What is a Principal Residence?

A very recent New York District Court decision (Cohen v. U.S., 2/28/14) provides a lot of good narrative for taxpayers wondering how Internal Revenue Code Section 121 (Exclusion of Gain From Sale of Principal Residence) truly works.  The taxpayers here sought a refund of taxes paid arising from the sale of certain real estate which they claimed was their principal residence, albeit the facts of the case included complications related to the use of the property by children and other family members.

Indeed, the Court notes “The central question in this case (is):  whether (the property) was used by the Cohens as their ‘principal residence’ during the period David and Nicole (son and daughter-in-law) were living there,” and the fact that the regulation discussing this term sheds little light on how it should be interpreted, providing only that whether property is used by a taxpayer as his principal residence depends upon all of the surrounding facts and circumstances.

The Court goes on to state that it is not “aware of any cases that discuss the term in factual circumstances similar to what has been presented here.”

Unfortunately, the taxpayers’ arguments were insufficient to carry the day in this case (to include securing the government’s agreement that the accuracy-related penalty should not apply).  But the discussion will be enlightening to folks whose living arrangements may not be quite so clear-cut relative to whether the Section 121 exclusion may be available to them.

Keep IRS Posted on Your Address

Folks sometimes wonder how important it is to keep IRS informed of your current address. Short answer: it is important – don’t overlook it.

Most importantly, some IRS communications are time sensitive, and bad things can happen if you don’t respond within a certain time frame. Thus, you don’t want their letters to you laying around in an old, perhaps unattended mail box, or returned to the “dead letter” department at the Post Office, where they may languish for many moons.

There are several ways to notify the IRS of an address change, including:

  • The filing of an annual (or other periodic) tax return, reflecting your current, new address
  • Submission of a Form 8822, or other written notification
  • Electronic notification – some taxpayers submit their new address information through one of the secure applications found on the IRS website, such as Where’s My Refund?

IRS Taking a Bite Out of Crime

So says the recent annual report of the IRS criminal division. Notwithstanding budget cuts (of something like 5% in agent resources), IRS touts its 2013 record on crime:

  • 12.5% increase in investigations initiated compared to 2012
  • 18% gain in prosecution recommendations

Identity theft continues to rankle the IRS — the criminal investigation unit initiated over 1,400 investigations and recommended prosecution of over 1,250 individuals in fiscal year 2013.

Further, IRS criminal investigations included activity on a range of tax money laundering, public corruption, terrorist financing and narcotics trafficking during the year.

Global Tax Reform on the Horizon

The United States has joined the international effort to make global tax reform a goal of the “Group of 20” (G20) countries, seizing on the perception that multinational companies are abusing perceived “loopholes” to avoid taxation.

“The G20’s work on tax cooperation is among our most important new initiatives,” says Treasury Secretary Jack Lew, who also thinks that all nations should adopt the automatic exchange of information as a global standard.

“This is not against multinationals,” quoth Organization for economic Cooperation and Development Director-General Angel Gurria. However, “Multinationals have to have legal assurance that they’re not going to be double-taxed, but they have to contribute; their fair share has to be put on the table.”

Occasional Realty Sale: Capital Gain or Ordinary Income?

Some taxpayers think that gains from sales of real estate automatically result in capital gain treatment, versus recognition of ordinary income.  A typical profile is the situation of an individual with spare cash to “invest” who partners with a contractor in a “spec” building project.  The “investor” commonly views such a venture no differently from the purchase of a stock, intending/hoping for an increase in value, and the eventual realization of a gain upon sale.

The question of whether any gain realized in the real estate situation is ordinary or capital will generally depend on all of the surrounding facts and circumstances, and many unhappy taxpayers have left the courthouse after a determination of ordinary income treatment, which typically means the taxpayer’s gain will be taxed at a considerably higher tax rate.

Before venturing forth in a deal of this nature, taxpayers should acquaint themselves (with the assistance of a tax pro) with the broad benchmarks which the courts have used in analyzing whether gain is capital or ordinary in nature, including:

  • The nature of the property acquisition
  • The frequency and continuity of sales
  • The nature and extent of the taxpayer’s actions (including participation in decisions associated with the venture)
  • Activity of the seller about the property
  • Extent and substantiality of the transaction

See the recent decision in Cordell D. Pool, et al v. Commissioner ,  TC Memo 2014-3 for more on this from a recent case dealing with a longstanding issue.

Obama Creates myRA Accounts

As announced in the recent State of the Union address, Obama has taken executive action and instructed the Treasury Department to create a new form of retirement account:  the “myRA.”  Not a whole lot to get excited about here, but an overview is of some interest:

  • Savers will benefit from “principal protection,” such that the account balance will never go down in value.
  • Contributions can be withdrawn tax free at any time.
  • Savers can keep the account balance when they change jobs (“portability”).
  • Workers can start an account with as little as $25.
  • The account will earn interest at the same variable interest rate that federal employees receive through the Thrift Savings Plan (TSP) Government Securities Investment Fund.
  • Taxpayers in low and middle income households earning up to $191,000 per year will be able to create a myRA account.
  • Participants can save up to $15,000, or for a maximum of 30 years, in their myRA account before transferring the balance to a private sector Roth IRA.

Let the Filing Begin!

IRS says the 2014 filing season begins January 31 – the first date, more or less, on which they will accept returns for processing.

And to help folks prepare their returns, IRS will make available a special series of daily “Tax Tips” beginning January 28.  More than 60 such “Tips” will be available through a free email subscription and cover a broad array of subjects, including:

  • Availability of free volunteer tax help
  • Fastest and safest way to get your refund
  • Tax return errors that slow down your refund
  • The home office deduction

To sign up, go to www.irs.gov and follow the instructions on the subscriptions page.

‘Zeroed Out’ GRATs Heading for Extinction?

A grantor retained annuity trust (GRAT) is a type of trust into which an individual transfers property while retaining an annuity interest for a specified term.  At the term’s end, the property passes to the child or beneficiary.  And if the present value of the remainder interest is virtually nothing, there is no gift tax consequence.

A Treasury explanation of the President’s fiscal year 2014 budget (which would crack down on such “zeroed out” GRATS) observes that “taxpayers have become adept at maximizing the benefit of this technique, often by minimizing the term of the GRAT (thus reducing the risk of the grantor’s death during the term), in many cases to two years, and by retaining annuity interests significant enough to reduce the gift tax value of the remainder interest to zero or to a number small enough to generate only a minimal gift tax liability.”

Present low interest rates and the recent surge in investment market returns have made GRATS particularly attractive, but if Obama has his way, things might change.

New Form 8960: Not as Simple as It May Seem

We have known about the new “net investment income tax” for a while now, anticipating its impact for the 2013 tax year.  IRS has just released a draft of the form on which this new tax will be calculated (Form 8960) and related draft instructions.  While the one page form appears innocuous enough, folks had better start familiarizing themselves with the nineteen pages of instructions (which include, by the way, five complex worksheets) and the concepts associated with just what is and what is not gross investment income, not to mention just what are the appropriate deductions in measuring the net taxable amount.  On the surface, many are probably thinking it’s just a simple matter of multiplying the taxpayer’s interest, dividends and gains by 3.8% and adding the result to the tax liability.

As usual, nothing which stems from the Internal Revenue Code and the related IRS regulations is ever that simple.

Check IRS You Tube Videos as Tax Season Commencement Nears

IRS has announced they will start accepting 2013 returns on January 31, and is doing what they can to help folks get in line for their refunds as early as possible.  Among others, consider these specific videos which taxpayers may access (http://www.youtube.com/user/irsvideos) to help them get their returns in order:

  • Assistance in finding free help from certified volunteers conversant with the electronic tax return filing process
  • Information regarding the requirements for filing tax returns, including income limits and age, and reasons why taxpayers may want to file even if they don’t have to
  • Tips on how to protect personal information and avoid becoming a tax scam victim
  • Information regarding which financial and tax files to keep and for how long