Michael Gray, CPA's

Real Estate Tax Letter

June 17, 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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Do you need help with finishing extended income tax returns, preparing amended income tax returns, or tax audits?

Now that April 18 has passed, it's time to focus on finishing extended income tax returns. Some of our readers have found errors in or are uncomfortable with tax returns that they prepared using tax software or were prepared by other tax return preparation companies. We can provide a second opinion. Others have received notices for tax audits and sometimes can't get the help they need from their tax return preparer. We can help with all of these. To make an appointment, call Dawn Siemer Mondays, Wednesdays or Fridays at 408-918-3162 from 9 a.m. to 5:00 p.m.

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Annual reports for foreign accounts and trusts and receipt of foreign gifts due.

Each year, a report must be filed for foreign bank and brokerage accounts owned by US residents and citizens for which US residents and citizens have signature authority. The form for accounts is TD F 90-22.1, Report of Foreign Bank and Financial Accounts. The forms for trusts are Forms 3520 and 3520-A, Annual Report of Transactions with Foreign Trusts and Receipt of Foreign Gifts, and Annual Information Return of a Foreign Trust With A U.S. Owner. You can get the forms at www.irs.gov.

The foreign bank account return is due June 30 for the previous year. The penalties for failure to file can be onerous, starting at $10,000. Congress and the IRS are giving a lot of attention to this area, including requiring reporting by foreign banks. Don't think you can "skate by."

The foreign trust and gift form is due on the due date of your individual income tax return, including extensions.

If you have a question whether you are subject to these reporting requirements, see a tax consultant immediately.

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California sales tax rate is scheduled to fall.

Tax increases enacted in the past to help with California’s budget crisis are expiring. One item that affects many of us is California sales tax. The rate is scheduled to fall 1% as of July 1, 2011. There is still a possibility of an extension by the California state legislature. The rate for Santa Clara County, where I live, will fall to 8.25%. The city of Campbell has a different rate, 8.50%.

Stand by. The budget just passed by the California legislature and vetoed by Governor Brown included a ¼% increase in the local sales tax. Governor Brown is still pushing for an extension of the 1% increase and a statewide vote on the issue.

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Federal unemployment tax rate scheduled to fall.

The federal unemployment tax rate (after a 5.4% credit for employers that pay state unemployment taxes on time) that applies to the first $7,000 of wages is scheduled to fall from 0.8% to 0.6% on July 1, 2011. President Obama is trying to get the current rate extended.

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IRS gives a break to some real estate pros.

Under the passive activity loss rules, losses from passive activities are limited to the income from passive activities. Rental real estate is generally considered to be a passive activity. There is a special exception for certain real estate professionals.

In order to qualify, more than half of the personal services performed by the taxpayer must be in real property trades or businesses in which the taxpayer materially participates. The taxpayer must also perform more than 750 hours of services during the year in real property trades or businesses in which the taxpayer materially participates.

The 750 hour test applies on a property by property basis unless the taxpayer elects to treat all of the taxpayer’s interest in rental real estate as a single rental real estate activity.

The election must be in writing and included on the taxpayer’s income tax return.

Many real estate professionals reported their rental real estate operations as a single activity, but failed to make the election.

The IRS has issued a revenue procedure granting an automatic extension of time to file the election. The election must be attached to an amended income tax return for the most recent tax year and mailed to the IRS service center where the taxpayer will file his current tax year income tax return.

The taxpayer will have to make certain representations, including that the rental activities were aggregated on the original return and that tax returns were timely filed for the years at issue.

A great benefit of following this procedure is that no filing fee is required. Without the procedure, taxpayers had to file for private rulings permitting the extension of time to file the election.

Taxpayers who have ruling requests pending on this issue will have them returned and the related filing fees will be refunded.

The real estate professional exception is not a “slam dunk.” If you want to claim it, get professional help to be sure you qualify.

(Note: California hasn’t conformed to the real estate professional exception. See your tax advisor about the tax rules for your state.)

(Revenue Procedure 2011-34, May 26, 2011.)

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9th Circuit reverses Tax Court and favors IRS on statute of limitations for inflated basis.

The 9th Circuit Court of Appeals reversed a Tax Court decision and held in favor of the IRS that the statute of limitations should be extended from three years to six years when the sales proceeds from sales of real estate were properly reported but the tax basis was inflated. The Court of Appeals found the IRS’s regulations issued in 2010 (T.D. 9511) to retroactively classify such a transaction as a substantial understatement of income, thus extending the statute of limitations should be upheld under the Supreme Court’s ruling of deference to the IRS on ambiguous tax positions in the Chevron decision (467 U.S. 837, 843 (1984)).

Although the taxpayer asserted the overstatement of basis was not ambiguous under the Colony (358 U.S. 29 (1958)) decision, the Court of Appeals agreed with the IRS that there is language in the Colony decision indicating that this is an ambiguous point. Therefore, the IRS should be allowed to fix it retroactively.

The Tax Court has repeatedly disagreed with this position.

It may be the Supreme Court will ultimately resolve this issue.

(Salmon Ranch, Ltd., 2011-1 USTC ¶ 50,405, June 3, 2011.

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California conformity could be a “pumpkin.”

Former California Governor Shwartzenegger approved SB 401, enacting conformity of California tax laws to many federal tax law changes of the past few years. Under Proposition 26, SB 401 will be repealed unless it is reenacted by a two-thirds vote of the Legislature before November 3, 2011. With the current political climate in Sacramento, the odds don’t look good. Be aware that all California estimated tax computations may be wrong for 2011 forward.

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

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Death of a trust beneficiary may require property tax reassessment in Californnia.

The California Court of Appeals has ruled twice that when a the life beneficiary of a trust dies, there is a change of ownership, possibly requiring a property tax reassessment, even if the trust continues for the life of the next beneficiary. The courts held that each beneficiary had equitable title to the property that passed to the next beneficiary.

The consequences of a “sprinkling power” or discretion of distribution among family members is unclear.

More “dynasty trusts” that don’t terminate after the death of a beneficiary but continue for multiple generations are being created. These trusts will be required to file change of ownership forms when a beneficiary dies.

(Phelps v. Orange County Assessment Appeals Board No. 1 (2010) 187 Cal. App. 4th 653, Reilly v. City and County of San Francisco (2006) 142 Cal. App. 4th 480, Spidell’s California Taxletter, June 1, 2011.)

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Financial Insider Weekly broadcast time changed for Marin County.

The broadcast time and day for Marin County has been changed to Tuesday at 9 p.m. The show is broadcast on Comcast Channel 26 and AT&T U-verse Channel 99 for Marin County.

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Financial Insider Weekly broadcast schedule for June and July.

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 June and July:

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"

July 6, Karl-Heinz Lachnit, Attorney, Silicon Valley Law Group, "Choices of forms for operating a business"
July 13, Jeffrey B. Hare, Attorney, APC, "Using a checkbook LLC to invest IRA and Roth funds"
July 20, James V. Quillinan, Attorney, Hopkins & Carley, "Tax planning for real estate change of ownership in California"
July 27, James V. Quillinan, Attorney, Hopkins & Carley, "Estate planning with temporary changes for 2011 and 2012"

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. 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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