Michael Gray, CPA's

Real Estate Tax Letter

August 4, 2008

© 2008 by Michael C. Gray
ISSN 1930-0387

A monthly report focusing on tax issues for the homeowner and real estate investor.

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Janet and I (Michael Gray) will be vacationing at Waikiki starting August 23. I’ll return to the office on September 1. If you need help with a tax issue in my absence, call Thi Nguyen, CPA at 408-918-3163. For help with an administrative issue or to make an appointment for when I return, call Dawn Siemer weekday afternoons at 408-918-3162.

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Do you need help preparing extended income tax returns?

Time marches on! The extended due date for 2007 calendar year corporate income tax returns is September 15, 2008. The extended due date for 2007 calendar year individual, partnership, estate and trust income tax returns is October 15, 2008.

If your 2007 income tax returns aren’t done yet and you are seeking help from a tax return preparer, call Dawn Siemer on a weekday afternoon for an appointment at 408-918-3162.

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Do you have an estate plan?

Although having a will and/or living trust is critically important, there is more to an estate plan than documents. What will the estimated cash requirements be for estate taxes, paying off debts and final expenses? How will your final expenses be paid? How should your retirement accounts be handled? Will your family be left in financial distress? Is there a succession plan for your business? Do you have a charity that you would like to provide for? If you would like our help in exploring these issues, please call Dawn Siemer for an appointment on a weekday afternoon at 408-918-3162.

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Housing Act is enacted, including a tax surprise.

President Bush signed The Housing Assistance Act of 2008 (H.R. 3221) on July 30, 2008. The tax part of this legislation is The Housing Assistance Tax Act of 2008.

The big surprise in the tax act that isn’t being widely discussed is a cutback in the home sale exclusion. The reduction applies for home sales in tax years after 2008. Gain eligible for the $250,000 exclusion for single persons, $500,000 for married, filing joint returns, is reduced for periods of non-qualifying use after 2008. For example, if you convert a principal residence to a vacation home or a rental, the gain eligible for exclusion is reduced for the period of non-qualified use. (Temporary absences, such as for a vacation or for medical treatment, still count as qualified use.) This is a major change that many people won’t understand, and is especially important for real estate investors who convert a principal residence either to or from rental or vacation property.

For example, John Taxpayer, a single person, bought a residence on January 1, 2007. It was his principal residence until December 31, 2008. He used it as a vacation home starting January 1, 2009. John sells the house on December 31, 2010 and has a $200,000 gain. Before the change in the tax law, the entire gain would be eligible for the $250,000 exclusion, resulting in no tax. After the change in the tax law, only one-half of the gain is eligible for the exclusion, The other $100,000 is taxable as a long-term capital gain.

The Act also includes a tax credit for first-time home buyers. The credit is 10% of the purchase price of a home, up to $7,500 ($3,750 for married taxpayers filing a separate income tax return. The credit is phased out for married persons filing a joint income tax return with modified adjusted gross income from $150,000 to $170,000, and for single taxpayers with modified gross income from $75,000 to $95,000. The credit is effective for homes purchased from April 9, 2008 through June 30, 2009. The credit is actually an interest-free loan that is repaid over a 15-year period. The balance must be repaid if the home is sold before the repayment period is over. A "first-time homebuyer" is defined as a person who had no ownership interest in a principal residence during the three-year period before the new home is purchased.

For taxpayers who claim the standard deduction, the Act allows non-itemizers to claim a real property tax deduction of the lesser of $500 ($1,000 for married, filing a joint return) or the amount of tax paid. This deduction is currently scheduled to be allowed only for 2008.

There are other more specialized tax provisions that I don’t have the space to discuss here. See your tax consultant.

A non-tax provision of the Act will increase the maximum "conforming" loan for certain "high cost" areas eligible for Fannie Mae and Freddie Mac to buy and the Federal Housing Administration to insure. Before changes, the maximum loan was $417,000. The Economic Stimulus Act of 2008 increased them to $729,750 for 2008. (See the February 8, 2008 edition of this newsletter.) After 2008, the limit under Housing Act will be $625,500 (further adjusted for inflation).

This is a very complex new law that includes emergency assistance for communities with abandoned and foreclosed homes, provisions for new federal licensing requirements for mortgage brokers and credit counseling for individuals in financial difficulty. It’s a very expensive, major piece of legislation intended to "stop the bleeding" in U.S. real estate. Let’s hope it’s successful.

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"Extreme Makeover" home may be foreclosed.

A Georgia home built during January 2005 for the Harper family by ABC’s Extreme Home Makeover and over 1800 community volunteers may be foreclosed. The estimated value of the donated materials and labor to build the home was about $450,000. The employees of Beazer Homes in Atlanta raised $250,000 in contributions for the family, including scholarships for the three children and a home maintenance fund.

The family used the home as the collateral for a $450,000 business loan for their construction business that failed.

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Parents allowed to deduct interest and taxes on home in their son’s name.

The Tax Court ruled in favor of a couple who claimed deductions for interest and taxes paid on a residence when the title was held in their son’s name.

The couple made all of the payments from the time the home was purchased. They weren’t able to qualify to buy a home themselves. They had always lived in the home.

The IRS said that since they had no legal obligation to make the mortgage payments and didn’t hold legal title to the home, the deductions should be disallowed. Further, the payments were made using a bank account of a corporation owned by the couple.

The Tax Court held the couple were the equitable and beneficial owners of the home and entitled to claim the deductions. The corporation was inactive and the couple used the corporate bank account to pay their personal bills.

This case is a good example of what not to do. These taxpayers had to go to a considerable amount of time and expense to secure their deductions by going to Tax Court. The corporate bank account should have been closed out when the corporation terminated business. The title for the home should have been changed to their names, or at least to include their names, after the purchase was done.

You are asking for trouble when you jointly own real estate and don’t share expenses according to ownership interests.

(Njenge v. Commissioner, T.C. Summary 2008-84 (7/15/2008).)

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Regulations explain how income for exchange funds are taxed.

Most Section 1031 tax-free exchanges are performed using a qualified intermediary to hold the funds until the acquisition of the replacement property is done.

The IRS has issued final regulations that explain how the investment income earned from the funds held by the qualified intermediary are taxed.

As a general rule, the exchange funds are treated as loaned by the taxpayer/exchanger to the qualified intermediary. The intermediary should report the income and deductions associated with the funds.

The parties may state in the exchange agreement that the earnings from the funds are payable to the taxpayer/exchanger. In that case, the income is taxable to the taxpayer/exchanger.

The regulations are effective for transfers of relinquished property made by taxpayers on or after October 8, 2008.

Under a transitional rule, for transfers made by taxpayers after August 16, 1986 but before October 8, 2008, the IRS will not challenge a reasonable, consistently applied method of accounting for income attributable to exchange funds.

(T.D. 9413, 73 Fed. Reg. 39,614 (7/10/2008).)

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Extension period reduced for pass-through entities.

The IRS has issued temporary and proposed regulations that will reduce the maximum extension of time to file for partnerships, estates and trusts from six months (to October 15 for calendar-year returns) to five months (to September 15 for calendar-year returns). This change should eliminate the problem that many partners and beneficiaries are currently experiencing of receiving their Schedule K-1 form with the items to report on their income tax return close to October 15. The new maximum extension period will be effective for income tax returns due on or after January 1, 2009. (IR-2008-84, T.D. 9407, NPRM REG-115457-08.)

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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.

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

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Michael Gray, CPA
2482 Wooding Ct.
San Jose, CA 95128
(408) 918-3162
FAX: (408) 938-0610
Hours: 8am - 5pm PDT Monday - Friday

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