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Michael Gray, CPA's

Real Estate Tax Letter

February 6, 2009

© 2009 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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Tax season is here! Make your appointment now!

There are only about two and one-half months left before the tax return due date. Time to get started now!

If we prepared your income tax returns last year, you should have already received instructions in the mail. If you havenít, please call Dawn Siemer at 408-918-3162.

To have us prepare your income tax returns, start with the online Tax Notebook organizer. Call Dawn Siemer at 408-918-3162 for instructions to get started. We also have a paper organizer, if you prefer. We still need your documents (W-2s, 1099s, receipts for donations) to prepare your income tax returns.

We can prepare most income tax returns using information provided online and by mail. If you wish a personal meeting, please call Dawn Siemer at 408-918-3162 to schedule an appointment. Our calendar is filling up fast!

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Time to revisit your home loan?

Home loan interest rates have been falling. For many homeowners, there is a refinancing opportunity now. Remember that we provide home loan brokerage services through our strategic partner, Wymac Capital, Inc. To explore whether we can help get financing for your new home, reduce the interest rate on your mortgage, or convert an adjustable rate mortgage to a fixed-rate mortgage, call Michael Gray at 408-918-3161.

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New offer for Real Estate Tax Handbook.

The introductory half-price offer for The Real Estate Tax Handbook, 2008 Edition has expired. As a reader of this newsletter, you are eligible for a 25% discount. For details, go to www.realestateinvestingtax.com/realestatetaxhandbookoffer.shtml.

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IRS issues guidance on first-time homebuyer credit.

The IRS has given examples of how the first-time homebuyer credit under Internal Revenue Code Section 36 may be allocated among unmarried co-owners of property. The credit applies to the purchase of a principal residence after April 8, 2008 and before July 1, 2009 by individuals who have not owned a principal residence for more than three years before the purchase. The Notice gives a lot of flexibility for the allocation. For example, if two individuals purchase a residence and otherwise meet the requirements to claim the credit, but one of them has too much modified adjusted gross income to claim the credit, all of the credit can be allocated to the individual who can use it.

(Notice 2009-12.)

(The homebuyer credit is being revisited in the Economic Recovery legislation now in process. Stand by for developments.)

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Cancellation of debt information return is just a starting point.

When a taxpayer has had a cancellation of debt and the creditor issues a Form 1099-C, that is just a starting point. For example, if the cancellation is in connection with the foreclosure of a non-recourse mortgage, the cancellation income will be included with sale proceeds to report the sale of the property. The debt may be excluded from income relating to insolvency or under the federal tax law excluding cancellation of debt for a principal residence, claimed on Form 982. Special disclosure may be required. See IRS Publication 4681 and see your tax consultant for more information and help.

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Disaster tax relief available.

The Emergency Economic Stabilization Act of 2008, passed last October, included a provision liberalizing the deduction for casualty losses attributable to federally declared disasters. The 10% of adjusted gross income limitation is waived effective for disasters declared in tax years beginning after December 31, 2007. The limitation for casualty and theft deductions was temporarily increased from $100 to $500 for tax years beginning in 2009 only.

In addition, effective for tax years beginning after December 31, 2007, the standard deduction is increased by the amount of the disaster loss deduction.

A list of federal declared disasters (formerly Presidentially-declared disasters) is available at www.fema.gov.

Other disaster tax relief includes a special five-year carryback for net operating losses, the ability to expense qualified disaster costs for a trade or business that otherwise would be required to be capitalized, and a 50% bonus depreciation allowance for real and personal property purchased to rehabilitate or replace similar property that is destroyed or condemned as a result of a presidentially-declared disaster.

Note that the real estate would otherwise have to be depreciated on a straight-line basis over a 27.5- or 39-year period. The bonus depreciation applies to property placed in service after December 31, 2007 with respect to disasters declared after that date and occurring before January 1, 2010.

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Questions and Answers

Question

My mother has Alzheimers and had to moved into a home just shy of 2 years ago. My brother has been living in the home. The home is in the family Trust and was re-appraised when my father passed 7 years ago for $750,000. Appears the value is now the same. We are discussing selling the home. Since my mother lived there 2 of the last 5 years, does the 2 year rule apply to the exclusion on paying capital gains on the sale? My brother says the $750,000 is "protected" against taxes regardless of how long my mother does not live there. I disagree.

Answer

When your father passed away, the house received a new tax basis. If the house was owned as community property by your mother and father (through the trust), the entire basis was adjusted. Not all states are community property states, so you should discuss this with a tax consultant.

If the property wasnít owned as community property, only the tax basis for your fatherís share was adjusted and your motherís share would continue.

The tax basis and selling expenses are subtracted from the sales price of the home to determine the gain from which the exclusion is subtracted, and the taxable gain determined.

It appears your mother qualifies as owning and using the home as a principal residence at least two of the last five years. There is also a special rule that provides if a taxpayer becomes physically or mentally incapable of self-care and owned and used the residence at least one year out of the last five before the sale, the sale will qualify for the exclusion. (IRC ß 121(d)(7).) That should give you some additional time to sell the house.

Question

I am selling some real estate located outside the United States. I have to convert the sales price to U.S. dollars for U.S. tax reporting, but Iím not sure what foreign exchange rate to apply.

Several IRS publications refer to the contract date. When I signed the contract of sale, I became legally bound to sell the property at the specified amount within a specified date. I decided to sell and signed the contract based on the prevailing exchange rate on that day and think that I should use that exchange rate to calculate the U.S. dollar equivalent of the sale price. Actual closing occurred on the date specified in the contract.

I wasnít able to find any specific reference in the IRS publication and U.S. tax code. Do you think my approach is legitimate and sustainable?

Answer

This is a more difficult question than you might think.

I wasnít able to find a reference specifically on point.

If the sale did not relate to a trade or business, the closest I could find was Revenue Ruling 1954-105, which specifically applies to sales of personal property, such as a watch, automobile or jewelry. According to that ruling, you would use the exchange rate prevailing on the date of the sale. Applying this theory to real estate, that would be the closing date. I think that makes sense, because thatís the date you have control of the funds.

Since I havenít found any other reference, I canít say your conclusion is wrong. I just feel more confident with my conclusion.

In the trade or business context, Internal Revenue Code Section 988 outlines the rules for foreign currency transactions. Itís pretty involved, so Iím not going to explain it in detail.

Since Iím not an expert in this area, you might want to consult with one.

Question

Here in Florida, as in many states, the majority of foreclosures/short sales, etc. are being experienced by investors vs. primary home owners. Please discuss the situation facing investors.

Answer

Most of the information in my article about short sales and foreclosures at www.realestateinvestingtax.com/shortsale.shtml applies to both personal homeowners and investors.

Remember that vacation homes and second homes are personal assets for which losses are not deductible and they arenít eligible for the exclusion for cancellation of debt income relating to a principal residence.

Owners of rental properties often have accumulated suspended passive activity losses that can be applied against the income from a debt cancellation with respect to the rental.

Losses from the sale of income-producing properties may be deductible as ordinary losses under Internal Revenue Code Section 1231. (The loss is reported on Form 4797.) The loss may offset cancellation of debt income. If the property isnít income producing, the loss may be a capital loss, limited to capital gains plus $3,000.

Taxpayers other than C corporations may elect to exclude cancellation of "qualified real property business indebtedness" from taxable income. (Internal Revenue Code Sections 108(a)(1)(D) and 108(c).) This is mostly debt incurred to acquire, construct, reconstruct or substantially improve real property used in a trade or business. (Rental real estate is not considered to be used in a trade or business.) Refinanced debt up to the qualifying amount of a previous debt also qualifies. The tax basis of depreciable real property is reduced for the excluded gain. The amount excluded is limited to the adjusted basis of depreciable real property before the discharge.

Exclusions for discharges of debt in bankruptcy in a title 11 case and up to the amount of insolvency are also available for cancellations of debt relating to investment real estate. The tax basis of assets must be reduced for the excluded gain.

See IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments (for Individuals) and Form 982 and instructions for more information.

I recommend that you get professional help when preparing your income returns with a cancellation of debt.


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 February 2009 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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