Michael Gray, CPA's

Real Estate Tax Letter

July 13, 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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The year is half over. How is it going?

Time marches on! It’s hard to believe the year is already half over. How is your year going? Are you reaching the goals that you set last January? Do you have developments, such as your company’s IPO or acquisition for which you need tax advice? Why not set an appointment now for a mid-year planning meeting or telephone conference? Call Dawn Siemer at 408-918-3162 from 9 a.m. to 5 p.m. Pacific Time to make an appointment.

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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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Is 2011 your last chance to position yourself for the 15% federal tax rate for long-term capital gains?

I wrote a blog post on this subject. You can read it at http://michaelgraycpa.com/2011/07/07/is-2011-your-last-chance-to-position-yourself-for-15-capital-gains/

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Deadline extended for Foreign Bank Account Reports when signature authority only.

The IRS has extended the due date for Form 90-22.1, the Report of Foreign Bank and Financial Accounts for calendar years before 2010 to November 1, 2011 when the report is only because the individual has signature authority over the account but otherwise has no financial in the account. (Notice 2011-54.) The deadline was not extended for the 2010 form.

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IRS finalizes five-month extension period for partnerships, trusts and estates.

The IRS has issued final regulations providing for a maximum five-month extension of time to file for partnerships, trusts and estates other than bankruptcy estates. This means most calendar year partnerships, trusts and estates can apply for an extension of time up to September 15.

At one time, these entities could get an extension up to six months to October 15, but partners and beneficiaries were getting their information returns too late to finish their income tax returns on time.

(T.D. 9531.)

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10th Circuit and DC Circuit uphold IRS on statute for overstatement of basis.

The 10th Circuit Court of Appeals and the Court of Appeals for the District of Columbia have both reversed Tax Court decisions and upheld the IRS in finding the six-year statute of limitations can apply when an understatement of tax liability is attributable to an overstatement of basis. These rulings are disturbing because they give retroactive deference to regulations issued by the IRS after the tax returns were filed.

(Intermountain Insurance Service of Vail, 2011-2 U.S.T.C. ¶ 50,468, June 21, 2011 and Salman Ranch, Ltd., 2011-1 U.S.T.C. ¶ 50,405, May 31, 2011.)

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Roof-mounted systems qualified for energy credit.

The IRS has said even though a portion of the property’s basis is allocated to the roof, the a roof-mounted solar energy system still qualifies for the energy credit.

(Letter Ruling 201121005.)

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Inn/hotel activity may not be aggregated with other real estate rentals for real estate professional test.

In order to qualify as a real estate professional, a taxpayer must spend more than 750 hours for the tax year working on real estate activities and more than one-half of his or her total working hours. The 750 hour test applies on a property-by-property basis unless the taxpayer elects to aggregate his or her real estate activities and treat them as one.

Pamela Bailey managed multiple real estate properties during 2004. One of the properties was an inn. If her management of the inn was included with the management of the other rental properties, she would have met the 750 hour test.

The Tax Court upheld the IRS, finding the management of the inn could not be aggregated with the management of the other rental properties. Management of a hotel or inn (lodging provided to transients) is considered to be a service, not a real estate activity.

(Bailey v. Commissioner, T.C. Summary Opinion 2011-22, March 3, 2011.)

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Tax Court finds property was purchased for investment.

Mark Gardner, who was a carpenter, had a history of buying, improving and reselling some properties and buying and holding other properties for investment.

He purchased some land that was approved for subdivision into five lots. After building an access road, he improved one lot and resold it to his brother and sold three unimproved lots. He reported a short-term capital gain for the sale of the three unimproved lots.

The IRS recharacterized the gain as business income from the sale of property held for sale to customers in the ordinary course of his trade or business. The income from the sale of the lots would then be subject to self-employment tax.

Mark told the Tax Court that his intention was not originally to resell the lots, but to build duplexes on them and hold them as a long-term investment. Building the access road was so expensive that he couldn’t afford to go ahead with the building project.

Mark’s explanation satisfied the Tax Court, which held against the IRS and found he was entitled to report the income as short-term capital gains.

Note: I expect to see more cases where the IRS will assert the sale of properties should be reported as business income. Many people are buying and “flipping” real estate acquired from short sales and foreclosures. This also creates an issue of unrelated business taxable income for properties acquired within IRAs and retirement accounts. These accounts may be subject to income taxes for these sales. IRAs and retirement accounts are not subject to self-employment tax.

(Gardner v. Commissioner, T.C. Memo. 2011-137, June 20, 2011.)

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Real estate income was not “passive” for S corporation test.

S corporations that have accumulated earnings and profits from previous operations as a regular “C” corporation can have their elections revoked if they have investment income exceeding 25% of their gross receipts for three consecutive years. Rental income from a net lease can be considered investment income for this test.

Rents for the active trade or business or renting property are not counted as investment income for this test. Rents are from the active trade or business of renting property if the the corporation provides significant services or incurs substantial costs in the rental business.

An S corporation submitted information about its rental real estate operations to the Internal Revenue Service. Based on the information provided, the IRS ruled the rental income for the S corporation was trade or business income, not investment income.

(Letter Ruling 201125011, March 14, 2011.)

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Deductions disallowed for unsubstantiated repairs for rental property.

The Tax Court disallowed deductions for repairs to a rental property for which it didn’t receive documentation. The Court held the case open for 30 days to provide time for the taxpayer to produce the records.

This case is a reminder that taxpayers needs to keep the documents to substantiate their income and deductions after filing their income tax returns. When there is a space problem, you can even use scanned records as substantiation. (Be sure to keep a back up in case your hard disk breaks!)

(Perry v. Commissioner, T.C. Summary Opinion 2011-76, June 27, 2011.)

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Real estate losses were subject to the passive activity loss limitation.

The Tax Court upheld the IRS in finding that rental real estate losses for Aris and Marilyn Jende weren’t currently deductible but were suspended under the passive activity loss rules. The Jendes weren’t able to demonstrate that they spent sufficient time to qualify for active participation as real estate professionals.

The Tax Court found the time claimed for maintenance and repairs was exaggerated. Time spent for investor activities and travel didn’t count for the participation test. The Court also disallowed most of the time spent for shopping and said those hours called into question other time recorded on the time logs.

The Jendes weren’t able to produce an election to aggregate the properties to qualify for the material participation test as real estate professionals.

The Tax Court upheld accuracy-related penalties against the Jendes.

This case is a reminder to learn about the passive activity loss rules and to document your qualification to claim losses currently. (Get a copy of IRS Publication 925 at www.irs.gov.) It’s not easy.

The IRS recently issued Revenue Procedure 2011-34 to enable taxpayers to “clean up” missing elections to aggregate properties. You should meet with your tax advisor about whether you should be making a filing under that Procedure.

(California hasn’t conformed to the Real Estate Professional rules. See your tax advisor about your state.)

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100th episode of Financial Insider Weekly is broadcast.

Wednesday, June 29, the 100th episode of Financial Insider Weekly was broadcast on CreaTV in San Jose and Campbell. Our guest was attorney and retired CPA David Howard of Hoge, Fenton, Jones & Appel, explaining the information reporting requirements for foreign bank and brokerage accounts and foreign trusts. Hooray!

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Financial Insider Weekly broadcast schedule for July and August.

Financial Insider Weekly is broadcast in San Jose and Campbell on Wednesdays at 7:00 p.m., Pacific Time. After August 15, 2011, the date and time will change to Fridays at 8:00 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 July and August:

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"
August 3, Michael Desmarais, Attorney, "Estate Planning For Second Marriages"
August 10, John Hopkins, Attorney, Hopkins & Carley, "Succession planning for a family business"
August 19 (new day & time!), Peggy Martin, ChFC, MSFS, CLU, The Family Wealth Consulting Group, "Sucially Responsible and Sustainable Investing"
August 26, Craig Martin, CFP®, The Family Wealth Consulting Group, "Alternative investments besides securities as part of a balanced portfolio"

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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Follow me on Twitter, Facebook and LinkedIn!

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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Check out my blog.

I have also started a blog at www.michaelgraycpa.com. Check it out!

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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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