10 NATP TAXPRO Journal / natptax.com

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1 10 NATP TAXPRO Journal / natptax.com

2 Top 25 Research Questions (and the answers, of course!) By NATP s Research Staff Throughout the year, NATP s Tax Knowledge Center answers tens of thousands of questions from members like you. The questions run the gamut from individual to corporate, and simple to complex, but every year there are some topics that pop up more often than others. Here s what you wanted to know in Spring 2015 / NATP TAXPRO Journal 11

3 1 Linda is moving out of state. She can t sell her home so she converts it to a rental. What basis will she use to depreciate the rental? Per Reg (i)-4(b) the depreciable basis for a personal asset converted to business use is the lower of (1) the adjusted basis, or (2) the FMV of the property on the date of conversion. The recovery period will be the one in effect in the year of the conversion. The recovery period for a personal home converted to a residential rental is 27.5 years. 2 Carl converted his home from a personal residence to a rental and later sold it. Since he owned and occupied the home for two of the past five years, is he entitled to exclude the gain under 121? How is this sale reported? As long as the taxpayer used the home during two of the past five years as his personal residence, he is entitled to exclude part of the gain under 121. The amount of depreciation allowed on the property, to the extent of the gain, is taxable as unrecaptured 1250 gain at a maximum capital gain rate of 25%. The sale is reported on Part III of Form 4797, Sale of Business Property. The gain on line 32 will carry over to line 6, Part I. The 121 exclusion will go on line 2. The net on line 7 represents the taxable depreciation and is reported on Schedule D. 3 Amy had a student loan canceled because of disability. She is solvent. Is the cancellation of debt taxable income? Yes. To exclude the cancellation of debt from income, one of the exceptions under 108 must apply. Section 108 does not provide an exception for disability. The only provision that would apply is insolvency. Since the taxpayer is solvent, she must include the debt cancellation in income. Section 108(f )(1) provides that income from the discharge of a student loan is not included in gross income if the discharge was made under a provision of the loan that all or part of the indebtedness would be discharged if the taxpayer worked for a certain period of time in certain professions for any broad class of employers. Since the discharge resulted from a hardship provision under the terms of the loan, 108(f ) would not apply. 4 Calvin made a nondeductible contribution to an IRA (a contribution to a Roth IRA was not an option because his AGI was too high). The taxpayer neither made deductible contributions to an IRA nor rolled over amounts from a qualified plan into a traditional IRA. Can Calvin convert the nondeductible traditional IRA to a Roth IRA immediately after the contribution and not recognize income in the year of conversion? Yes. There is no set amount of time that the taxpayer must leave contributions in a traditional IRA before converting it to a Roth IRA. If Calvin has never made any deductible contributions to an IRA, he will be able to convert the nondeductible IRA to a Roth IRA without recognizing any income on the conversion. 5 Laura owns a vacation home that is both rented and used personally during the year. Can she do a 1031 exchange to defer the gain from the sale of the vacation home? No. The deferral of gain in a like-kind exchange under 1031 is normally not available for homes unless the home was held for the production of income or as investment property. A vacation home does not qualify for like-kind exchange, even if one of the motives in acquiring the home was the prospect of appreciation (Moore). However, Rev. Proc provides a safe harbor for when a second home will qualify as held either for productive use in a trade or business or for investment purposes. Under Rev. Proc , the IRS will not challenge that a property qualifies for 1031 gain deferral if: The relinquished property has been held for at least 24 months immediately preceding the exchange and in each of the two 12-month periods immediately preceding the exchange, the taxpayer (1) rents the residence to another person at fair market value for at least 14 days, and (2) does not use the property more than the greater of 14 days or 10% of the total number of days the property was used; and The replacement property is held for at least 24 months immediately after the exchange and in each of the two 12-month periods immediately following the exchange, the taxpayer (1) rents the residence to another person at fair market value for at least 14 days, and (2) does not use the property more than the greater of 14 days or 10% of the total number of days the property was used. 12 NATP TAXPRO Journal / natptax.com

4 If personal use is more than the greater of 14 days or 10% of the rental days, gain cannot be deferred under Just after selling his rental property, Stan s realtor tells him he can do a 1031 exchange by buying replacement property within a certain number of days. Can Stan defer the gain from the sale of the property by buying another rental property? No. The taxpayer has already received the cash (boot), which fully triggers the recognition of gain. The taxpayer needed a qualified intermediary to receive the sales proceeds and then purchase the replacement property to qualify for a tax-deferred exchange under Kelly received a payment pursuant to the National Mortgage Settlement due to a foreclosure on her principal residence. Is the settlement payment taxable? It depends on why the taxpayer received the settlement payment. Rev. Rul includes several different scenarios designed to address the taxability of the settlement based on why the taxpayer received the payment. 8 Alfonzo is a U.S. citizen by birthright but has lived in another country for his entire life. He just recently found out at the age of 30 that he should be filing U.S. income tax returns. Is his income really taxable to the United States? Yes. U.S. citizens and resident aliens are taxed on worldwide income, whatever source derived. Whether it s taxable in another country theoretically has little bearing on whether it s taxable in the U.S. The assumption is that it s always taxable. However, it s best to consult the tax treaty. Normally a treaty that contains a savings clause doesn t help U.S. citizens or resident aliens. 9 Ted failed to take a required minimum distribution (RMD) from his IRA. Is there any way he can avoid the 50% tax on the excess accumulation? Yes. The IRS can waive the penalty if the taxpayer takes steps to correct the error (takes the RMD) and explains that the error was due to reasonable cause. Ted needs to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, for the year he should have taken the RMD and ask the IRS to waive the 50% penalty. The RMD is taxable in the year it is withdrawn. 10 Roger received Form 1099-A reporting the foreclosure of a fully depreciated residential rental that was worth $100,000. Can he exclude from gross income any gain on the deemed sale by filing Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082 Basis Adjustment), and use the insolvency exclusion? No. The insolvency exclusion only applies to cancellation of debt income reported on Form 1099-C. The taxpayer cannot exclude from gross income the gain on the deemed sale due to foreclosure using the insolvency exclusion. However, if the deemed sale results in a loss, the loss is deductible regardless of insolvency. 11 Barb has several IRAs that consist of deductible and nondeductible contributions. The taxpayer is not eligible to make a contribution to a Roth IRA for 2014 because her AGI is too high. Can Barb convert only the nondeductible traditional IRA contributions to a Roth IRA without taking into account any other traditional IRA accounts containing deductible contributions? No. When converting a traditional IRA to a Roth IRA, the taxpayer must aggregate all traditional IRAs to determine the tax-free amount in the conversion. In Barb s case, part of the conversion will be taxable. 12 Lonn passed away in In 2014, his surviving spouse received a Form 1099 C in his name and social security number for debt that was canceled in How does the surviving spouse report the deceased spouse s canceled debt? The cancellation of debt (COD) is reported on the decedent s estate income tax return, Form If the estate meets an exception for reporting the COD as taxable income (insolvency, bankruptcy, etc.), the taxpayer can attach Form 982 to Form 1041 to report the exclusion. Spring 2015 / NATP TAXPRO Journal 13

5 13 Sue inherited her mother s principal residence. Her mother was the only owner of the residence at the time of her death. Sue fixed up the home and sold it eighteen months later. There was no requirement to file Form 706, United States Estate (and Generation- Skipping Transfer) Tax Return. What is her basis in the home? In general, the basis of the home is the fair market value on the date of the decedent s death [ 1014(a)(1)]. Improvements that the taxpayer made to the home are added to the basis. 14 Are health insurance costs for a selfemployed taxpayer who receives a premium tax credit still deductible? Yes, with a special calculation. The IRS is still in the process of finalizing regulations to clarify the self-employed health insurance deduction for taxpayers who are receiving premium tax credits. In the meantime, the IRS released Rev. Proc , which provides examples in calculating the self-employed health insurance deduction. Effectively, you must repeat calculations to determine the deduction based on what the taxpayer is receiving through the year as a premium tax credit. 15 Stuart has always reported his foreign investment income on his Form 1040 but never filed an FBAR (FinCen Form 114). What should he do? The taxpayer should file prior year FBAR forms electronically. Per IRS FAQ regarding late filing, the IRS normally won t penalize individuals who file their FBAR late as long as they have reported their world-wide income on timely filed returns. Those who neglected to declare the income should consider the streamline disclosure process. 16 Roxanne owned a second home, which she never rented to others or used personally. She sold the second home at a loss. Is that loss deductible? It depends. In order to deduct a loss under 165, the taxpayer must have acquired the asset with the primary intent of making a profit. Numerous court cases have stated that simply holding it for the possibility of appreciation is not enough to show profit intent. The presumption is more likely a nondeductible personal loss. However, it s rebuttable if the taxpayer can show that her primary intent was to produce income from the residence and not to hold the property for personal enjoyment. 17 Don is self-employed and has a SEP. Can he contribute to the SEP, based on his selfemployment contribution, and to his traditional IRA? The SEP-IRA is considered a qualified employer plan and has no bearing on the traditional or Roth IRA contribution limits. The IRA contribution limit applies to the combined contributions to all of the taxpayer s traditional and Roth IRAs only [IRC 408A(c)(2)]. 18 An employer does not provide a group health plan, but instead reimburses employees for a portion of the premiums that they personally pay for coverage. Can this reimbursement be made tax-free to the employees? No. The Department of Labor states that if the employer uses an arrangement that provides cash reimbursement for the purchase of an individual market policy, the employer s payment arrangement is part of a plan, fund or other arrangement established or maintained for the purpose of providing medical care to employees, without regard to whether the employer treats the money as pre-tax or post-tax to the employee An NOL carryback to a prior year resulted in the taxpayer s social security benefits becoming nontaxable. There are other recomputations as well. As a result, it appears these recomputations create an NOL in the carryback year. Is this possible? No. The NOL for the carryback year is calculated without taking the carryback amount into consideration. Therefore there would not be an NOL generated in the carryback year. 20 In the case of separated parents, who is the custodial parent? The custodial parent is the parent with whom the child spends the most number of nights. It doesn t matter what is stated in the divorce decree. During a leap year, if the nights are equal, the parent with the highest AGI is the custodial parent. 14 NATP TAXPRO Journal / natptax.com

6 21 John was injured in a car accident. He received a settlement that included payment for physical injury and punitive damages. Is the entire settlement amount treated as nontaxable damages received due to physical injury? No. Punitive damages, which are awards to punish the wrongdoer, are taxable to the recipient whether they are received for physical or nonphysical injury. Only the amount received for physical injury is excluded from taxable income. 22 Cheryl owned a residence where she lived for six years. She placed her home up for sale and purchased a new home. She moved into the new home on June 1 before she sold her old home. To help offset expenses, Cheryl rented her old home until it sold on August 15. Is the rental income she received reported on Form 1040 Schedule E? No. The IRS allows for a temporary rental of a principal residence while it is up for sale. The facts and circumstances indicate that Cheryl did not intend to convert her former residence to a rental activity. The income she received for the 2½ months is not reported on a Schedule E, rather it s reported on line 21 of Form 1040 as other income, reduced, but not below zero, by related expenses. 23 Tim owned his residence for five years and has used it as his principal residence for the entire time. Tim became engaged to Jane three years ago, and she moved in with him. In 2014, Tim and Jane married and they decided to sell the house. Can the couple claim the full $500, exclusion or are they limited to Tim s $250,000 because Jane does not meet the ownership test? Reg (a) (3) allows the full $500,000 exclusion if the couple files a joint return. At least one spouse must meet the ownership test, both must meet the use test, and neither could have used the exclusion in the two years prior to the sale. Even though Jane did not own the home, she met the use test with regard to the residence. 24 George rolled his $100, (k) over to an IRA in order to facilitate a ROBS (rollover for business start-up) transaction. He only made pre-tax contributions to the 401(k). The IRA was absorbed into the retirement plan of the new C corporation and 100% of the stock was issued to the retirement plan, giving the C corporation the cash. Unfortunately, the business failed and the stock is worthless. Can George take a loss for worthless stock? No. The stock of the corporation is not owned by George, rather the retirement plan owns the shares. Retirement plans are separate entities from the plan owner; therefore only the plan recognizes the loss resulting from the worthlessness of the stock. Economically, George has lost all of his retirement funds. If the retirement plan is distributed to George, he would not have a loss because he made all pre-tax contributions and has no basis in the plan. If George had been allowed to make (and actually did make) non-deductible (after-tax) contributions to the plan, he would have been allowed a loss to the extent of his remaining basis. 25 A married couple separated in February 2014 and did not live together for the remainder of the taxable year. There was no final divorce before December 31, 2014, and the couple filed separate returns for Since they did not live together at any time during the last six months of the year, can each of them convert their regular IRA to a Roth IRA before the due date (plus extensions) for filing their tax return for 2014? No. Married taxpayers who file separate returns and live together at any time during the tax year are not permitted to convert a regular IRA to a Roth IRA. If they did not live together at any time during the year, they may be considered unmarried for purposes of converting an IRA to a Roth IRA [Reg A-4, Q&A-2(b)]. n Spring 2015 / NATP TAXPRO Journal 15