in tandem with turning your thermostat to 78 degrees. If you’ve been running your fan clockwise during the previous months, be sure to change the direction so the air moves down into the room.

Invest In a Smart Thermostat

With these babies, you can regulate the temps when you’re not home from an app on your phone or via voice commands. For instance, you can set the A/C to a toasty 80 degrees when you’re not home to save money. Two good brands to check into are Nest and Ecobee, but here’s a list of others. They’re well worth the cost.

Close Your Curtains and Blinds

When the sun’s rays enter your home, they not only heat up the room, but also your thermostat. The best time to shut your curtains and blinds is during the warmest part of the day, between (roughly) 10 a.m. and 3 p.m. This will help insulate your windows and stop the cool air from escaping.

Consider the Placement of Your Thermostat

Where do you have this? If it’s next to a hot window, your poor A/C will work harder than it needs to because it will think the room’s hotter than it is. Other places not to put it are near doors that could let in drafts. Or by bathrooms that are usually warm and steamy. In fact, the U.S. Office of Energy Efficiency and Renewable Energy advises to avoid placing thermostats near lamps or TVs. Why? They release heat that could confuse the sensors of your poor, struggling device.

Avoid Activities that Heat Up the House

Try to refrain from using the oven, dishwasher or dryer during the middle of the day. This heats up the house. Instead, use the microwave, grill outside or – if you can stand it – wash your dishes by hand. If you need to dry clothes, wait until after sundown.

Check Your Air-Conditioner

If you had some issues with it last summer, get someone (a professional) to take a look at it before the high temps descend upon you. If you make a few small repairs, you’ll save mightily in the long run.

If you implement one or all of these tips, you’ll be in a much better, cooler place come full-on summer, the time of year when you most want to chill.

Sources

8 Best Practices For Saving Money On Air Conditioning This Summer

https://www.cnet.com/home/energy-and-utilities/lower-your-electric-bill-this-summer-with-these-air-conditioni

Ways Technology Can Improve Business Cash Flow

Cash flow awareness is vital in running the day-to-day activities of a business. Keeping track of the inflows and outflows helps a company make better plans and decisions, such as the right time to expand. Cash flow knowledge reveals where a business is spending money and can protect business relations, among other benefits. However, tracking cash flow is a challenge for many businesses.

To avoid business failure due to poor cash flow management, business owners are investing in software applications to help manage cash flow challenges. Modern technology enables access to these applications over the cloud, giving small- and medium-sized businesses the opportunity to benefit from them. These cash flow management tools help companies improve cash flow in various ways.

  1. Remove Manual Paper Systems that Cost Time and Money
    Using a cash flow automated system, it’s possible to create and send invoices directly to clients through email. This saves on time that would otherwise be used for printing invoices, mailing, bank trips, and going through paperwork comparing details. It is also possible to automate recurring invoices, saving the time used to create and send invoices.
  2. Makes it Easy for Clients to Pay
    Paying invoices takes time if a client has to keep confirming the payment details. However, an automated invoice can contain a pay now link, which facilitates quick payments for applications that include access to online payment options.
  3. Helps Avoid Data Entry Errors and Reduces Risks
    There is no need to move from one platform to another to check details, manually enter details, verify figures, etc. This ensures fewer errors, such as those generated when copying details like bank information to a check, or paying the wrong amount. Sorting out these errors takes time, hence delaying payments.
  4. Cash Flow Forecast
    The applications offer access to account insights in real time using cloud-based software and mobile apps, making it possible to forecast when clients are likely to pay and when bills are due. Access to live data also means there is no more dealing with complicated spreadsheets and paper ledgers. This way, a business can plan its actions to ensure positive cash flow. For instance, a business can delay paying vendors and plan when best to pay bills without running out of standby cash.
  5. Avoid Late Payments
    Late payments can result in fines that will cost the business unnecessary losses. However, with software that automatically sends invoice reminders, it is possible to make timely payments.
  6. Centralized Cash Flow System
    All activities involving cash transactions are located in one system, offering the ability to see cash inflows and outflows at a glance. As a result, a business can streamline its accounts and monitor cash flow; and since it includes real-time reporting, it’s easy to spot any red flags and solve problems that could adversely affect a business.
  7. Leverage on Data Analytics
    A centralized system will collect data and store it in one place. By deploying artificial intelligence technology that performs data analysis, a business can better forecast its cash flow. This also provides insight into how changes such as a new products or price adjustments affect cash flow.

Choosing a Cash Flow Tool

Cash flow automation enables a business to maintain a positive cash flow and have cash in its reserves to afford reinvesting in its operations, settling debts, and handling other operating costs. However, before investing in an automation tool, it’s recommended to analyze different tools to find the best fit for your business. Each tool is different and built to address various business problems.

Some features to look out for include integration with the existing accounting system, payments and invoicing, accepting a variety of payment methods, and security.

Besides getting the most suitable application, there are other considerations to establishing a healthy cash flow. Technology has its benefits, but it does not act as a cure for a poorly implemented system. For instance, if employees don’t know how to use new technology, its impact will be limited. Therefore, a business should establish a workflow process before implementing any new technology.

Rushing Baby Formula supplies, Helping Ukraine and Punishing Russia

To amend the Child Nutrition Act of 1966 to establish waiver authority to address certain emergencies, disasters and supply chain disruptions, and for other purposes. (HR 7791) – In response to the recent nationwide shortage of infant formula, Congress passed a bill authorizing $28 million to fund emergency supplies and to address the potential for future shortages due to emergencies, disasters or supply chain disruptions. The bill was introduced by Rep. Jahana Hayes (D-CT) on May 17. It passed in the House on May 18 and unanimously in the Senate on May 19. It is currently awaiting signature by the president.

Ukraine Democracy Defense Lend-Lease Act of 2022 (S 3522) – This legislation was introduced on Jan. 19, by Rep. John Cornyn (T-TX). It passed in the Senate on April 6, the House on April 28, and was signed into law by President Biden on May 9. The bill waives certain requirements that constrain the president’s authority to lend or lease defense articles intended for Ukraine’s government or other Eastern European countries affected by Russia’s war. For example, prohibiting a loan or lease period of more than five years. Furthermore, the president must establish procedures to ensure quick delivery of defense articles loaned or leased to Ukraine. The provisions of this bill are scheduled to terminate at the end of FY 2023.

Additional Ukraine Supplemental Appropriations Act, 2022 (HR 7691) – Introduced by Rep. Rosa DeLauro on May 10, this bill authorizes $40.1 billion in emergency funding for U.S. agencies to aid Ukraine’s response to Russia’s invasion. The funding is available only through fiscal year 2022 (which ends Sept. 30). The appropriations are designed to provide defense equipment, migration and refugee assistance, support for nuclear power issues, emergency food assistance, economic assistance, and property seizures related to the invasion. U.S. agency recipients include the Department of Justice, the Department of Defense, the Nuclear Regulatory Commission, the Department of Health and Human Services, the Department of State, the U.S. Agency for International Development, the Department of Agriculture and the Treasury Department. The bill passed in the House and Senate on May 19 and awaits the president’s signature.

Ukraine Comprehensive Debt Payment Relief Act of 2022 (HR 7081) – This bill is designed to advocate debt assistance for Ukraine among domestic and international financial institutions. Specifically, the legislation calls for an immediate suspension of Ukraine’s debt service payments to respective institutions, offering concessional financial assistance to Ukraine, and providing economic support to both refugees from Ukraine and to the countries receiving them. The bill was introduced by Rep. Jesus Garcia (D-IL) on March 17. It passed in the House on May 11 and is under review in the Senate.

Russia and Belarus SDR Exchange Prohibition Act of 2022 (HR 6899) – The purpose of this legislation is to prevent financial assistance to Russia or Belarus. Specifically, it prohibits the U.S. Treasury Department from making transactions that involve the exchange of Special Drawing Rights held by the Russian Federation or Belarus. Special Drawing Rights (SDR) are reserve assets contributed by member countries and maintained by the International Monetary Fund (IMF). The act was introduced by Rep. French Hill (R-AK) on March 2. It passed in the House on May 11 and is in the Senate.

Isolate Russian Government Officials Act of 2022 (HR 6891) – Introduced by Rep. Ann Wagner (R-MO) on March 2, this bill is designed to exclude Russian government officials from certain international meetings, such as the Group of 20, the Basel Committee for Banking Standards, and the Bank for International Settlements. The bill’s mandate is scheduled to end either within five years, or 30 days after the president has reported (to Congress) the end of the Russian-Ukraine war. The act passed in the House on May 11; it currently resides in the Senate.

Asset Seizure for Ukraine Reconstruction Act (HR 6930) – This bill would authorize a task force to identify legal actions that can be used to confiscate the assets of foreign individuals affiliated with Russia’s political leadership. The work group also is directed to report (to Congress) its recommendations for more energy-related sanctions on Russia’s government, as well as any additional authority the president can use to seize assets. The act was introduced by Rep. Tom Malinowski (D-NJ) on March 3. It passed in the House on April 27 and is under consideration in the Senate.

Secure 2.0 Retirement Bill

Combating Employee Hesitancy to Return to the Office

Pulse survey

https://www.gallup.com/workplace/236183/thinking-flexibly-flexible-work-arrangements.aspx

https://www.dol.gov/agencies/whd/flsa

How Will the Federal Reserve React to Increasing Inflation?