Michael Gray, CPA's

Real Estate Tax Letter

November 7, 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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Michael Gray will be out of the office most of November.

Michael Gray will be out of the office from November 11 through November 24. Our office will be closed for Thanksgiving on November 27 and 28. With year-end training updates to prepare for next tax season, Christmas and New Years, he also will have limited availability during December. We recommend that you reserve your year-end planning appointment now. Call Dawn Siemer weekdays except Tuesday at 408-918-3162.

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Interest deduction disallowed for loan modification.

A married couple had a loan modification where the lender added $30,000 of past-due interest to the principal of a replacement loan. The lender issued a Form 1098, Mortgage Interest Statement, showing $9,000 of interest received during 2010. The taxpayers claimed $48,000 as a home mortgage interest deduction on the 2010 federal income tax return.

The Tax Court upheld the IRS in disallowing the additional interest. Since the replacement mortgage loan was with the same lender, the interest wasn't paid by the taxpayers during 2010. (If the taxpayers had refinanced the mortgage with a different lender, they might have succeeded in deducting the $30,000 past-due interest added to the new mortgage.)

(Copeland, TC Memo. 2014-226.)

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IRS Chief Counsel says residence exclusion can eliminate the benefit of passive losses.

Suspended passive activity losses are recognized when the passive activity is sold. What if the passive activity was a residence qualifying for the exclusion for sale of a principal residence? According to the IRS Chief Counsel, the loss is applied against the gain from the sale of the residence. Since the gain might otherwise be excluded, this can eliminate the tax benefit of the "freed up" passive losses.

For example, Jane, a single taxpayer, sells her rental home during 2014 for a $200,000 gain. The home was previously her principal residence, and qualifies for the $250,000 exclusion of gain. Jane had $30,000 of unused passive activity losses when she sold the home. According to the IRS Chief Counsel, the $30,000 loss is applied against the $200,000 gain, leaving $170,000 which is excluded from taxable income using the sale of principal residence exclusion. Since the gain would be excluded from taxable income anyway, Jane would receive no tax benefit from her passive losses.

If Jane's gain before applying the passive activity loss deduction was $280,000, she would have received a tax benefit by reducing the gain by the $30,000 passive loss to $250,000, enabling her to use her full $250,000 exclusion for sale of a principal residence.

(CCA 201428008, April 21, 2014.)

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Deduction allowed for buy-out of lease.

ABC Beverage Corporation found that the rent it was paying under its lease was too high. It exercised an option to buy the property for more than $9 million. Appraisals valued the property without the lease at $2.75 million and the fair market value of the property with the lease was about $9 million.

ABC capitalized $2.75 million of the purchase price and deducted $6.25 million as a business expense for terminating the lease.

The IRS disallowed the deduction and claimed the entire purchase price should be capitalized.

The Sixth Circuit Court of Appeals upheld a summary opinion by a U.S. District Court that the portion of the payment for terminating the lease was tax deductible.

The Court had made a similar ruling before in Cleveland Allerton Hotel, Inc. v. Comissioner (48-1 U.S.T.C. 9218.) The Court examined Supreme Court and other decisions since 1948 and found no reason to change its conclusion.

Remember the lessee was buying the property from the lessor, so it was receiving a business benefit from the purchase and elimination of the lease. If the facts are right, this can be a great result when buying leased property.

(ABC Beverage Corporation, 2014-1 U.S.T.C. 50,320, June 13, 2014.)

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Charitable contribution deduction disallowed for failure to disclose quid pro quo.

The Tax Court upheld the IRS in disallowing a charitable contribution deduction by a limited liability company for its contribution of exterior and interior conservation easements on a building. In exchange for the donation, the taxpayer received from a city (1) approval of zoning changes and (2) the recommendation by a city agency that the city's Planning Board grant a view plane (height) variance.

The taxpayer didn't value these benefits and offset the value against the appraised value for the easements. (The taxpayer's tax attorney recommended that the offset should be done, but the taxpayer said it didn't believe the benefits received had any value.)

Therefore, the deduction was disallowed and an accuracy penalty was imposed. The taxpayer should have at least disclosed the benefits received in its tax return.

(Seventeen Seventy Sherman Street, LLC., T.C. Memo. 2014-124.)

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Estate exemption portability election extended for some taxpayers - but time is short!

Back in February, the IRS issued Revenue Procedure 2014-18, extending the due date for estates of decedents who died during 2011 or 2012 to file an estate tax return solely to make a "portability election" to December 31, 2014. The portability election allows a surviving spouse to receive and use the unused lifetime estate and gift tax exemption of a deceased spouse.

For example, Jane was deceased on December 1, 2013. She didn't make any gifts during her lifetime and would only have a taxable estate of $500,000. Her estate was below the threshold for which a federal estate tax return is required to be filed. If the portability election was made, her surviving spouse, Judy (same sex couple), would receive Jane's unused exemption of $5,250,000 - $500,000 = $4,750,000. In order for the portability election to be made, a timely federal estate tax estate return would have to be filed for Jane.

I intentionally used the same-sex married couple example, because these are the individuals most likely to benefit from this Revenue Procedure. Before the federal Supreme Court's Windsor decision last year, they weren't eligible to make a portability election or qualify for a federal estate tax marital deduction.

If you think you or a friend or relation qualify and would benefit from making this election, see or refer them to a qualified tax return preparer now.

(Revenue Procedure 2014-18.)

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Completed contract method not allowed for land development.

The Howard Hughes Company, LLC was in the land development business and sold residential lots. It claimed it was eligible to defer income from the sale of the lots under the completed contract method.

The Tax Court upheld the IRS in disallowing the completed contract method as an accepted accounting method for this taxpayer. The Hughes Company didn't build homes on the lots and sell them to final consumers. In contrast, Shea Homes (142 T.C. No. 3, February 12, 2014) was in the home building business and was successful in persuading the Tax Court that the completed contract method was appropriate because additional services, such as a water plant and recreational facilities, weren't completed until after most of the homes in a project were sold.

(The Howard Hughes Company, LLC, 142 T.C. No. 20, June 3, 2014.)

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Retirement plan contribution limits increased for 2015.

The IRS has announced 2015 cost of living adjustments for retirement plan contributions. The 401(k) elective contribution will increase from $17,500 to $18,000. The "catch up" contribution for plan participants age 50 and over will increase from $5,500 to $6,000. The limitation for defined contribution plans, such as profit sharing plans, will increase from $52,000 to $53,000. The annual benefit limit for defined benefit plans will be unchanged at $210,000.


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Maximum social security wage base increases for 2015.

The maximum wages subject to social security taxes will increase from $117,000 for 2014 to $118,500 for 2015.

(SSA News Release and Fact Sheet.)

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California offers a tax break for donations helping fund college educations.

California is offering a 60% tax credit for 2014 for donations to fund Cal Grants. (The credit will be 55% for 2015 and 50% for 2016.) The credit is called the California College Access Tax Credit. The credit will be allowed on the California income tax return instead of a donation deduction, but the donation will still be deductible on the federal income tax return.

The credit can't be used to reduce the California regular tax below the California alternative minimum tax. Unused credits can be carried forward for six years.

In order to claim the credit, a taxpayer will have to submit an application and be granted a credit allocation. The maximum amount of tax credits that can be allocated and certified for 2014 is $500 million.

Applications will be available on the California Educational Facilities Authority web site, www.treasurer.ca.gov, beginning November 3, 2014.

(Spidell's Flash E-mail, 10/29/14 and Spidell's California Taxletter®, October 1, 2014, page 3.)

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Privacy policy update.

We recently updated our privacy policy with our current hosting company and some additional information about how we collect information about our visitors. For more information, visit www.realestateinvestingtax.com/noindex/privacy.shtml.

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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 anytime, or Wednesdays, Thursdays, or Fridays before 2pm to make an appointment.

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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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Financial Insider Weekly broadcast schedule for November and December.

Financial Insider Weekly is broadcast in San Jose and Campbell on Fridays at 9:30 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 7 and 14, 2014, Cynthia Sue Larson, MBA, Life Coach, "How to manage emotions for financial decisions"
November 21, 2014, Mari Ellen Loijens, Silicon Valley Community Foundation, "Why and how to promote charitable giving in your family"
November 28, 2014, Tom Oviatt, Wymac Capital, Inc., "Reverse mortgage developments"
December 5 and 12, 2014, Deborah Price, Money Coach, The Money Coaching Institute, "The heart of money - a couples' guide to financial harmony"
December 19, 2014, Don Pollard, CLU, ChFC, Advanced Professionals, "Update on individual health insurance under Health Care Reform
December 26, 2014, Don Pollard, CLU, ChFC, Advanced Professionals, "Group medical insurance for small businesses"

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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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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