Michael Gray, CPA's

Real Estate Tax Letter

February 8, 2013

© 2013 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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Make your tax preparation appointment now.

If you would like to schedule an appointment for a tax preparation interview, also please call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162. (Appointments are generally scheduled on Tuesdays and Thursdays.)

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IRS is experiencing processing delays.

With Congress’s late adoption of tax legislation on January 1, the IRS is scrambling to update forms and its efiling programming. Since we haven’t adopted a federal budget this year, refund checks could be delayed. (Meanwhile, please don’t delay getting the information to prepare your income tax returns to your tax return preparer.)

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W-2s, 1099s and DE 542 reminder.

Remember that most 2012 annual information returns, such as W-2s and 1099s, should have already been issued to payees and should be sent to the tax authorities by February 28.

Amounts paid using a credit card should not be included on Form 1099. Those amounts are being reported by the merchant companies.

Although requirements for real estate operators to issue Forms 1099 were repealed, real estate operators that are real estate professionals should prepare them anyway. Some taxpayers who weren’t concerned about qualifying as real estate professionals will want to for 2013 to avoid the Medicare tax for investment income. See your tax advisor for details.

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Michael Gray interviewed on the Financial Survival Network

Michael Gray was interviewed on January 29 about the Fiscal Cliff tax legislation for a radio show on the Financial Survival Network. You can listen to the interview here:


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Remember to update payroll tax rates

The IRS has released updated 2013 tax rate tables. Software providers should have issued or will soon issue updates incorporating those tables. Be sure to download them if you process payroll internally.

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Ordinary deduction allowed to developer for expired option.

Phillip Sutton worked as the general manager for a real estate developer and started rehabilitating and reselling houses on his own account using an LLC. During 2007, he made an option to purchase some real estate with the intention of developing and reselling it. Due to the economic recession, he was unable to proceed with his development plans, and abandoned the option during 2008. Mr. Sutton claimed an ordinary business loss for $48,000 of option payments.

The IRS claimed the deduction should be treated as a capital loss, limited to $3,000. The IRS claimed Mr. Sutton purchased the option as an investment and that “Neither Sutton LLC, nor Mr. Sutton ever held real property for sale to customers in the ordinary course of their trade or business.”

Under Internal Revenue Code Section 1234(a)(1), the gain or loss from the failure to exercise an option to buy or sell property is treated in the same character as the property would have had in the hands of the taxpayer.

The Tax Court found that Mr. Sutton had in fact rehabilitated several properties and expended considerable effort in trying to develop the property under option. The Court ruled the loss was a currently deductible ordinary loss.

When you read this case, you wonder why the IRS chose to go to court for this one.

(Sutton v. Commissioner, T.C. Summary Opinion 2013-6, February 6, 2013.)

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Passive losses disallowed for real estate agent.

Gary Hoskins was a licensed real estate agent in Florida. He owned properties in Florida and Ohio, some of which were rented, some of which were in the process of being sold, some of which were short term vacation rentals. In 2006, Mr. Hoskins made an election to treat all interests in rental real estate as a single rental real estate activity. He claimed the losses from his real estate properties as tax deductions against his other taxable income.

The IRS disallowed the deductions as passive activity losses and found some of the properties weren’t rental properties that could be included in the election.

Mr. Hoskins wasn’t able to document that his time spent relating to the rental properties was sufficient to qualify as “material participation.”

In order to qualify as a “real estate professional” with respect to rental properties, a taxpayer must be able to document the time spent relating to the properties. Having a real estate sales license and working full time as a real estate salesperson wasn’t sufficient.

The Tax Court upheld the IRS in disallowing the losses as passive activity losses and also upheld accuracy-related penalties assessed by the IRS.

This case is another illustration that documenting a taxpayer’s status as a real estate professional is challenging. The IRS and the courts want to see contemporaneous daily time reports, appointment books, calendars and similar documents detailing real estate activities.

These records will become even more important to demonstrate that real estate rental activities are a trade or business not subject to the 3.8% Medicare surtax on investment income.

Meet with your tax advisor to create a game plan for documenting your real estate professional status.

(Hoskins v. Commissioner, T.C. Memo. 2013-36, February 4, 2013.)

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Court relies on sale after death for estate and gift tax valuation.

Shirley Giovacchini was deceased on October 8, 2001. Four days before her death, her trust entered into an agreement to sell about 1,790 acres of Tahoe property held in a limited partnership. The sales price for the property was based on appraisals. The sale closed on January 14, 2003.

Some of the property was sold before Ms. Giovacchini’s death at a lower value, based on an update of an earlier appraisal. Values for a gift during 2000 by Ms. Giovacchini and for her estate tax return were also based on updates of an earlier appraisal made valuing the property as of May 28, 1997.

The IRS determined underpayments of tax and accuracy-related penalties, based on the sales price for the property in 2003.

The Tax Court agreed with the IRS that the sale price should be relied upon as the primary indicator of the value of the property. The Court made various adjustments to reduce the amount to a date of death value under the circumstances. (The IRS values were $25,185,000 as of June 27, 2000 and $36,280,000 as of October 8, 2001. The Court’s values were $18.5 million and $21.3 million, respectively.)

The Tax Court also found for the taxpayer that accuracy-related penalties shouldn’t apply. The taxpayer had reasonable cause for the understatement. The taxpayer relied on professionals who also relied on an appraisal. The property was difficult to value.

(Estate of Giovacchini v. Commissioner, T.C. Memo. 2013-27, January 24, 2013.)

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1031 exchange disallowed.

Jessie Yates III and Melissa Yates received a residence in an attempted Section 1031 exchange. They moved into the residence four days after closing.

The IRS treated the residence as unlike property or boot, because it wasn’t business or investment property, and assessed accuracy-related penalties.

Jessie and Melissa represented themselves in Tax Court.

The Tax Court found in favor of the IRS.

(Yates v. Commissioner, T.C. Memo. 2013-28, January 24, 2013.)

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Please share your good experiences with Michael Gray, CPA.

As you know, more and more people are going to the internet to find information about service providers. We hope you will share some good words about experiences that you have had with our firm. Some of the sites where you can share your experiences include yelp.com, siliconvalley.citysearch.com, and Google+.

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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 February and March.

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 February and March:

February 1, 2013, attorney John Hopkins of Hopkins & Carley, “Succession planning for a family business”
February 8, 2013, David Beck, CFP® of Bay Area Planners, “How to prepare for the challenge to families of financing a college education”
February 15, 2013, Professor Patricia Cain of Santa Clara University School of Law, “Tax developments for same sex couples”
February 22, 2013, Professor Patricia Cain of Santa Clara University School of Law, “Estate and gift tax planning for same sex couples”
March 1, 2013, attorney G. Scott Haislet, “Section 1031 Tax-Deferred Exchanges”
March 8, 2013, attorney G. Scott Haislet, “Short sale and foreclosure wars”
March 15, 2013, attorney Bernard Vogel III, Silicon Valley Law Group, “Alternative forms for businesses”
March 22, 2013, attorney Michael W. Malter, Binder & Malter, LLP, “What you should know about bankruptcy for individuals”
March 29, 2013, Tom W. Anderson, President, Retirement Industry Trust Association, “How to invest in real estate using your Roth or IRA account”

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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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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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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