Michael Gray, CPA's

Real Estate Tax Letter

November 8, 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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The year is almost over! Time for year-end planning.

The holiday season will soon be upon us. Some retailers decided to get an early start and had “Black Friday” sales last week!

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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A South Bay live luncheon seminar for tax professionals.

Michael Gray, CPA will give a live luncheon presentation for the Tax Interest Group, Silicon Valley San Jose chapter of the California Society of Certified Public Accountants on Friday, November 19 from noon to 1:30 p.m. The topic is the Small Business Jobs Act of 2010. The luncheon will be at Bella Mia Restaurant in San Jose. The pre-registered investment is $30 for CalCPA members and $35 for nonmembers. For reservations, call Stephanie Stewart at 408-983-1122 or register online at www.calcpa.org.

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A Peninsula live luncheon seminar for tax professionals.

Michael Gray, CPA will give a live luncheon presentation for the Tax Interest Group, Peninsula Silicon Valley chapter of the California Society of Certified Public Accountants on Wednesday, November 17 from noon to 1:30 p.m. The topic is the IRS Disclosure and Use Rules. The luncheon will be at Hobees Restaurant in Belmont. The pre-registered investment is $25 for CalCPA members and $30 for nonmembers. For reservations, call Jane Dunbar at 650-802-2465 or register online at www.calcpa.org.

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2010 returns with homebuyer credit can be efiled.

The federal efile system has been upgraded for 2010 to permit submitting scanned documents. This improvement will permit taxpayers who are claiming the first-time homebuyer credit to efile their 2010 income tax returns. A copy of the HUD-1 closing statement should be scanned and included with the efiled return.

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California election tax results.

Proposition 24, which would have changed the way that income is taxed for multiple state businesses, was defeated. The measure also would have repealed net operating loss carrybacks (to become effective in future years) and cut net operating loss carryforwards to 10 years. This was a business-favorable result and will help California’s tax system be more similar to other states, reducing double taxation of income.

Proposition 26, which requires the same approval process for “fees” as for taxes, passed. As a result, it will be more difficult for the state and municipalities to raise revenues and create more budget challenges.

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Report says Medicare tax not a disaster for residence sales.

The Congressional Research Service has issued a report about the application of the new 3.8% Medicare tax to real estate sales. The tax was enacted as part of the Health Care and Education Reconciliation Act of 2010. The tax will apply to investment income for married couples with adjusted gross income exceeding $250,000 and single persons with adjusted gross income exceeding $200,000. The tax will also apply to estates and trusts with income exceeding the highest tax bracket for the tax year.

The report notes that the tax will not apply to gain from the sale of a principal residence that is excluded from taxable income (up to $500,000 for married, filing joint returns and $250,000 for singles). Therefore, the tax shouldn’t be burdensome for most individuals who sell their residences.

(There are some places in California, including many in Santa Clara County, where high home prices can still result in gains exceeding the exclusion thresholds.)

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Home mortage exceeding $1 million can qualify for deduction.

The IRS has ruled that a mortgage incurred by a taxpayer to acquire, construct or substantially improve a qualified residence can qualify as “home equity indebtedness” to the extent it exceeds $1 million.

For example, if John Taxpayer purchased a principal residence for $1,500,000 with a $300,000 down payment and a $1,200,000 mortgage, $1,000,000 of the mortgage would be acquisition indebtedness, $100,000 would be home equity indebtedness, and $100,000 would be indebtedness for which an interest deduction wouldn’t be allowed.

(Equity indebtedness is also limited to the excess of the fair market value of the residence over the acquisition indebtedness.)

Previously, the IRS had taken the position that home equity indebtedness had to be a separate indebtedness from the acquisition mortgage. Two Tax Court rulings, Pau v. Commissioner, T.C. Memo. 1997-43, and Catalano v. Commissioner, T.C. Memo. 2000-82, also followed this theory.

The ruling does not discuss the limitation on the deduction for qualified residential interest under the alternative minimum tax rules. Any qualified residential interest allowed for regular tax reporting not incurred for acquiring, constructing or substantially improving a qualified residence is not deductible for computing the alternative minimum tax. (Internal Revenue Code Sections 56(b)(1)(C) and 56(e).) For example, if a home equity loan used to purchase a car was later refinanced into a first mortgage, interest relating to the loan used to buy the car would not be deductible when computing the alternative minimum tax.

(Revenue Ruling 2010-25, 2010-44 IRB.)

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Be careful with 401(k) Roth conversions.

The IRS has posted information about the new rules for in-plan Roth conversions for 401(k) plans enacted as part of the Small Business Jobs Act of 2010. In order to make a conversion, a participant must be eligible to receive a plan distribution. Usually, this will require the individual to be terminated or to reach age 59 ½. Most plans will need to be amended in order to permit these conversions. It will probably be hard to do one during 2010.

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IRS announces pension plan limits for 2011.

The IRS has published the limits for qualified retirement plan contributions for 2011. Since inflation was very low for 2010, the limits are unchanged, but the phaseouts have changed slightly. Here is a brief list of the limits. See the announcement for the phase outs. 401(k) $16,500. 401(k) catch up for those age 50 or older $5,500. Traditional IRA $5,000. Catch up for IRA, age 50 or older $1,000. Annual benefit limit for defined benefit plan, $195,000. Defined contribution plan (SEP, profit sharing, money purchase pension, ESOP) $49,000.

(Announcement IR-2010-108, October 28, 2010.)

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IRS will begin accepting records in electronic format.

The IRS has announced that it will begin accepting taxpayer records in electronic format instead of traditional books and records for tax audits. The IRS is training agents to use QuickBooks Premier Accountant Edition. Such records should not be submitted to the IRS via email.

(Headliner at the IRS web site, www.irs.gov.)

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IRS considering relaxing some return preparer requirements.

In a speech on October 26 to the AICPA’s Fall Tax Meeting in Washington, D.C., IRS Commissioner Dough Shulman provided some welcome news to tax practioners relating to implementation of the new return preparer requirements.

For 2011, which is the first year of implementation, the continuing education requirements will be waived. The IRS hasn’t worked out the details of how to approve the classes yet.

The IRS is considering waiving the requirement that a preparer meet the registration requirements when the preparer is working for a CPA, attorney or an enrolled agent who will sign the return. If the IRS adopts this position, it will be very helpful to CPAs, attorneys and enrolled agents who hire temporary workers for tax season and for new graduates hired by the firms. There still may be practical issues to be ironed out for store front tax return preparation businesses.


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California taxes former residents on installment sale.

A married couple left California and moved to Montana in December 2004. They made an installment sale of corporate stock that wasn’t publicly traded during 2004. They didn’t report installment sale proceeds received after they moved as taxable income for California.

The State Board of Equalization upheld the Franchise Tax Board in finding installment sale income from a sale made while a California resident is taxable in California.

Spidell Publishing recommends that taxpayers who want to avoid having an installment sale taxed in California should wait until after they have moved to another state before even looking for a buyer.

Remember that a state tax credit may be available in the new home state or in California to help reduce a double tax.

(Appeal of Frazar (June 16, 2010), California State Board of Equalization Case No. 494349, Spidell’s California Taxletter®, October 1, 2010.)

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Financial Insider Weekly broadcast schedule for November and December.

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

Here are the scheduled interviews for November:and December:

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”
December 1: Michael Desmarais, Attorney, “Your rights as a beneficiary of an estate or trust”
December 8, Robert Temmerman, Jr., Attorney, Temmerman, Cilley & Kolmann, “I’m an executor. Now what?”
December 15, Robert Temmerman, Jr., Attorney, Temmerman, Cilley & Kolmann, “I’m a trustee. Now what?”
December 22, James Brown, ASA, CFP®, Perisho, Tombor, Ramirez, Filler & Brown PC, “The Role of the Business Valuation Specialist”
December 29, Frank Doyle, Attorney, WealthPLAN, “Estate Planning Using Family Limited Partnerships”

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.


Has there been any change or update to the passive activity loss rules relating to the income limitation? (Phase out of $25,000 limit for passive activity losses from real estate in which a taxpayer actively participates when for 50% of adjusted gross income exceeding $100,000.) With most households having two breadwinners these days, hardly anyone seems to qualify for the deduction.


The limitation is in Internal Revenue Code Section 469(i), and it has not been changed since 1986. There are no provisions for inflation adjustments.

There is no proposal that I am aware of for a change.

Write your representatives in Congress!


My parents are living in a residence owned by me. I pay everything for the house, but I have never lived there. I want to sell the home. Can the gain qualify for the exclusion for gain from the sale of a residence?


No. The residence must have been your principal residence. You don’t “get credit” for your parents’ use of the home for this test. (Internal Revenue Code Section 121(a).)

The only exception is you get to count use by a former spouse for a residence received as part of a property division in a divorce or used by a former spouse pursuant to a divorce decree. (Internal Revenue Code Section 121(d)(3).)

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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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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