Michael Gray, CPA's

Real Estate Tax Letter

October 18, 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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Boo! The year is almost over! Time for year-end planning.

Hot on the heels of Halloween are Thanksgiving and the holiday season. When we traveled to Ireland and Scotland, Christmas displays were erected right after Halloween, because they don’t celebrate Thanksgiving when we do.

I hope you’re having a good year. We know many are not, so give generously if you are doing well.

With the final extended due date for 2009, October 15, behind us, it’s time for year-end planning. This is going to be one of the most difficult years for year-end planning in my 36 years in public accounting, because the Bush tax cuts are expiring at the end of 2010 and we don’t know what extension legislation, if any, will be enacted. We don’t even know the AMT exemption for this year! Congress might not pass extension legislation until next year! We can only guess what the tax laws are going to be after this year. Despite that, we need to estimate the taxes that may be due in April and otherwise work with our broken crystal balls.

Call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162 to make your year-end planning appointment now.

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Missed Michael Gray’s webinar? Playback is available.

Entrust Group is providing a playback link for the webinar that Michael Gray gave together with Lamarr Baxter about “When IRAs and Roths Must Pay Income Taxes.” Here is the playback link: http://cc.readytalk.com/play?id=g1mtna. (You have to provide contact information to access the webinar.)

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California is “a little short of cash” for refunds.

The Franchise Tax Board announced on October 14 that refunds on corporate and individual income tax returns will be delayed until there is enough cash in the state treasury to pay the refunds. As an alternative, overpayments can be applied to the next year’s estimated tax instead of applying for a refund. Then future estimated tax payments or withholding can be reduced. (Spidell’s Flash E-Email.)

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Business casualty loss disallowed.

The Tax Court ruled a married couple that owned and operated a construction company weren’t able to deduct the losses from a fire on an uninsured cabin that they owned. The losses weren’t incurred in the operation of a trade or business, or with the intent to earn a profit, so they weren’t business losses. The non-business loss didn’t exceed 10% of their adjusted gross income.

The property was used for retreats by members of their church.

(Sandoval v. Commissioner, TC Memo 2010-208.)

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Casualty loss allowed for corrosive drywall damage.

The IRS has issued guidance for relief to homeowners who had property losses resulting from the effects of corrosive drywall installed in homes between 2001 and 2009. Amounts paid to repair damages to a personal residence or household appliances resulting from corrosive drywall may be treated as casualty losses under Internal Revenue Code Section 165 in the year of payment.

A taxpayer who does not have a pending claim for reimbursement of the expenses may deduct 100% of the amounts paid.

A taxpayer who has a pending claim for reimbursement may claim 75% of the unreimbursed amount paid during the tax year. If a reimbursement is later received for amounts previously deducted, the reimbursement should be reported as taxable income under the tax benefit rule.

(Revenue Procedure 2010-36, 2010-42 IRB.)

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IRS issues guidance on series LLCs.

The IRS has issued proposed regulations for series LLCs. Under the proposed regulations, each series unit established by the LLC would be treated as a separate entity for federal tax purposes.

(NPRM REG-119921-09.)

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Hours “on call” don't count for passive activity test.

The Tax Court ruled that the time spent by a taxpayer “on call” doesn’t count as hours worked on real estate rental properties. The taxpayer didn’t meet the 750-hour requirement for real estate professionals.

(Moss, 135 T.C. No. 18.)

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Recharacterization of passive activities is not a change of accounting method.

IRS Chief Counsel has said that recharacterizing a taxpayer’s activities from nonpassive to passive under the passive activity loss rules is not a change in method of accounting. Therefore, the IRS cannot make any adjustments under the change of accounting rules to prevent the duplication or omission of any amounts.

Determining whether a taxpayer materially participated in an activity does not concern a method of accounting. The taxpayer is simply meeting a qualification requirement. If a correction is made because a test was failed, it’s simply a correction of an error.

(TAM 201035016.)

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No tax basis for shareholders of an S corporation for guaranteed loans.

The 8th Circuit Court of Appeals upheld two Tax Court decisions finding that S corporation shareholders didn’t have enough basis in their stock to claim losses from the corporation on their individual income tax returns.

The loans were from a bank, another C corporation and a partnership in which the shareholders were partners.

In order to be counted as tax basis for an S corporation investment, the loan must be directly from the shareholder to the corporation.

In addition, the shareholders transferred loans they made to the S corporation to the C corporation. They had previously deducted losses using the tax basis from those loans, so the tax basis of the loans was reduced. As a result, they realized taxable income for the excess of the fair market value of the loans, deemed to be the face amount, over the tax basis.

(Russell, CA-8, USTC ¶ 50,585.)

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Small Business Jobs Act is enacted.

President Obama signed the Small Business Jobs Act (the Jobs Act) into law on September 27, 2010. Finally we have some tax laws enacted this year, but many of the Bush tax cuts are still scheduled to expire after this year, the federal estate tax is still repealed for 2010 and we still don’t know what the alternative minimum tax exemption is for 2010.

Here are a few tax highlights of the Jobs Act:

  1. 50% first-year bonus depreciation has been extended for acquisitions from January 1, 2010 through December 31, 2010. Bonus depreciation has also been extended for personal property with a recovery period of 10 years or longer, and for transportation property. Unlike the expense election, there is no taxable income limit for bonus depreciation and there is no phase out based on the amount of equipment purchased.

    Under the new law, bonus depreciation is not allocated to cost for long-term contracts when the constructed assets have a depreciable life of seven years or less.

    In order to allow a bigger depreciation deduction when bonus depreciation is claimed for an automobile, the maximum deduction is increased an additional $8,000 when bonus depreciation is claimed. The 2010 maximum deductions will be $11,060 for passenger automobiles and $11,160 for light trucks.


  2. The Internal Revenue Code Section 179 expensing election limit has been increased for tax years beginning in 2010 and 2011 from $250,000 (former limit for 2010) to $500,000. The deduction will be phased out for equipment purchases exceeding $2 million (was $800,000 for 2010).

    The definition of Section 179 property eligible for expensing has temporarily been expanded to include qualified real property, defined as qualified leasehold improvement property, qualified restaurant property and qualified retail improvement property. The maximum amount of qualified real estate eligible for expensing is $250,000. Taxpayers may also elect to exclude qualified real estate from the expensing, such as if claiming the property would result in having more than $2 million in additions, phasing out the deduction.

    “Off the shelf” computer software also continues to be eligible for the expense election.


  3. S corporations pay a “built-in gains” tax for appreciated property disposed within 10 years after making the election. Under the American Recovery and Reinvestment Act of 2009, the holding period was reduced to seven years for 2009 and 2010. Under the Jobs Act, the holding period has been reduced to five years for dispositions in a tax year beginning in 2011, provided the fifth year in the recognition period precedes the tax year beginning in 2011.


  4. For qualifying stock acquired during the period from September 27, 2010 through December 31, 2010, the exclusion of gain for certain small business stock has been increased from 75% to 100%. Since this period is so short, I’m not going to explain the details. See your tax advisor.


  5. Effective for the first tax year beginning after December 31, 2009 (2010 for most taxpayers), the deduction for health insurance costs for a self-employed person for the individual and his or her immediate family for income tax reporting will also be deductible when computing the self-employment tax. (Let’s hope this one will be extended after 2010.)


  6. Effective for distributions after September 27, 2010, an employee can roll over in-plan distributions from a “regular” 401(k), 403(b) or 457 retirement plan account to a Roth account under the same plan. The plan must permit “in service” distributions, so plans might have to be amended to permit the transfer. In addition, for distributions during 2010, the taxpayer may either report the taxable income resulting from the transfer in equal amounts for 2011 and 2012 or elect to report all of the income for 2010. (Same as for regular to Roth IRA conversions for 2010.)


  7. The information return reporting requirements for payments of $600 or more have been extended to rental property expenses, effective for payments made after December 31, 2010.

For more details about how the new rules affect you, see your tax advisor, or call Michael Gray at 408-918-3161.

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Financial Insider Weekly broadcast schedule for September and October.

Financial Insider Weekly is broadcast in San Jose and Campbell on Wednesdays at 7:00 p.m., Pacific Time on Comcast channel 15. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for the rest of October and for November:

October 20: Richard Lambie, Professional Fiduciary, “The Role of the Professional Fiduciary”
October 27: Mark Erickson, Attorney, “Divorce, California Style – Child Custody”
November 3: Mark Erickson, Attorney, “Divorce, California Style – Spousal Support”
November 10: Jeffrey Hare, Attorney, “Using a Checkbook LLC with a Self-Directed IRA”
November 17: Jann Besson, Attorney, Besson & Yarbrough, “Medi-Cal Benefits for Long-Term Disability”
November 24:, John Hopkins, Attorney, Hopkins & Carley, “Promoting Community Giving as a Family Value”M

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.

Question

We bought a house in 1987 for about $300,000 and used it as a principal residence until March, 2007. At that time, it was converted to a rental property. We would like to transfer the home to our children as a gift.

Would the tax basis of the residence still be $300,000, or would it be the current fair market value of about $750,000?

Would the transfer be subject to any taxes?

What is the maximum gift amount to transfer to each child?

Answer

The tax basis of property received as a gift is the lesser of the fair market value on the date of the gift or it’s adjusted basis to the donor. In your case, that would be $300,000, less any accumulated depreciation for the period rented.

The transfer would probably be a reportable gift. Gifts are reported on Form 709, the U.S. Gift Tax Return. You can get a copy, with instructions, at www.irs.gov. The form is due by April 15 of the year following the gift. Some states also impose gift taxes. (California isn’t one of them.)

The annual gift tax exclusion for 2010 is $13,000 per donor, per donee. That means you and your spouse can give up to $26,000 to each child without a tax consequence.

If you live in California, you will also need to claim the exclusion from real estate tax reassessment for transfers of less than $1 million of real estate for each child.

It may be you should get some help from a tax professional for this gift. That’s our business!

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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Follow me on Twitter, Facebook and LinkedIn!

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.

You can also follow me on other social media sites, Facebook and LinkedIn.

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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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