Michael Gray, CPA's

Real Estate Tax Letter

November 5, 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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Happy Thanksgiving!

This year, Thanksgiving is on November 27. We hope you are able to celebrate and enjoy the holiday with your family and/or friends.

For our clients, thank you for your business. The purpose of our business is to serve you, and our existence depends on you.

For our readers, thank you for subscribing to our newsletter. We hope you will continue to find reading it enjoyable and rewarding.

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Now is the time for year-end planning.

Now that Halloween is past, we know the year will soon be over. Michael Gray has jury duty the first week of December, and of course we will be closed on Thanksgiving and the day after and on Christmas Eve and Christmas Day. That means there will be a limited number of year-end planning appointments available. Make your reservation now by calling Dawn Siemer at 408-918-3162.

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"Bailout" legislation includes tax legislation.

The "bailout" package passed by Congress and signed by President Bush on October 3 to stabilize the U.S. economy includes two tax acts: the Energy Improvement and Extension Act of 2008 and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008.

There are too many tax breaks for me to list here. I think the most significant item is alternative minimum tax relief highlighted in the "Extra" edition of this newsletter on October 9. Also see the article posted at www.stockoptionadvisors.com/refund.shtml. For the first time in years, we know what the alternative minimum tax exemptions are well before the end of the year, which will really help tax advisors do a better job with year-end tax planning.

See below about seminars that I will be leading.

Ask your tax advisor for information about how the Acts will affect you.

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Michael Gray gives pre-"bailout" 2008 tax legislation update.

Michael Gray will be giving a webcast for CPELink on November 19. The "bailout" will not be covered in this webcast. For details, go to this link: www.cpelink.com/product/detail.php?p=1057.

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Live "Bailout" Tax Legislation seminar.

Michael Gray will give a breakfast briefing on the Energy Improvement and Extension Act of 2008 and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008 on November 17, 2008. This event is for the Silicon Valley San Jose Chapter of the California Society of Certified Public Accountants and qualified for continuing education credits for CPAs and attorneys. For details and a registration form, go to this link: www.taxtrimmers.com/08-11seminar.pdf.

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Have you not received your federal tax refund?

The IRS is trying to locate taxpayers to claim 383,000 refund and economic stimulus payments totaling about $266 million. If you are wondering if you’re one of them, check the IRS web site at www.irs.gov (stimulus payment) and www.irs.gov/individuals/article/0,,id=96596,00.html (refund) or call 866-234-2942 (stimulus payment) or 800-829-1954 (refund).

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S corporation rules released for loans from shareholders.

The IRS has issued final regulations about how shareholders of S corporations determine their tax basis for deducting losses relating to "open account" loans from shareholders. The regulations are effective for shareholder advances made on or after October 20, 2008.

The regulations treat open account debt exceeding $25,000 to be treated as a separate indebtedness, limiting the ability of shareholders to reloan funds to an S corporation to increase their basis and avoid income.

If you have an S corporation that is generating losses, you should discuss these rules with your tax advisor because they may effect your year-end planning.

(T.D. 9428.)

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Questions and Answers


What happens if someone had a house that was their principal residence but was converted to a rental a year or two before a short sale. Do they qualify for relief from debt cancellation for a principal residence?


The only guidance that we have about this question is the Internal Revenue Code adopting tax relief for cancellation of debt for a principal residence. Section 108(h)(2) says that qualified principal residence indebtedness is acquisition indebtedness qualifying for a tax deduction for principal residence interest as an itemized deduction under Section 163(h)(3)(B).

A rental residence doesn’t qualify for this deduction and therefore a debt cancellation for a rental residence doesn’t appear to qualify for the exclusion.


How are 2nd mortgages handled for the exclusion for cancellation of debt relating to a principal residence?


They are analyzed the same way as a first mortgage. Whether the mortgage is a recourse debt is a question to be resolved under state law. As I understand it, in California any mortgage used to purchase a principal residence is nonrecourse. See your attorney.

If the second mortgage was "acquisition indebtedness" incurred for the purchase or improvement of the residence or to refinance a previous "acquisition indebtedness," it should also qualify for exclusion subject to the limitations explained in my article.


I purchased property in 2005 for $1,100,000 using about $450,000 from proceeds in a 1031 exchange as a down payment. My adjusted basis was about $650,000. The original mortgage for the property was about $500,000. After one year I refinanced for $797,000 and took $297,000 in cash. Now the fair market value of the property is about $600,000.

If I short sale or walk away, am I still responsible for the full capital gain tax? If I sell for less than the adjusted basis, am I still responsible for capital gains taxes?


If the sale price of the property is the fair market value, which you estimated was $600,000, and given your tax basis of the property was $650,000, you will probably have a loss relating to the sale. If this was a rental property, the loss could be an ordinary Section 1231 loss.

You will have ordinary cancellation of debt income of about $797,000 - $600,000 = $197,000.

To really see how your situation will settle out, you need to consult with a tax advisor. That’s our business!


I’m a California real estate investor starting to "flip" residential properties. Am I able to avoid California state taxes and/or self-employment taxes by conducting these transactions using a Delaware LLC?



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

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

Many other questions relate to short sales and foreclosures. See our article on that subject at www.realestateinvestingtax.com/shortsale.shtml

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Do you know about our other newsletters?

For general tax developments, tax planning ideas, business development ideas and book reviews, subscribe to Michael Gray, CPA's Tax & Business Insight at taxtrimmers.com/subscribe2.shtml.

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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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