Tax Professional

The Tax Consequences of a Short Sale or Foreclosure: Vacation Homes (Part 3)

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.

Tax Professional

The Tax Consequences of a Short Sale or Foreclosure: Rental Property (Part 2)

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.

Tax Professional

IRS Announced 2006 Retirement Limits

IRS ANNOUNCES NEW RETIREMENT SAVINGS
CONTRIBUTION LIMITS FOR 2006

The following is a summary of the annual contribution limits for retirement savings plans for 2006:

Plan Type	Contribution Limit	Age 50 & Older “Catch Up”
Traditional and Roth IRA	$4,000	$1,000
SIMPLE Plans	$10,000	$2,500
401(k) and 403(b)	$15,000	$5,000
SEP Plans	Lesser of 25% of compensation, or $44,0000	N/A
Defined Contribution Plans	Lesser of 100% of compensation, or $44,000	N/A

Please contact our office at (561) 624-2118 if you have any questions.

Tax Professional

Year End Tax Planning 2006

GLENN G. SCHANEL, CPA AND ASSOCIATES , PA
YEAR-END TAX PLANNING STRATEGIES FOR 2006
Fall 2006

As this year enters the home stretch, there is still time to plan to reduce your 2006 federal income taxes. Adding to existing  tax-saving strategies are some new ones presented by recent tax legislation. On the other hand, the uncertain fate of several popular tax breaks that expired at the end of 2005 could make 2006 year-end planning more difficult.

Tried and True Strategies

Here are some proven strategies that may help you reduce your taxes once again this year. Of course, before applying any of these strategies to your personal situation, consult with one of our tax professionals.

Deductible Interest. Consider making your January 2007 mortgage payment (which includes December’s interest) in late December 2006 , so that the mortgage interest will be deductible on your 2006 return (applicable only if you itemize deductions on your income-tax return).

Medical and Miscellaneous Itemized Expenses. Your deductions are limited to the amounts that exceed 7.5% of adjusted gross income for medical expenses and 2% of adjusted gross income for miscellaneous expenses.Bunching two years of your or your
family’s unreimbursed medical or miscellaneous itemized expenses (such as certain job-related expenses and investmen t expenses) into one year may allow you to surpass the deduction floors and help you gain an itemized deduction for part of your expenses.

Charitable Contributions. If you are planning to make a charitable donation in early 2007, consider a 2006 year-end donation instead. Contributions charged on your credit card in 2006 count as 2006 deductions, even if you don’t receive or pay the credit card bill until 2007.

However, if you are a high earner facing a limitation on your itemized deductions or if you expect to be in a much higher tax bracket in 2007, accelerating these payments into 2006 may not be your best course of action. In addition, if you claim high deductions in 2006, you may be subject to the alternative minimum tax. See us for more details.

Income Deferral. Review any opportunities you may have to push taxable income into a later tax year. Deferral strategies are specially effective if you expect to be in the same or a lower tax bracket in the year in which you will be reporting the income on your tax return. Any of these strategies may help cut your 2006 taxes:

• Ask your employer to defer paying your 2006 year-end bonus until early 2007.
• Maximize 2006 contributions to any tax-deferred retirement savings plan in which you participate , such as a 401(k) plan or a 403(b) tax-sheltered annuity. If you are age 50 or older, you may be able to make additional “catch up” contributions to your
• plan.
• If you are self-employed and use the cash method of accounting for income-tax purposes, time late 2006 customer billings so that payment won’t be received until 2007.

Self-employed business owners who do not already have a tax-deferred retirement plan should consider starting one before year-end. Options to examine include a so-called “solo 401(k)” plan, a Simplified Employee Pension (SEP) plan, or a SIMPLE plan.

Investment Strategies . If you have investments with “paper losses” and you are thinking about selling any of these poor performers before the end of the year, remember that capital losses offset the capital gains you may have realized.Any net loss is deductible against up to $3,000 of ordinary income per year.

Consider selling appreciated stock or other investments on which you have “paper gains” before year-end to absorb any capital losses that exceed $3,000. If this is not desirable, any unused capital losses may be carried forward for deduction in future years, subject to limitations.

Remember, too, that the maximum tax rate on 2006 qualifying dividends and net long-term capital gains is 15%. Ordinary income tax rates range as high as 35%.

New Strategies

Prepare for a Roth Conversion . Earlier this year, a new law removed the income limit for high earners who want to convert their traditional Individual Retirement Account to a Roth IRA. But this change isn’t effective until 2010.

If the income limit applies to you and you are interested in a Roth IRA, you might want to consider making contributions to a traditional IRA now with the intent of converting that IRA to a Roth IRA in 2010. Even if you cannot make deductible IRA contributions (due to you or your spouse being an active participant in an employer -sponsored retirement plan and exceeding certain income limits ) , you can make nondeductible contributions to a traditional IRA now. On conversion in 2010, only the IRA earnings on the nondeductible contributions would be taxed, and any Roth IRA earnings from then on would be nontaxable (assuming tax law rules are met). See us for more details.

Charitable Gifts from IRAs. If you are age 70½ or older, you can contribute as much as $100,000 a year from your IRA directly to one or more qualified charities without paying federal income tax on the distribution. So, if you are a charitably inclined eligible taxpayer, you can benefit your favorite charity with IRA money without having to receive a taxable distribution from your IRA. This tax break is only available for 2006 and 2007.

Charitable Gifts of Clothing or Household Items. New rules apply to contributions of clothing and household items made after August 17, 2006. In general, the items must be in “good used or better” condition. However, you can still deduct the value of an item that isn’t in good or better condition if the value of the donation is more than $500 and you  include a qualified appraisal with your tax return.

Kiddie Tax. To minimize income shifting from parents to their young children in lower tax brackets, the tax law requires children who have more than a small amount of unearned income ($1,700 in 2006) to pay tax on that excess income at their parents’ marginal tax rate. A new law increases the age of  children to whom this “kiddie tax” applies. Effective for 2006, the kiddie tax applies to children under age 18 (formerly, age 14). Due to this change, higher -income parents should consider investing any assets put aside for their under-age-18 children in investments that generate little or no current taxable income (such as U.S. savings bonds, municipal bonds, or growth stock index funds).

Energy Tax Breaks. Tax credits are available for energy efficient and alternative energy home improvements. Among the items for which credits are available: energy efficient exterior windows and doors, furnaces and central air conditioning units, and solar water heaters. Also, credits are available for the purchase of certain hybrid and alternative fuel vehicles.

Uncertain Tax Breaks

As we write this, Congress is still debating extending to 2006 certain tax breaks that expired at the end of 2005. Among those breaks: the itemized deduction for state and local sales taxes, the above-the-line deduction for the teacher’s out-of-pocket expenses for supplies used in the classroom, and the above-the-line deduction for higher education expenses. Be prepared in your
planning if these items are not extended.

For More Details

Want to learn more about these and other strategies that might cut your 2006 tax bill? Talk to us. Our tax planning know-how can benefit you.

Tax Professional

June 2007 Tax Alert

TAX ALERT
NEW LAW INCLUDES BUSINESS/PERSONAL TAX CHANGES

A portion of a supplemental spending and minimum wage bill recently signed into law included several tax provisions that may have an impact on you and your business. The Small Business and Work Opportunity Tax Act of 2007 contains $4.8 billion in small
business tax breaks -but also includes $4.4 billion in revenue raisers.

We have briefly summarized below just two of the changes that may affect you

Section 179 Expensing Deduction .The new law increases both the maximum annual expensing amount and the threshold phaseout amount. For tax years beginning in 2007, the practical impact of these changes is to increase the annual expensing limitation from $112,000 to $125,000 and to increase the phaseout amount from $450,000 to $500,000.

Kiddie Tax. In general, the revenue code imposes taxes on a young child’s unearned income in excess of $1,700 at the child’s parents’ tax rate. A 2006 tax law increased the age at which the kiddie tax applies, from under age 14 to under age 18. Now, the new law modifies that change so that the kiddie tax applies generally to children under 19 years old, effective in tax year 2008. More importantly for many taxpayers, the law will also apply the kiddie tax if the child:

• Is over age 18 (but under age 24) and
• Is a full-time student and
• Has earned income that does not exceed one half of the student’s total support.

Summary

With the business tax changes and the new kiddie tax rules, your tax planning may need a tune-up. Why not contact us today to find out more about how the new tax law may affect your situation.