Each week the Tax Knowledge Center will pose a question to you. Please note that the question and answer provided does not take into account all options or circumstances possible. The feature is intended to create some interest and insights into the topic provided. The answer will appear here.
This week's question is brought to you by Erik Lammert, JD, from our Tax Knowledge Center.
May 17, 2012
Question: Ruth, a retiree, qualified for a reverse mortgage. She received it as a lump sum payment several years ago and used it to supplement her small pension and social security. Ruth died recently, and the reverse mortgage loan, along with its accumulated interest, must now be repaid. Her children are wondering whether the payment of the interest on the loan is deductible, either by Ruth’s estate, or by her heirs. What do you tell them?
Answer: If a reverse mortgage is repaid by the estate after the borrower dies, the principal and interest accrued to the date of death are deductible on the estate tax return (Form 706) as a debt of the estate [IRC Sec. 2053(a)(4)]. It is not deductible on the estate’s Form 1041, because it is not an administrative expense of the estate.
If taxpayers who acquire property subject to a liability from a decedent pay off the interest on a reverse mortgage after the borrower dies, they can claim the interest in the year that they pay it, as a “deduction in respect of a decedent” under §691(b). But there are still limitations, as the amount of interest claimed as a deduction cannot exceed the interest paid on $100,000 of debt (the limit on the amount that can be considered home equity debt, which is how the IRS views reverse mortgage loans).
May 10, 2012
Question: Ken’s position with ABC, Inc. requires a good deal of driving. The company provides a car for this purpose. Ken’s out-of-pocket travel expenses are reimbursed by ABC, Inc. under an accountable plan. Ken is six foot, five inches tall and the compact cars the company provides make for an uncomfortable ride on longer trips. So, on days when Ken must travel longer distances he uses his own vehicle and keeps track of his mileage. Prior to coming into your office this year, Ken has been filing his own return and deducting the business use of his car using the standard mileage rate. You ask Ken why he has been deducting the mileage subject to the 2% AGI limitation when ABC, Inc. has an accountable plan. He explains that ABC, Inc. is a small company and he doesn’t turn in the mileage because he feels guilty about them paying extra just because he’s tall and prefers his own car. He understands the 2% limitation, and is satisfied with the tax benefit he is able to receive using Form 2106. Can Ken continue to deduct the business use of his vehicle on Form 2106?
Answer: No, the business expenses Ken incurred are ordinary and necessary of the employer and not Ken. In this case, because Ken was eligible for reimbursement and chose not to submit the expenses, he cannot deduct them on his personal return. Tax court determined that failing to seek reimbursement didn’t convert the employer’s expenses into an employee expense [Govier, William, (1990) TC Memo 1990-61; Putnam, Steve D., (1998) TC Memo 1998-285].
May 3, 2012
Question: In January 2011, TMI, Inc., an S corporation, made leasehold improvements to the building they were leasing to an unrelated third party. The building had an original cost of $600,000 and has been depreciated for 12 years using a 39-year class life. As part of the lease agreement, TMI, Inc. was required to make some improvements to the interior portion of the building. TMI, Inc. spent $375,000 on improvements, which are qualified leasehold improvements for purposes of §179 and §168(k).TMI, Inc. has its return on extension and would like to use §179 for the first $250,000 of the improvements and bonus depreciation on the remaining $125,000. The current tenant has shown interest in buying the building for $1.2 million. What will the consequence of taking the §179 and bonus depreciation have on the gain on the sale of the property?
Answer: Because the §179 and bonus depreciation are considered to be accelerated depreciation, the first portion of the gain on the sale of the building will be recaptured as ordinary income under §1250. To the extent the $250,000 and $125,000 exceed the allowable straight-line depreciation up to the point of sale, the gain will be ordinary. The remaining gain will be allocated to unrecaptured Section 1250 gain, which is capital gain due to straight-line deprecation and finally, the remainder of the gain will be Section 1231 gain.
April 26, 2012
Question: Edward and his son Eugene purchased a residential rental real estate property together as tenants in common. Edward and Eugene own equal 50% interests in the property and have agreed to share income and expenses equally. Have Edward and Eugene created a partnership for federal income tax purposes and are they required to file Form 1065?
Answer: No. According to Reg. 301.7701-1(a)(2), the mere co-ownership, rental and maintenance of real property held for the production of income does not create a partnership for federal income tax purposes. Since Edward and Eugene own equal interests and have agreed to share income and expenses equally, a partnership has not been created for federal income tax purposes and they are not required to file Form 1065. Edward and Eugene will report their respective share of the income and expenses on their own Form 1040 Schedule E. Also, since the arrangement is not considered a partnership, Edward and Eugene do not need to elect under IRC Sec. 761(a) to be excluded from all partnership provisions of the Internal Revenue Code. However, making an affirmative election out of partnership status will remove any doubt to whether a partnership exists.
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