Michael Gray, CPA's Real Estate Tax Letter

December 9, 2016

© 2016 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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'Tis the season for year-end planning.

There is only a month and a half remaining for 2016. Make your year-end planning appointment now. Call Dawn Siemer on Mondays, Wednesdays or Fridays at 408-918-3162.

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Days closed for the holidays.

Our office will be closed December 23 and 26 and January 2. Happy holidays!

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1031 exchange with subsidiary disallowed.

An incorporated real estate leasing company sold a piece of real estate for a realized gain of about $1,888,000. The sale proceeds were deposited with a qualified intermediary. The company didn't find a satisfactory replacement property within the 45-day identification period, so the exchange was completed with the purchase of property from a subsidiary of the company. The subsidiary had a realized gain of about $3,127,000 on its "leg" of the transaction. The subsidiary sold its replacement property within two years of the exchange, but used a net operating loss to eliminate the tax on the gain.

The Tax Court upheld the IRS in disallowing the exchange as tax-deferred. Under Internal Revenue Code Section 1095(f) an exchange between related parties is disallowed if one of the properties is sold within two years of the exchange, unless the taxpayer can establish that one of its principal purposes wasn't the avoidance of federal income tax.

In this case, the elimination of the tax using a net operating loss carryover "poisoned" the exchange. As a result, the parent had to pay income tax for its "leg" of the exchange.

(The Malulani Group, Limited and Subsidiary v. Commissioner, T.C. Memo. 2016-209, November 16, 2016.)

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Losses for worthlessness disallowed.

A real estate developer S corporation claimed a $10.8 million loss on its 2008 income tax returns. $8,928,845 of the loss was attributable to worthlessness of residential lots. The owner of the S corporation deducted the loss on his 2008 income tax return and claimed refunds for carryback of the net operating losses.

The Eighth Circuit Court of Appeals upheld the Tax Court in disallowing the losses for worthlessness of the properties.

Although the S corporation had shut down its office and terminated its employees during 2008, the company continued to settle recourse mortgages secured by the properties that were foreclosed upon, sold some of the properties and continued to develop some of the properties.

Therefore, the properties were not abandoned and were not wholly worthless as of December 31, 2008.

The general rule for properties that are security for recourse mortgages is the property is not considered to be disposed until the property is transferred in foreclosure.

This is a sad case for a person who suffered major losses due to the 2008 housing market crash. Some of his losses might have been deductible for later years.

(Tucker, 2016-2 U.S.T.C. 50,482, November 21, 2016.)

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Trump tax proposals make tax planning more uncertain.

We sent subscribers to this newsletter a summary of some of President-elect Trump's tax proposals. If you didn't receive it and would like to have it, call Dawn Siemer at 408-918-3162 or email her at dgsiemer@taxtrimmers.com.

A proposal that I didn't discuss is to repeal head of household filing status. That change could result in a tax increase for single-parent households. The Republican proposal in Congress doesn't include this change, and I think it will likely be eliminated as tax reform is negotiated.

As Yogi Berra said, "It ain't over 'til it's over!" Uncertainty reigns.

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First real estate tax payment due date is December 12.

Remember to make your first real estate tax payment by December 12 to avoid a nasty penalty. Some people like to pay the full amount to accelerate the tax deduction for the second installment. Before doing so, check whether you are subject to the alternative minimum tax for 2016, which eliminates the tax benefit.

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Fourth-quarter calendar year corporate estimated tax payment is due December 15.

The final 2016 estimated tax payment for calendar-year corporations is due December 15, 2016. Not all corporations can base their federal estimated tax payments on the previous year's income tax return. For example, new corporations and corporations that had no tax liability for the previous year must compute their estimated tax using the current year's facts. See your tax advisor for assistance.

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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, 2017. Remember California taxpayers with taxable income of $1 million or more must pay their estimated taxes using the current year's facts.

Consider making the payment by December 31, 2016 for a 2016 tax deduction. Watch the alternative minimum tax.

Depending on your situation, you might be better off waiting until 2017 to make the final California estimated tax payment. Under the Trump tax proposal, the alternative minimum tax would be repealed. Another proposal is to increase the standard deduction.

See your tax advisor.

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Consider deferring income.

Under the Trump tax proposals, most high-income individuals and businesses will have lower tax rates in 2017 than in 2016. That means it's better to wait to take long-term capital gains and to receive dividends and ordinary income (like bonuses) next year. See your tax advisor about whether this applies to you and any actions you should or shouldn't take.

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Estates and trusts should plan distributions.

The maximum 39.6% federal income tax rate and the 3.8% tax on net investment income hit estates and trusts especially hard. They apply when the undistributed estate or trust income exceeds $12,400. If possible, the income of the estate or trust should be distributed to beneficiaries before the year-end, since the threshold for these taxes is much higher for individuals. (The income of some trusts is automatically considered distributed. See your tax advisor.) An election is also available to treat distributions made during the first 65 days of the following year (for example, January 31, 2017) as distributed for a taxable year (for example 2016).

In most cases, capital gains don't qualify for the distribution deduction. See your tax advisor.

The beneficiaries should be involved in this decision and be informed about the additional income to be reported on their income tax returns (in writing) to avoid unpleasant surprises.

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Remember to "reset" payroll on January 1.

Software providers will issue updates including the new payroll tax tables as of January 1, 2017. Be sure you have installed those updates before processing your first payroll for 2017.

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Should you make additional tax payments before December 31?

State estimated tax payments and early property tax payments made by December 31 are generally tax deductible for the regular tax. However, many people are finding they are subject to the alternative minimum tax. Deductions for taxes (and miscellaneous itemized deductions) aren't allowed for the alternative minimum tax, so there could be no benefit for a tax prepayment. A tax advisor can project your tax picture to determine if the AMT will apply. Turbo Tax and other tax preparation software can also be used to make the computations.

This situation has changed somewhat because of the 3.8% net investment income (NII) tax. Part of the state tax payment may be a "good" deduction for the NII tax even though there is no AMT benefit. See your tax advisor.

Under the Trump tax proposals, the alternative minimum tax would be repealed. In that case, it might be better to make your state tax payment next year.

Another proposal is to increase the standard deduction to $15,000 for singles and $30,000 for married persons filing joint returns. For some taxpayers, this will eliminate the deduction for state income taxes. Those taxpayers might be better off paying their state income taxes this year.

See your tax advisor.

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Should you adopt an accounting policy for small equipment purchases by December 31, 2016?

An election is available to currently deduct small expenditures when the taxpayer doesn't have an applicable (audited) financial statement. Items up to $2,500 may be currently deducted, effective for amounts paid or incurred for tangible property on or after January 1, 2016, for taxable years beginning on or after January 1, 2016. The election doesn't apply for inventoriable costs.

Among other requirements, in order to qualify for the current deduction: at the beginning of the taxable year, the taxpayer must have accounting procedures treating as an expense for non-tax purposes - (1) amounts paid for property costing less than a specified dollar amount; or (2) amounts paid for property with an economic useful life of 12 months or less. The taxpayer must also treat the amount paid for the property as an expense on its books and records in accordance with the accounting procedures. The amount paid for the property may not exceed $500 per invoice or per item, as substantiated by the invoice.

Note the de minimus election is made each year on the income tax return for the business.

In order to be in position to make the election for 2017, you must have the accounting policy in place by December 31, 2016 and implement that policy in your accounting throughout 2017. If you didn't have the policy for 2016, consider getting it in place by December 31, 2017. We recommend that the policy should be written.

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New California efiling and electronic deposit requirement.

During 2016, California adopted new efiling and electronic payment requirements. Effective January 1, 2017, employers with 10 or more employees will be required to electronically submit employment tax returns, wage reports and payroll tax deposits to the Employment Development Department. All remaining employers will be subject to this requirement beginning January 1, 2018.

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New Form I-9 issued.

Remember to complete Form I-9, Employment Eligibility Verification, for all new employees. Use the revision dated November 14, 2016. You can find the forms at www.uscis.gov or at an office supply store. You do not submit Form I-9 to a government agency, but keep it in the employee's personnel file.

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New California Security Choice Retirement Program.

Governor Brown approved the California Security Choice Program on September 29, 2016. Under the new law, all California employers with five or more employees who do not offer their employees another retirement savings option will be required to to participate in the California Secure Choice Retirement Program. Initially beginning 12 months after the opening of enrollment, employers of 100 or more employees must arrange to allow employees to participate in the plan. Beginning 24 months after the opening of enrollment, employers of 50 or more employees must participate. Beginning 36 months after the opening of enrollment, the mandate applies to employers with 5 or more employees.

If this applies to your business, see your tax advisor for details.

(California SB 1234.)

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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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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 and siliconvalley.citysearch.com.

We use Angie's List to assess whether we're doing a good job keeping valued customers like you happy. Please visitAngiesList.com/Review/4258970 in order to grade our quality of work and customer service.

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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:

December 2 and 9, 2016, William D. Mahan, attorney at law, "Why you need a will"
December 16, 2016, William D. Mahan, attorney at law, "Tax considerations of title"
December 23 and 30, 2016, Phil Price, EA, The Price Company, "Qualified retirement plans for small businesses"
January 6, Don Pollard, CLU, ChFC, Advanced Professionals, "Health Insurance Update for Individuals"
January 13, Don Pollard, CLU, ChFC, Advanced Professionals, "Health Insurance Update for Small Businesses"
January 20 and 27, Peter Moss, Wymac Capital, "Residential mortgage market update"

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 Twitter, Facebook, LinkedIn and Google+!

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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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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