Michael Gray, CPA's

Real Estate Tax Letter

August 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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Welcome, Minerva Siemer!

Minerva Siemer was born about 8:14 p.m. on August 1, 2012. She weighed about six pounds, 9 ounces and was 20 inches long. She is a beautiful baby girl with dark, curly hair. Minerva is the second child for her parents, my daughter Dawn and her husband John Siemer. She is the fourth grandchild for my wife, Janet and me. We are thrilled!

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Remember September 17 estimated tax due date.

The next federal estimated tax payment for individuals and calendar-year corporations is September 17. In most cases, California doesn’t require an estimated tax payment for September 17 because the first two estimated tax payments are front-loaded.

If your estimated tax payments aren’t based on last year’s income tax returns, you should be working with your tax advisor to annualize your tax liability.

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Extended calendar-year corporate, partnership and fiduciary income tax returns are due September 17.

The extended due date for calendar-year corporation, partnerships and fiduciary income tax returns is September 17. The old October 15 deadline for partnerships and fiduciaries was changed a few years ago to help partners and beneficiaries finish their income tax returns on time.

If you want our help finishing your tax returns, call Michele Brantley on Wednesdays at 408-918-3162 to make an appointment. At this late date, we can’t guarantee your tax returns will be finished by September 17.

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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 tax planning environment is cloudy.

The Presidential and other elections mean that little is likely to be done relating to expiring tax laws for this year until after the election – probably early in 2013. The alternative minimum tax exemption “patch” adjustment for inflation hasn’t been passed for 2012.

California’s recent revelation of “side accounts” for various agencies have probably reduced the likelihood that Jerry Brown will be successful in have a tax increase approved by the voters this fall.

The increased federal estate tax and generation-skipping tax exemption is an opportunity for many families to make some big gifts during 2012, possibly using a “dynasty trust”. There is a risk of “claw back” but even the 35% tax rate for taxable gifts is attractive for 2012.

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Cancellation of debt income disallowed for wrong valuation date.

Bernard and Desiree Shepherd had $4,412.06 of credit card debt cancelled on September 3, 2008, for which Capital One issued a Form 1099-C to the Shepherds.

The Shepherds claimed the cancellation should be excluded from income because they were insolvent.

The Tax Court upheld the IRS in finding the evidence provided for their insolvency was in error.

The taxpayers submitted as evidence of value for a beach house a settlement for local property tax purposes for 2010 showing a value of $380,000. The settlement was signed on May 16, 2011. A valuation for local property tax purposes isn’t binding for federal income tax purposes and the date of valuation didn’t correspond to the date of the cancellation of debt.

The taxpayers submitted a letter dated March 29, 2011 from Chase Home Finance showing a value for their principal residence as of March 2011 of $380,000. They also provided a tax bill showing a net taxable value of $337,700. Neither of these items were acceptable to the IRS or Tax Court, because they weren’t qualified appraisals of the residence value immediately before the cancellation of debt.

The taxpayers also omitted Mr. Shepherd’s pension from the list of assets on the date of discharge. The Tax Court agreed with the IRS that at least a portion of the pension was available to be withdrawn as a loan, and should have been included in the list of assets.

Therefore, the cancellation of debt income was included in taxable income for the taxpayers.

Part of the service a tax return preparer should provide to a taxpayer is guidance in documenting an exclusion from income of cancellation of debt income. In this case, the taxpayer should have hired a qualified appraiser to prepare appraisal reports of the value of the properties as of the day before the cancellation of debt, September 2, 2008.

(Bernard and Desiree Shepherd v. Commissioner, T.C. Memo 2012-212 (July 24, 2012).)

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S corporation not disqualified for real estate leasing activity

An S corporation owned commercial and rental property. The corporation, through its employees and through contractors, provides services including maintaining and repairing the property, identifying new tenants, negotiating leases, renewals and other agreements with tenants, collecting rents and other amounts due from tenants, paying bills for the property, trash removal, and inspecting the property.

If an S corporation has accumulated C corporation earnings and profits, and more than 25% of its gross receipts for three consecutive years of passive investment income, the S election is terminated.

The IRS ruled that the activity was sufficient in this case that the income was not passive investment income and the S election wasn’t terminated.

(IRS Letter Ruling 201229007, March 22, 2012.)

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Automobile travel expenses disallowed.

A real estate agent recommended that John, Jr. and Lindsey Walthall should invest in “fixer upper” homes to create an income stream.

The Walthall claimed they traveled to inspect investment homes almost every day during 2008, but they never bought one. They claimed $16,550 in automobile expenses for 30,000 miles of driving.

The Tax Court disallowed the automobile expenses as nondeductible personal expenses. The couple made no appointments with the sellers or real estate agents for the homes. All of the traveling appeared to happen during regular commutes either to their employment on weekdays or to the homes of their relatives on weekends.

This is the type of deduction that sticks out on a tax return and is a flag for an IRS audit.

(John and Lindsey Walthall v. Commissioner, T.C. Summary Opinion 2012-65 (July 9, 2012.)

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Deduction for rental expenses limited to income.

In an “unpublished” opinion, the Ninth Circuit Court of Appeals upheld the Tax Court in disallowing deductions in excess of income relating to renting a portion of a home where the taxpayer resided. The excess deductions are clearly disallowed under Internal Revenue Code Section 280A(c)(5). (The taxpayer represented himself before the Court and before the Tax Court.)

(Rodolfo Velasques v. Commissioner, USTC ¶ 50,449 (July 5, 2012).)

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Medicare premiums are deductible as self-employed medical insurance.

The IRS has issued Chief Counsel Advice relating to the deductibility of Medicare premiums for partners and S corporation shareholders. All medicare parts may be deducted as self-employed medical insurance, even if the shareholder/partner pays for the premiums and is reimbursed for them. The payment by a partnership is treated as a guaranteed payment and the payment by an S corporation is treated as W-2 income.

The deduction is limited to the net income from the partnership or S corporation.

The deduction is not allowed for amount paid during a month in which the taxpayer is eligible to participate in any subsidized health plan maintained by an employer of the taxpayer or of the taxpayer’s spouse.

Taxpayer who didn’t previously deduct these payments may amend their income tax returns for open years and deduct them.

(IRS Letter Ruling 201228037 (May 1, 2012).)

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Is your business generating income in more than one state?

The rules for multiple state taxation are very complicated, including when your business is subject to income tax or required to collect sales tax. In California, a business can elect to base its California franchise (income) tax on only a sales factor, or on a three-factor (property, payroll and sales) formula. For service-based businesses with the single (sales) factor formula, income is sourced to the state where the customer benefits from the services. If the three-factor formula is elected, income is sourced where the cost is incurred. Obviously, there can be radically different results under the two elections.

You might have heard that internet businesses can be required to collect California sales tax if they have “affiliates” to whom they pay commissions for referral links to their web sites. The chief target of this rule is Amazon.com.

If you are selling goods or services in several states, you really should be discussing these issues with your tax advisor. If you would like to discuss them with Michael Gray, call Michele Brantley at 408-918-3162 on Wednesdays from 8:30 a.m. to 5:30 p.m. to make an appointment.

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Oops! Repossession results in new Proposition 13 property tax base.

With “creative financing”, sellers often take back a note secured by the property when they sell real estate. Just as the banks have experienced, sellers of real estate also occasionally have to foreclose or repossess their property when a buyer defaults on the note.

When the property is reacquired via foreclosure, the transaction is a change of ownership and the property is reassessed to current fair market value on the date the property is reacquired. (Property Tax Rule 462.120(b).)

An exception is the parent-child transfer exclusion, for which a Proposition 58 exemption should be claimed.

The creditor who repossesses the property should file a change of ownership form, Form BOE-502-AH, within 90 days after the transfer. An appraisal should be done to establish the fair market value for the property. Check your county assessor web site for the form.

(Spidell’s California Taxletter, August 1, 2012, page 10.)

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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 August and September:

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"
September 7, 2012, Dick Blakeley, RIA, The Blakely Group, Inc., "A financial planning case study"
September 14, 2012, Craig Martin, CFP®, The Family Wealth Consulting Group, "Investing basics"
September 21, 2012, Craig Martin, CFP®, The Family Wealth Consulting Group, "Alternative investments besides stocks and bonds"
September 28, 2012, Gregory Carpenter, BTI Group Merges & Acquisitions, "Preparing to sell a business"

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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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