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Table of Contents

• Welcome to our premiere issue.
• Have you issued information returns for your business yet?
• Remember these forms for new employees and for independent contractors.
• AMT deduction not allowed for co-op real estate taxes.
• Exclusions from sale of residences allowed for unforeseen circumstances.
• Questions and Answers
  • Could your residence be the ultimate tax shelter?
  • Can I defer gain on my home sale by buying a more expensive home?
  • Can I apply the two-year rule to an inherited property?
  • Can I avoid taxes on my residence without living there two years?
  • What happens if only one member of a partnership lives in a house purchased jointly?
  • Can I avoid or reduce capital gains on the sale of my summer home?
• Do you have other tax issues?
• Subscribe to the Real Estate Tax Letter

Welcome to our premiere issue.

We have been flooded with questions about real estate tax issues, so we decided to create a separate newsletter for that area. This newsletter will require a paid subscription, but we will have a teaser-headline edition to invite new subscribers.

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Have you issued information returns for your business yet?

Forms 1099 and W-2 should have been issued to payees by January 31. The government copies should be mailed or efiled by February 28.

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Remember these forms for new employees and for independent contractors.

California employers should submit Form DE 34 to the Employment Development Department within 20 days after a new employee starts work. Form DE 542 should be submitted for independent contractors. The State of California uses the information on these forms to help collect child support payments, but all employees and independent contractors are required to be included on the report.

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AMT deduction not allowed for co-op real estate taxes.

The Second Circuit Court of Appeals ruled that a married couple’s share of real estate taxes paid by a cooperative housing corporation is treated like other real estate taxes for a personal residence – tax deductible for regular tax reporting but not deductible when computing the alternative minimum tax. (Lauren Ostrow and Joseph Teiger v. Commissioner, 2006-1 USTC 50,116.)

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Exclusions from sale of residences allowed for unforeseen circumstances.

The IRS ruled that three taxpayers could exclude the gain from the sales of their residences (subject to the prorated $250,000 limit, $500,000 for joint filers) due to unforeseen circumstances.

In the first case, the taxpayers moved from their first residence to another residence located closer to their children’s schools, with the intention of moving back. After they moved, another child was born in the family, so the first home was too small. The IRS ruled that, since the taxpayers did not foresee having another child, the sale of the first residence after the birth of that child was due to unforeseen circumstances. (LTR 200601022)

In the second case, the taxpayers moved to their first residence relating to a new job. After they moved into the home, they became aware they were in a "rough" neighborhood. One of their children was assaulted and one of the parents was so severely assaulted that a visit to a hospital emergency room was required. The taxpayers sold the first home and bought a second home in a safer neighborhood. The IRS ruled the taxpayers sold the first home because of unforeseen circumstances relating to neighborhood conditions. (LTR 200601009.)

In the third case, the taxpayers moved to their first home relating to moving after retirement. The taxpayers’ daughter, who lived in another state, lost her job and divorced her husband. Because of the daughter’s changed financial circumstances, she and her child needed to move in with her parents, the taxpayers. Children weren’t allowed to live in the taxpayers’ retirement community. They sold the first home and bought another home where the daughter and grandchild could move in while the daughter searches for full-time employment. The IRS ruled the sale was due to an unforeseen circumstance of the daughter losing her job and becoming divorced, needing shelter. (LTR 200601023)

Although other taxpayers can’t rely on these private rulings, they illustrate the flexibility provided by the unforeseen circumstances exclusion. Taxpayers who find they have to sell their residence less than two years after moving in can often get the benefit of at least part of the exclusion from the sale of a principal residence.

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Questions and Answers

Dear readers:

Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" where you should be able to find the answers to most of these questions.

Question

I bought my condo for $90,000 and am selling it for $99,000. The problem is we want to close the sale on February 17, 2006 and bought the house on February 27, 2004. We would fail the two-year test. We are buying another home for $290,000, and the closing for the purchase is also scheduled for February 17, 2006.

Will we have to pay a capital gains tax, even though we are buying another property? Both are primary residences.

Answer

The old rule of deferring a gain by buying a more expensive residence was repealed in 1997.

Unless you can change the closing date or come up with a good "unforeseen circumstance" for a partial exclusion, the gain will be taxable.

Question

My father transferred his home to my sister and me by quit claim deed when our mother passed away in August, 2005. The home is paid for. I would like to sell my share to my sister, leaving her as the sole owner. Would I have to pay taxes on the sale proceeds? Does the two-year rule apply here?

Answer

The two-year rule only applies when the home is your principal residence. Even if you did live in the residence, it’s too soon to qualify, unless you have an "unforeseen circumstance."

Find out from your father what the tax basis for the residence was. At least part of the basis should have been adjusted as of your mother’s date of death. Your father might need some help from an accountant or attorney to determine this. It may be the gain is much smaller than you think it is.

Question

My wife and I live in Maryland. We are looking to sell our current primary residence, which we bought on November 21, 2004. If we sell before that date in 2006, we will not meet the two-year holding period requirement. We also don’t have an "unforeseen circumstance" that we are aware of for a partial exclusion.

Our potential gain is $200,000. We don’t want to wait until November, but we don’t want to pay a tax on the gain. Can you help?

Answer

I’m not a magician. The law gives a road map on how to qualify to exclude the gain. Unless you can come up with an "unforeseen circumstance" like a change in employment, I suggest that you follow the road map and wait until after November 21, 2006 to sell your current residence.

Question

If two siblings jointly buy a house through a partnership in which each is a 50% partner, and one sibling uses the house as a primary residence, can that sibling benefit from the primary residence exclusion when the house is sold?

Answer

Owning the home as a partnership muddies the waters. I suggest the home should be owned as tenants in common (undivided interests). Then the resident owner should qualify for the exclusion.

(By the way, even though many families are buying homes this way, tax-wise it’s very messy.)

Question

I sold my mobile home in Florida after owning it 27 years. My primary residence is in Michigan. Can I avoid the capital gains tax or reduce it? We used the Florida home about 5 months out of the year.

Answer

Whether the residence qualifies for an exclusion is a question of fact. The facts you have given to me don’t meet the requirements. If you had asked before the sale, we might have discussed setting up an installment sale or something. Now you have to deal with the consequences of your actions. If you sold the property during 2006, look for any items you might own that could generate a capital loss to offset the gain. The most ideal item would be a "loser" stock that you can sell.

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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

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IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.