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Table of Contents

• Third quarter estimated tax payments are due.
• Extended due date for calendar year corporations is coming.
• Not much time left for calendar year non-corporate taxpayer income tax returns.
• Sale of land by estate to decedent's child not self-dealing.
• S corporation not disqualified by rental income.
• Stock in New York cooperative apartments qualifies for like-kind real estate exchange.
• No mortgage interest or property tax deduction allowed under lease-option agreement.
• IRS issues guidelines on capitalization versus deducting expeditures.
• Pension Protection Act of 2006.
• Questions and Answers
  • Principal residence answers.
  • How long do I have to report the capital gains after I sell my home?
• Do you know about our other newsletters?
• Subscribe/Remove yourself from this newsletter.

Third quarter estimated tax payments are due.

The third quarter estimated tax payment for calendar year entities, including most individuals, is due on September 15. Some taxpayers with irregular income make payments based on their actual information for the year. If this applies to you, get in touch with your tax advisor now. If we can be of service to you in this area, call Dawn Siemer at 408-918-3166 for an appointment.

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Extended due date for calendar year corporations is coming.

The extended due date for calendar year C and S corporations is September 15. That is also the extended due date for making deductible employer payments to qualified corporate retirement plans, including defined benefit plans, profit sharing plans, ESOPS and 401(k) plans. If this due date applies to you, hopefully you have everything well under control by this time.

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Not much time left for calendar year non-corporate taxpayer income tax returns.

The extended due date for calendar year noncorporate taxpayers, including most individuals, partnerships, estates, and trusts is October 15. That is also the extended due date for making deductible employer payments to qualified retirement plans of these entities, including Keoghs, SEPs, defined benefit plans, profit sharing plans, ESOPS and 401(k) plans. The extended due date for 2005 gift tax returns is also October 15. This is a critically important due date, so please be sure your income tax returns are filed on time. In some situations, penalties can even be imposed when there is a tax overpayment. If we can be of service to you in this area, call Dawn Siemer at 408-918-3166 for an appointment.

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Sale of land by estate to decedent’s child not self-dealing.

The IRS privately ruled that the sale of land for which a private foundation had a beneficial interest by a probate estate to a child of the decedent was not an act of self-dealing, which would be subject to an excise tax.

The estate met five requirements for an exception to self-dealing. (1) The executor had a power of sale with respect to the land. (2) The sale would be approved by a probate court having jurisdiction over the estate. (3) The sale would occur before the estate is considered terminated for federal income tax purposes. (4) Neither the estate nor the private foundation would lose any fair market value in the sale. (An appraisal was prepared to establish the fair market value of the land for the sale.) (5) The interest of the estate and the private foundation under the sale would be at least as liquid as their interests were before the sale.

(Letter Ruling 200628038 4/18/2006.)

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S corporation not disqualified by rental income.

The IRS has privately ruled an S corporation did not receive disqualifying passive investment income when it received rental income from its business of owning and operating rental real estate.

An S corporation will have its S election terminated if it has accumulated earnings and profits from being a C corporation in the past or merging with another corporation with C earnings and profits and more than 25% of its gross receipts for three consecutive years are passive investment income.

"Rents" can be passive investment income. There is an exception when the rents are derived in the active trade or business of renting property. The S corporation is in the active trade or business of renting property if it provides significant services or incurs substantial costs in the rental business. This exception usually doesn’t apply for net leases.

The taxpayer in this case was able to demonstrate it provides significant services, including identifying new tenants, negotiating leases and agreements with tenants, maintaining the interior and exterior of the properties, paying taxes and maintaining insurance on the properties, and more.

(Letter Ruling 200628005 3/13/2006.)

The IRS made a similar determination for an S corporation leasing and operating a property consisting of retail shopping, entertainment, restaurant and commercial office space.

(Letter Ruling 200629005 4/11/2006.)

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Stock in New York cooperative apartments qualifies for like-kind real estate exchange.

A partnership proposed to make a Section 1031 like-kind exchange of stock of New York cooperative apartments for other real estate investments. The IRS found that, under New York law, stock in a cooperative apartment is real property. Therefore the stock qualifies as like-kind property.

(Letter Ruling 200631012 4/13/2006.)

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No mortgage interest or property tax deductions allowed under lease-option agreement.

The Tax Court ruled that a taxpayer could not deduct mortgage interest and property taxes until the purchase option was exercised under a lease-option agreement. The taxpayer’s rental payments were the mortgage payments and property tax payments for the house. The landlord evidently said the taxpayer could deduct the mortgage interest and property taxes, but the IRS found in an audit that the taxpayer didn’t have the necessary ownership of the property to be entitled to the deductions.

(Jones v. Commissioner, T.C. Memo 2006-176 (8/22/2006).)

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IRS issues guidelines on capitalization versus deducting expenditures.

The IRS has issued proposed regulations explaining how to decide whether expenditures relating to tangible property are currently deductible or must be capitalized. The proposed regulations won’t be effective until they are finalized, but provide useful information when evaluating how to treat expenditures for tax reporting.

For example, when you buy real estate that’s in disrepair and fix it up before you start to rent it, most of the rehabilitation expenses must be capitalized. If you previously owned the property and a condition develops requiring a repair, such as an environmental spill, the rehabilitation would be currently deducted.

In some cases, modifications for new building codes may significantly improve the structural soundness of a building. These modifications would be a "betterment" that must be capitalized.

As an alternative to making judgment calls as to whether an expenditure must be capitalized or not, the taxpayer may elect the repair allowance method. This is a method of accounting that becomes binding on future expenditures. Under the repair allowance method, expenditures up to a repair allowance are currently deductible and expenditures exceeding the repair allowance must be capitalized. The IRS will publish percentages to apply to the average unadjusted basis of the taxpayer’s property by MACRS asset class. In most cases, the capitalized amounts will be depreciable.

(REG-168745-03, 71 FR 48589, 8/21/2006.)

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Pension Protection Act of 2006.

President Bush signed the Pension Protection Act of 2006 on August 17, 2006. This is a huge tax act that includes changes beyond the pension area, including new rules for charitable contributions, private foundations, and donor advised funds.

Here are some real estate-related changes.

• Effective for contributions made after July 25, 2006, new requirements have been added for contributions of easements on building exteriors located in registered historic districts. In order for a contribution of a qualified real estate interest that is a restriction relating to the exterior of a building located in a registered historic district to be considered "exclusively for conservation purposes, (1) the interest must include a restriction that preserves the entire exterior of the building; (2) the donor and donee must enter into a written agreement certifying under penalty of perjury that the donee is a qualified organization with a purpose of environmental protection, land conservation, open space preservation or historic preservation and has the resources to manage and enforce the restriction and a commitment to do so; (3) for any contribution made in a tax year beginning after August 17, 2006 the taxpayer must include a qualified appraisal of the qualified property interest, photographs of the entire exterior of the building, and a description of all restrictions on the development of the building with his tax return for the tax year of the contribution.



• A taxpayer who claims a deduction for a qualified conservation contribution in excess of $10,000 for the exterior of a building in a registered historic district must pay the IRS a $500 filing fee. The new fee applies for contributions made 180 days after August 17, 2006.
  
  A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for "conservation purposes" and that prohibits the donee from making certain transfers.



• Effective for contributions after August 17, 2006, a charitable deduction is disallowed for a qualified conservation contribution relating to a structure (including non-depreciable structures such as private residences) or land area by reason of the property’s location in a registered historic district. The deduction is allowable for buildings located in a registered historic district.



• Effective for contributions made after August 17, 2006, the amount of the charitable deduction for a qualified conservation contribution must be reduced by an amount that bears the same ratio to the fair market value (FMV) of the contribution as the sum of rehabilitation credits allowed to the taxpayer for the five preceding tax years for a building that is part of the contribution bears to the FMV of the building on the date of the contribution.



• Effective for contributions made in tax years beginning after December 31, 2005 and before January 1, 2008, the adjusted gross income percentage limitation for qualified conservation contributions of real property is increased from 30% to 50% for most taxpayers and 100% for farmers. The excess is carried forward to each of the 15 succeeding tax years. Qualified conservation contributions will be reported separately from other charitable contributions.

If you are dealing with qualified conservation contributions, I recommend that you work with a tax advisor to cover the details.

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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?" (www.realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.

Question

How long do I have to report the capital gains after I sell my home?

Answer

Any capital gains are reported on your income tax returns for the year of sale. For 2006, the income tax returns are due on April 16, 2007. Remember to apply any exclusion you may be entitled to. (See our report – "Could your residence be the ultimate tax shelter?")

Also, watch the estimated tax requirements. For most taxpayers, there is no penalty for underpayment of estimated tax provided last year’s tax is paid through withholding. If you need help with this, see a tax advisor.

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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.