Tax Break for Sales of Inherited Homes

Article Highlights: 

• Inherited Basis 
• Certified Appraisals 
• Loss On Sale 
• Potential Law Change 

People who inherit property are often concerned about the taxes they will owe on any gain from that property’s sale. After all, the property may have been purchased years ago at a low cost by a deceased relative but may now have vastly appreciated in value. The usual question is: “Won’t the taxes at sale be horrendous?”

Clients are usually pleasantly surprised by the answer—that special rules apply to figuring the tax on the sale of any inherited property. Instead of having to start with the decedent’s original purchase price to determine gain or loss, the law allows taxpayers to use the value at the date of the decedent’s death as a starting point (sometimes an alternate date is chosen). This often means that the selling price and the inherited basis of the property are practically identical, and there is little, if any, gain to report. In fact, the computation frequently results in a loss, particularly when it comes to real property on which large selling expenses (realtor commissions, etc.) must be paid. 

This also highlights the importance of having a certified appraisal of the home to establish the home’s tax basis. If an estate tax return or probate is required, a certified appraisal will be completed as part of those processes. If not, one must be obtained to establish the basis. It is generally not acceptable just to refer to a real estate agent’s estimation of value or comparable sale prices if the IRS questions the date of death value. The few hundred dollars it may cost for a certified appraisal will be worth it if the IRS asks for proof of the basis. 

Another issue is whether a loss on an inherited home is deductible. Normally, losses on the sale of personal use property such as one’s home are not deductible. However, unless the beneficiary is living in the home, the home becomes investment property in the hands of the beneficiary, and a loss is deductible but subject to a $3,000 ($1,500 if married and filing separately) per year limitation for all capital losses with any unused losses carried forward to a future year. 

In some cases, courts have allowed deductions for losses on an inherited home if the beneficiary also lives in the home. In order to deduct such a loss, a beneficiary must try to sell or rent the property immediately following the decedent’s death. In one case, where a beneficiary was also living in the house with the decedent at the time of death, loss on a sale was still deductible, when the heir moved out of the home within a “reasonable time” and immediately attempted to sell or rent it. 

This treatment could change in the future, however. The President’s Fiscal Year 2016 Budget Proposal includes a proposal that would eliminate any step up in basis at the time of death and would require payment of capital gains tax on the increase in the value of the home at the time it is inherited. 

If you have questions related to inheritances or home sales, please give this office a call.

www.paulandersoncpa.com

Writing Off Your Start-Up Expenses

Article Highlights: 

• $5,000 first-year start-up expense write-off 
• Start-up expense write-off limitations 
• Timely filing requirements 
• Qualifying start-up expenses 

Business owners – especially those operating small businesses – may be helped by a tax law allowing them to deduct up to $5,000 of the start-up expenses in the first year of the business’s operation. This is in lieu of amortizing the expenses over 180 months (15 years). 

Generally, start-up expenses include all expenses incurred to investigate the formation or acquisition of a business or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense must also be one that would be deductible if it were incurred after the business actually began. An example of a start-up expense is the cost of analyzing the potential market for a new product. 

As with most tax benefits, there is always a catch. Congress put a cap on the amount of start-up expenses that can be claimed as a deduction under this special election. Here’s how to determine the deduction: If the expenses are $50,000 or less, you can elect to deduct up to $5,000 in the first year, plus you can amortize the balance over 180 months. If the expenses are more than $50,000, then the $5,000 first-year write-off is reduced dollar-for-dollar for every dollar in start-up expenses that exceed $50,000. For example, if start-up costs were $54,000, the first-year write-off would be limited to $1,000 ($5,000 – ($54,000 – $50,000)). 

The election to deduct start-up costs is made by claiming the deduction on the return for the year in which the active trade or business begins, and the return must be filed by the extended due date. 

Qualifying Start-Up Costs - A qualifying start-up cost is one that would be deductible if it were paid or incurred to operate an existing active business in the same field as the new business and the cost is paid or incurred before the day the active trade or business begins. Not includible are taxes, interest, and research and experimental costs. Examples of qualified start-up costs include: 

• Surveys/analyses of potential markets, labor supply, products, transportation facilities, etc.; 
• Wages paid to employees and their instructors while they are being trained; 
• Advertisements related to opening the business; 
• Fees and salaries paid to consultants or others for professional services; and 
• Travel and other related costs to secure prospective customers, distributors, and suppliers. 

For the purchase of an active trade or business, only investigative costs incurred while conducting a general search for or preliminary investigation of the business (i.e., costs that help the taxpayer decide whether to purchase a new business and which one to purchase) are qualified start-up costs. Costs incurred attempting to buy a specific business are capital expenses that aren’t treated as start-up costs. 

If you have a question related to start-up expenses, please give this office a call. 

Intallment Sale -- a Useful Tool to Minimize Taxes

Selling a property one has owned for a long period of time will frequently result in a large capital gain, and reporting all of the gain in one year will generally expose the gain to higher than normal capital gains rates and subject the gain to the 3.8% surtax on net investment income added by Obamacare.

Capital gains rates: Long-term capital gains can be taxed at 0%, 15%, or 20% depending upon the taxpayer’s regular tax bracket for the year. At the low end, if your regular tax bracket is 15% or less, the capital gains rate is zero. If your regular tax bracket is 25% to 35%, then the top capital gains rate is 15%. However, if your regular tax bracket is 39.6%, the capital gains rate is 20%. As you can see, larger gains push the taxpayer into higher capital gains rates.

Surtax on net investment income – Tax law treats capital gains (other than those derived from a trade or business) as investment income upon which higher-income taxpayers are subject to a 3.8% surtax on net investment income. A large gain generally pushes a taxpayer’s income over the threshold for this tax. For individuals, the surtax is 3.8% of the lesser of (1) the taxpayer’s net investment income or (2) the excess of the taxpayer’s modified adjusted gross income (MAGI) over the threshold amount for his or her filing status. The threshold amounts are: 

• $125,000 for married taxpayers filing separately. 
• $200,000 for taxpayers filing as single or head of household. 
• $250,000 for married taxpayers filing jointly or as a surviving spouse. 

This is where an installment sale could fend off these additional taxes by spreading the income over multiple years. 

Here is how it works. If you sell your property for a reasonable down payment and carry the note on the property yourself, you only pay income taxes on the portion of the down payment (and any other principal payments received in the year of sale) that represents taxable gain. You can then collect interest on the note balance at rates near what a bank charges. For a sale to qualify as an installment sale, at least one payment must be received after the year in which the sale occurs. Installment sales are most frequently used when the property that is sold is real estate, and cannot be used to report the sale of publicly traded stock or securities. 

Example: You own a lot for which you originally paid $10,000. You paid it off some time ago, leaving you with no outstanding mortgage on the lot. You sell the property for $300,000 with 20% down and carry a $240,000 first trust deed at 3% interest using the installment sale method. No additional payment is received in the year of sale. The sales costs are $9,000.

Computation of Gain Sale Price       $300,000  Cost         <  $10,000>  Sales costs   <   $9,000> Net Profit      $281,000 Profit % = $281,000/$300,000 = 93.67%

Of your $60,000 down payment, $9,000 went to pay the selling costs, leaving you with $51,000 cash. The 20% down payment is 93.67% taxable, making $56,202 ($60,000 x .9367) taxable the first year. The amount of principal received and reported each subsequent year will be based upon the terms of the installment agreement. In addition, the interest payments on the note are taxable and also subject to the investment surtax. 

Thus in the example, by using the installment method the income for the year was reduced by $224,798 ($281,000 – $56,202). How that helps the taxpayer’s overall tax liability depends on the taxpayer’s other income and circumstances.

Here are some additional considerations when contemplating an installment sale. 

Existing mortgages – If the property you are considering selling is currently mortgaged, that mortgage would need to be paid off during the sale. Even if you do not have the financial resources available to pay off the existing loan, there might be ways to work out an installment sale by taking a secondary lending position or wrapping the existing loan into the new loan. 

Tying up your funds – Tying up your funds into a mortgage may not fit your long-term financial plans, even though you might receive a higher return on your investment and potentially avoid a higher tax rate and the net investment income surtax. Shorter periods can be obtained by establishing a note due date that is shorter than the amortization period. For example, the note may be amortized over 30 years, which produces a lower payment for the buyer but becomes due and payable in 5 years. However, a large lump sum payment at the end of the 5 years could cause the higher tax rate and surtax to apply to the seller in that year – so close attention needs to be paid to the tax consequences when structuring the installment agreement. 

Early payoff of the note – The buyer of your property may decide to pay off the installment note early or sell the property, in which case your installment plan would be defeated and the balance of the taxable portion would be taxable in the year the note is paid off early or the property is sold, unless the new buyer assumes the note. 

Tax law changes – Income from an installment sale is taxable under the laws in effect when the installment payments are received. If the tax laws are changed, the tax on the installment income could increase or decrease. Based on recent history, it would probably increase. 

Installment sales do not always work in all situations. To determine whether an installment sale will fit your particular needs and set of circumstances, please contact this office for assistance.

Tax Filing Deadline Rapidly Approaching

Article Highlights: 

• Balance due payments 
• Contributions to a Roth or traditional IRA 
• Estimated tax payments for the first quarter of 2015 
• Individual refund claims for tax year 2011 

Just a reminder to those who have not yet filed their 2014 tax return that April 15, 2015 is the due date to either file your return and pay any taxes owed, or file for the automatic six-month extension and pay the tax you estimate to be due. 

In addition, the April 15, 2015 deadline also applies to the following: 

• Tax year 2014 balance-due payments – Taxpayers that are filing extensions are cautioned that the filing extension is an extension to file, NOT an extension to pay a balance due. Late payment penalties and interest will be assessed on any balance due, even for returns on extension. Taxpayers anticipating a balance due will need to estimate this amount and include their payment with the extension request.
   
• Tax year 2014 contributions to a Roth or traditional IRA – April 15 is the last day contributions for 2014 can be made to either a Roth or traditional IRA, even if an extension is filed.
   
• Individual estimated tax payments for the first quarter of 2015 – Taxpayers, especially those who have filed for an extension, are cautioned that the first installment of the 2015 estimated taxes are due on April 15. If you are on extension and anticipate a refund, all or a portion of the refund can be allocated to this quarter’s payment on the final return when it is filed at a later date. If the refund won’t be enough to fully cover the April 15 installment, you may need to make a payment with the April 15 voucher. Please call this office for any questions.
    
• Individual refund claims for tax year 2011 – The regular three-year statute of limitations expires on April 15 for the 2011 tax return. Thus, no refund will be granted for a 2011 original or amended return that is filed after April 15. Caution: The statute does not apply to balances due for unfiled 2011 returns. 

If this office is holding up the completion of your returns because of missing information, please forward that information as quickly as possible in order to meet the April 15 deadline. Keep in mind that the last week of tax season is very hectic, and your returns may not be completed if you wait until the last minute. If it is apparent that the information will not be available in time for the April 15 deadline, then let the office know right away so that an extension request, and 2015 estimated tax vouchers if needed, may be prepared. 

If your returns have not yet been completed, please call right away so that we can schedule an appointment and/or file an extension if necessary.

Receive Your Refund Faster With Direct Deposit

Article Summary: 

• Speed 
• Security 
• Convenience 
• Options 
• Funding an IRA 

Don’t wait around for a paper check. Have your federal (and state, if applicable) tax refund deposited directly into your bank account. Selecting Direct Deposit is a secure and convenient way to get your money into your pocket more rapidly. 

• Speed - When combining e-file with direct deposit, the IRS will likely issue your refund in no more than 21 days.
   
• Security - Direct deposit offers the most secure method of obtaining your refund. There is no check to lose. Each year, the U.S. Post Office returns thousands of refund checks to the IRS as undeliverable mail. Direct deposit eliminates undeliverable mail and is also the best way to guard against having a tax refund check stolen.
   
• Easy - Simply provide this office with your bank routing number and account number when we prepare your return and you’ll receive your refund far more quickly than you would by check.
   
• Convenience - The money goes directly into your bank account. You won’t have to make a special trip to the bank to deposit the money yourself.
   
• Eligible Financial Accounts - You can direct your refund to any of your checking or savings accounts with a U.S. financial institution as long as your financial institution accepts direct deposits for that type of account and you provide valid routing and account numbers. Examples of savings accounts include: passbook savings, individual development accounts, individual retirement arrangements, health savings accounts, Archer MSAs, and Coverdell education savings accounts.
   
• Multiple Options - You can deposit your refund into up to three financial accounts that are in the your name or your spouse’s name if it is a joint account. You can’t have part of the refund paid by paper check and part by direct deposit. With the split refund option, taxpayers can divide their refunds among as many as three checking or savings accounts at up to three different U.S. financial institutions. Check with your bank or other financial institution to make sure your direct deposit will be accepted.
   
• Deposit Can’t Be to a Third Party’s Bank Account - To protect taxpayers from scammers, direct deposit tax refunds can only be deposited into an account or accounts owned by the taxpayer. Therefore, only provide your own account information and not account information belonging to a third party.
   
• Fund Your IRA - You can even direct a refund into your IRA account. 

To set up a direct deposit, you will need to provide the bank routing number (9 digits) and your account number for each account into which you wish to make a deposit. Please have these numbers available at your appointment. 

For more information regarding direct deposit of your tax refund and the split refund option, we would be happy to discuss your options with you at your tax appointment.

Tuition for School to Treat Learning Disabilities is Deductible

Article Highlights: 

• Tuition To Treat Learning Disabilities is Deductible 
• Medical Deduction 
• Special Teaching Techniques 

IRS has privately ruled that for a child diagnosed with multiple learning disabilities, tuition paid to attend a school designed to assist students in overcoming their disabilities and developing appropriate social and educational skills was a deductible medical expense. 

Treating a child's learning disabilities can place a heavy financial burden on parents. As the ruling illustrates, the tax law may help by allowing a deduction for the cost of educating such a child. 

However, like other deductible medical expenses, this cost is deductible only to the extent that medical expenses for the year cumulatively exceed 10% (7.5% through 2016 if the taxpayer is age 65 or over) of the taxpayer's adjusted gross income. 

Medical care includes the cost of attending a special school designed to compensate for or overcome a physical handicap, in order to qualify the individual for future normal education or for normal living. This includes a school for the teaching of Braille or lip reading. The principal reason for attending must be the special resources for alleviating the handicap. The cost of tuition for ordinary education that is incidental to the special services provided at the school, and the cost of meals and lodging supplied by the school also is included as a medical expense. The distinguishing characteristic of a special school is the substantive content of its curriculum, which may include some ordinary education, but only if the ordinary education is incidental to the school's primary purpose of enabling students to compensate for or overcome a handicap. 

IRS ruled that where the school uses special teaching techniques to assist its students in overcoming their condition and that these techniques along with the care of other staff professionals are the principal reasons for the child’s enrollment at the school then the school is a “special school”. Thus the child’s tuition at the school in those years he is diagnosed as having a medical condition that handicaps his ability to learn are deductible. 

The Tax Court has also held and IRS has privately ruled that, where a school attended by a student with a medical problem doesn't qualify as a special school because the ordinary education isn't incidental to the special services provided, the costs of the special program or special treatment (but not the entire tuition) may still be a deductible medical expense. 

If you have questions related to this or other medical deductions please give this office a call.

www.paulandersoncpa.com

Don't Overlook Spousal IRA

Article Highlights:

• Spousal IRA 
• Compensation requirements 
• Maximum Contribution 
• Traditional or Roth IRA 

One frequently overlooked tax benefit is the “spousal IRA.” Generally, IRA contributions are only allowed for taxpayers who have compensation (the term “compensation” includes: wages, tips, bonuses, professional fees, commissions, alimony received, and net income from self-employment). Spousal IRAs are the exception to that rule and allow a non-working or low-earning spouse to contribute to his or her own IRA, otherwise known as a spousal IRA, as long as the spouse has adequate compensation. 

The maximum amount that a non-working or low-earning spouse can contribute is the same as the limit for a working spouse, which is $5,500 for years 2013 through 2015. If the non-working spouse is age 50 or older, the spouse can also make “catch-up” contributions (limited to $1,000 for 2013 through 2015), raising the overall contribution limit to $6,500. These limits apply provided the couple together has compensation equal to or greater than their combined IRA contributions. 

Example: Tony is employed and his W-2 for 2015 is $100,000. His wife, Rosa, age 45, has a small income from a part-time job totaling $900. Since her own compensation is less than the contribution limits for the year, she can base her contribution on their combined compensation of $100,900. Thus, Rosa can contribute up to $5,500 to an IRA for 2015. 

The contributions for both spouses can be made either to a Traditional or Roth IRA, or split between them, as long as the combined contributions don't exceed the annual contribution limit. Caution: The deductibility of the Traditional IRA and the ability to make a Roth IRA contribution are generally based on the taxpayer’s income: 

• Traditional IRAs – There is no income limit restricting contributions to a Traditional IRA. However, if the working spouse is an active participant in any other qualified retirement plan, a tax-deductible contribution can be made to the IRA of the non-participant spouse only if the couple's adjusted gross income (AGI) doesn't exceed $183,000 in 2015 (up from $181,000 in 2014). This limit is phased out in 2015 for AGI between $183,000 and $193,000 (up from $181,000 and $191,000 in 2014).
   
• Roth IRAs – Roth IRA contributions are never tax-deductible. Contributions to Roth IRAs are allowed in full if the couple’s AGI doesn’t exceed $183,000 in 2015 (up from $181,000 in 2014). The contribution is ratably phased out for AGI between $183,000 and $193,000 (up from $181,000 and $191,000 in 2014). Thus, no contribution is allowed to a Roth IRA once the AGI exceeds $193,000. 

Example: Rosa, in the previous example, can designate her IRA contribution to be either a deductible Traditional IRA or a nondeductible Roth IRA because the couple’s AGI is under $183,000. Had the couple’s AGI been $188,000, Rosa’s allowable contribution to a deductible Traditional or Roth IRA would have been limited to $2,750 because of the phaseout. The other $2,750 could have been contributed to a nondeductible Traditional IRA. 

Please give this office a call if you would like to discuss IRAs or need assistance with your retirement planning.