Michael Gray, CPA's
Real Estate Tax Letter
December 12, 2011
© 2011 by Michael C. Gray
ISSN 1930-0387
A monthly report focusing on tax issues for the homeowner and real estate investor.
Table of Contents
- Happy holidays!
- Our holiday schedule.
- It's time for year-end tax planning.
- DVD of live seminar on short sales and foreclosure available.
- First property tax payment is due.
- Time to make year-end related party payments for certain calendar year corporations, pass-through entities.
- Have you taken your required distribution from your retirement account or IRA for 2011?
- Remember to take a physical inventory on January 1.
- Remember to “reset” payroll on January 1.
- Should you make additional tax payments before December 31?
- Should you donate publicly traded stock?
- Donating a car to charity?
- Should you make a donation from an IRA account?
- Do you have unrealized capital losses?
- Will 2011 and 2012 be your last chance to 15% long-term capital gains?
- Should you make a Roth conversion during 2011?
- Should you buy business equipment by December 31, 2011?
- Would it be better to be married in December 2011 or January 2012?
- Should you sell depreciated ISO shares by December 31, 2011?
- Should you make family gifts before the end of 2011?
- California liability relief for short sales extended.
- First-time homebuyer credit allowed when taxpayer didn't occupy the home.
- California penalties for independent contractor missclassifications.
- FICA and FUTA exemptions apply to family members of disregarded entity owners.
- Franchise Tax Board explains property tax deduction.
- Gifts of family limited partnership interests disregarded.
- Estate tax deduction allowed for interest expense.
- Financial Insider Weekly broadcast schedule.
- Questions and Answers
- Questions related to the sale, short sale or foreclosure of a principal residence.
- Does a new California law change tax consequences of a short sale?
- Follow me on Twitter, Facebook and LinkedIn!
- Do you know about our other newsletters?
- Check out my blog.
- IRS Circular 230 Disclosure
- Subscribe/Remove from Michael Gray, CPA's Real Estate Tax Letter.
Happy holidays!
Yes, it really is that time of year. We hope that you and your family enjoy a happy and safe holiday season, and that 2012 will be a healthy and prosperous year for you.
Our holiday schedule.
Michael Gray will be out of the office from December 16, returning December 27. Dawn Siemer won’t be available after December 12 until January 2.
It’s time for year-end tax planning.
As you can see from the above schedule, Michael Gray will have very limited availability for year-end tax planning meetings. Reserve your appointment now by calling Dawn Siemer today at 408-918-3162. On the days he is in the office after December 12, call Michael Gray directly at 408-918-3161. Although Michael Gray usually only meets with clients on Tuesdays and Thursdays, he has opened up more days this December.
DVD of live seminar on short sales and foreclosure available.
Since the seminar was located in Campbell, California, many people were unable to come. We are making a DVD available of the presentation with handouts and bonuses available until January 31, 2012. The DVD is “guerilla style” (like a home movie.) For details, use this link www.realestateinvestingtax.com/shortsale-seminar.shtml.
First property tax payment is due.
Since December 10 falls on Saturday, the first property tax payment for the 2011-2012 fiscal year in Santa Clara County is due December 12. Avoid a late payment penalty – mail your payment early!
Time to make year-end related party payments for certain calendar year corporations, pass-through entities.
In order to take current tax deductions for payments by accrual-basis businesses to cash-basis related parties for wages, interest and rent, the payments should be made by the year-end of the entity. For a calendar-year entity, that’s December 31. The limitation applies to owners who control C corporations, owners of 2% of S corporations, partners of partnerships, members of LLCs and certain members of the owners’ families.
If you have any questions about this issue, consult with your tax advisor.
Have you taken your required distribution from your retirement account or IRA for 2011?
Remember that account owners who are over age 70 ½ generally must take a required minimum distribution by December 31. There is an exception permitting a distribution by April 10 of the next year for the first year a distribution is required. There is another exception for certain non-controlling employees who keep working after age 70 ½. The penalty for missing the distribution is severe. If you have questions, see your tax advisor.
Annual distributions are also required for inherited retirement and IRA accounts, including Roth accounts.
Remember to take a physical inventory on January 1.
Calendar year businesses with inventories should take a physical count as of January 1. This creates a “clean” record for the income tax return.
Remember to “reset” payroll on January 1.
Software providers will issue updates including the new payroll tax tables as of January 1, 2012. Be sure you have installed those updates before processing your first payroll for 2012.
Should you make additional tax payments before December 31?
State estimated tax payments and early property tax payments made by December 31 are generally tax deductible for the regular tax. However, many people are finding they are subject to the alternative minimum tax. Deductions for taxes (and miscellaneous itemized deductions) aren’t allowed for the alternative minimum tax, so there could be no benefit for a tax prepayment. A tax advisor can project your tax picture to determine if the AMT will apply. Turbo Tax and other tax preparation software can also be used to make the computations.
Should you donate appreciated publicly traded stock?
It’s the season for giving. Many of us make extra donations during December to share our bounty with others. Appreciated publicly-traded stock that has been held for more than a year is an ideal asset for a donation. Under the Internal Revenue Code, the long-term capital gain is excluded from taxable income and the charitable contribution deduction is the fair market value of the stock, so there is a double tax benefit. Also, publicly traded stock isn’t subject to the appraisal requirements that apply for other property. It’s a win-win-win! Remember to get a good acknowledgement letter to document the donation, including a statement that “no goods or services were received in exchange for the donation”.
Donating a car to charity?
Remember that an appraisal is required for noncash contributions with a value exceeding $5,000. See Form 8283 and instructions as the IRS web site, www.irs.gov. (There is a Declaration of Appraiser on the form.)
Should you make a donation from an IRA account?
Individuals who are over age 70 ½ can have up to $100,000 of distributions made from their IRA directly to a charity. The distribution can satisfy the required minimum distribution requirement and is excluded from taxable income. Since the distribution is excluded from taxable income, more deductions will be allowed for medical expenses and miscellaneous itemized deductions, and the limitation that otherwise applies to charitable contributions will not apply to the distribution.
If you can afford it, this is a great tax benefit that also benefits the community. (Remember, you don’t have to give the whole $100,000!)
Do you have unrealized capital losses?
With the roller coaster movement of the stock market, many people have investments that have declined in value. If you have realized capital gains during 2011, be sure to sell the depreciated stock before the end of the year to offset the losses against the gains. Be careful for the “wash sale” tax trap. If you buy the same stock or get an option to buy the same stock during the period 30 days before and 30 days after a sale at a loss, the loss is disallowed.
Will 2011 and 2012 be your last chance for 15% long-term capital gains?
If Congress does nothing, the Bush tax cuts are now set to expire after 2012. I don’t expect tax reform or extensions to be done until some time after the 2012 election. This could be a good time to report capital gains, while tax rates are “on sale.”
Should you make a Roth conversion during 2011?
Conversions of regular IRAs and 401(k) accounts to Roth accounts are now permitted without a limitation based on adjusted gross income. Federal tax rates are at a historic low and may be increasing when the Bush tax cuts end after 2012. Distributions from Roth accounts after a waiting period are tax free, and no distributions are required to be taken during the original account owner’s lifetime.
Should you buy business equipment by December 31, 2011?
Tax relief legislation increased the bonus depreciation allowance for new business equipment (subject to special limitations for cars and trucks) to 100% for equipment acquired and placed in service after September 8, 2010 and before January 1, 2012. That means expenditures for new equipment purchased during 2011 are currently deductible, without limitation (except for most cars and trucks). If you were planning to make a business equipment purchase soon, you should go ahead by December 31, 2011, because 100% bonus depreciation is currently scheduled to expire after 2011.
The Section 179 expense election is still available for up to $500,000 of used equipment, with a phaseout with more than $2 million of acquisitions that won’t apply for most small businesses.
Should you invest in small business stock before December 31, 2011?
There is a 100% exclusion of gain when certain requirements are met for an investment in qualified small business stock during 2011. The exclusion is scheduled to decrease for investments made after 2011. See your tax advisor for more information.
Would it be better to be married in December 2011 or January 2012.
It can make enough of a difference to make a nice contribution to your honeymoon. If both spouses have high incomes, January 2012 is probably better. If one spouse has most of the income, December 2011 is probably better. “The devil is in the details.” The only way to really know is to make tax projections.
Should you sell depreciated ISO shares by December 31, 2011?
When you exercise an incentive stock option, the excess of the fair market value of the stock over the option price on the later of the date of exercise or the vesting date (unless a Section 83(b) election is made) is taxable for the federal alternative minimum tax. If the stock falls dramatically in value after the date of exercise, this can create a tax dilemma. There is an “escape hatch” if the stock is sold before the end of the year of exercise or of vesting. In that case, ordinary income is reported based on the sales price of the stock over the option price for both regular and alternative minimum tax purposes. The sale must be made to an unrelated party. A “wash sale” rule applies, so the same stock can’t be purchased during the period from 30 days before the sale until 30 days after the sale, and an option to purchase the shares can’t be acquired during the same period or the “escape hatch” rule won’t apply. See your tax advisor for details.
Should you make family gifts before the end of 2011?
Remember you can give up to $13,000 per year to each donee without being subject to gift tax. This means a husband and wife can give up to $26,000 to each of their children.
In addition, the lifetime gift exemption is currently $5 MILLION! After 2012, the exemption is scheduled to decline to $1 million. (Again, whether Congress will extend the $5 million exemption probably won’t be resolved until after 2012.) Now may be a great time to make a big gift during 2011 or to plan a big gift during 2012. See your tax advisor and estate planning attorney. Use common sense. Don’t make a big gift if it puts you in financial distress.
California liability relief for short sales extended.
Governor Brown has approved Senate Bill 458 effective on July 15, 2011 that limits the liability of an owner of housing with up to four units to the property for the first mortgage holder and junior mortgage holders when the mortgage holders approve a short sale. In other words, after the lenders approve a short sale and it closes, the lenders may no longer pursue the borrower for collection. As I understand it, this could make the debt relief from a short sale superior to a foreclosure when there is a second mortgage for a property.
I always recommend that anyone who is contemplating a short sale or foreclosure seek legal counsel. I am not a lawyer.
See the Q & A below about the tax consequences of this change.
First-time homebuyer credit allowed when taxpayer didn’t occupy the home.
A taxpayer bought a home in 2008 with the intention of using the first-time homebuyer credit to finance remodeling it. Under the terms of the contract, the title for the home didn’t transfer until he made the last payment.
The Tax Court ruled that, although the taxpayer didn’t receive the legal title to the home until the last payment was made, he assumed all of the benefits and burdens of ownership when he entered the contract, the contract for deed was a purchase of the home under Texas law. (The taxpayer was a Texas resident.)
The taxpayer received a refund, including the $7,500 credit, during February 2009. The IRS issued a statutory notice of deficiency denying the credit during August 2009.
The Tax Court decided that the residency requirement was different for the credit from the “two out of five years” for the exclusion of gain from the sale of the residence. It was sufficient that the taxpayer intended to occupy the home after the remodeling was done.
(Woods v. Commissioner, 137 TC No. 12, October 28, 2011.)
California penalties for independent contractor misclassifications.
California has enacted Senate Bill 459, which makes the willful misclassification of independent contractors “unlawful.” Penalties for misclassification apply to the employer and to any paid person who advised the employer. Attorneys and employees of the business are exempt from penalties.
The California Labor Workforce Development Agency has the authority to impose a civil penalty of $5,000 to $15,000 for each violation of a single misclassified individual. If the Labor Commissioner or a court determines there is a pattern and practice of these violations, a civil penalty of $10,000 to $25,000 may be imposed.
There are also fines for requiring a “willfully misclassified” independent contractor to pay his or her own expenses.
“Willful misclassification” is “avoiding employee status for an individual by voluntarily and knowingly misclassifying that individual as an independent contractor.”
The new law also requires the registrar of the Contractor’s State License Board to “initiate disciplinary action against a licensee within 30 days of receiving a certified copy of an agency or court order.”
FICA and FUTA exemptions apply to family members of disregarded entity owners.
The IRS has issued final, temporary and proposed regulations extending the exemption from FICA and FUTA taxes for wages paid to certain family members and the religious exemption to disregarded entities. For example, if a child of the owner who is under age 18 works for a single-member LLC owned by the parent, the wages paid to the child aren’t subject to FICA or FUTA. Wages paid to a spouse who works in the trade or business of the other spouse are subject to FICA and Medicare taxes, but are exempt from FUTA.
A child or spouse that works for a corporation isn’t eligible for the exemption, even if the corporation is 100% owned by a parent or spouse.
Wages of members of certain religious sects who work for other members of the sect may also be excluded from FICA and FUTA. The entity must file and receive an approval for an application certifying they are members of a qualifying sect.
(T.C. 9554; NRPM REG-136565-09).
Franchise Tax Board explains property tax deduction.
The California Franchise Tax Board has issued reminders to California taxpayers that not all of the amounts on their real estate property tax bills are tax deductible as itemized deductions. The deductible part is the “ad valorem” tax, which is computed based on the assessed value of the property. Many bills include “parcel taxes” and other amounts on them for billing convenience.
Here is a Franchise Tax Board web page devoted to this issue:
www.ftb.ca.gov/individuals/Real_Estate_Tax_Deduction/index.shtml
It would be a good courtesy for the county tax collectors to note on the bills and their web sites what the tax deductible portion of the bill is, as the California Department of Motor Vehicles has done for auto registrations.
This notification doesn’t relate to a change in the tax laws. California is evidently trying to increase revenues by becoming more conscientious in enforcing current tax laws.
Gifts of family limited partnership interests disregarded.
The Tax Court upheld the IRS in disregarding gifts of family limited partnership interests and including the assets of the partnership in a decedent’s taxable estate. The partnership wasn’t managed as a separate entity from the donor. Personal expenses were paid from the partnership bank account. The partnership made disproportionate distributions to the donor. There was commingling of the funds of the donor and the partnership. The donor didn’t retain enough assets outside the partnership to pay his personal living expenses, including his estate taxes.
This case is an unfortunate example of how failing to observe the formalities of properly operating a partnership as a separate business entity can have disastrous consequences.
(Estate of Liljestrand v. Commissioner, T.C. Memo. 2011-259.)
Estate tax deduction allowed for interest expense.
A trust owned by a decedent borrowed funds from a trust not owned by the decedent in order to pay federal estate taxes. The IRS said the interest shouldn’t be deductible on the federal estate tax return. The Tax Court ruled against the IRS and in favor of the taxpayer, finding the loan was for a reasonable purpose relating to the administration of the estate and necessary to pay the estate taxes, there was a reasonable expectation of repayment and the interest rate was reasonable.
The Tax Court upheld the IRS in disallowing an estate tax deduction for the ongoing management of the trust assets that weren’t related to the administration of the trust.
(Estate of Duncan v. Commissioner, T.C. Memo. 2011-255, 102 T.C.M. 421, October 31, 2011.)
Financial Insider Weekly broadcast schedule for December and January.
Financial Insider Weekly is broadcast in San Jose and Campbell on 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 December and January:
- November 4, 2011, Mark Erickson, attorney, “Divorce – California Style: Child Custody”
- December 16, 2011, Craig Martin, CFP®, The Family Wealth Consulting Group, “The Role of the Fee-Only Financial Planner”
- December 23, 2011, William Mitchell, CPA, “I’m Being Audited By The IRS! Now What Should I Do?”
- December 30, 2011, William Mitchell, CPA, “I Owe Back Taxes To The IRS! Now What Should I Do?”
- January 6, 2012, Scott Haislet, CPA and Attorney, “Real Estate Professionals and Passive Activity Losses”
- January 13, 2012, Scott Haislet, CPA and Attorney, “1031 Tax Deferred Exchanges of Real Estate”
- January 20, 2012, Bettie Baker Marshall, Attorney, “Caring for incapacitated family members and friends”
- January 27, 2012, David Beck, CFP®, “How a family can pay for a college education”
Financial Insider Weekly is also broadcast as follows:
- Sunday at 5:30 a.m. on Comcast Channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola.
- Sunday at 5 p.m. on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California.
- Monday at 3:30 p.m.on Comcast Channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola.
- Monday at 4 p.m. and 7 p.m. Pacific Time on cable channel 19 in Morgan Hill. Broadcast on the internet at the same time as streaming video at www.mhat.tv.
- Monday at 7:30 p.m. on Comcast channel 15 in Saratoga.
- Tuesday at 4 p.m. and 7 p.m. Pacific Time on cable channel 19 in Morgan Hill. Broadcast on the internet at the same time as streaming video at www.mhat.tv.
- Tuesday at 9:00 p.m. on Comcast channel 26 and AT&T U-verse channel 99 in Marin County.
- Thursday at 5:30 p.m. on Comcast channel 27 in Santa Cruz County and Charter Communications channel 73 in Capitola and Watsonville.
- Thursday at 10 p.m. on Comcast channel 28 in Hayward, Alameda and Fremont and on AT&T U-Verse Channel 99, Hayward public access TV 28 in California.
- Friday at 4 p.m. on cable channel 15 in Cupertino, Los Altos and Mountain View.
- Friday at 4:30 p.m. on Comcast channel 15 in Los Gatos.
- Friday at 6:00 p.m. on Comcast and Astound channel 29 in San Francisco. Online streaming video at www.bavc.org, "public access TV".
- Saturdays at 12:30 p.m. on Comcast channel 27 in Santa Cruz County and on Charter Communications Channel 73 in Watsonville and Capitola.
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!
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.
Question
How is your article, “Tax Consequences of a “Short Sale” of Real Estate vs. Foreclosure”, changed for Californians by Senate Bill 458 that recently became law? Are all amounts not repaid considered non-recourse and therefore not taxable? Will you update the article?
Answer
Thank you for writing. Senate Bill 458 extends anti-deficiency protection to junior mortgages in addition to first mortgages for residential housing up to four units, which were covered by Senate Bill 931 earlier in the year.
I discussed this issue with an attorney friend. It seems to us the home mortgage after refinancing is still non-recourse, because the short sale requires the lender’s consent. Until the lender gives consent to the short sale, the lender isn’t limited to the proceeds of the property for satisfaction of the loan.
Based on that understanding, my article is unchanged, except adding some discussion about the two statutes. I will be writing an update in January 2012.
This may not be the last word on this issue. I expect to see litigation about whether the status of mortgages has been changed to non-recourse in the future, but we may not see rulings on the issue for years.
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