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You Make the Call

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 Sheri Fronsee, CPA, from our Tax Knowledge Center.

October 30, 2014

Question: Carl owns a commercial rental property that he no longer wants. If he sold the building there would be a $150,000 taxable gain. Instead of selling the building, his realtor suggests a §1031 like-kind exchange for a residential rental property to defer the gain. The realtor further suggests that he should only rent it out for a year or so, then move in and treat it as a personal residence. By doing this the realtor insists that the deferred gain of $150,000 on the §1031 like-kind exchange would be excluded under §121 once Carl lives in the home as a principal residence for two years. Is the realtor correct?

Answer: Yes and no. Some of the gain may be excluded, but not all of it. Carl can exchange the commercial rental for a residential rental and defer the $150,000 gain. However, if he plans on using the §121 exclusion by converting the rental to a personal residence there are three issues.

  1. Carl must own the property for at least five years from the date of acquisition and he must live in it personally two of those five years.
  2. Depreciation taken during the period of rental use is not excluded.
  3. Since the property was acquired after December 31, 2008, and started out as a rental, the property is “tainted” with nonqualified use. Any gain would have to be allocated between qualified and nonqualified use. Only gain allocated to qualified use can be excluded while gain relating to nonqualified use is not excluded.

October 23, 2014

Question: Larry is a new client. He brought in his 2012 and 2013 tax returns for you to review because he felt his former preparer did not handle some of his investments correctly. He provides you with copies of K-1s from several publicly traded partnerships (PTPs) that he has invested in over the last two years. Some of the partnerships have losses, while others report income. Larry believes the losses from these partnerships should have offset the income from the profitable investments, but his former preparer did not do so. Have his returns been prepared correctly with regard to these PTPs?

Answer: Under §469(k), each PTP stands on its own. The losses from a particular PTP can only be used when there is income from the same PTP or the taxpayer fully disposes of his PTP interest. As such, the losses from other PTPs cannot be used to offset income from another PTP. The preparer appears to have correctly handled the losses and income from these investments on Larry’s tax return.

October 16, 2014

Question: Tucker, age 22, is a full-time college student. He paid for his tuition and fees, supplies and other living expenses with student loans and income from a part-time job. In 2014, he borrowed $40,000 in student loans and received $5,000 in wages and used all the money for his own support. His parents provided less than half of his support and as a result, cannot claim him as a dependent. Can Tucker claim the refundable portion of the American Opportunity Tax Credit (AOTC)?

Answer: No. A student cannot claim the refundable AOTC if they would be subject to the kiddie tax provisions [§25A(i)(5)]. A child is subject to the kiddie tax provisions if:

  1. The child has not attained age 18 as of the close of the tax year or has earned income that does not exceed half of his or her support and is either age 18 or a full-time student age 19-23;
  2. Either parent of the child is alive at the close of the tax year; and
  3. The child does not file a joint return for the taxable year.

Since Tucker’s earned income did not exceed half of his support, he is subject to the kiddie tax provisions. Thus, he does not qualify for the refundable portion of the AOTC.

October 9, 2014

Question: A taxpayer has an office in home in 2014 and elects to use the safe harbor method. Will any of this deduction be taxable when he later sells the home and qualifies for the §121 exclusion?

Answer: No. A taxpayer using the safe harbor method for determining expenses for a tax year can't deduct any depreciation (including any additional first-year depreciation) or §179 expense for the part of the home that's used in a qualified business use of the home for that tax year. The depreciation deduction allowable for that part of the home for that tax year is deemed to be zero (Rev. Proc. 2013-13).

October 2, 2014

Question: Your client has made only nondeductible contributions to his traditional IRA. He filed Form 8606 each year these nondeductible contributions were made to help establish basis. Your client’s father died and named him as the designated beneficiary of his father’s traditional IRA. The father made only deductible contributions to his IRA (i.e., no basis). If your client takes a distribution from his own IRA, does he take into account the value of the inherited IRA to determine how much of the distribution is taxable?

Answer: Based on IRS Publication 590, the answer is no. If you inherit a traditional IRA from a person who had a basis in the IRA because of nondeductible contributions, that basis remains with the IRA. Unless you are the decedent's spouse and choose to treat the IRA as your own, you cannot combine this basis with any basis you have in your own traditional IRA(s) or any basis in traditional IRA(s) you inherited from other decedents. If you take distributions from both an inherited IRA and your IRA, and each has basis, you must complete separate Forms 8606 to determine the taxable and nontaxable portions of each of those distributions.

Looking for past You Make the Call questions and answers? Archived questions are available to Members in the NATP Research Archives.

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