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Michael Gray, CPA's

Real Estate Tax Letter

October 3, 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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Do you need help preparing extended income tax returns by October 15?

Time marches on! 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 arenít 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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Trick! The year is three-fourths over!

Pumpkin patches are springing up, soon to become Christmas tree farms. Many people will be glad to see this year come to a close. Hope you have a Happy and Safe Halloween!

Also remember, as Robert Schuller says in his book title, "Tough times donít last, but tough people do."

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Schedule your year-end planning appointment.

Since we are in the last quarter of the year, itís time for year-end tax planning. If you need an appointment, call Dawn Siemer weekday afternoons at 408-918-3162.

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Federal "Bailout" legislation includes extension of relief for residential mortgage debt forgiveness.

The federal "bailout" legislation, H.R. 1424, passed October 3, 2008 and includes an extension of the exclusion from taxable income of discharge of indebtedness income from qualified personal residence indebtedness. It was previously scheduled to expire on December 31, 2009 and is now extended to December 31, 2012.

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California mortgage debt forgiveness partial conformity enacted.

Governor Schwartzenegger signed S.B. 1055, California partial conformity legislation for mortgage debt forgiveness, on September 25. The law is intended to make California law closer to federal legislation enacted in the Mortgage Foregiveness Debt Relief Act of 2007.

As a reminder, the California law is different from the federal law in several respects:

  • The California maximum qualified principal residence indebtedness eligible for the exclusion would be limited to $800,000 or $400,000 for married persons filing a separate return. The federal limits are $2 million or $1 million for married persons filing a separate return.
  • The California maximum cancellation of debt exclusion is $250,000 or $125,000 for married persons filing a separate return. The federal exclusion is limited to the amount of qualified principal residence indebtedness.
  • California would allow the exclusion for 2007 and 2008. The federal exclusion is also allowed for 2009.

Remember, the tax basis of the residence is reduced for the excluded gain.

The California legislation also abates penalties and interest for late payment of tax for a 2007 income tax return relating to the discharge of qualified residence indebtedness.

Remember, the exclusion applies to recourse mortgages for a principal residence. The exclusion usually wouldnít apply to a non-recourse mortgage because a foreclosure or short sale with a non-recourse mortgage includes the mortgage amount in the sale proceeds.

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"Short Sales v. Foreclosures" article updated.

Our article, "Tax Consequences of a Short Sales of Real Estate v. Foreclosures" has been updated to include the above federal and California legislation. You can get the update at no charge at www.realestateinvestingtax.com/shortsale.shtml.

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GAO says taxpayer reporting of real estate activities needs improvement.

The Government Accountability Office (GAO) has issued a report Ė Tax gap: Real estate reporting compliance.

The IRS has estimated underreported taxes for rental real estate activities on 2001 income tax returns of about $13 billion.

According to the GAO, at least 53% of individual taxpayers with rental real estate misreported their rental real estate income. 80% of those taxpayers had their tax returns prepared by professional tax return preparers.

The majority of the errors were attributable to taxpayers who claimed deductions that they couldnít substantiate or were not entitled to.

Another problem area is taxpayers who also use their rental property as a residence or who rent property at less than fair rental value. These taxpayers may not be eligible to deduct losses from their real estate operations on their income tax returns.

Errors were also made for the classification of activity for the property and applying the passive activity loss limitations on losses.

The GAO recommended more information reporting for rental real estate operations, including a clarification of whether such operations are a "trade or business" for which information reporting is required, and that the address for rental properties be information required to be included for income tax reporting.

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California budget includes tax provisions.

The California state budget, signed by Governor Schwartzenegger on September 23, includes several provisions requiring the acceleration of tax payments. Here are a few highlights:

  • Calendar-year LLCs must pay their 2008 fee on April 15, 2009 and estimated 2009 fee on June 15, 2009.
  • The net operating loss (NOL) deduction is suspended for 2008 and 2009 except for certain small businesses. NOLs may be carried back for two years for losses generated in taxable years beginning on or after January 1, 2011.
  • The first two calendar-year 2009 estimated tax payments for individuals and corporations will be increased to 30% each and the last two reduced to 20%.
  • Individual taxpayers with income over $1 million may not use the 110% of last yearís tax safe harbor for estimated tax payments for 2009.

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IRS issues guidance on bonus depreciation and expense election.

The IRS has issued guidance about 50% bonus depreciation and the increased expense election under the Economic Stimulus Act of 2008. An important clarification is that the expense election can be made on an amended return. A building isnít eligible for these tax benefits, but most carpeting, furniture, and equipment are eligible. (Revenue Procedure 2008-54.)

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Foreign-owned disregarded entities canít avoid withholding for real estate dispositions.

The IRS has issued a private letter ruling clarifying that a foreign-owned U.S. entity that has filed Form 8832, Entity Classification Election, to be disregarded from their foreign owners is subject to 10% U.S. tax withholding for transfers of U.S. real estate. The entity may not certify that it is the transferor of a U.S. real property interest. The deemed owner must provide a certificate of non-foreign status to avoid withholding. The form of certification is defined at Treasury Regulations ß 1.1445-2(b)(2)(iii). (Letter Ruling 200836029, 8/6/2008.)

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

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

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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.

The September 2008 newsletter focusing on tax issues for the homeowner and real estate investor, by certified public accountants in California.

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