Michael Gray, CPA's

Real Estate Tax Letter

August 14, 2010
© 2010 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 with finishing extended income tax returns, preparing amended income tax returns, or tax audits?

Now that April 15 has passed, it’s time to focus on finishing extended income tax returns. Some of our readers have found errors in or are uncomfortable with tax returns that they prepared using tax software or were prepared by other tax return preparation companies. We can provide a second opinion. Others have received notices for tax audits and sometimes can’t get the help they need from their tax return preparer. We can help with all of these. To make an appointment, call Dawn Siemer Mondays, Wednesdays or Fridays at 408-918-3162 from 9 a.m. to 5:00 p.m. Pacific Time.

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Is the San Jose Real Estate Investors Association for you?

Michael Gray, CPA is an affiliate member of the San Jose Real Estate Investors Association (SJREI). This is a great educational and mutual support organization. The exchange of information among the participants is as helpful as the presentations by the speakers. If you are interested in investing in real estate, I highly recommend it. The next East Bay chapter meeting will be held at the Hyatt Place Dublin next Wednesday, July 7, at 7 p.m. The next South Bay chapter meeting will be held at the Biltmore Hotel in Santa Clara next Thursday, July 8 at 7 p.m. The next Mid-Peninsula chapter meeting will be held at the Crowne Plaza Hotel in Foster City Tuesday, July 20 at 7 p.m. For details, visit their web site at www.sjrei.net.

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What the IRS doesn’t want you to know about Family Limited Partnerships.

This half-hour pre-meeting presentation will be given by Michael Gray next Tuesday, August 17, at 6:30 p.m. for the San Jose Real Estate Investor’s Association at the Crowne Plaza Hotel in Foster City. To register, visit their web site at www.sjrei.net.

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Home must be re-qualified for principal residence exclusion when rebuilt.

Taxpayers demolished their former principal residence and built a new residence on the site. The taxpayers never lived in the newly-built residence. Based on their living in the previous residence, they would qualify for the exclusion of gain from the sale of a principal residence.

The Tax Court, with five dissents, ruled that building a new residence at the site resets the clock to qualify for the exclusion. By analyzing the legislative history and regulations, the majority found the exclusion was designed to apply to the sale of a dwelling unit the taxpayer uses as a principal residence. In this case, the dwelling unit was destroyed.

It seems to me there is a good chance the taxpayer may decide to appeal this decision. It was a very close call.

(Gates, 135 T.C. 1, July 1, 2010.)

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Loss disallowed because of litigation.

A real estate developer was not able to claim a business loss deduction for purportedly worthless property because of continuing litigation. The builder was in dispute with a neighboring landowner about access to the property. Since the lawsuit wasn’t resolved at the end of the tax year, the loss wasn’t a closed and completed transaction.

(D.L. White Construction, Inc. TC Memo. 2010-141, June 28, 2010.)

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Updated First-Time Homebuyer Credit Form issued.

The IRS has issued updated Form 5405, First-Time Homebuyer Credit and Repayment of the Credit with accompanying instructions. The form and instructions have been updated to reflect changes adopted in the Homebuyer Assistance and Improvement Act of 2010. You can download the updated form at the IRS web site, www.irs.gov.

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Extension granted for single rental real estate election.

The IRS granted extensions of time for making the election to treat all of their interests in rental real estate as a single real estate activity for purposes of determining whether the activity was passive. This election is important for real estate professionals who are claiming their real estate activities are not subject to the passive activity loss limits for federal tax reporting. The taxpayers had inadvertently failed to include the statement required under Treasury Regulations Section 1.469-9(g)(3) with their income tax returns for the relevant tax years. The IRS found the taxpayers acted reasonably and in good faith, and granting the extension did not prejudice the interests of the government.

If you failed to make the election, consider requesting an extension as these taxpayers did. It’s better than having the IRS disallow your losses as a result of a tax audit. This has become a significant audit issue.

(Letter Rulings 201031008 and 201031009.)

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Parking garage rental not "passive investment income" for S corporation test.

When an S corporation that has accumulated C corporation earnings and profits has gross receipts for three consecutive taxable years that include more than 25% passive investment income, the S election is terminated. Real estate rental income can be passive investment income.

An S corporation asked if the income from its parking lot operations were passive investment income. A number of services were provided, including accounting and bookkeeping, internal auditing, billing and collections, daily property inspection, common area maintenance, janitorial services, landscaping, maintenance and repair of building structural components and systems, elevator maintenance and repair, pest control, and providing security services through a third party.

Based on the information provided by the S corporation, the IRS ruled income from operating, managing and leasing parking facilities were not passive investment income.

(Letter Ruling 201027022.)

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Financial Insider Weekly broadcast schedule for August and September.

Financial Insider Weekly is broadcast in San Jose and Campbell on Wednesdays at 7 p.m., Pacific Time. Note this is a new broadcast time effective August 17 You can watch it on Comcast channel 15 for those cities. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for the rest of August and September:

August 18: Scott Haislet, Attorney and CPA, "The Short Sale and Foreclosure Wars"
August 25: David Howard, Attorney and retired CPA, "Information reporting requirements for foreign bank accounts and trusts"
September 1: Jim Beall, California Assembly representative, "California’s State Budget Challenge"
September 8: Mark Ericson, Attorney, "Divorce – California style – the basics"
September 15: Craig Martin, CFP, "Investing in Turbulent Times"
September 22: Craig Martin, CFP, "The role of the fee-only financial planner"
September 29: William Mahan, Attorney, "Short sales and foreclosures – mechanics"

Financial Insider Weekly is also broadcast as follows:

Back episodes available at https://www.youtube.com/user/financialinsiderweek.

Let me know any ideas that you have for topics or guests. Guests will usually have to be located in or near the Silicon Valley in California.

Hope you can watch or record the show. Please tell your friends about it!

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Questions and Answers

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?" (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.


Our CPA is telling us that the interest for a second home we are having built is not deductible should we decide to rent the house during the summer season. Our bank will write a 30-year mortgage at the end of the construction period and the mortgage is designated as for a second home.

We also have another "second" home and a primary residence. The total of our mortgages with our primary home does not exceed one million dollars.

Will our residential interest deductions be limited?


Yes. In general, you can only claim the residential interest deduction for your principal residence and one other residence. (IRC Section 163(h)(4)(A).) So, even if the mortgages for three properties total less than $1 million, you may only claim the interest deduction for two.

If the residence is rented out for too many days, it doesn't qualify for the residential interest deduction. In order to qualify as a residence, the second home must be used for personal purposes for the greater of (1) 14 days or (2) 10% of the number of days during the year for which the unit is rented at a fair rental. (IRC Sections 163(h)(4)(A), and 280A(d)(1).

If the home is used too many days for rental, the income and deductions, including interest expense, may be reportable on Schedule E as rental income or loss, subject to the passive activity loss limitations.

A residence under construction may be treated as a qualified residence for a period up to 24 months if the residence becomes a qualified residence when it is ready for occupancy. (Temporary Regulations Section 1.163-10T(p)(5)(i).

Good luck!

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Follow me on Twitter!

If you enjoy Twitter, please follow me at www.twitter.com/michaelgraycpa. I would especially appreciate retweets of our messages announcing episodes of Financial Insider Weekly.

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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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