Michael Gray, CPA's

Real Estate Tax Letter

July 1, 2012

© 2012 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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It’s time for tax planning and working on amended, extended and late income tax returns.

It's time to have a second look at income tax returns that were filed for possible amended income tax returns. Taxpayers who filed extensions are also looking for help getting their income tax returns done.

If you would like our help, call Michele Brantley on Wednesdays from 9 a.m. to 5 p.m. Pacific Time to make an appointment. Michele's telephone number is 408-918-3162.

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The year is half over! How's it going?

Remember those New Year's resolutions, personal financial plans and business strategic plans that it seems you made just yesterday? Are they being implemented? Have you had any significant transactions that we should be discussing? Have you made that appointment with an attorney to have your estate plan done? May we be of service in helping you accomplish your goals during the last half of the year?

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Dawn is on maternity leave.

We're expecting a new granddaughter late in July, so Dawn is taking some time to prepare and to care for her new baby girl. Michele Brantley will be handling Dawn's duties in her absence, which is a challenging job! Dawn's plan is to return in October to help process returns for the final extended due date for 2011 individual income tax returns, October 15.

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IRS loses in disallowance of S corporation losses, resulting in allowance of passive activity loss from rental.

James and Marc Macguire (James’s son) owned two S corporations. One was a used car dealership, called Auto Acceptance. The other was a finance company, called CNAC, that bought contracts from the used car dealership. The used car dealership has big losses, but the finance company made money.

James and Marc didn’t have enough of an investment in CNAC to be able to deduct losses passed through to them as S corporation shareholders. Following the advice of their advisors, CNAC distributed accounts receivable from Auto Acceptance to James and Marc. James and Marc contributed the accounts receivable to Auto Acceptance, and increased their investment in Auto Acceptance for the contributed amounts, so then they had enough of an investment to deduct their losses passed through from Auto Acceptance.

The transactions were documented with shareholder meeting minutes, assignment paperwork and journal entries.

The IRS proposed to disallow the deductions, claiming there was no economic substance to the transactions.

A side effect of the disallowance of the S corporation losses would have been the disallowance of a $25,000 deduction relating to an active participation rental property claimed by Marc Maguire and his wife, Pamela, because their adjusted gross income for 2006 fell below $100,000 after a net operating loss carryback of the S corporation losses.

The Tax Court ruled against the IRS. It said there is no rule prohibiting a distribution of assets from one S corporation to its shareholders so they can contribute those assets to another S corporation that they own to create sufficient investment to deduct its losses.

These transactions were sufficiently well-documented, including the intention to achieve the desired result under the guidance of skilled tax advisors.

(James and Joy Maguire v. Commissioner; Marc and Pamela Maguire v. Commissioner, T.C. Memo. 2012-160, June 6, 2012.)

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Second Circuit reverses Tax Court decision, allows deduction for facade easement.

The Tax Court previously ruled in favor of the IRS, disallowing a $115,000 deduction for a facade easement because it believed the appraisal didn’t meet the substantiation requirements. The Tax Court said the appraisal failed to state the method of valuation and the basis of the valuation. The Second Circuit Court of Appeals reversed the Tax Court, finding the explanation of the method and basis for the valuation in the appraisal was sufficient to meet the requirements in the regulations. The IRS is examining almost all tax returns that include a charitable deduction for a conservation easement. If you are planning to claim the deduction, be sure it is well-documented under the guidance of a skilled tax advisor. Be prepared to defend yourself from an IRS challenge.

(H.T. Scheidelman, 2012-1 USTC ¶50,402, June 19, 2012.)

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Should you make a significant gift during 2012?

You might recall that the exemption equivalent for the federal estate and gift taxes has temporarily been increased for 2011 and 2012. The exemption equivalent for 2012, adjusted for inflation, is $5,120,000. The maximum estate and gift tax rate is 35%.

After 2012, the exemption equivalent is scheduled to be $1 million and the maximum estate and gift tax rate is scheduled to be 55%.

Married couples with more than $10 million in net worth should be seriously considering an aggressive gift plan for 2012. The benefits of the exemption can be leveraged using a family limited partnership or life insurance.

There is a risk of a "clawback" in an estate tax return for decedents dying after 2012, but it still seems worthwhile to seriously consider making a significant gift during 2012. (See the blog post below for an explanation.)

You should only go ahead with the gift plan after consulting with your estate planning attorney and tax advisor.

See my blog post on this subject. http://tinyurl.com/big2012gift (Call Michele on Wednesdays at 408-918-3162 if you want us to mail you a copy.)

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Should you consider making a charitable remainder trust

If you have a significantly appreciated asset, such as publicly traded stock, that would qualify for a long-term capital gain if sold, you might consider setting up a charitable remainder trust. Current low interest rates result in a bigger tax deduction for gifts to such trusts. When you make a gift to a charitable remainder trust, the trust can sell the appreciated asset tax free. You get a current tax deduction for the remainder interest, subject to a 30% of adjusted gross income limit, with a carryover for the donation over the limit. Then the trust can make diversified investments and pay you income during your lifetime. The balance of the trust is distributed to a qualified charity at your death.

These trusts are usually made by individuals who are interested in benefiting a charity they like, because the principal of the trust is not going to their families. The principal is often replaced using life insurance, possibly in an irrevocable life insurance trust.

There is an annual cost for maintaining these trusts for tax return preparation, asset management and possibly trustee fees, so they should only be used for significant gifts.

If you are interested in finding out more, consult with your estate planning attorney and tax advisor, or call 408-918-3162 on Wednesdays from 9 a.m. to 5 p.m. for an appointment to meet with Michael Gray.

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IRS issues guidance on estate exemption portability.

The IRS has issued temporary regulations and proposed regulations relating to the election to make the unused exclusion amount for a deceased spouse available for a surviving spouse. At this time, the election is only available for individuals who were deceased during 2011 and 2012 for the unused exclusion to be used by surviving spouses who are deceased during 2011 and 2012.

The current federal estate tax rules, mostly enacted as part of the Bush Tax Cuts, are currently scheduled to expire after 2012.

As a precaution in case this portability election is extended, many elections are being filed for deceased individuals for whom federal estate tax returns otherwise wouldn't be required.

Under the temporary regulations, the portability election is made by timely filing a complete federal estate tax return.

In response to complaints about the expense of preparing a complete federal estate tax return, including documenting the value of all assets, the IRS has relaxed the valuation and documentation requirements somewhat for property that qualifies for the marital deduction or a charitable deduction. No federal estate tax would result from the transfer of such property.

Since the federal estate tax return is due nine months after death and the due date can be automatically extended an additional six months, it probably makes sense to file for an extension for any no-tax estate when there is a surviving spouse and an individual subject to U.S. estate tax is deceased during 2011 or 2012. Then you can buy a little time to decide whether it's worth the effort to prepare the federal estate tax return and make the election.

(T.D. 9593, June 18, 2012,NPRM REG-141832-11, June 18, 2012.)

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Community public access television needs our help.

Public access television is a vital part of our educational outreach to various communities. These are usually nonprofit, charitable organizations, like public television stations. Unlike those stations, most of the programming for the public access stations comes from local producers.

This programming includes the local arts, productions by students at local schools, community outreach by churches, independent local producers discussing current social issues, educational programming by local providers like ourselves and much more. In other words, public access television makes a unique, important contribution to the communities it serves.

With the difficult times we are experiencing, many public access stations are facing severe financial challenges, and might not survive without more community financial support. I urge you to consider making a donation to your local public access television station. Here is a link for a list of public access television stations in California: http://www.communitymedia.se/cat/linksca.htm.

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Financial Insider Weekly broadcast schedule for July and August.

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 July and August:

July 6, 2012, David Howard, attorney, Hoge, Fenton Jones & Appel, "Information reporting requirements for foreign bank accounts and foreign trusts"
July 13, 2012, James Brown, ASA, CFP®, Perisho, Tombor, Ramirez, Filler & Brown, PC, "The role of the business valuation specialist"
July 20, 2012, Dean Fabro, Bank of the West, "Small Business Financing"
July 27, 2012, Francis Doyle, attorney, WealthPLAN, "Preserving family assets using a family limited partnership or LLC"
August 3, 2012, Judy Barber, Family Money Consultants, LLC, "The transfer of family wealth to the next generation: What's the money for?"
August 10, 2012, Judy Barber, Family Money Consultants, LLC, "Raising money-smart kids in the midst of affluence"
August 24, 2012, Gregory Carpenter, BTI Group Merges & Acquisitions, "How to buy a business"
August 31, 2012, Gregory Carpenter, BTI Group Merges & Acquisitions, "Preparing to sell a business"

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.

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Follow me on Twitter, Facebook, LinkedIn and Google+!

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, LinkedIn, and Google+.

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I have also started a blog at 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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