Michael Gray, CPA's

Real Estate Tax Letter

May 9, 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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Do you need help with your extended 2013 income tax returns?

The extended due date for calendar year business income tax returns is September 15 and the extended due date for calendar year individual income tax returns is October 15. We are already hard at work for these tax returns for many of our clients and we would welcome more. May we be of service with your extended returns? Call Dawn Siemer at 408-918-3162 on Mondays, Wednesdays or Fridays to make an appointment.

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Do you need help with amended income tax returns?

We have already been meeting with folks who want a second look at their 2013 income tax returns for possible corrections. Call Dawn Siemer at 408-918-3162 on Mondays, Wednesdays or Fridays to make an appointment.

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The earlier you do tax planning, the better.

Many people wait until the year-end for tax planning, but it's better to do it earlier in the year when it's easier to act on it. Why not make a tax planning appointment today? Call Dawn Siemer at 408-918-3162 on Mondays, Wednesdays or Fridays to make an appointment.

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Guarantee by LLC member puts member at risk.

The IRS Chief Counsel has issued advice stating that when a member of an LLC guarantees a debt of the LLC and there is no right of contribution from members other than the LLC and the member isn't otherwise protected against loss, the member is considered to be at risk with respect to the debt. The conclusion is important, because the amount at risk gives the member an additional investment amount for which losses can be claimed.

If the debt for which a guarantee is given was previously qualified nonrecourse financing (usually nonrecourse financing secured using real estate), the other members of the LLC could be considered as having received distributions of cash, which could result in their having taxable income.

Business owners have to balance the tax benefits of getting deductible losses against the liability they accept, since the purpose of an LLC is to seek protection from liability.

(AM 2014-003.)

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Trust qualified as a "real estate professional."

In a case that will become important for exempting certain rental real estate income from the 3.8% net investment income tax, the Tax Court has ruled a trust can qualify as a "real estate professional" so that its real estate activities can be excluded from the passive activity limitations. The participation of individuals who served both as trustees and employees of the trust's wholly-owned limited liability company was counted as participation of the trust, so that it could meet the 750 hour test and more than one-half of business activity test.

In this case, losses that would otherwise have been suspended under the passive activity loss rules were allowed as current tax deductions.

(Note this case does not apply to a revocable living trust. The income and deductions for those trusts are reported on the income tax return of the grantor(s). The trust for this case was irrevocable. Almost all of the investment income for irrevocable trusts can be subject to the 3.8% net investment income tax, so the case is very significant for irrevocable trusts that hold rental real estate that generates significant rental income.)

(Frank Aragona Trust, 142 T.C. No. 9, March 27, 2014.)

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Real estate agent can't deduct rental losses.

Charles and Delores Gragg deducted losses from two rental properties on their 2006 and 2007 income tax returns. Delores worked as a full-time licensed real estate agent. The Graggs claimed that as a full-time real estate professional, Delores didn't have to establish material participation for the properties in order to be exempt from the passive activity loss rules and currently deduct the losses.

A federal district court in California upheld the IRS's determination that material participation must also be established for the properties in order to qualify to currently deduct the losses. Since the Graggs didn't elect to treat all interests in real estate as one activity, material participation must be established for each property.

(Since the Graggs' total rental income from the two properties was only $15,600 for 2006 and $20,000 for 2007 while Delores's earnings as a real estate agent were $217,132 for 2006 and $312,320 for 2007, she clearly didn't have time for material participation in the rental properties.)

This case illustrates the confusion in the real estate community of the "real estate professional" rules. The IRS is actively pursuing these cases, so be sure to get good advice about how to document your status as a real estate professional with material participation for your properties if you are going to claim the benefits.

(Gragg, 2014-1 U.S.T.C. 50,245, March 31, 2014.)

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Foreclosure makes passive loss carryovers currently deductible.

The IRS Chief Counsel has ruled that a foreclosure of real property subject to a recourse debt qualifies as a fully taxable disposition under the passive activity loss rules. Therefore, any passive activity losses carried forward with respect to the foreclosed property are currently deductible for the year of the foreclosure.

In this case, the taxpayer qualified for an exclusion of cancellation of indebtedness because he was insolvent. The Chief Counsel noted that, according to Internal Revenue Code Section 108(b)(4), reductions to tax attributes related to excluded cancellation of indebtedness income are made after the determination of tax for the year of discharge. Since there were no passive activity loss carryovers left to reduce, no reduction was required.

(IRS Letter Ruling 201415002, February 11, 2014.)

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Corrections issued from Net Investment Income Regulations.

The IRS has issued corrections to the final Net Investment Income Regulations that were issued during December 2013. The corrections clarify that foreign taxes for which a deduction instead of a tax credit is claimed for regular tax reporting are also deductible when computing the net investment income tax.

They also clarify that a 500 hour test applies to each rental property for exclusion from net investment income unless the taxpayer elects to aggregate all real estate activities as a real estate professional. (Some taxpayers were interpreting the regulations as previously stated to mean that if you qualify for one property, you qualify for all properties.)

(TD 9644.)

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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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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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Broadcast times change for Financial Insider Weekly in Santa Cruz County, Watsonville & Capitola.

The broadcast days and times for Financial Insider Weekly have changed to Sunday at 1 p.m. and Tuesday at 10:30 a.m. The show is broadcast on Comcast channel 26 in Santa Cruz County and Charter Communications Channel 2 in Watsonville and Capitola.

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Financial Insider Weekly broadcast schedule for May and June.

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 May and June:

May 9, 2014, attorney Jeffrey B. Hare, P.C., "Legal due diligence for real estate transactions"
May 16, 2014, Phil Price, E.A., The Price Company, "Retirement plan alternatives for small businesses"
May 23, 2014, Mayuri Onerheim, "Money, Spirituality, Consciousness"
May 30, 2014, attorney Michael Desmarais, "Your rights as a beneficiary"
June 6, 2014, attorney Michael Desmarais, "Estate planning for second marriages"
June 13, 2014, attorney Jann Besson of Law Offices of Besson & Yarbrough, "Medi-CAL benefits for Long-Term Care"
June 20, 2014, Hilary Martin Hendershott, CFP®, The Family Wealth Consulting Group, "Why most people will never achieve their financial goals"
June 27, 2014, Craig Martin, CFP®, The Family Wealth Consulting Group, "The role of emotions in investing"

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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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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For general tax developments, tax planning ideas, business development ideas and book reviews, subscribe to Michael Gray, CPA's Tax & Business Insight at taxtrimmers.com/subscribe2.shtml.

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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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