Michael Gray, CPA's

Real Estate Tax Letter

February 11, 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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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 haven’t, 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 are setting up a secure internet portal for sending documents. Call Dawn Siemer for instructions.

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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Some California businesses are required to file use tax returns.

California businesses that reported more than $100,000 in gross receipts from a business or rental property on their 2010 federal income tax returns and that don't file sales tax returns are required to electronically file a California use tax return for 2010. Businesses that registered with the State Board of Equalization last year should also file. The use tax returns and tax payments are due April 15, 2011. A use tax return must be filed even if there is no tax due.

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IRS delays processing of 2010 income tax returns.

Since Congress passed tax legislation extending the Bush tax cuts and increasing the AMT exemption for 2010, the IRS has to play catch up in releasing tax forms. They have announced that tax returns with itemized deductions won’t be processed until February 14, 2011.

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California adopts debtor protection for short sales.

California has adopted a new law relating to short sales, effective January 1, 2011. The law is California Senate Bill 931, which adds new Section 580e to the California Code of Civil Procedure. Under the new law, the lender is limited to the amount received from the short sale of a property to satisfy the first mortgage for a dwelling of not more than four units. This type of law is called an anti-deficiency statute.

Notice that junior mortgages, such as equity lines of credit, aren’t subject to the limitation.

Since the law favors borrowers, lenders have been hurt by this legislation. It may be lenders will approve fewer short sales in the future.

The tax consequences of this change are uncertain. Does this change existing recourse mortgages to non-recourse mortgages? I suggest that the mortgages should be treated like recourse mortgages for a principal residence that is foreclosed. In that case, the anti-deficiency statute doesn’t convert the status of the mortgage to non-recourse. We’ll know better in ten years, when the inevitable court cases on the issue are decided.

By the way, I’m not a lawyer. I always recommend that property owners seek legal counsel to oversee a short sale or foreclosure.

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Rental properties should be eligible for cancellation of debt relief.

Besides the exclusions from income for bankruptcy and insolvency, there are two Internal Revenue Code provisions giving relief for cancellation of trade or business debt. One, which applies to taxpayers other than C corporations, is an exclusion for cancellation of qualified real property indebtedness (§ 108(a)(1)(D)). The other is a tax deferral for trade or business indebtedness, allowing the income to be recognized over a five-year period (§ 108(i)). (An advantage of the deferral approach is there is no reduction in the tax basis of the taxpayer’s property.)

In the past, I haven’t felt these special tax rules should apply to rental property, because of the “trade or business” requirement. Rental real estate operations are generally considered to be “investment” operations. After consulting with the IRS National Office and other practitioners for some time about this issue, I finally stumbled on an IRS ruling with a different conclusion.

In Chief Counsel Advice (CCA) 200919035, the IRS Chief Counsel states that “qualified real property indebtedness” includes rental property, unless the taxpayer uses the property for more than 14 days in the tax year.

In many cases, the loss from a short sale of rental property will offset the income from cancellation of debt.

If you had cancellation of debt income from rental property in a back year for which you reported income resulting in a significant tax, you might want to revisit whether you can benefit from the exclusion or the deferral. See your tax advisor.

I have updated the article, “Tax Consequences of a “Short Sale” of Real Estate v. Foreclosures” to include these tax breaks. Here is a link to the article: www.realestateinvestingtax.com/shortsale.shtml.

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Taxpayer allowed to depreciate property as residential.

A limited liability company had purchased land and built a mixed-use structure on it. The units included residential apartments, commercial space and a commercial parking garage. The taxpayer had been depreciating the property over 39 years as nonresidential real property.

The taxpayer proposed to establish a plan of condominium ownership of the building, dividing it into five condominium units, which would principally be residential but include commercial space and the parking lot.

The IRS ruled the property could be treated as a single building because they are built on a single tract of land (contiguous parcels) and are operated as a single integrated unit. Therefore the taxpayers could apply the facts for the entire structure in determining whether it would qualify for depreciation over a 27.5-year period as residential real estate. (Letter Ruling 201103006.)

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Financial Insider Weekly broadcast schedule for February and March.

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:

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”
March 2, Lamarr Baxter, Entrust Administration, “Investing in real estate using your IRA or Roth account”
March 9, Lamarr Baxter, Entrust Administration, “Making alternative investments besides real estate using your IRA or Roth Account”
March 16, Professor Patricia Cain, Santa Clara University, “Income tax problems of same sex couples”
March 23, Professor Patricia Cain, Santa Clara University, “Estate and gift tax problems of same sex couples”

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.

Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter. Write mgray@taxtrimmers.com.

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.

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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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