Michael Gray, CPA's

Real Estate Tax Letter

November 9, 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 year-end tax planning.

With the coming holidays and continuing education days, Michael Gray will have very limited availability for year-end tax planning meetings. Reserve your appointment now by calling Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Tax relief for victims of Hurricane Sandy.

If you or anyone you know has been affected by Hurricane Sandy, take a look at Michael Gray's blog post on the subject and pass it on! michaelgraycpa.com/2012/11/07/tax-relief-for-victims-of-hurricane-sandy/

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Many retirement account thresholds increase for 2013.

The IRS has announced a host of retirement account contribution changes for 2013:

(IR-2012-27.)

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Remember residential debt cancellation break expires after this year.

The federal and California exclusions for cancellation of certain acquisition debt for a principal residence are scheduled to expire on December 31, 2012. See our article about short sales and foreclosures at www.realestateinvestingtax.com/shortsale.shtml. If you have a short sale of your principal residence in process, you usually will want to try to have the sale close by December 31. Otherwise, you might qualify for a different exclusion, such as insolvency.

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Gift tax annual exclusion will increase for 2013.

The gift tax annual exclusion per donor, per donee for "present interest" gifts will increase from $13,000 for 2012 to $14,000 for 2013.

(Rev. Proc. 2012-41.)

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New IRS rules for repairs, depreciation, materials and supplies explained.

I wrote a brief summary of these important new rules, which will require filing change of accounting method forms for 2012 or 2013. You can read it here: michaelgraycpa.com/2012/10/31/new-irs-rules-for-repairs-depreciation-materials-supplies/

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Deductions for business expenses disallowed.

The Tax Court upheld the IRS's disallowance of deductions for a real estate consultant. He wasn't able to substantiate his deductions. He did provide copies of receipts, but had no books or records and didn't adequately explain the business purpose for the expenses, and many of the receipts were illegible.

He also wasn't able to substantiate his home office expenses.

This case illustrates the importance of keeping good records, although the result seems harsh considering he produced copies of receipts and a bookkeeper had helped him assemble his tax information.

The result might have been worse than it otherwise would have because the taxpayer represented himself instead of hiring a lawyer to represent him.

(Scott Chrush v. Commissioner, T.C. Memo 2012-299, October 25, 2012.)

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Deductions for business expenses and itemized deduction for legal fees disallowed.

After a successful career as a business executive, Richard Kaufman retired at age 46. He and his wife, Sarah, investigated many real estate projects but didn't proceed with building and selling homes at a profit. They built a home as a prototype and used it as a residence, and incurred significant legal fees to secure an easement to protect the view for the property. The Kaufmans reported interest income as business income on Schedule C for 2007 and claimed deductions for business expenses, including 1/3 of the legal fees, and itemized deductions for 2/3 of the legal fees.

The Tax Court upheld the IRS in disallowing the deductions and recharacterizing the interest income as investment income, not business income. The Court found the activity of the taxpayers wasn't a trade or business because they didn't develop and sell homes. The taxpayers said a portion of the legal fees was to defend their business reputation, but the Court said there was no business reputation to defend. The Court said the rest of the legal fees related to a personal asset, the residence, and therefore weren't tax deductible. (Possibly they could be capitalized to the cost of the property.)

The lesson is the IRS and the courts will look hard at the activities of taxpayers to determine whether there really is a trade or business. They want to see actual development, buying and selling of homes and rentals that are generating income to justify deducting business expenses.

(Kaufman v. Commissioner, T.C. Summary Opinion 2012-100, October 16, 2012.)

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Conservation agreement provided required acknowledgment.

RP Golf, LLC granted a conservation easement to a charity, the Platte County Land Trust. No letter was issued by the Land Trust stating no goods or services were received in exchange for the gift. The IRS claimed the charitable contribution deduction should be disallowed because it wasn't properly substantiated.

The Tax Court ruled against the IRS. The Tax Court said the written agreement for granting the easement plainly showed that no compensation was paid for the easement and was sufficient to satisfy the substantiation requirement.

(It's always best to get an acknowledgement letter that meets the IRS's “letter of the law” requirements to avoid expensive litigation like in this case. The IRS is auditing almost all conservation easements.)

(RP Golf, LLC v. Commissioner, T.C. Memo. 2012-282, October 3, 2012.)

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IRS lets taxpayer defer gain for involuntary conversion.

A taxpayer's home was destroyed in a presidentially declared disaster. He received insurance proceeds for the loss and replaced the former residence with a new one including moving into the replacement residence, but didn't report the details as required. The IRS ruled the taxpayer should file amended returns for the year of replacement to report the details, and the gain from the involuntary conversion would be deferred according to Internal Revenue Code Section 1033.

(Letter ruling 201240006, July 5, 2012.)

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Some California LLCs can avoid minimum tax.

A domestic LLC that hasn't conducted any business in California may cancel its registration within 12 months of filing its Articles of Organization by filing Form LLC-4/8, Certificate of Cancellation. If these requirements are met, the LLC isn't required to pay the first year's annual tax. The form must be filed before the tax has been paid or it's nonrefundable.

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Remember to get consent for nonresident LLC members.

If a nonresident member of a California LLC fails to sign Form FTB 3832, LLC's List of Members and Consents, the LLC must complete Form 568, Schedule T to compute the member's tax liability. When the nonresident member signs Form FTB 3832, he or she is agreeing to file a California income tax return to report his or her taxable income from the LLC.

Distributions to nonresident members are subject to 7% California tax withholding. The tax computed on Schedule T may be reduced by any amount withheld for distributions during the taxable year.

(Spidell's California Taxletter, November 1, 2012, Page 12, "Failure to sign member consent means LLC must pre-pay tax.")

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Community public access television needs our help.

As you can see below, 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: www.communitymedia.se/cat/linksca.htm.

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Financial Insider Weekly broadcast schedule for November and December.

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 November and December:

November 9, 2012, Kathleen Wright, attorney, American Red Cross, "Financial preparation for a disaster"
November 16, 2012, Emmett Carson, PhD, CEO, Silicon Valley Community Foundation, "How to promote community giving as a family value"
November 23, 2012, Phil Price, EA, The Price Company, "Qualified Retirement Plans for closely-held business"
November 30, 2012, William Mahan, attorney, of counsel to Gates Eisenhart Dawson, "Tax and financial considerations of title"
December 7, 2012, William Mahan, attorney, of counsel to Gates Eisenhart Dawson, "Why you need a will"
December 14, 2012, William Mitchell, CPA, "I'm being audited by the IRS! What should I do?"
December 21, 2012, William Mitchell, CPA, "I don't agree with my IRS audit report. What should I do?"
December 28, 2012, William Mitchell, CPA, "I owe back taxes to the IRS! What should I do?"

Financial Insider Weekly is also broadcast as follows:

Past episodes of Financial Insider Weekly are posted on YouTube. One way to watch them is to go to our web site, www.financialinsiderweekly.com, and click on "Past Episodes."

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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Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter. Write mgray@taxtrimmers.com.

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Michael Gray, CPA
2190 Stokes St. Ste. 102
San Jose, CA 95128
(408) 918-3162
FAX: (408) 998-2766
Hours: 8am - 5pm PDT Monday - Friday

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