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 Sherrie Weldon, EA, from our Tax Knowledge Center.
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.
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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.
August 14, 2014
Question: Your client, Pastor Mike, comes to his tax preparation appointment and gives you his Form W-2 from the church. Since he is a minister, you expected to see Boxes 3-6 of the W-2 empty; but they were filled in so you asked Pastor Mike why. He proudly declared, “I didn’t want to pay self-employment taxes so I had the church withhold FICA and the church paid their half. Is that okay?” What do you say?
Answer: Your answer should be “no, that is not okay.” Ministers under the control of an employer (e.g., a local body of believers) are by statute dual-status workers. They are treated as common-law employees for income tax purposes [Reg. §31.3401(c)-1] but they are self-employed for social security tax purposes [§§1402(a)(8) and 3121(b)(8)(A)]. That means W-2s are issued for their wages but Boxes 3-6 are not filled in. If the church agrees, the minister can request federal income tax withholding, which will be reportable in Box 2. Otherwise, ministers should be instructed to make estimated payments if needed. If the church needs further guidance for the unique issues pertaining to minsters, you can refer them to IRS Pub. 517,
Social Security and Other Information for Members of the Clergy & Religious Workers.
August 7, 2014
Question: Your client called to report that upon noticing water on the walls in three rooms of his home, he decided to check his roof and discovered holes in the roof. The holes were caused by squirrels that had eaten through the roof wood, permitting rain water to soak through down the house walls. Can he claim a casualty loss for the cost of repairing the holes in his roof caused by squirrels?
Answer: No. The IRS issued a private letter ruling in response to this very question. It said a casualty is the complete or partial destruction of property resulting from an identifiable event of a sudden, unexpected, and unusual nature. In this case the damage was not 'unexpected' and 'unusual' because it is common knowledge that squirrels are destructive. Therefore the loss is not a casualty within the meaning of §165(c)(3) [Private Letter Ruling 8133097].
July 31, 2014
Question: Joe and Rachel installed five solar-powered skylights in their home during 2014. They understand the credit for energy efficient windows is no longer available, but their salesman stated that they should receive a 30% tax credit for these skylights. The total cost of the skylights was $11,000 ($9,500 for the skylights and an additional $1,500 for installation). Can they receive a credit of $3,300 on their 2014 tax return?
Answer: Based on Notice 2013-70, Q&A 29, if a solar panel generates electricity for an improvement made to the taxpayer’s residence, a credit is available under §25D. However, the credit is only allowed for the component of the improvement that uses solar energy to generate electricity, not the entire improvement. The allocable portion of labor is also eligible for the credit. As such, Joe and Rachel need to receive information from the salesman regarding the allocable cost of the solar panel used for these skylights. The full cost of the skylights and labor is not used for the credit.
July 24, 2014
Question: Brian operates a dairy farm and has elected farm income averaging in previous years. He used to file as single, but in 2014, Brian married Tabitha. Brian is concerned that he will not be able to use farm income averaging in the current year because of the change in his filing status. Can Brian elect farm income averaging in 2014?
Answer: Yes. A taxpayer is not prohibited from using income averaging solely because of a change in filing status [Reg. §1.1301-1(f)(2)]. Brian must use taxable income as reported in the prior year even if it is of a different filing status. However, to be consistent with the original filing status, the proper set of tax rates must be applied to the base years. Thus, Brian would apply the single rates to the income assigned to the tax years 2011 through 2013.
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