Please note that the question and answer provided does not take into account all options or circumstances possible.
This week's question is brought to you by Liza Corbisier, EA, from our Tax Knowledge Center.
September 25, 2014
Question: Jeff, age 45, and Gina, age 43, divorced in 2014. Gina had $200,000 in her employer-sponsored §401(k) plan at the time of divorce. The divorce decree indicated that Gina is required to transfer $100,000 of her §401(k) plan to Jeff under a qualified domestic relations order (QDRO). The transfer is completed and Jeff kept $60,000 in the account and took the remaining $40,000 as a cash distribution. Is the $40,000 Jeff opted to receive in cash subject to the 10% early distribution penalty under §72(t)?
Answer: No. The amount received under a QDRO is not subject to the 10% early distribution penalty. If Jeff chooses to keep all or part of the distribution (i.e., not roll it over), he is taxed on only the amount he keeps and is not subject to the 10% early distribution tax regardless of his age [IRC Sec. 72(t)(2)(C)]. Jeff will receive Form 1099-R reporting the $40,000 distribution.
September 18, 2014
Question: Auggie rents a building where he operates his Schedule C business. During tax year 2013, he made $175,000 of improvements to the building, which were considered qualified leasehold improvements. With his accountant, he made the decision to expense the total cost of the improvements under §179. In 2013, his Schedule C only generated a taxable income of $75,000; he had no other business income. Therefore, $100,000 of the §179 was not allowed and was carried forward to 2014. What happens with the taxpayer’s carryover of the §179 in 2014?
Answer: The election to expense qualified real property under §179 expired as of December 31, 2013. Qualified real property is defined as qualified leasehold improvements, qualified restaurant property and qualified retail improvement property. The cost of any qualified real property that was elected to be expensed under §179 that was disallowed due to an income tax limitation cannot be carried over to a tax year beginning after 2013. Any excess amount is treated as placed in service on the first day of 2013 for purposes of computing depreciation (Notice 2013-59). Thus, the $100,000 carryover is not available for 2014 and must be treated as placed in service in 2013 and depreciated.
September 11, 2014
Question: You obtain a new client in 2014, who is a member of an LLC. The client hands you Schedule K-1 from the partnership indicating it’s the final K-1. The client tells you that he walked away from his interest of the LLC. The final K-1 has zero income and no deductions. Last year’s Schedule K-1 had a negative capital account and allocated nonrecourse liabilities.
Does your client get a loss in 2014 for his abandonment of the LLC interest?
Answer: No, in fact, he may have a gain to report. LLC members can have nonrecourse liabilities allocated to him or her. They are categorized as nonrecourse since the member is not liable for the debt. This is irrelevant for §752 purposes. In summary, §752 treats increases in allocated liabilities of the partnership as capital contributions, thus, decreasing basis. Conversely, §752 treats reductions in allocated partnership liabilities as distributions. An LLC member can still receive an allocation of liabilities. The reduction in liabilities from one year to the next is a deemed distribution and can be considered a gain on a deemed sale of the interest.
Using negative capital accounts to arrive at basis, however, makes a lot of assumptions. Since capital accounts are not the same as basis, you need to calculate basis and compare it to the deemed distribution by a reduction of liabilities. The difference is gain, despite no actual cash received.
If you’d like to know more about capital accounts, nonrecourse and recourse loans, NATP has an on-demand webinar that you can take at your leisure. This webinar delivers in-depth information on these subjects.
September 4, 2014
Question: Renee and Robert are married and jointly own a rental property that generated a $35,000 loss for the year. They also own 50/50 of an S corporation that Robert materially participates in and Renee does not. The S corporation generated $90,000 of net income with $45,000 allocated to each shareholder. Because Renee does not participate in the business and her income is considered passive, they are hoping to offset all of the rental loss against her passive income from the S corporation. Is this possible?
Answer: No, this is not possible. When spouses jointly own a business where one spouse materially participates and the other does not, both are treated as nonpassive. One spouse’s activity flows to the other [IRC Sec. 469(h)(5)]. Both spouses are considered nonpassive, and nonpassive income cannot offset passive losses. Renee and Robert will be allowed a rental deduction of $25,000 and the remaining $10,000 will be carried forward. Additionally, their income is already at $90,000. If there is any additional income causing their MAGI to go above $100,000, additional rental loss could be phased out and carried forward. Rental losses are phased out for MFJ filers when MAGI is between $100,000 and $150,000. After $150,000, the rental loss deduction will be zero for the current year and fully carried forward.
August 28, 2014
Question: Your client converted her former primary residence to a rental property about three years ago. Her cost basis is $350,000 and the FMV of the property at the time of conversion was $300,000. Approximately, $30,000 of depreciation was taken on the property. She sold the property for $310,000. Does she have a gain or a loss?
Answer: Neither! When a personal asset is converted to business or income-producing use, its basis for depreciation is the lower of the adjusted basis on the date of conversion, or the FMV of the property at the time of conversion [Reg. §1.168(i)-4(b)]. When the converted property is later sold at a gain, the basis in the converted property is the original cost or other basis plus amounts paid for capital improvements, less any depreciation taken. If the sale results in a loss, however, the starting point for basis is the lower of (1) the property's original cost or other basis, or (2) FMV at the time it was converted from personal to rental property [Reg. §1.165-9(b)(2)]. This rule is designed to ensure that any decline in value occurring while the property was held as a personal residence (i.e., before conversion to rental property) does not later become deductible upon sale of the rental property. Thus, a loss from the sale of converted property is allowed only to the extent the property has declined in value following the conversion and taking into account any depreciation allowed or allowable.
With this client’s fact set, basis for determining loss is $270,000 ($300,000-$30,000). Basis for determining gain is $320,000 ($350,000-$30,000). No reportable gain or loss occurs because (1) no gain results when the original cost is used in the gain computation, and (2) no loss results when using the lower of cost or FMV for determining loss.
August 21, 2014
Question: Janice has a traditional IRA and a §401(k) plan. She is 71 and must take a $10,000 required minimum distribution (RMD) from her IRA and a $25,000 RMD from her §401(k) for 2014. Janice would like to leave her IRA alone, so she asks you if she can take the total amount of her RMDs ($35,000) from her §401(k) plan. What do you tell Janice?
Answer: Unfortunately, Janice cannot do this. For RMD purposes, taxpayers can aggregate their IRAs. In other words, the RMD is calculated separately for each IRA and the sum of the separately calculated RMDs can be taken from one or more of the taxpayer's IRAs [Reg. §1.408-8, Q&A 9]. However, an IRA and a §401(k) plan cannot be aggregated for RMD purposes. Therefore, Janice must take her RMDs from each account, $10,000 from her IRA and $25,000 from her §401(k) plan. If she takes the entire $35,000 from her §401(k), she hasn’t taken the RMD from her IRA and will be subject to a 50% penalty on the excess accumulation in her IRA.
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