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Michael Gray, CPA's Real Estate Tax Letter

October 26, 2016

© 2016 by Michael C. Gray
ISSN 1930-0387

A monthly report focusing on tax issues for the homeowner and real estate investor.

Table of Contents

Bulk land sale taxed as ordinary income.

Gregory Boree acquired undeveloped land with a business partner in November 2002. In March 2005, Mr. Boree bought out his business partner and his wife became the second member of the LLC.

The Borees sold residential lots for which they reported ordinary income and deducted all of the operating expenses for holding the real estate while negotiating with government agencies for rezoning the property and different development proposals, during which the LLC was represented as the developer for the property.

On February 6, 2007, the Borees sold the remainder of the property to another developer.

They reported business deductions of $46,360 on Schedule C and the gain from the sale of the land as long-term capital gain.

The Tax Court upheld the IRS in recharacterizing the gain as ordinary income and a 20% penalty for substantial understatement of income tax.

The Eleventh Circuit Court of Appeals also upheld the IRS in recharacterizing the gain as ordinary income. The Eleventh Circuit didn't accept the taxpayers' representation that their status had been changed from developers to investors because of their continued activity for development of the property with government agencies and because they claimed business deductions and ordinary income from the sale of lots throughout the time the property was held.

In favor of the taxpayers, the Eleventh Circuit held the taxpayers acted in good faith and relied upon the advice of their tax return preparer in claiming capital gain treatment for the sale, so the 20% penalty for substantial understatement of tax didn't apply. Since the tax deficiency was $1,784,242, the penalty reduction was probably about $356,000 - well worth the litigation.

(Boree v. Commissioner, 2016-2 U.S.T.C. 50,406, September 12, 2016.)

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IRS loses! Taxpayer substantially complied with the requirements for a donation deduction.

An LLC made a part-sale, part-gift of land to the Maricopa Flood Control District.

The LLC attached Form 8283, signed by one of two appraisers, and two appraisals to its income tax return. The donation deduction was for the excess of $1.5 million appraised value over the sale price of $735,000.

The IRS claimed the taxpayer didn't meet the requirements for the charitable contribution and that the appraisal wasn't a qualified appraisal. It also asserted a penalty for substantial understatement of income tax.

For its appeal, the taxpayer hired another appraiser, who developed a value of $2.167 million. The IRS's appraiser said the property was only worth $505,800.

The Tax Court said the taxpayer substantially complied with the requirements for the donation deduction. It accepted the Form 8283 and the appraisal submitted by the taxpayer. The Tax Court also accepted the appraised value submitted for the trial, $2.167 million, as the correct value for the property and accepted the donation deduction based on that value.

So, the IRS left this contest with less tax than when they started.

(Cave Butees, LLC v. Commissioner, 147 T.C. No. 10, September 20, 2016.)

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Good news! QTIP election is accepted with a portability election.

In the past, the IRS has said a QTIP (qualified terminable interest property) election wasn't effective unless making the election resulted in a lower federal estate tax. After that announcement, Congress enacted a portability election to enable a surviving spouse to receive the unused lifetime estate and gift tax exemption of a deceased spouse.

When a QTIP election is made for a qualified trust, the trust property qualifies for the estate and tax marital exemption and the trust property is included in the taxable estate of the surviving spouse. That also means the tax basis of the property in the QTIP trust receives a new tax basis (cost to determine gains and losses for income tax reporting) at the death of the surviving spouse.

Now the IRS has announced the QTIP election can be made when there is no tax reduction as a result of a portability election. A QTIP election will only be voided if an executor request that it be voided.

This is complex stuff, but worth discussing with your attorney whether your estate plan should be updated.

(Revenue Procedure 2016-49.)

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James Gray "kickstarts" new version of Crazier Eights.

James Gray, who is my son, has created a marvelous family card game, called Crazier Eights. He invented it because family members like my wife, Janet, and me were too intimidated to play Magic The Gathering with him. The basic concept of the game is similar to crazy eights or Uno, and the cards have special abilities and are decorated with terrific artwork. These days it seems everyone is walking around with their noses in their smart phones. Crazier Eights is a game with some social interaction.

Now James is introducing a new Camelot edition of Crazier Eights, and has initiated a Kickstarter to finance his startup costs. As a contributer to the kickstarter, you can get a copy of the game and other bonuses. Here is a link for the Kickstarter web site - tinyurl.com/craziercamelot. I hope you'll visit the site to learn more.

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Does your group need a speaker?

We are seeking opportunities to speak before groups. Topics include recent tax developments, tax issues relating to real estate, how estate planning has changed recently, tax issues relating to alternative investments using retirement accounts, and marketing topics such as "How I created a public access television show broadcast on eleven Bay Area stations." To make arrangements, call Michael Gray at 408-918-3161.

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Please share your good experiences with Michael Gray, CPA.

As you know, more and more people are going to the internet to find information about service providers. We hope you will share some good words about experiences that you have had with our firm. Some of the sites where you can share your experiences include yelp.com and siliconvalley.citysearch.com.

We use Angie's List to assess whether we're doing a good job keeping valued customers like you happy. Please visitAngiesList.com/Review/4258970 in order to grade our quality of work and customer service.

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Financial Insider Weekly broadcast schedule for October and November.

Financial Insider Weekly is broadcast in San Jose and Campbell on Fridays at 9:30 p.m., Pacific Time. You can watch it on Comcast channel 15 for San Jose and Campbell. The show is broadcast as streaming video at the same time at www.creatvsj.org.

Here are the scheduled interviews for October and November:

October 21 and 28, Nancy Ross, Bauer Shepherd & Ross and Associates, "How a collaborative approach can make a divorce a less painful process"
November 4, Robert E. Temmerman, Jr., Esq., Temmerman, Cilley & Kohlmann, LLP, "I'm an executor! Now what?"
November 11, Robert E. Temmerman, Jr., Esq., Temmerman, Cilley & Kohlmann, LLP, "I'm a trustee! Now what?"
November 18 and 25, Rebecca Dupras, Esq., Silicon Valley Community Foundation, "Why and how to promote charitable giving in your family"

Financial Insider Weekly is also broadcast as follows:

Past episodes of Financial Insider Weekly are posted on YouTube. One way to watch them is to go to our web site, www.financialinsiderweekly.com, and click on "Past Episodes."

Let me know any ideas that you have for topics or guests. Guests will usually have to be located in or near the Silicon Valley in California.

Hope you can watch or record the show. Please tell your friends about it!

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Questions and Answers

Michael Gray regrets he can no longer personally answer email questions. He will answer selected questions in this newsletter.

Dear readers:

Many of your questions relate to the sale of a principal residence. We have an article at our web site, "Could your residence be the ultimate tax shelter?" (www.realestateinvestingtax.com/residence.shtml) where you should be able to find the answers to most of these questions.

Many other questions relate to short sales and foreclosures. See our article on that subject at www.realestateinvestingtax.com/shortsale.shtml.

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Follow me on Twitter, Facebook, LinkedIn and Google+!

If you enjoy Twitter, please follow me at www.twitter.com/michaelgraycpa. I would especially appreciate retweets of our messages announcing episodes of Financial Insider Weekly.

you can also follow me on other social media sites, Facebook, LinkedIn, and Google+.

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Check out my blog.

I have also started a blog at michaelgraycpa.com. Check it out!

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For general tax developments, tax planning ideas, business development ideas and book reviews, subscribe to Michael Gray, CPA's Tax & Business Insight at taxtrimmers.com/subscribe2.shtml.

Have employee stock options? Subscribe to our free newsletter, Michael Gray, CPA's Option Alert! To learn more, visit stockoptionadvisors.com/subscribe.shtml.

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A monthly newsletter focusing on tax issues for the homeowner and real estate investor, by certified public accountants in California.
Michael Gray, CPA
2190 Stokes St. Ste. 102
San Jose, CA 95128
(408) 918-3162
FAX: (408) 998-2766