Michael Gray, CPA's

Real Estate Tax Letter

July 10, 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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Extension season is here.

If you would like us to prepare your extended 2012 income tax returns, please call Dawn Siemer Mondays, Wednesdays or Fridays from 9 a.m. to 5 p.m.

We can also prepare amended income tax returns to clean up tax returns that were previously filed.

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Now is the time for tax planning.

The year is already half over. How is it going? With many tax changes this year, especially for taxpayers with high incomes or high net worths, now is a good time for income and estate tax planning. To make an appointment, call Dawn Siemer Mondays, Wednesdays or Fridays from 9 a.m. to 5 p.m.

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Should you terminate a bypass trust in light of recent tax law changes?

I have written a blog post on this subject at http://michaelgraycpa.com/2013/06/28/should-you-terminate-a-bypass-trust-in-light-of-recent-tax-law-changes/. A copy has been sent with paper copies of this newsletter. If you would like to receive a copy, call Dawn Siemer on Monday, Wednesday or Friday at 408-918-3162.

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Purchase allocation agreement was binding

The Eleventh Circuit Court of Appeals has affirmed the Tax Court in holding that an allocation of the purchase price that was included as part of the purchase agreements for two buildings was binding and couldn’t be superceded by later cost segregation studies. The taxpayer was attempting to change the depreciation method from 39-year straight line to accelerated seven year double declining balance and fifteen year 150% declining balance methods.

The original allocation agreements stated they would apply "for all purposes (including financial accounting and tax purposes)."

According to Internal Revenue code Section 1060, an asset allocation agreement is binding on the buyer and seller, unless the allocation or fair market value is not appropriate. The purpose of the law is to prevent inconsistent reporting of a transaction by a buyer and a seller.

The lesson is to have the cost segregation study done when the purchase as made and use it for making the allocation of purchase price in the original agreement.

(Peco Foods, Inc. & Subsidiaries v. Commissioner, 2013-2 U.S.T.C. ¶ 50,412, July 2, 2013.)

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IRS reconstruction of income accepted.

A couple underreported income from an unincorporated trucking business, a child care business, a rental business and real estate activities (including the sale of a house). The IRS reconstructed their income by analyzing their bank deposits. The couple contested the reconstructed income, claiming some of the money was from amounts borrowed to build a home.

The IRS conceded amounts received from loans from the husband’s father and sister were not taxable income.

The Tax Court found witnesses for the taxpayer’s defense weren’t credible.

The taxpayers also claimed they shouldn’t be subject to the accuracy penalty because they relied on a professional tax return preparer.

The Tax Court ruled in favor of the IRS and assessed accuracy-related penalties for failure to report income.

(Yakov Kobel and Anna Berkovich v. Commissioner, T.C. Memo. 2013-158, June 27, 2013.)

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Exchange of leasehold interest for fee interest wasn’t like kind.

A hotel company built a hotel on leased property and sold it. The sale proceeds were deposited with a Qualified Intermediary and were used to purchase fee interests in two other hotels. The taxpayer reported the transactions as a tax-deferred exchange under Internal Revenue Code Section 1031.

The lease term for the leased property was originally 33 years, and 21 years and four months remained on the lease at the time of the sale. According to the terms of the lease, any improvements made by the lessee would be owned by the lessor at the end of the lease.

The Tax Court ruled in favor of the IRS that the exchange didn’t qualify because the properties weren’t like-kind. The Court said the remaining lease was too short-term to be like-kind with the fee interest. An example in the regulations states a 30-year leasehold property interest would be considered like-kind to a fee interest. Since the improvements were subject to the terms of the leasehold agreement and would become property of the lessor at the termination of the lease, they also aren’t equivalent to a fee interest.

(VIP’s Industries, Inc. & Subsidiaries v. Commissioner, T.C. Memo. 2013-157, June 24, 2013.)

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Extension of time to make debt cancellation election granted.

Taxpayers failed to make an election under Internal Revenue Code Section 108(c)(3)(C) on Form 982 in their tax return for the year of cancellation of qualified real estate indebtedness to avoid the current taxation of the income and reduce the tax basis of real estate still held by the amount of the deferred income. They also didn’t report the income, because it was omitted on a Schedule K-1 by a limited liability company partially owned by the taxpayers. The IRS had not examined the income tax returns or discovered the understatement of income.

The IRS granted a request for an extension of time under Internal Revenue Code Section 9100 for the taxpayers to make the election.

Treasury Regulations Section 301.9100-3 provides that requests for extensions of time for regulatory elections … will be granted when the taxpayer provides evidence (including affidavits) to establish that the taxpayer acted reasonably and in good faith, and granting relief will not prejudice the interests of the government.

Treasury Regulations Section 301.9100-3(b)(1) provides that a taxpayer will be deemed to have acted reasonably and in good faith if the taxpayer (i) requests relief before the failure to make the regulatory election is discovered by the Service, (ii) failed to make the election because of intervening events beyond the taxpayer’s control, (iii) failed to make the election because, after exercising reasonable diligence, the taxpayer was unaware of the necessity for the election, (iv) reasonably relied on the written advice of the Service, or (v) reasonably relied on a qualified tax professional, and the tax professional failed to make, or advise the taxpayer to make, the election.

(Letter Ruling 201325004, March 18, 2013.)

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New reporting requirements for some California tax-deferred exchanges.

California has passed new legislation effective January 1, 2014 that will require taxpayers who exchange California real estate for property located out of state to file an annual information return with the Franchise Tax Board. The information return will be required for the year of the exchange and each year that the gain or loss is deferred. If the taxpayer fails to file the information return, the Franchise Tax Board may estimate the net income and assess tax, interest and penalties. (Yes, this one stinks!)

(AB 92 added Revenue and Taxation Code Sections 18032, 24953. Spidell’s Flash E-mail.)

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Abandonment of property resulted in capital gain, not loss.

The Tax Court ruled in favor of the IRS that a taxpayer’s abandonment of a residence resulted in a capital gain, not a loss.

The taxpayer reported a $313,737 ordinary loss for the abandonment of the rental property.

The property was subject to a nonrecourse mortgage with a balance of $325,855. The IRS computed a taxable capital gain from the abandonment of the $325,855 mortgage balance – ($333,239 purchase price – $12,118 accumulated depreciation) = $4,734.

When real estate subject to a nonrecourse mortgage is abandoned and foreclosed upon, there is a deemed sale of the property for the balance of the mortgage. (Treasury Regulations Section 1.1001-2(a)(1).)

(Malonzo v. Commissioner, T.C. Summary Opinion 2013-47, June 10, 2013.)

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Employer healthcare mandate postponed.

The Obama Administration has announced the mandate in the Patient Protection and Affordable Care Act (PPACA) that employers with more than 50 employees provide employee healthcare coverage starting in 2014 is postponed until 2015. The penalty for not providing this coverage is also postponed until 2015.

The PPACA also requires individuals to have health care insurance coverage in 2014 or pay a penalty and requires the states to have marketplace exchanges. These requirements haven’t been postponed.

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Guidelines issued for Employer Wellness Programs.

In 2015, employers with 50 or more employees will be required to provide health insurance for their employees (see above). Premium reductions are allowed when employees adhere to a wellness program.

The IRS, the Department of Health and Human Services, and the Department of Labor have jointly issued final regulations on the design of these wellness programs. Large employers should study these new regulations to determine whether to adopt such a program or whether such a program that is already in place should be modified.

(T.D. 9620.)

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More businesses excused from part of Schedule M-3 reporting.

The IRS has announced on its web site that, effective for tax years ending December 31, 2014 and later, corporations and partnerships with at least $10 million but less than $50 million of total assets by the end of a tax year will be allowed to file Schedule M-1 instead of Schedule M-3, Parts II and III. Those taxpayers will still be required to complete Schedule M-3, Part I, lines 1-12. The change applies to corporations and partnerships filing Forms 1120, 1120-C, 1120-F, 1120S, 1065 and 1065B.

Those businesses will continue to have the option of completing all of Schedule M-3.

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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 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 12, 2013, Dick Blakeley, The Blakely Group, Inc., "How family business meetings can help avoid financial elder abuse"
July 19, 2013, Craig Martin, CFP®, The Family Wealth Consulting Group, "Asset class investing"
July 26, 2013, Craig Martin, CFP®, The Family Wealth Consulting Group, "Investment diversification using alternative investments"
August 2, 2013, Peggy Martin, MSFS, ChFC, CLU, The Family Wealth Consulting Group, "Socially Responsible and Sustainable Investing"
August 9, 2013, Professor Patricia Cain, Santa Clara University School of Law, "Tax Considerations of the Federal Supreme Court rulings on same sex marriages"
August 16, 2013, Craig Martin, CFP®, The Family Wealth Consulting Group, "How to make sure your retirement portfolio outlives you"
August 23, 2013, David Beck, CFP®, Bay Area Planners, "Funding For A College Education Using Federal Tax Benefits"
August 30, 2013, David Beck, CFP®, Bay Area Planners, "Government financial help for families of deceased veterans"

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.

For your questions about dependent exemptions, see IRS Publication 501 at www.irs.gov.

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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.

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Check out my blog.

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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