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Michael Gray, CPA's

Real Estate Tax Letter

December 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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Happy Holidays!

2008 will soon be a memory. Many people will be glad to see this year end. Remember that anyone with health, family and friends has a lot to be thankful for.

We hope you enjoy a Happy Holiday season despite the scary economic news. If you are well-off financially, we hope you are able to give generously to help those who are less fortunate than you are. If you aren’t so well off this year, we hope next year will be a much better one for you.

Our office will be closed on Christmas Eve day, Christmas day and New Years day.

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Now is the time for year-end planning.

There are 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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Real Estate Tax Handbook released.

The Real Estate Tax Handbook, 2008 Edition has just been released. As a reader of this newsletter, you are eligible for a a special introductory offer, expiring December 31, 2008. For details, go to www.realestateinvestingtax.com/realestatetaxhandbookoffer.shtml.

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’Tis the season for refinancing?

The federal bailout efforts are bearing fruit in the form of reduced mortgage interest rates. Remember that we provide mortgage brokerage services through Wymac Capital, Inc. If we can be of service with refinancing your mortgage or helping to finance buying a new home, call Michael Gray at 408-918-3161.

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Remember to make your property tax payment.

The due date of the first installment of California real estate tax is December 10. There is a nasty penalty for making a late payment, so remember to make your payment on time.

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Calendar corporate estimated tax payment is due December 15.

The fourth quarter estimated tax payment for calendar-year corporations is December 15. The rules for how much needs to be paid in to avoid estimated tax penalties have become complex, depending on the facts for your corporation. See your tax advisor about how much you should deposit.

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IRS relaxes 36-month rule for cancellation of debt.

The IRS has issued new regulations that limit the automatic reporting of cancellation of debt income after a three-year period has passed without collection. This means that banks, credit unions, savings and loan associations and federal executive agencies won’t have to automatically issue a Form 1099-C when a customer is still trying to work out clearing up a loan (including credit card debts). If the loan is secured with adequate security, the lender shouldn’t issue a cancellation of debt report when payments on the loan are late.

These new rules will help many individuals during the current economic situation avoid having to report cancellation of debt income unnecessarily or to refute reports issued by their creditors.

(T.D. 9430.)

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2009 standard mileage allowance announced.

The IRS has announced the standard mileage allowance for employees, self-employed individuals or other taxpayers for claiming deductions for business, charitable, medical and moving expenses.

The business rate for 2009 is 55˘ per mile, and was 58.5˘ per mile for the second half of 2008. (Includes 21˘ per mile of depreciation, reducing the tax basis of the vehicle, for 2008 and 2009.)

The medical and moving rate is 24˘ per mile for 2009, and was 27˘ per mile for the second half of 2008.

The charitable rate is 14˘ per mile for 2009, the same as for 2008.

(Revenue Procedure 2008-72.)

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Single-member LLC owner couldn’t avoid payroll tax liability.

An owner of a "disregarded" single-member LLC claimed the IRS’s check-the-box regulations were unreasonable and invalid when fighting personal liability for the LLC’s employment taxes. The Ninth Circuit Court of appeals upheld a district court decision holding that the IRS rules were reasonable and the taxpayer was personally liable.

The IRS has issued new rules effective January 1, 2009 that even a single-member LLC must separately report its payroll information. However, the owner can still be held personally liable for the LLC’s taxes as a responsible person.

(Kandi, CA-9, September 25, 2008.)

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Be careful with the expense election for fiscal-year partnerships and S corporations.

The IRS has issued an explanation of how to claim the increased expense election for depreciable business property (mostly personal property) enacted in the Economic Stimulus Act of 2008. Under the Act, the maximum expense that can be claimed for 2008 is $250,000, increased from $128,000. The level of qualifying purchases where the expense election is phased out has also been increased for 2008 to $800,000 from $500,000.

The IRS explanation highlights a problem for fiscal-year passthrough entities like partnerships and S corporations. The limitations apply at both the passthrough entity level and the partner/member/shareholder level, which could result in lost deductions. For example, during ABC S corporation’s fiscal year ended June 30, 2009, the corporation acquired and elected to expense $250,000 of equipment on July 15, 2008. At the partnership level, the purchase qualifies. The information for that fiscal year will be reported on the sole shareholder’s income tax return for 2009. Since the increased expense election that applies for 2008 does not apply for 2009, the shareholder will be limited to about $128,000 of expense election for that year. The excess deduction of $122,000 would be lost and the tax basis of the S corporation stock is required to be reduced for the lost deduction.

Clearly this is an item that is begging for a technical correction from Congress. Meanwhile, fiscal year passthrough entities should consider limiting their expense elections based on the limitations that apply to their shareholders, partners and members.

(Also note: trusts and estates aren’t eligible to claim the expense election.)

(Revenue Procedure 2008-54, 2008-38 I.R.B. 722.)

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Last chance for expense election for large SUVs?

The expense election can now be claimed for up to $25,000 of the cost of a heavy SUV with a loaded weight over 6,000 pounds that is used 100% for business. Congress is considering cutting back on this deduction. If you are planning to buy one for business use anyway, consider doing it before the end of 2008. (Note – If the vehicle is used less than 50% for business, it isn’t eligible for the expense election.)

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IRS announces correction of due date for information returns.

The IRS has announced on its web site that the due date in its instructions for providing certain information returns to recipients for 2008 is in error. The correct due date for Form 1099-B, Proceeds from Broker and Barter Exchange Transactions and Form 1099-S, Proceeds For Real Estate Transactions, should be February 17, 2009, not March 1. The February 17 due date also applies to Form 1099-MISC, Miscellaneous Income, if substitute payments are reported in box 8 or gross proceeds paid to an attorney are reported in box 14. The due date to issue the form to recipients for other Forms 1099-MISC is February 2, 2009.

The changes were enacted in the Emergency Economic Stabilization Act of 2008.

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Deductions for rental expenses limited to rental income.

Bernie Riley charged a below fair-market rental to a caretaker of her vacation property and also rented a finished basement in her residence to her son and daughter-in-law. She claimed expenses exceeding her rental income resulted in tax-deductible losses.

When a taxpayer rents a dwelling for less than fair rental value, the taxpayer is deemed to use the property for personal purposes. If a member of the taxpayer’s family uses a dwelling as a personal residence, personal use is attributed to the taxpayer unless the property is leased for a fair rental.

In this case, the Tax Court found that Bernie received below fair market rent for both the vacation property and the basement in her residence. The deductions for rental expenses were therefore limited to the rental income received, and the net losses from the properties were disallowed.

(Riley v. Commissioner, T.C. Summary 2008-142 (11/12/2008.))

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Installment payment of estate tax allowed for LLC assets.

A decedent owned three rental properties in a single-owner LLC. The decedent was actively involved in managing two of the properties. The IRS ruled the two properties qualified as interests in closely-held businesses, so the estate tax attributable to those properties was eligible to be paid in up to ten installments.

(Letter Ruling 200845023.)

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Exchange allowed for office lease and equipment.

A business and a neighboring business both needed more space for expansion. They structured a transaction with a new landlord to have new office space built, including leasehold improvements and office equipment. The transaction included having a qualified intermediary hold funds for an exchange. The IRS ruled that the transaction qualified as a tax-deferred exchange.

(Letter Ruling 200842019.)

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California Supreme Court won’t review Ventas.

The California Supreme Court has denied the petition by counsel in Ventas v. Franchise Tax Board to review the decision of the California Court of Appeals relating to limited liability company (LLC) fees. The Court of Appeals ruled that California’s LLC fee should be based on apportioned income, but the state wasn’t required to refund the tax that would have been determined under a correct formula.

This ruling relates to LLCs that are doing business in multiple states.

The taxpayer is still considering filing an appeal to the U.S. Supreme Court. The issue involved is a federal Constitutional

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Questions and Answers

Question

I have an investment property that is "upside down." Cost basis = $600k; current value = $350k, mortgage = $500k.

If I am successful in doing a short sale at $350k, I would have a loss of $250k. Can I use that to offset the cancellation of debt income of $150k?

Answer

It depends.

If the property is a rental property or was used in a trade or business, the loss is called a "Section 1231 loss." Section 1231 losses are applied first to Section 1231 gains. Net long-term Section 1231 gains are taxed as long-term capital gains (subject to special tax rates for any accumulated depreciation) and net Section 1231 losses are deductible as ordinary losses. So, if this is your only transaction and you qualify, the loss can be deducted against the cancellation of debt income.

If the property wasn’t rental property or used in a trade or business, such as a vacation home, a second home or unimproved property, the loss is either a non-deductible personal loss or a capital loss, limited to capital gains plus $3,000. In this case, you won’t get an offset against your cancellation of debt income.

Question

In your examples relating to tax consequences of a short sale, you use the term "tax basis." Does this refer to the owner’s purchase price + improvements – accumulated depreciation, or the assessed value for property taxes?

Answer

I am referring to the amount used to determine gain or loss for income tax reporting. Although it might be purchase price + improvements – accumulated depreciation, it can be different for inherited property, property received in a gift, or property acquired in a tax-deferred exchange.


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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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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Michael Gray, CPA
2190 Stokes St., Suite 102
San Jose, California 95128-4512
(408) 918-3162
Fax (408) 998-2766
email: mgray@taxtrimmers.com
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