Michael Gray, CPA's

Real Estate Tax Letter

January 15, 2014

© 2014 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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Tax preparation materials will soon be on the way.

We are mailing instructions to our clients this week and next. If we prepared your tax returns last year and you haven't received instructions by January 20 or you would otherwise like to receive instructions, call Dawn Siemer on a Monday, Wednesday or Friday at 408-918-3162.

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Make your tax return preparation interview appointment now.

Most personal interview appointments for preparing 2013 individual income tax returns will be scheduled in February. Many clients send their information without having an interview, but if you need that personal attention, you should schedule your interview appointment now. Call Dawn Siemer Monday, Wednesday or Friday at 408-918-3162.

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IRS releases draft instructions for surtax on net investment income.

Final Form 8960 for the 3.8% surtax on net investment income still hasn't been released by the IRS. Draft instructions for the form were released on January 6, 2014. You can find the draft form and instructions at irs.gov/draftforms. The late release of this form and instructions will probably result in more extended income tax returns for high income taxpayers.

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Gain from sale of land was ordinary income.

An LLC reported as an installment sale a large capital gain for the sale of land that was subdivided as residential lots. The Tax Court upheld the IRS in finding the sale was of land held primarily for sale to customers in the ordinary course of business, not investment, so the gain was ordinary income. A sale with ordinary income doesn't qualify to be reported as an installment sale.

This is a case study for how being unprepared to present your case in Tax Court can have disastrous consequences. The taxpayer didn't present documentation to the Court about the frequency of its sales and whether they were made to multiple customers.

On its initial income tax return, the taxpayer listed its principal business as "development" and its product or service as "real estate." The IRS also found two affidavits filed in 2001 that (1) "Concinnity is the developer of proposed subdivision Elk Grove...", and "As of June 13, 2001, Concinnity has entered into buy-sell agreements for the sale of 81 lots within…(phase 1) of Elk Grove PUD."

(Cordell D. Pool, et al v. Commissioner, T.C. Memo. 2014-3, January 8, 2014.)

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Couple didn't qualify as real estate professionals.

A married couple had seven rental properties, which the husband managed. Both the husband and wife had full time jobs in 2008 and 2009, but the husband was unemployed for part of 2009. The Tax Court found that the husband failed to meet the requirements to be a real estate professional because he worked more hours as a salesperson than in the real estate business during 2008 and worked less than 750 hours in the real estate business during 2009. In addition, the taxpayers admitted providing fraudulent substantiation for some expenses to the IRS, for which deductions were disallowed.

(Adeyemo v. Commissioner, TC Memo. 2014-1, January 2, 2014.)

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IRS issues guidance for National Mortgage Settlement Payments.

The IRS has explained the tax treatment of payments made to qualified borrowers under the National Mortgage Settlement. Six scenarios are described, which I don't have space to explain. The payments are generally treated as additional amounts realized from a foreclosure. Amounts received for multiple-unit properties that include a principal residence and rental units are allocated to the principal residence. In most cases, the amounts received will reduce a non-deductible loss. If there is a gain, it might be excludable under the rules for the sale of a principal residence. If depreciation was previously claimed for the principal residence, some of the proceeds may be taxable as "depreciation recapture."

(Revenue Ruling 2014-2, December 18, 2013.)

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Sister living in brother's home couldn't deduct mortgage payments.

Lourdes Puentes was living in her brother's home. He became unemployed and unable to pay his mortgage payments. Lourdes made the payments for him, and deducted the interest on her individual income tax return.

The Tax Court upheld the IRS in denying the deduction. Lourdes had no legal or equitable ownership interest in the property securing the loan.

(Puentes v. Commissioner, T.C. Memo 2013-277, December 9, 2013.)

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More extensions are likely for 2013 income tax returns.

The IRS has issued final regulations for the 3.8% net investment income tax, but still hasn't issued Form 8960 and instructions for reporting the tax. They are also behind the usual schedule for being able to accept electronically filed income tax returns (accepting January 31, 2014 instead of January 21) because of the recent shutdown from the federal government sequester.

Consequently, we think it's likely there will be more extensions of time to file for high-income taxpayers for the 2013 tax year. Please don't let that delay you from sending the information to prepare your income tax returns to us as soon as possible. That would create a real logjam on April 15.

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Does your group need a speaker?

We are seeking opportunities to speak before groups. Topics include recent tax developments, tax issues relating to real estate, how estate planning has changed recently, tax issues relating to alternative investments using retirement accounts, and marketing topics such as "How I created a public access television show broadcast on eleven Bay Area stations." To make arrangements, call Michael Gray at 408-918-3161.

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Fourth quarter estimated tax payment for non-corporate taxpayers is due January 15.

The final estimated tax payment for individuals and calendar-year estates and trusts is due January 15, 2014. Remember California taxpayers with taxable income of $1 million or more must pay their estimated taxes using the current year's facts. California passed a retroactive tax increase in the last election. There is no penalty for not paying the additional tax with your 2013 estimated tax payments, but you might want to do it for a deduction on your 2013 federal income tax return. Watch the alternative minimum tax. See your tax advisor.

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

Remember that most 2013 annual information returns, such as W-2s and 1099s, should be issued to payees by January 31 and 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.

Also remember that Form 542, Report of Independent Contractors, should also be submitted for ongoing independent contractor arrangements by January 20. The due date is the earlier of 20 days after the date $600 or more of payments have been made to the independent contractor or the date a contract has been entered for $600 or more of services during a calendar year.

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 2014 to avoid the Medicare tax for investment income. See your tax advisor for details.

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Watch FUTA adjustment on year-end report.

California, among other states, has a cutback in its state credit for federal unemployment taxes. That means additional payments of up to $63 per employee will be due with Form 940. Be sure this adjustment is done with your year-end report for 2013.

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A penalty can apply if you don't have qualified health insurance coverage.

For 2014, a penalty applies for each month a taxpayer or a taxpayer's dependent doesn't have qualified health insurance coverage. The annual penalty is the greater of $95 per person, $47.50 for dependents under age 18, or 1% of adjusted gross income over $10,150 for singles, $20,300 for joint returns plus $3,950 per dependent. You divide by twelve to get the monthly amount. Remember help is available, including from insurance agents who sell this coverage. In some places, the penalty is waived for the first three months of 2014, but not for residents of California. Also, the penalty is waived in certain circumstances, including for certain low-income taxpayers. See your tax advisor.

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Expiring tax provisions will make tax planning uncertain for 2014.

Many tax benefits enacted to help taxpayers during the "Great Recession" and for other purposes have expired as of December 31, 2013. Examples include a higher ($500,000) limitation for expensing depreciable business property, 50% bonus depreciation for new depreciable business property, the research credit, the exclusion for cancellation of certain mortgage indebtedness for a principal residence, the tax deduction for state and local general sales taxes, tax-free direct distributions of up to $100,000 from individual retirement accounts to charities, higher exclusion for certain sales of qualified small business stock, a reduction in the time during which the built-in gains tax applies for shareholders of S corporations, and many more.

Last year, Congress enacted extension legislation on January 1 to keep these provisions in place. This year, there is no "fiscal cliff" incentive for Congress to take quick action. The provisions can be extended up to the end of the year.

Congress is also debating tax reform legislation to reduce the maximum federal income tax rate and eliminate many tax incentives.

I don't expect to see a conclusion on these issues until late in 2014. That will make it hard to do tax planning this year.

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Annual payroll letter sent to business owner clients.

Each year we write a letter summarizing the payroll tax rates and payroll tax deposit requirements for the coming year. We also describe when Forms 1099 are required to be prepared for payees. If you would like to have a copy of the letter, please call Dawn Siemer at 408-918-3162.

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Standard mileage rate decreases.

The IRS has announced the optional business standard mileage rate will decrease from 56.5¢ per mile for 2013 to 56¢ per mile for 2014. The rate for medical and moving expenses is 23.5¢ per mile and the charitable rate is 14¢ per mile.

(Notice 2013-80.)

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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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Financial Insider Weekly broadcast schedule for January and February.

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 January and February:

January 17, 2014, Lori Greymont, CEO, Summit Assets Group, "Residential real estate investing in Atlanta, Georgia and Birmingham, Alabama"
January 24, 2014, Lori Greymont, CEO, Summit Assets Group, "Different ways to invest in real estate"
January 31, 2014, Raymond Sheffield, attorney at law, Sheffield Law Office, "Charitable remainder trusts"
February 7, 2014, Raymond Sheffield, attorney at law, Sheffield Law Office, "Estate tax planning for retirement accounts"
February 14, 2014, Raymond Sheffield, attorney at law, Sheffield Law Office, "Handling retirement accounts after a death"
February 21, 2014, Professor Patricia Cain, Santa Clara University School of Law, "Tax issues for same sex couples"
February 28, 2014, David Howard, attorney at law, Hoge, Fenton Jones & Appel, "Tax reporting of foreign bank and investment accounts for individuals"

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.

Dear readers:

Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" (www.realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.

Many other questions relate to short sales and foreclosures. See our article on that subject at www.realestateinvestingtax.com/shortsale.shtml.

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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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Follow me on Social Media!

Want to see new episodes of Financial Insider Weekly as soon as they're posted on Youtube? Like to see Michael Gray's blog posts as soon as they're live? We post them (and more) on social media!

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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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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