After The Storm – What Are the Tax Implications to Plan For?
Articles by: Richey May, Jul 21, 2022
By: Jared Frost – CPA, AMP Partner In Charge, Mortgage Banking Tax Services
A perfect storm of market and economic conditions triggered by a worldwide pandemic created unprecedented production in 2020 and 2021. As with all storms, eventually, the tide recedes. The industry is working through much more challenging conditions in 2022. Those conditions, which include significantly higher interest rates, lower margins, and much lower overall volume, will result in much lower profitability for most companies, potentially including losses on a tax basis. In a year like this, it can make sense to try to incur as much of the pain from a book income standpoint this year, putting it all behind you and focusing on a stronger 2023, but the best strategy from a tax standpoint might run counter to that. What decisions can you make this year and in 2023 to reduce your overall tax liability now and in the future?
Generate alternative streams of income for 2022
I know – easier said than done, right? But utilizing your losses requires income in the current or future years. Therefore, the first thing to do as you plan the remaining months of 2022 is to determine how to generate or accelerate income from other sources. One must also consider the character of the income and the impact of that character on tax liabilities. For example, while capital gains generate taxable income, utilizing ordinary losses against these gains is not as tax efficient since the loss is now offsetting income potentially taxed at a more favorable rate. Now is the time to develop or examine your alternative streams of ordinary income and look to accelerate them into 2022, if possible. Some potential sources of income include:
- Is a Mortgage Servicing Right (MSR) sale right for you? When did you last review your MSR strategy? It may be time to take a look at selling MSRs as you consider all factors in determining whether to retain or release servicing rights. Our Mortgage Banking Consulting expert, Seth Sprague, CMB, discusses the intricacies of this strategy here. The tax implications of this strategy are also multi-faceted and should be analyzed before engaging in any sales process. Specifically, in general, MSR sales result in large gains for tax purposes with a significant portion of the gain being treated as a capital gain. As mentioned above, this may not be the most tax efficient strategy for utilizing ordinary losses.
- Are there ways to accelerate income from traditional sources? Closing loans or selling certain assets (i.e. REOs, fixed assets, etc.) at a gain before year-end can move that income from a future year into 2022. This income will avoid taxation if sufficient losses exist to offset it.
- What is your overall tax situation? Do you currently hold investments (other than in your mortgage company) that would generate ordinary income? Determine if you have the cash to invest in other trade or business activities or other investments that will produce ordinary income this year. Utilizing ordinary losses against ordinary income produces the best result from a tax perspective.
Determine which expenses can be deferred into 2023
The strategic decisions you make as you plan the back half of the year can help you determine which expenses should stay in 2022 and which should be deferred into 2023. This can be particularly challenging for accrual-basis taxpayers that incur expenses before year-end (even if those expenses are unpaid), but opportunities still exist for deferring some expenses into next year.
The goal for planning the back half of the year is to increase ordinary income and decrease expenses, regardless of the size of the loss. This will allow you to move losses from 2022 into 2023 or beyond.
Leveraging the Loss in the Most Tax Efficient Way
While you will be able to carry net operating losses (NOLs) forward indefinitely within the rule limitations (see below), finding ways to generate or accelerate income in 2022 allows you to utilize these tax benefits now rather than waiting until future tax years. How do the rules impact your 2022 tax liability? Net losses from all trade or business activities are limited to $270,000 ($540,000 for married individuals filing a joint return). Losses disallowed by this limitation become net operating losses (NOLs) carried forward to the following tax year. As previously noted, these NOLs will continue to carry forward to future tax year(s) indefinitely.
Now is the time to start planning how 2022 will end. The outcomes and answers for you and your business are not simple and must be approached from multiple perspectives. Please contact us at firstname.lastname@example.org to schedule a call with Richey May to review your strategy and help navigate these turbulent times in the mortgage industry.