Income tax
How long should you keep your tax records?
October 5, 2010 by admin · Leave a Comment
I am frequently asked by clients how long they should retain their personal income tax records. The records supporting your income tax return may have to be produced if IRS (or a state or local taxing authority) was to audit your return.
In general, the IRS only has three years from the date you filed the return (or, if later, three years after the return was due) to assess additional taxes. For example, if your 2009 individual income tax return is filed by its original due date of April 15, 2010, the IRS will have until April 15, 2013 to assess a tax deficiency against you. If you file your return late, the IRS generally will have three years from the date you filed the return to assess a deficiency.
However, there are exceptions to the three-year rule. The assessment period is extended to six years if the IRS believes that more than 25% of gross income is omitted from a return. Also, if you don’t file a tax return, the IRS has no specific time period which limits their ability to assess additional taxes. If the IRS claims that you never filed a return for a particular year, keeping a copy of the return will help you to prove that you did.
While it’s impossible to be completely sure that the IRS won’t at some point seek to assess tax, retaining tax returns indefinitely and supporting records for six years after the return is filed should be adequate. If you file your returns electronically, be sure to get copy for your records.
One important caveat to this rule applies to a transaction that may occur in one year, but for which the amount that is taxable depends upon a transaction from an earlier year. For example, suppose you bought a home in 1986 for $100,000 and made $20,000 of capital improvements in 1993. To determine the tax consequences of the sale, it’s necessary to know your cost basis. If you sell your home in 2010, and your return for that year is audited, you may have to produce records relating to the original purchase in 1986 and the capital improvement in 1993. So those records should be kept for at least six years after your 2010 return is filed instead of just six years after the transactions they relate to occurred.
Similar considerations apply to other property which is likely to be bought and sold-for example, securities. In particular, remember that if you reinvest dividends to buy additional shares of stock, each reinvestment is a separate purchase of stock. The records of each reinvestment should be kept for at least six years after the return is filed for the year in which the stock is sold.
So, there is a lot of information that you can safely shred. Just keep in mind the six year rule, and avoid the mistake of destroying something that may fall outside the six year window, but might be critical to substantiating a transaction or deduction in the future.
By Glenn Schanel, CPA
Click Here to Download a Printable PDF of this Article
Glenn Schanel, CPA, CFP® is the President of Schanel & Associates, PA, Certified Public Accountants. The firm provides tax, accounting, and consulting services to clients throughout South Florida and the United States.
The information contained in this communication is intended as general guidance on matters of interest only. The application and impact of laws can vary widely based on specific facts involved. Given the changing nature of laws, rules and regulations, and the inherent hazards of electronic communication, there may be delays, omissions, or inaccuracies in information contained in this transmission. The information contained herein should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisors. Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained in this communication, unless explicitly provided otherwise, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Income tax
The Tax Consequences of a Short Sale or Foreclosure: Vacation Homes (Part 3)
November 18, 2009 by admin · Leave a Comment
The Tax Consequences of a Short Sale or Foreclosure: Vacation Homes
By Glenn Schanel, CPA, CFP®
(This article is the third in a three part series on the tax consequences of short sales and foreclosures. This installment will cover properties that qualify as vacation residences or second homes.)
A vacation or second home is a residence that is used for personal purposes but which does not qualify as a principal residence. Unfortunately, when it comes to a foreclosure or short sale, a transaction involving a vacation home is the situation most likely to result in an unfavorable tax situation.
Tax on Gains
The gain/loss on a short-sale or foreclosure transaction is calculated as the market price or sale price minus the cost basis. The cost basis on a vacation home is the sum of the purchase price, the purchase costs, and capital improvements. Any gains that result from the transaction must be reported as a taxable capital gain. Losses, however, are not deductible, because a vacation home is considered personal-use property.
Debt Forgiveness Income
Even if a vacation home is sold at a loss through a short sale or foreclosure, the taxpayer may still be subject to debt forgiveness income.
Debt forgiveness income is the difference between the loan amount at the time of the foreclosure or short-sale and the market price or sale price. As a general rule, debt forgiveness income is taxable as ordinary income, but there are several exceptions. Debt forgiveness income does not need to be included as income if:
(1) the debt discharge occurs as a result of a Title 11 bankruptcy case.
(2) the taxpayer is insolvent at the time of discharge (your liabilities exceed your assets).
(3) the loan is non-recourse (the lender cannot pursue you personally).
There is a catch, however. If a taxpayer elects to avoid taxes on debt cancellation income, other tax benefits (called attributes) must be reduced to the extent that the income is not recognized. In other words, the relief is temporary because it only defers the tax consequences into the future. The taxpayer can choose to reduce the basis of the depreciable property or to follow a prescribed ordering of tax attribute reductions. These include net operating losses, capital loss carryovers and passive loss carryovers.
In summary, the foreclosure or sale of a second/vacation home is likely to result in a very unfavorable tax situation. Capital losses are not deductible, but gains are taxable, and any related cancellation of debt can result in higher taxes now or in the future.
Consult with a Tax Professional
This can be a complicated issue, so we recommend that anyone involved in one of these transactions consult with a tax professional to review their particular situation. If you or someone you know is involved in a foreclosure or a short sale and is concerned about the possible tax consequences, please feel free to contact our offices at (561) 624-2118 to schedule a consultation.
Glenn Schanel, CPA, CFP® is the President of Schanel & Associates, PA, Certified Public Accountants. The firm provides tax, accounting, and consulting services to clients throughout South Florida and the United States.
The information contained in this communication is intended as general guidance on matters of interest only. The application and impact of laws can vary widely based on specific facts involved. Given the changing nature of laws, rules and regulations, and the inherent hazards of electronic communication, there may be delays, omissions, or inaccuracies in information contained in this transmission. The information contained herein should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisors. Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained in this communication, unless explicitly provided otherwise, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Income tax
The Tax Consequences of a Short Sale or Foreclosure: Rental Property (Part 2)
November 2, 2009 by admin · Leave a Comment
By Glenn Schanel, CPA, CFP®
(This article is the second in a three part series on the tax consequences of a short sale or foreclosure. This installment covers properties that qualify as rentals.)
You may be one of the many South Floridians who purchased one or more investment properties at or near the height of the real estate boom and now are left holding a property that has significantly depreciated in value. Meanwhile, the mortgage, along with insurance, taxes and other costs of ownership are putting a severe strain on your monthly cash flow. Renting the property can help alleviate some of this pressure, but with so many rental properties on the market, the rent can be considerably less than the monthly carrying costs. As a result, you may be considering a short sale arrangement or even a foreclosure.
However, before going forward with a short sale or foreclosure on a rental property, it is not only important to understand the legal implications, but it is also critical to understand all of the potential tax consequences, because they can be significant.
Tax on Capital Gains
The tax law treats both a short sale and a foreclosure of your rental property as a sale. The gain or loss is calculated as the market price or sale price minus your cost basis. In most cases, there will be a loss, and unlike with a personal residence, the loss on a sale of rental property is immediately deductible. This is generally referred to as a Section 1231 loss. This means that the loss is likely to qualify as an ordinary, as opposed to a capital loss. As a result, the tax benefit of the loss is at higher, ordinary tax rates. This is the one primary advantage over properties held for personal use.
Debt Forgiveness Income
Debt forgiveness income is the difference between the loan amount at the time of the foreclosure or short-sale and the market price or sale price. While Congress did provide tax relief for debt forgiveness income related to a principal residence, debt forgiveness income continues to be taxable for rental properties. However, there are two basic exceptions to this general rule:
(1) When the amount forgiven/deficiency is included in a bankruptcy filing.
(2) When you are insolvent at the time the debt is forgiven.
One more exception applies if your rental qualifies as Section 1231 property. In this case, you may be able to reduce the cost basis of the rental property without being insolvent. The result is that you don’t report the income from the debt forgiveness but you have a lower loss on the “sale’ of your property. To use this strategy, you must make an election and the debt forgiven must be “qualified acquisition indebtedness,” (i.e. debt incurred to acquire, construct or improve a property.)
Consult with a Tax Professional
This can be a complicated issue, so we recommend that anyone involved in one of these transactions consult with a tax professional to review their particular situation. If you or someone you know is involved in a foreclosure or a short sale and is concerned about the possible tax consequences, please feel free to contact our offices at (561) 624-2118 to schedule a consultation.
Glenn Schanel, CPA, CFP® is the President of Schanel & Associates, PA, Certified Public Accountants. The firm provides tax, accounting, and consulting services to clients throughout South Florida and the United States.
The information contained in this communication is intended as general guidance on matters of interest only. The application and impact of laws can vary widely based on specific facts involved. Given the changing nature of laws, rules and regulations, and the inherent hazards of electronic communication, there may be delays, omissions, or inaccuracies in information contained in this transmission. The information contained herein should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisors. Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained in this communication, unless explicitly provided otherwise, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Income tax
The Tax Consequences of Short Sales and Foreclosures: Principal Residences
November 2, 2009 by admin · Leave a Comment
By Glenn Schanel, CPA, CFP®
(This article is the first in a three part series on the tax consequences of a short sale or foreclosure. This installment will cover properties that qualify as a principal residence.)
The last thing a person involved in a foreclosure or short sale needs is a crushing tax bill, so it is important to understand and be aware of potential tax consequences. When it comes to a qualified principal residence, taxes can be avoided in most, but not all, circumstances.
A principal residence for tax purposes is a home that a taxpayer has owned and lived in for at least two of the past five years. Keeping that definition in mind, we will consider both the capital gains tax and the tax on debt forgiveness income that could result from a short sale or foreclosure.
Tax on Capital Gains
The gain/loss on a short-sale or foreclosure transaction is calculated as the market price or sale price minus the taxpayer’s cost basis. In the event there is a loss, there is nothing to report for tax purposes, because a loss on a principal residence or any personal property is not deductible. If there is a gain on the residence, then the taxpayer is eligible to exclude up to $250K (or up to $500K for a married couple that files married filing jointly) of this gain.
Therefore, when it comes to a foreclosure or short sale on a principal residence, unless the capital gain exceeds the exclusion maximums, there will be no capital gains tax.
Debt Forgiveness Income
Debt forgiveness income is the difference between the loan amount at the time of the foreclosure or short-sale and the market price or sale price. As a general rule, debt forgiveness income is taxable, but there are some exceptions.
The Mortgage Forgiveness Relief Act of 2008 says that debt forgiveness income can be excluded if the debt can be considered “Qualified Principal Residence Indebtedness” (QPRI). QPRI is any debt that is secured by a principal residence and was incurred to acquire, construct or improve a principal residence.
Therefore, a potential income recognition problem does exist if a taxpayer had refinanced and used any “cash-out” proceeds for some purpose other than home improvement. In that case, the income would be taxable unless the taxpayer qualifies for an exclusion under the bankruptcy or insolvency exceptions.
Consult with a Tax Professional
This can be a complicated issue, so we recommend that anyone involved in one of these transactions consult with a tax professional to review their particular situation. If you or someone you know is involved in a foreclosure or a short sale and is concerned about the possible tax consequences, please feel free to contact our offices at (561) 624-2118 to schedule a consultation.
Glenn Schanel, CPA, CFP® is the President of Schanel & Associates, PA, Certified Public Accountants. The firm provides tax, accounting, and consulting services to clients throughout South Florida and the United States.
The information contained in this communication is intended as general guidance on matters of interest only. The application and impact of laws can vary widely based on specific facts involved. Given the changing nature of laws, rules and regulations, and the inherent hazards of electronic communication, there may be delays, omissions, or inaccuracies in information contained in this transmission. The information contained herein should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisors. Pursuant to Regulations Governing Practice Before the Internal Revenue Service, any tax advice contained in this communication, unless explicitly provided otherwise, is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
