(775) 786-6141
Landlords who want to deduct 100 percent of their rental property expenses must be sure to watch the personal use of their rental property.
In the case of Mark A. Van Malssen and Patricia D. Kiley v. Commissioner, T.C. Memo 2014-236, T.C.M., the taxpayers were limited in the amount of rental expenses that they could claim because their personal use of the rental property exceeded 14 days.There is a section in the Internal Revenue Code that limits the amount of rental expenses that can be deducted when personal use of the rental property exceeds 14 days. When that is the case, instead of being able to deduct 100 percent of rental expenses, the owner must allocate those expenses.
The allocation percentage is derived by dividing the number of days the property was rented by the total number of days that the rental property was used. The number of days the rental property was used is determined by adding the rental days and the personal use days together.
Mark A. Van Malssen and Patricia D. Kiley had deducted 100 percent of their rental property expenses on their 2008 and 2010 jointly filed 1040 returns. In both of these years, it was determined by the facts and circumstances of the case that the personal use of the rental property had exceeded 14 days.
Therefore, instead of deducting 100 percent of their expenses, they should have allocated the expenses based on the above allocation percentage.
The issue in this case was how many personal days the taxpayers had used their rental property. The taxpayers said they used the rental property in both 2008 and 2010 for 14 days. Had this beenthe only personal use of the rental property, they would have been entitled to claim 100 percent of the rental expenses as a deduction.
An IRS regulation states that when the principal purpose of use of the dwelling unit is to make repairs and maintenance, those days do not count as personal days.
Whether the principal purpose is for repairs and maintenance or for personal use is determined under a facts-and-circumstances test.
A number of times over the course of 2008 and 2010 Mr. Van Malssen made the 350-mile trip from his home to the rental property in South Carolina. If the purpose of the trip is deemed to be primarily business, then the travel days are not considered to be personal days. If the primary purpose of the trip is personal, then those travel days are considered to be personal days.
The travel days were caused because it took the whole day for Mr. Van Malssen to drive from his personal residence to the rental property.
Mr. Van Malssen kept very detailed logbooks regarding his personal and business use of the rental property. The court used thoselogbooks when determining whether the different travel days counted as personal use days.
When traveling to the rental property, if more than 50 percent of the days spent at the rental property are related to making repairs and maintenance, then all of the days spent at the rental property and the one day of travel time are all deemed to be nonpersonal use.
But if less than 50 percent of the days spent at the rental property were related to repairs and maintenance, then the one day of travel time is deemed to be personal use time.
Because the court ruled that some of the travel time from the main residence to the rental property was properly counted as personal time, the taxpayers exceeded 14 personal use days in both tax years 2008 and 2010.
Because of this fact, the taxpayers were required to allocate the rental property expenses instead of deducting 100 percent of them. The court denied some of the rental expenses and a deficiency judgment was asserted against the taxpayers.
©2014 CPAmerica International
Discharge of debt is generally considered income for tax purposes – and it will be again in 2014 for principal residence indebtedness.
Many taxpayers took advantage of not being taxed on discharge of debt for principal residences from Jan. 1, 2007, through Dec. 31, 2013. Unfortunately, this exclusion has ended effective for the 2014 tax year. It applied to homeowner’s mortgages or equity loans secured by their residence.
For those who had their home reposed by the bank or had a short sale in which the fairmarket value of the home was less than the balance owed on the mortgage, the bank allowed them to walk away from the mortgage without paying the remaining balance still owed.
And because the IRS had a provision in one of their code sections in which this deficient balance was not considered to be taxable income, the taxpayer did not have a taxable event as a result of this transaction.
Starting in 2014 this loophole is no longer available. If the bank forgives debt related to a mortgage or home improvement loan secured by your primary residence, that debt forgiveness will now be considered taxable income.
The company that discharged the debt will send a 1099 form at tax time, and the taxpayer will be required to include the amount of debt discharged as income the tax return.
The IRS provides for five situations in which this discharge of debt is not taxable income. Those five situations are:
The general rule regarding gifts to employees is that they are taxable income to the employee.
There are some exceptions to this general rule. Two of the more common exceptions are:
1. Employee achievement awards
2. De minimis (small) fringe benefits
Employee achievement awards are nontaxable. These awards are tangible property that is given to the employees as a reward for length of service or for achieving some sort of a safety standard.
The IRS worries that employee achievement awards are actually a form of disguised compensation. That is why when the company is giving out these awards, they should be presented in some type of ceremonial format.
The amount of the gift that the employee is allowed to exclude from income is tied to the amount the company claims as a deduction. If the awards are given by a company that does not have a qualified plan, the maximum amount of the deduction for the company is $400. Therefore, the maximum amount the employee is able to exclude from income and treat as a nontaxable gift would be $400.
So, for example, if the employee received an award with a fair market value of $650, $400 of that would be considered a gift and $250 would be considered taxable compensation.
If the gift is given to an employee by a company that does have a qualified plan – an established written plan that does not discriminate in terms of eligibility or benefits to highly compensated employees – the maximum amount of the deduction for the company would be $1,600. The employee would then be able to exclude this same amount from income and treat it as a gift.
Other categories of gifts that are nontaxable are de minimis fringe benefits. De minimis fringe benefits are property or services that are so small as to make accounting for it unreasonable or administratively impracticable.
Not all de minimis fringe benefits are gifts. In fact, most are not. The IRS provides some guidance on what a de minimis fringe benefit is. The following three items are considered to be de minimis fringe benefits that impact the discussion of nontaxable gifts:
1. Birthday or holiday gifts of property with a low fair market value.
2. Occasional theater or sporting event tickets.
3. Flowers, fruit, books or similar property provided to employees under special circumstances.
These three items would be considered gifts and not added to the employees W-2 wages.
Employers that give gifts to employees for the holidays would be well advised to know what the rules are. Otherwise that gift might end up being taxable income to that employee.
Penalized for withdrawing funds early? All is not lost.
You are entitled to a deduction for a penalty imposed on an early withdrawal of funds from a timed savings account or a certificate of deposit. And you are entitled to this deduction even if you do not itemize deductions on your 1040 return.
However, you must file Form 1040 to claim this deduction. You cannot claim it on either Form 1040A or Form 1040 EZ.
The Internal Revenue Code has a section that benefits taxpayers who are penalized because they withdrew funds from a certificate of deposit or a timed savings account. When an account owner makes a withdrawal of these types of funds early, the bank or savings institution imposes a penalty.
The amount of this penalty is required to be reported to the taxpayer on Form 1099-INT at the end of the tax year. Line 2 of this form contains the amount of the early withdrawal penalty. The amount of interest income earned during the year on the investment is reported on line 1 of the same form.
In certain instances, the amount of the penalty can exceed the amount of interest income earned on the account.
This type of deduction is referred to as an above-the-line deduction because the deduction is used in completing the taxpayer’s adjusted gross income (AGI). AGI is all of a taxpayer’s sources of income added together, reduced by a group of deductions known as below-the-line deductions.
The deduction of an early withdrawal penalty is an example of one type of above-the-line deduction.
©2014 CPAmerica International
Chet Lee West found out the hard way that you cannot suppress evidence, claiming it was barred under the six-year statute of limitations, when charged with income tax evasion.
West was trying to invoke Internal Revenue Code Section 6531, which outlines the periods of limitations on criminal prosecutions. But that section doesn’t apply because it is a procedural limitation designed to bar stale claims and charges. It doesn’t affect the introduction of relevant evidence.
The facts of United States vs. Chet Lee West (U.S. District Court, Nebraska, 2014-2 U.S.T.C., ¶50,486, Oct. 2, 2014) reveal that, on July 17, 2013, the grand jury for the district of Nebraska returned an indictment against West charging him with three counts of income tax evasion.
The deadline to file pretrial motions was Jan. 31, 2014. On Aug. 18, 2014, West filed a pretrial motion to suppress. He was trying to suppress any evidence that occurred before Dec. 31, 2006. Any evidence that occurred before this time period would lie outside of the statute of limitations.
The United States responded to this by stating that West’s motion was untimely and lacked merit.
The deadline to file pretrial motions was July 17, 2013. West filed his pretrial motion well after this deadline – on Aug. 18, 2014. It has been established by prior court cases that “if a party fails to file a pretrial motion before the pretrial motion deadline, the party waives that issue.”
The court should have denied West’s motion because it was not filed by the deadline. But it decided to proceed with the case and decide it on its merits.
Code Section 6531 does not disallow the admission of evidence. “The statute of limitations is a defense to being prosecuted, not for admitting evidence. As long as the prosecution is timely filed, the statute of limitations has no bearing on the admissibility of evidence.” In this case, the prosecution was filed in a timely manner.
What determines whether the evidence is admissible is its relevance, not the date of the evidence. Evidence that is relevant is admissible unless it is prohibited by the Supreme Court, United States Constitution, federal statute or the federal rules of evidence. None of these prohibitions applied in this case.
Therefore, the judge determined that Code Section 6531 did not apply and denied West’s motion to suppress the evidence. ■
Joseph Sanchez mailed a petition challenging a deficiency assessed against him by the Internal Revenue Service. Unfortunately for Sanchez, the IRS dismissed his petition because the agency did not receive it in a timely manner.
This situation involved a dispute over Sanchez’s tax year 2010 individual income tax return. The IRS sent Sanchez a notice of deficiency claiming that he owed approximately $13,000 of additional tax, penalties and interest.
The letter from the IRS clearly stated that Sanchez had 90 days from the date of the letter to file a petition with the U.S. Tax Court. The letter even stated the “last date to petition the tax court: March 3, 2014.”
On March 3, 2014, Sanchez had a third party deliver to the U.S. Postal Service a letter containing his petition to the IRS. This petition was Sanchez’s response to the deficiency assessed against him.
The third party even gave a written statement to the court, claiming she had delivered the letter containing the petition documents to the post office on March 3, 2014. She further stated that, instead of waiting in a long line, she had dropped the petition paperwork off at the post office without having a certified mail receipt stamped by a post office employee.
Therefore, the third party had no documentation showing that the post office had received the package on March 3, 2014.
The court actually received the petition documents on March 10, 2014. The envelope containing the petition documents had a U.S. Postal Service postmark date of March 4, 2014.
On the envelope was also a stamp printed on a computer by a third party using software from Stamps.com, as well as a certified mail sticker. The stamp showed the date of March 3, 2014.
The IRS has a section in its regulations that deals with this issue. The regulation section provides that “if the envelope has a postmark made by the U.S. Postal Service in addition to a postmark from another entity, the postmark made by the other entity is disregarded. In determining whether the envelope was mailed in a timely fashion, the date provided by the U.S. Postal Service is the date used.”
In this case, that date was March 4, 2014. For Sanchez to have made a timely response, he would have needed to have his envelope postmarked no later than March 3, 2014.
Therefore, the court had no choice but to dismiss the case on the grounds that the petition was not timely filed. A judgment in the amount of roughly $13,000 was entered on behalf of the IRS (Joseph Sanchez v. Commissioner, U.S. Tax Court, T.C. Memo 2014-223, Oct. 22, 2014).
This situation could have been avoided had the third party delivered the letter to the U.S. Postal Service in time to have it stamped as of March 3, 2014.
Mortgage interest is usually the largest itemized deduction on most people’s tax returns unless they give a lot to charity. But there are limitations on the amount of home mortgage interest you can deduct.
Home mortgage interest is deductible on Schedule A of your tax return if it is secured by your qualified residence.
A “qualified residence” is either the principal or second residence of the taxpayers. The second residence is designated by the taxpayers on an annual basis should they own more than two homes.
For example, taxpayers could have a mortgage on their main home and a mortgage on their cottage, and they could write off the interest portion of both of the loans – provided they meet the criteria of two types of deductible residence interest: acquisition indebtedness and home equity indebtedness.
“Acquisition indebtedness” is basically the original mortgage on your home and a second residence. The mortgage must be secured directly by your home or second residence as collateral.
You can use the mortgage to buy, construct or substantially improve your home. You are limited to deducting interest paid on the first $1 million of debt on your home and second residence, or $500,000 for a married taxpayer filing a separate return.
The deduction for home equity indebtedness has two limitations. First, you are limited to deducting the interest on the first $100,000 of the loan, or $50,000 for a married taxpayer filing a separate return.
The second limitation requires the aggregate amount of the home equity loan not to exceed the qualified residence’s fair market value minus the amount of acquisition indebtedness on the residence. In other words, the total amount of debt on the property cannot exceed the fair market value of the property.
With the way the tax law is presently structured, the maximum amount of acquisition and home equity indebtedness that you can incur and still write off the interest is $1.1 million. The interest paid on the loan amount in excess of $1.1 million would be treated as nondeductible personal interest.
So there is nothing wrong with buying that $2 or $3 million mini-mansion you’ve been dreaming about. You just won’t be able to write off all the home mortgage interest pertaining to that purchase. ■
Taxpayers may deduct from their gross income certain interest they pay on a qualified education loan, according to Section 221 of the Internal Revenue Code.
This deduction is known as an “above the line” deduction because it is a deduction on page one of your tax return. You do not have to file a Schedule A and itemize your deductions to claim this one.
You need to meet the criteria to claim this deduction. One requirement is that you be the taxpayer who has a legal obligation to make interest payments on the loan.
The person whose name is on the promissory note has the legal obligation.
For example, if your parents paid your student loan payments for you, they would not be entitled to a deduction on their tax return because they do not have a legal obligation to make student loan payments. Their dependent child does.
Another criterion is that you cannot be claimed as a dependent by another person. Otherwise, the student loan interest deduction will be disallowed. You must be an independent taxpayer to claim this deduction.
Some criteria apply to married taxpayers. To claim the student loan interest deduction, the married taxpayers need to file a joint tax return. If they file married filing separately, they receive no deduction.
If a third party makes student loan payments on behalf of a taxpayer who is legally obligated to make the payment, the taxpayer is treated as having made the payment. The taxpayer is allowed the student loan interest deduction.
The theory behind this is that the third party has made a gift to the taxpayer. The taxpayer then used that gift to make the student loan payment. Therefore, the taxpayer receives the deduction.
The maximum amount of the deduction is $2,500 regardless of your filing status. Single taxpayers and married taxpayers filing a joint return have the same ceiling on the amount of student loan interest they can deduct.
There are also some income limitations regarding the deduction. For 2014, single taxpayers with modified adjusted gross income in excess of $80,000 and married taxpayers filing jointly with modified adjusted gross income over $160,000 are not eligible for the deduction.
©2014 CPAmerica International
Douglas and Renitta Lundy are a married couple who failed to distinguish between disability payments that are excludable from income and the income that such payments may produce when they are invested.
In 2005, the Lundys had a dispute with the IRS regarding their 2005 Form 1040 return. The IRS was treating $42,181 of retirement income, which had been reported on a Form 1099-R, as taxable income.
The Lundys were treating that amount of money as nontaxable. Their position was that the money represented disability retirement benefits, which were fully exempted from taxes.
The Lundys ended up winning the case and did not have to pay income taxes on the $42,181 received as the result of a disability.
Fast-forward a few years to the timely filing of the Lundys’ 2011 Form 1040 return. They filed a joint return as in previous years. Mr. Lundy had wages of $11,983.
Mrs. Lundy had net self-employment income of $19,326. A Schedule C was attached regarding the self-employment income.
The 2011 return showed a total amount of $3,536 in income taxes due. This amount consisted of $1,093 in regular income tax, $2,374 in self-employment tax and an estimated tax penalty amount of $69.
The Lundys did not make any estimated income tax payments nor did they have any money withheld from Mr. Lundy’s wages.
No payment was enclosed when the tax return was submitted, so the Lundys made no tax payments at all for tax year 2011.
For a number of months, the taxpayers and the IRS went back and forth on the issue of whether any of this income was taxable in 2011. The two parties exchanged letters and various correspondences.
Finally in April 2013, the IRS sent out a form called a “Final Notice of Intent to Levy and Notice of Your Right to a Hearing.” This is the final step the IRS takes
before it levies bank accounts. The notice was sent out regarding the unpaid 2011 income taxes. The Lundys followed up on this notice with a Form 12153, “Request for a Collection Due Process or Equivalent Hearing.”
In addition, they attached a letter to the form. Their letter stated that whatever income they had derived by investing their original tax-exempt disability benefits would also be nontaxable to them. They were adamant about their opinion.
The facts in this case were not in dispute. The Lundys felt that they did not owe any income tax on the wages or the self-employment income.
Their defense was that nontaxable disability income was the seed money that started the Schedule C business and therefore any income earned from the Schedule C
business should be nontaxable as well. They didn’t address why they felt that Mr. Lundy’s wages should be nontaxable.
Internal Revenue Code Section 61(a) provides that gross income means all income from whatever source derived. This includes compensation for services and income derived from business. Exclusions from income are construed narrowly, and taxpayers must bring themselves within the clear scope of the exclusion.
Because they did not have an applicable exclusion, Mr. Lundy’s wage income and Mrs. Lundy’s net business income are included in gross income (Douglas W. Lundy and Renitta H. Lundy v. Commissioner, U.S. Tax Court, TC Memo, 2014-209, TCM, Oct. 8, 2014).
The Lundys’ disability income from tax year 2005 was nontaxable. Any income earned from that money, which was invested in business assets, is not. The Lundys learned this the hard way. They ended up owing the IRS the $3,536, plus additional interest and penalties.
©2014 CPAmerica International
Gerald Wayne Wheeler and the IRS seemed to be playing a game of “Who’s the True Earner?” – and Wheeler lost.
The U.S. Tax Court recently settled sales proceeds, inventory basis, rental payment and income questions raised by the IRS in Gerald Wayne Wheeler v. Commissioner, U.S. Tax Court, T.C. Memo 2014-204.
In this case, Wheeler had owned Specific Enterprises, an S corporation. The company was a cabinet door business during the late 1980s through 2002.
Specific Enterprises was operated at a commercial building, which Wheeler owned. During 2002, the business was liquidated and closed. The business assets were equipment and inventory.
A separate entity called Cabinet Door Shop, LLC, was now operating out of the commercial building owned by Wheeler. Cabinet Door Shop was managed by one of Wheeler’s three daughters. The assets of Cabinet Door Shop were the equipment and inventory originally owned by Specific Enterprises.
Wheeler received the assets of Specific Enterprises in liquidation. He held those assets personally.
Wheeler created a trust called RCC Capital Group. Wheeler transferred ownership of the assets and inventory received from Specific Enterprises to RCC. He also transferred ownership of his commercial building and land to RCC.
RCC exchanged two promissory notes valued at a total of $1.65 million in consideration of the assets, inventory, land and commercial building received. RCC then leased these assets to Cabinet Door Shop.
Wheeler drafted the rental agreement and determined the amount of the rental payments. The contract was for two years starting in January 2003 and running through the end of December 2004. The representatives of RCC and Cabinet Door Shop were not involved in the contract negotiations.
Cabinet Door Shop made rental payments to RCC of $273,000 for 2003 and $126,000 for 2004. RCC did not exercise its right to buy the building from Wheeler until March 2004.
After receiving the rental payments from Cabinet Door Shop, RCC turned around and remitted exactly the same amounts to Wheeler. So, Wheeler received $273,000 and $126,000 for 2003 and 2004, respectively.
In a separate deal between Wheeler and Cabinet Door Shop, inventory was sold to Cabinet Door Shop in the amount of $80,798.
Cabinet Door Shop ceased rental payments to RCC in June 2004. RCC in turn stopped paying Wheeler. Wheeler stated that the remaining payments owed to him by RCC were a gift to RCC.
Wheeler failed to file 1040 returns for 2003 and 2004. The IRS prepared those returns on his behalf.
The first issue that the U.S. Tax Court addressed was the sale of the inventory between Wheeler and Cabinet Door Shop. Wheeler’s position was that, because his basis in the inventory exceeded the sales price of the inventory, he had no income from the transaction.
Wheeler was unable to prove the amount of his cost or basis in his inventory. The information Wheeler provided the IRS was deemed not sufficient to establish his basis, so it was disregarded.
If the taxpayer provides some reasonable evidentiary basis, the court can estimate the basis.
Wheeler did not provide any facts or details that permitted the court to estimate the basis of his inventory. Therefore, the court ruled that the inventory had no basis, and the entire sales proceeds amount of $80,798 was included in income.
The second issue that the Tax Court addressed was regarding the sale of the land, building and equipment to RCC. The court held that this was a sham transaction. The “true earner” of income is the person or entity that controls the earning of such income – not necessarily the entity that receives it.
Wheeler is the true earner of the income for three reasons:
1. Wheeler personally owned the assets that were being rented to Cabinet Door Shop – at least he did for the first 14 months of the lease. The assets were not transferred to RCC until March 15, 2004. The lease with Cabinet Door Shop started in January 2003.
2. RCC was merely a conduit for the income. RCC received the rental payments from Cabinet Door Shop and sent that exact same amount to Wheeler.
3. There was no separation of trust administration from the operation of Cabinet Door Shop. In essence, Wheeler maintained control over RCC even though he didn’t technically own it. This was evidenced by the fact that Wheeler negotiated and set the price for the asset lease between RCC and Cabinet Door Shop. Wheeler also convinced RCC not to file any trust tax returns for the applicable time period.
For these three reasons, the court concluded that the rental payments were actually taxable income to Wheeler, not to RCC.
©2014 CPAmerica International
