Michael Gray, CPA's

Real Estate Tax Letter

January 14, 2011

© 2011 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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New Year!

2011 is here! Congress has given us a little breathing room by extending the Bush tax cuts. (See below.)

It’s time to make resolutions and take tax action for a better year ahead.

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Tax preparation materials will soon be on the way.

We are mailing instructions to our clients this week. If we prepared your tax returns last year and you haven’t received instructions by January 20 or you would otherwise like to receive instructions, call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162.

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Make your tax preparation appointment now.

If you would like to schedule an appointment for a tax preparation interview, also please call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162.

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Final 2010 estimated tax payment is due January 18.

Remember the final estimated tax payment for calendar-year individuals, estates and trusts is due January 18. You might want to check with your tax advisor about reducing the payment if you had much lower capital gains in 2010 than in 2009, you are entitled to the increased federal refundable minimum tax credit, or your facts have otherwise changed.

Remember that California now has a strange estimated tax deposit schedule for 2010. There was no payment due on September 15, but 30% of the estimated tax for 2010 is due on January 18, 2011.

In addition, if any California estimated tax deposit is $20,000 or more, the payments must be made electronically. Once a payment is made electronically, the taxpayer must continue to make future payments electronically. The payments are made at the Franchise Tax Board’s web site, www.ftb.ca.gov.

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W-2s, 1099s and DE 542 reminder.

Remember that most 2010 annual information returns, such as W-2s and 1099s, should be issued to payees by January 31 and sent to the tax authorities by February 28.

Also remember that Form 542, Report of Independent Contractors, should also be submitted for ongoing independent contractor arrangements by January 20. The due date is the earlier of 20 days after the date $600 or more of payments have been made to the independent contractor or the date a contract has been entered for $600 or more of services during a calendar year.

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Real estate operators will issue 1099 forms next year.

One of the tax law changes adopted during 2010 was to require taxpayers who receive rental real estate income to issue Form 1099 to service providers to whom they paid more than $600 after 2010.

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For tax return preparers – do you have “use” consents from your clients?

Many tax return preparers are in the process of getting engagement letters for their annual tax return preparation engagements. If they offer services beyond tax return preparation to their clients, including tax planning, they should also be getting written client “use” consents. I have posted a recent presentation that I made, dressed as Patrick Henry(!) on the IRS Disclosure and Use Rules at www.taxtrimmers.com/threat.shtml, including YouTube video, an mp3 recording, handout materials, and a link to a Commerce Clearing House site about the issue. Check it out! Tweet it!

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Electronic payment of payroll taxes, etc.

Remember banks can no longer accept federal tax payments with depository coupons. Federal tax payments must now be made electronically, using the EFTPS system. These payments include payroll taxes, corporate estimated tax payments and excise tax deposits.

I set myself up for EFTPS last fall. It was a hassle to get set up, but now I will save time by avoiding trips to the bank.

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Estates and trusts should consider making distributions.

Complex trusts and estates that have a calendar year end can elect to treat distributions made up to March 6, 2010 as made during 2009. Trustees and executors should update their tax records and review their situation with a tax advisor about whether a distribution should be made. Remember to discuss the situation with affected beneficiaries, since taxable income will be shifted from the estate or trust to the beneficiaries.

A reason for shifting the income is estates and trusts with taxable income over $11,200 are subject to the maximum 35% federal tax rate.

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Update your payroll tax tables.

Many businesses don’t update their accounting software each year. Remember to update your payroll tax tables before processing your first 2011 payroll, or it will probably be in error.

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California offers a $5,000 electric car rebate for a very few.

California is offering a $5,000 rebate for certain electric cars, but has only budgeted 1,200 Nissan Leafs will qualify. The Chevy Volt isn’t eligible for California’s rebate. For further information, visit www.energycenter.org/cvrp.

(Spidell’s California Taxletter, January 1, 2011.)

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California’s tax increases expire after 2010.

The .25% personal income tax rate increase for 2009 and 2010 has expired. The maximum California individual income tax rate is again 9.3%. The payroll tax withholding tables have been adjusted for the decrease. The 10% withholding increase for budget purposes continues in effect for 2011.

The California sales and use tax rates are scheduled to decrease by 1% on July 1, 2011.

Governor Brown is expected to introduce a ballot proposition to increase tax rates and avoid some draconian spending cuts for California.

(Spidell’s California Taxletter, December 1, 2010.)

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Bush Tax Cuts Extended.

Congress has passed and President Obama signed on December 16, 2010 the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. The legislation extends the Bush income tax cuts for 2011 and 2012 for all taxpayers. That means the 35% maximum federal income tax rate for ordinary income and the 15% maximum rate for long-term capital gains remain in effect for 2011 and 2012.

Here are a few more highlights:

A tax cut that will broadly apply is the reduction of the employee’s social security tax rate from 6.2% to 4.2% for 2011. A similar tax cut applies to the self-employment tax for self-employed taxpayers. Since the maximum social security wages for 2011 is $106,800, the maximum tax savings will be $2,136. All taxpayers who receive wages will see this tax benefit on their first paycheck received for 2011.

Education benefits of the American Opportunity Tax Credit (available for married couples with modified AGI up to $160,000), the annual exclusion for up to $5,250 qualified education expenses paid on behalf of an employee, the $2,500 above-the-line deduction for student loan interest, and the $2,000 limit for contributions to a Coverdell Education Savings account have all been extended two years for 2011 and 2012.

The alternative minimum tax exemption (finally) was increased to $47,450 for individual taxpayers, $72,450 for married tax payers filing joint returns and $36,225 for married taxpayers filing separate returns for 2010. The exemption for 2011 will be $48,450 for individual taxpayers, $74,450 for married taxpayers filing joint returns and $37,225 for married taxpayers filing a separate return.

Individual taxpayers will be able to reduce both regular and alternative minimum tax liability by non-refundable personal credits, including the credit for nonbusiness energy property, for 2010 and 2011.

The tax credits for qualified energy efficiency improvements have been extended for 2011 only, but they have been scaled back. The credits were 30% to a maximum of $1,500 for 2010. For 2011, lower percentages and ceilings will apply. Otherwise eligible expenses will be reduced for amounts previously expensed. It will be hard for taxpayers to get many tax benefits from these expenditures for 2011.

The exclusion for up to $100,000 of amounts distributed from an IRA owned by a taxpayer who is over age 70 ½ that are directly paid to a charity is extended for 2010 and 2011. The amount distributed is considered distributed to the taxpayer for the purposes of determining whether the requirement for making a minimum required distribution has been met.

Executors for decedents who died during 2010 will have a choice of estate tax repeal for 2010 with carryover basis or having the estate tax in effect with a $5 million exemption equivalent, a 35% federal estate tax rate and “fresh start” (stepped up) basis. The due date for estate tax returns for a decedent who died during 2010, the due date for paying estate tax and the date for making a qualified disclaimer are extended to September 16, 2011.

The federal estate tax and the federal gift tax are “re-unified” for 2011 and 2012, with a $5,000,000 exemption equivalent and a 35% tax rate, with “fresh start” basis. An unused exemption with respect to a deceased spouse who died during 2011 and 2012 will be “portable” and added to the exemption for the surviving spouse. (The unused exemption available will be from the last living spouse.) These estate tax provisions are a band-aid that will continue to be hard to work with for long-term estate planning.

The generation-skipping tax has a $5 million exemption equivalent for 2010 with a ZERO tax rate. It is restored for 2011 and 2012 with a 35% tax rate and a $5 million exemption equivalent.

Bonus depreciation is extended and expanded. (Remember bonus depreciation only applies to new property.) The first-year bonus depreciation allowance is 100% of the cost of qualified property placed in service after September 8, 2010 and before January 1, 2012 (January 1, 2013 for longer-lived and transportation property like aircraft.) The allowance will be 50% for property placed in service after December 31, 2011 and before January 1, 2013 (after December 31, 2012 and before January 1, 2014 for longer-lived and transportation property). This provision is better than the expense election because there is no phase-out for large amounts of depreciable property acquired.

For taxable years beginning in 2012, the maximum amount a taxpayer may expense is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced by the cost amount for qualifying property placed in service during the taxable year over $500,000. The eligibility of off-the-shelf software for the expense election is extended through 2012.

For more details, see your tax advisor.

Congress gave American taxpayers a nice Christmas present. We’ll see whether we will be in the same pickle in two years.

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Standard mileage rates announced.

The business standard mileage reimbursement rate for 2011 is 51¢ per mile. It was 50¢ for 2010. The standard mileage rate for medical and moving expenses for 2011 is 19¢ per mile. It was 16.5¢ for 2010. The standard mileage rate for charitable contributions is 14¢ per mile. It doesn’t change. (IR-2010-119, Notice 2010-88.)

The IRS has changed a previous position and will now allow taxpayers who use vehicles for hire, such as taxi cab drivers, to use the standard business rate. (Revenue Procedure 2010-51.)

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IRS issues guidance for “in plan” Roth conversions.

The IRS has issued guidance relating to in-plan Roth conversions inside company 401(k) and 403(b) plans. These conversions are permitted after September 27, 2010 under the Small Business Jobs Act of 2010. For 401(k) plans, a conversion will be permitted if the plan is amended to permit it by the later of the end of the plan year in which the amendment is effective or December 31, 2011. An important point to know is, unlike IRA to Roth conversions, a 401(k) to Roth 401(k) conversion can’t be reversed after the end of the plan year. (Be sure you’re right before going ahead.) (Notice 2010-84.)

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Tax Court rules “flipping” properties was business income.

Wendell and Sharon Garrison bought and sold at least 15 properties over a three-year period. They never rented any of the properties and most of the sales were within four months after purchase. They claimed the income from the sales should be taxable as short-term capital gains.

The Tax Court upheld the IRS in finding the sales were in a trade or business, and therefore taxable as ordinary income and subject to self-employment tax. In addition, since the taxpayers failed to produce records substantiating their deductions for rehabilitating the properties, the deductions were disallowed.

(It didn’t help that the Garrisons filed their federal income tax returns for 1998, 1999 and 2000 late on March 22, 2002.)

(Wendell V. and Sharon T. Garrison v. Commissioner, T.C. Memo. 2010-261, December 1, 2010.)

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IRS issues audit technique guide for deductible repairs v. capitalized costs.

A major issue for real estate operations is whether expenses for repairs are currently deductible or must be capitalized as improvements. The IRS recently issued an audit technique guide on the subject. You can get it at the IRS web site, www.irs.gov.

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Tax Court allows taxpayer to deduct property taxes paid by her mother.

A taxpayer’s mother paid medical expenses and property taxes on her behalf. The Tax Court ruled the taxpayer may deduct these expenses as paid by her through an indirect gift.

(Judith F. Lang v. Commissioner, T.C. Memo. 2010-286, December 30, 2010.)

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S corporation income from real estate rental is not passive for excess investment income test.

An S corporation that has accumulated C corporation earnings and profits and has investment income exceeding 25% of its gross receipts for three consecutive years will have its Subchapter S election revoked. (Internal Revenue Code Section 1362.) The IRS privately ruled that an S corporation that provided management services for commercial rental real estate, including real estate held in other entities that didn’t provide the services themselves, did not have passive income from the real estate activities under the investment income rules. The income would still probably be passive under the passive activity rules under Internal Revenue Code Section 469.

(Letter Ruling 201050002, September 8, 2010.)

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Deductions disallowed for business mileage for poor substantiation.

A taxpayer had a real estate brokerage and property management business in addition to being a university professor. He claimed a net loss of $16,962 from the real estate business for 2006, including $13,636 of car and truck expenses. (He only had $1,980 of gross income for the business.) The only evidence he provided for the business use of the vehicle was a calendar noting the mileage and city destination. The Tax Court upheld the IRS in disallowing the deduction for business mileage. The taxpayer didn’t note specific properties as a destination or specific clients for which properties were being inspected.

(Mahdavi v. Commissioner, T.C. Summary Opinion 201-178, December 29, 2010.)

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Extension to make single activity election granted.

Taxpayers may benefit from making an election to treat all of their real property activities as a single entity – especially taxpayers who are real estate professionals. They may be able to avoid passive activity loss limitations for federal tax reporting. The IRS allowed an extension of time for taxpayers to make the election.

(Letter Ruling 201050022, September 7, 2010.)

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Appeal denied for jury decision of property value.

The Fifth Circuit Court of Appeals denied a request to appeal the decision of a jury upholding the estate value of real estate as $25 million, which was the amount the property was actually sold for after the death of the decedent who had an ownership interest in the property. The court held the rezoning of the property after death was foreseeable. The decedent was trying to sell the property for the same amount as the amount realized. Discounts for lack of control and lack of marketability were disallowed “because the Estate controlled the general partner interest, which had nearly unfettered control over the Partnership’s assets.” (This was definitely not a taxpayer friendly decision.)

(Michael R. Levy, Executor of the Estate of Meyer Levy v. U.S., Fifth Circuity, 2010-2 U.S.T.C. ¶60,608, December 1, 2010.)

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Related party exchange allowed.

The IRS has privately ruled that a series of Section 1031 exchanges involving a real estate investment trust (REIT) and a related entity, using separate qualified intermediaries would not fail. It was represented that, after the dust settles, the REIT and entity would hold the replacement properties for more than two years. Minimal cash, if any, would be received by either party in the exchanges. This was a very complex, facts-specific transaction, which might be worth studying for those who specialize in such transactions.

(Letter Ruling 201048025, August 25, 2101.)

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Financial Insider Weekly broadcast schedule for January and February.

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 the rest of January and February:

January 19, Kathleen Wright, Attorney, American Red Cross, “Preparing Your Finances For A Disaster”
January 26, Naomi Comfort, Attorney, Hawks & Comfort, LLP, “Health Care Reform Update”
February 2, Craig Martin, CFP®, The Family Wealth Consulting Group, “How to stretch your investment dollars during retirement”
February 9, Peggy Marting, ChFC, the Family Wealth Consulting Group, “Long-term care insurance”
February 16, Dean Fabro, Bank Of The West, “Small Business Financing”
February 23, Janis Carney, Attorney, Carney, Sugai & Sudweeks, LLP, “Veteran’s Administration Pension Benefits for Long-Term Care”

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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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

For your questions about dependent exemptions, see IRS Publication 501 at www.irs.gov.

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.

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Visit our new article!

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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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