Michael Gray, CPA's

Real Estate Tax Letter

May 20, 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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Time for finishing extended returns, checking for errors and planning.

Now that April 18 has passed, we are focusing on finishing extended income tax returns and tax planning. We have also had a number of people come to us for a second look at their 2010 income tax returns. They are questioning whether there are errors, and we have found some that will reduce tax bills. To make an appointment, please call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Second estimated tax payment due June 15.

The second estimated tax deposit for individuals, most trusts and calendar year corporations is June 15. If you aren’t making your payments primarily through withholding from wages or making estimated tax payments based on your 2010 income tax returns (110% of last year’s tax liability if your adjusted gross income exceeds $150,000), you probably should make an annualized estimated tax payment based on this year’s income and deductions. We provide this service.

Remember that California taxpayers with gross income exceeding $1 million must base their estimated tax payments on current year income and deductions and don’t qualify for the exception based on last year’s tax return.

Also remember that many California taxpayers are now required to make their estimated tax payments electronically, usually using WebPay at www.ftb.ca.gov. The Franchise Tax Board is sending penalty bills to people who don’t make their payments electronically when they are required to. See your tax advisor to find out whether the requirement applies to you.

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Calendar year California LLC estimated fee payment due June 15.

California LLCs pay a fee based on their gross receipts in addition to an $800 tax. The current year (2011) fee, which may be based on the fee for the previous year (2010), is due on June 15, 2011. The payment is made using Form FTB 3536, or can be made online using Web Pay at the Franchise Tax Board’s web site, www.ftb.ca.gov.

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Foreign account report due June 30.

The due date for 2010 Form TD 90-22.1, the report of foreign bank accounts and brokerage accounts owned outside the United States, is due on June 30, 2011. The due date can’t be extended. The IRS is on a compliance rampage for this form. Be sure to file it if it applies to you. (The highest total balance of foreign accounts that you own or over which you have signature authority is $10,000 or more.)

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IRS voluntary compliance initiative for foreign accounts.

If you missed filing the forms for foreign bank and brokerage accounts and for foreign trusts (Form 3520) in the past, the IRS has an initiative for you to “catch up” without fear of criminal prosecution. You are required to file the forms and amended income tax returns for any unreported income for the last eight years and to pay penalties. The forms must be filed and at least arrangements made to pay taxes and penalties by August 31, 2011. If you have (or might have) this situation, I recommend that you consult with a tax attorney who is familiar with the rules. The branch of the IRS that enforces the requirements is the Criminal Investigations Division.

Here is a link for IRS questions and answers on the voluntary compliance initiative:

http://www.irs.gov/businesses/international/article/0,,id=235699,00.html

You can also find the questions and answers by going to the IRS website, www.irs.gov, and searching for “voluntary compliance initiative fbar”.

A very serious consequence for not complying is your tax return preparer may not be able to prepare your income tax return. See Q & A 47.

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California requires withholding for nonresident landlord's rents.

The California Franchise Tax Board (FTB) has been aggressively enforcing nonresident withholding. Property managers are required to withhold on gross rents reduced only by property management fees. As a result, many nonresident landlords who use a California property manager will have overwithheld California income taxes.

The property owner may apply for a reduction or waived withholding. The FTB has discretion whether to grant the reduction or waiver. The forms are FTB Form 588, Nonresident Withholding Waiver Request and FTB Form 589, Nonresident Reduced Withholding Request. The forms should be submitted at least 21 business days before the payment is made.

The FTB says that a waiver will usually be granted for nonresident landlords who file California income tax returns and pay any taxes owed.

The waiver is good for up to two years, so the nonresident landlord will have to reapply for the waiver.

The withholding is reported to the FTB Form 592. The payment is submitted using Form 592-V. The withholding is reported to the nonresident landlord using Form 592-B.

(Spidell’s California Taxletter, May 1, 2011, page 49.)

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IRS loses on statute of limitations for inflated basis.

The Tax Court held against the IRS relating to whether the statute of limitations should be extended from three years to six years when the sales proceeds of a sale of securities during 2000 was properly reported but the tax basis of the securities was inflated. The IRS was relying on regulations that it issued in 2010 (T.D. 9511) to retroactively classify such a transaction as a substantial understatement of income, thus extending the statute of limitations.

The Tax Court found that a retroactive regulation to extend the statute of limitations when it had already expired was ineffective.

(Carpenter Family Investments, LLC v. Commissioner, 136 T.C. No. 17, April 26, 2011.)

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CFO was a responsible person liable for withholding taxes.

The Chief Financial Officer of an auto body repair shop was found to be liable for unpaid withholding taxes as a “responsible person.” The repair shop was a limited liability company. The CFO was responsible for paying bills and prepared the payroll and income tax forms for the business. The CFO claimed he shouldn’t be a responsible person because he didn’t set the priorities for making payments, but followed instructions from the Chief Operating Officer, who insisted that payments be made on a loan made by the COO to the business before tax payments. A federal district court found the CFO had sufficient authority to be held responsible for the tax payments.

The unfortunate lesson is it can be risky to be a “responsible person” for a company that is in financial difficulty. Be sure payroll taxes, especially the “trust fund” employee share, are paid first.

(United States v. Cooke, D.C. Ind., 2011-1 USTC ¶ 50,333.)

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Allowance of bundled fees for fiduciaries extended.

The IRS has extended an interim allowance of bundled fees for administration and asset management for any tax year beginning before the date final regulations are issued. This provision will benefit trusts where a bank or brokerage company is the trustee. If the fees are separately stated, the asset management fee is subject to the two percent floor for miscellaneous itemized deductions.

(Notice 2011-37.)

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Cancellation of debt for disregarded entities clarified.

The IRS has issued proposed regulations that clarify how the insolvency exclusion is determined when there is a debt cancellation for a disregarded entity, such as a grantor trust or a single-member LLC. The insolvency is not determined just for the disregarded entity, but for the taxpayer who is the owner for the entity.

(NPRM REG-1154159-09.)

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Carryover basis reporting postponed.

The IRS has postponed the filing date for Form 8939, Allocation of Increase in Basis for Property Acquired From A Decedent. The form applies when the executor elects to have estate tax repeal apply for a decedent who died during 2010. Form 8939 was supposed to be included with the decedent’s final income tax return, due on April 18, 2011.

The IRS still hasn’t issued the final version of Form 8939, and the estate tax was reinstated for most decedents who died during 2010.

Now they are saying to file the final income tax return without Form 8939 and stand by for further guidance.

(IR-2011-13.)

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Small employer reporting of health insurance benefits postponed.

The IRS has announced that it won’t require small employers to include information about health insurance paid for employees on their Form W-2 until 2013 for W-2s issued for 2012. A “small employer” is an employer required to file fewer than 250 W-2 forms for the previous taxable year.

The transitional relief postponement also applies to:

(IR-2011-31, Notice 2011-28.)

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California retroactively conforms to federal exclusion for medical benefits covering adult children.

On April 11, 2011, California enacted AB 36, which conforms California’s tax law to exclude from taxable income medical benefits for nondependent adult children under age 27. The exclusion was part of the Federal Health Care Act in 2010. Some taxpayers should file amended California income tax returns to exclude the income.

The Franchise Tax Board says employees who received a W-2 that included these medical benefits in California income should request that their employer issue Form W-2C, excluding the benefit from income. This will be a big headache for California employers. Alternatively, employees may use form FTB 3525 as a substitute for Form W-2C.

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Disregarded entity can result in being subject to California tax.

The California Franchise Tax Board issued Legal Ruling 2011-01 on January 11, 2011. Under the ruling, activities of a disregarded entity are attributed to its owner. This means that if a single member LLC or a qualified subchapter S subsidiary is doing business in California, so is the owner. For details, see your tax advisor.

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Financial Insider Weekly broadcast schedule for May and June.

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 May and June:

May 25, William Mahan, Attorney, “Income and estate considerations of how you hold title to property”
June 1, Naomi Comfort, Attorney, Hawks & Comfort, “How to handle retirement accounts after a death”
June 8, G. Scott Haislet, Attorney and CPA, “Selling your principal residence”
June 15, G. Scott Haislet, Attorney and CPA, “The short sale and foreclosure wars”
June 22, Greg Carpenter, BTI Group Mergers & Acquisitions, “How to buy a business”
June 29, David Howard, Attorney, Hoge, Fenton, Jones & Appel, “Reporting requirements for foreign bank and investment accounts”

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

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.

Question

Are real estate taxes deducted at the short sale closing (which in turn decrease the amount the bank gets, which increases the debt foregiveness) deductible by the homeowner on Schedule A even though they did not technically pay them?

Answer

Yes.

The taxpayer is still selling the property that he or she owns, just for an amount less than the balance of the mortgage. The property taxes are being paid using the proceeds from the sale of the property.

Question

My wife’s father passed away during 2008. My wife was his sole beneficiary. He had probate estates in California and Nevada.

The Nevada property is rental real estate.

If the Nevada property isn’t sold during the probate, will we have to pay capital gains taxes if the property is sold for less than the value when her father passed away in 2008?

Answer

The property received a new tax basis (cost to determine gain or loss) as of the date of her father’s death. The tax basis is the fair market value on the date of death. (Internal Revenue Code Section 1014.)

As rental property, your wife can claim depreciation deductions on the rental schedule. The tax basis is reduced for the accumulated depreciation deductions.

Since your wife is the sole beneficiary and executor, any activity of the estates is taxable on her individual income tax return.

Question

How do you report “K-1” real estate rental income from an LLC on Form 1040?

If the only source of income is the rental income, can the taxpayer use Schedule E and not Schedule C, so that no self-employment tax is paid on the rental income?

Is an LLC required to have two members to allow rental income to go on Schedule E?

Can an individual and his wife be considered as two members of an LLC, if two members are required?

Answer

Your questions indicate to me that you should be considering hiring a professional tax return preparer. (That’s our business!)

An LLC can be a single member LLC or have more than one member. (A husband and wife can be treated as one taxpayer for this purpose.)

The income and deductions for rental property in a single member LLC are reported at Part I of Schedule E, as if owned personally by the taxpayer. A single member LLC is a “disregarded entity.”

The income and deductions for an LLC with more than one member are first reported on the Federal Partnership Income Tax Return, Form 1065. (For California reporting, Form 568.) The LLC then issues Schedule K-1 forms to the members showing their shares of information to be reported.

The K-1 rental income is reported at Part II of Schedule E. Form 8582 may also be required to compute passive activity loss limitations.

Rental income isn’t subject to self-employment tax.

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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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