Is Print Material Worth the Paper it is Printed On Anymore ?

Originally published on Passive Activities and Other Oxymorons on May 2nd, 2011.
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Revenue Ruling 2010-25

I've been kicking myself for posting a backlog of material that I think is getting stale.  It's from March and maybe even February.  Today I received my copy of the latest issue of the Journal of Accountancy.  As usual it includes something from the most current issue of The Tax Adviser, which I'll probably get tomorrow.  Here is what the ruling is about.  There is a limitation on home mortgage indebtedness based on the outstanding balance of the mortgage.  The limit is a mortgage balance of $1,000,000,  In order to qualify the loans proceeds must have been attributable to acquiring a residence and secured by such residence.

Then there is home equity indebtedness.  Interest on that is also deductible with the mortgage balance limit being $100,000.  Home equity indebtedness just has to be secured by a residence.  You can have spent the money on anything.  So what happens if somebody takes out a mortgage of say $1,500,000 to purchase a residence.  To make the math easy lets say its at 5% and was outstanding all year.  I and a lot of other practitioners thought you could deduct $55,000 of the $75,000 you had to pay.  $50,000 is acquisition indebtedness.  $5,000 is home equity indebtedness.  As it turns out there were two tax court decisions that said otherwise (Pau TCM 1997-43 and Catalano TCM 1997-43).  According to those decisions you can spend home equity indebtedness proceeds on anything except the acquisition of the residence securing it.

Revenue Ruling 2010-25 might seem a little shocking to those who think the IRS is voracious behemoth.  The ruling says the (I hate to say this) common-sense view, which is more favorable to the taxpayer, is correct.  So it's nice to have some good news there in the Journal of Accountancy and the Tax Adviser.  I think, however, the information would have been more useful in say February or maybe even March since you probably don't want to have to amend a return for a $5,000 deduction.  As a matter of fact, a lot of taxpayers with the business affairs that go with $1,000,000 plus houses might be afraid that an amended return would trigger an audit.  (It's a common belief.  After 30 years I still don't know whether there is anything to it.)

Well here is the observation that is the point of this post.  You could have read about the ruling in this blog on November 10.  Not to give myself too much credit.  These guys, whom I haven't been following, had it on October 26.  It was here on October 14.  Rubin on Tax, who always seems to beat me to the punch when we blog on the same thing also had it in October.  James Edward Maule of Mauled Again also had it a little ahead of me.

I'm not striving to give up to the minute information.  I try to put a little more into my posts than just the bare material, so if something is covered by a lot of bloggers I'm probably not going to be at the head of the pack.  There is big difference between one month and six, though.  More importantly there is a big difference between two months before the beginning of tax season and two weeks after the end.  The article in the Journal really doesn't add anything that could possibly justify a six month wait for the information.

Danger Danger Will Robinson - Housing Stock to Be Devastated

Originally published on Passive Activities and Other Oxymorons on March 17th, 2011.
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So one rule that I have for the blog is to not comment on tax policy.  The PAOO Prime Directive is "It is what it is. Deal with it."  I violate the rule about as often as Captain Kirk used to violate the Federation's Prime Directive, roughly every other week or so.  Here is a new rule.  If somebody asks me nicely to write about something in my blog, I will, particularly if they ask me nicely twice.  I've decided that this rule overrides the Prime Directive.  Let's call it the Super Prime Directive.

So here is the very nice email I just received:

Hello Peter

I sent you an email last week and didn't hear back so I wanted to follow up. Congress and the Administration are looking into scaling back or eliminating the Mortgage Interest Deduction. The consequences would be devastating to the recovering housing market and the tens of millions of home owners who benefit from the deduction.
The House recently introduced a resolution to retain the mortgage interest deduction and I hope that you’ll help spread awareness about it on Passive Activities and Other Oxymorons. We created http://SaveMyMID.org to support this initiative and I've also created a useful site for bloggers and journalists to borrow resources from:
http://savemymid.info

Please let me know if you have any questions or need more information. If you are able to post about this, I'd love to get the link and share it with my team.

Thank you,
Ruth--

Ruth Potter

Ruth@SaveMyMID.info

You should check out the website.  It has some really nice pictures and is very well done.  The gist of the site is in the text over a picture of a lovely home with an American flag on it:

The mortgage interest deduction is at risk of being terminated.  The consequences would be devastating to home owners, the housing market and the nation's economy.

Being self absorbed and also because it was easy, I recomputed my 2009 tax return without the home mortgage deduction.  It would have cost me $2,075.  I'll call it forty bucks a week to be accurate, but not precise.  I suppose I could stop buying Mountain Dew and a chocolate frosted donut every morning.  Most likely though, it would mean my kids will inherit a little less or that I will run out of money when I am 94 instead of 96.  Then I tried to think how bad could it possibly be for somebody else.  Because of the limitation on the balance of a mortgage that can create a deduction you are not going to see many mortgage interest deductions north of $50,000.  To keep the math simple I'm going to say losing that deduction might cost somebody $20,000.  Now that's a lot of money.  Of course I have a hard time with the idea of spending more than $1,000,000 on a house.  If the deduction is going to make the difference maybe you should be shopping for a starter home in the $500,000 range.  I know.  It's easy for me to say not living in Silicon Valley.

I'm sorry that given that someone has nicely asked me to write about something that I can't quite share their passion.  Check out their website and see what you think though.  And if you want me to write about something all you have to do is ask.  Agreeing with you will cost extra.

Even More About Short Sales

Originally published on Passive Activities and Other Oxymorons on February 20th, 2011.
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I received a very gratifying email yesterday :

We are happily settled in our new home. Thank you for all your help.

The lady who sent it had been trying to purchase a home on a short sale where the seller was receiving a relocation grant.  The seller had an outstanding IRS lien.  The collection agent responsible for releasing the lien finally gave in after she sent him a copy of CCA 201102058 which she had learned about from my blog post.  What is really intriguing is this particular development seems not to have attracted any notice to speak of.  Check out this search.  It seems like, except for one broken link, I'm the only one who has written on this.

My friend, Stephen McWilliam, a Florida realtor has suggested to me that this may be because the HAFA relocation money is not really flowing yet, making the problem more of a theoretical one. Stephen is a really smart guy.  I have a pretty good aptitude for what I do and I have experience and focus.  It's always a little humbling to realize that other people I meet in business and am able to help would probably be better at what I do than I am.  Fortunately they chose other fields.  I think in economics this is referred to as "comparative advantage".  At any rate, Stephen mentioned something about the tax aspects of short sales that had never occurred to me.  Presumably when you are behind on your mortgage you owe both interest and principal.  When the short sale goes through for some transitory moment the money is yours even though your don't get to touch it.  If the bank applies the proceeds to interest, you should potentially be able to deduct that interest and should be looking for a Form 1098.  I usually try to tie my posts to specific pronouncements, but I haven't been able to find anything that addresses this head on.

This is separate from the issue of getting a Form 1099-C which may require you to recognize income on a short sale.

IRS More Liberal Than Tax Court on Home Mortgage Interest

Rev. Rul. 2010-25, 2010-44 IRB 571, 10/14/2010

This was originally published on PAOO on November 10th, 2010.

Back under the good old Internal Revenue Code of 1954, interest paid was pretty much deductible. In terms of making life complicated for those not among the ranks of the captains of industry, the one thing that was worse than the passive activity loss rules were the new rules about interest deductibiltiy. Interest expense must be divided into three components trade or business interest, investment interest and personal interest. Trade or business interest is deductible, but might be suspended by the passive activity loss rules (At that point it will have lost its identity as interest and just be part of the loss). Investment interest is deductible, but only as an itemized deduction and only to the extent of investment income, generally (Don't get me started on people who invest in hedge funds that are traders in securities) and personal interest is non-deductible. Of course that's not the whole story. I'm not going to discuss student loan interest. The three broad categories trade or business, investment and personal are all you get when you are only looking at how the money was spent.

Which brings us to residence interest. There are two types. Acquisition indebtedness is used to purchase one or two residences. In addition to tracing the indebtedness to an acquisition of a personal residence the debt must be secured by "such" residence. There is a limit, not on the amount of interest but rather on the amount of indebtedness. $1,000,000 - not indexed for inflation. Then there is home equity indebtedness. The only requirement is that it be secured by a personal residence. If you borrowed money against your house to put into a business you can decide from year to year whether to treat the interest as home equity indebtedness which will give you a sure itemized deduction or trade or business interest deductible in arriving at adjusted gross income (generally better than an itemized deduction) but possibly subject to being suspended if the business is a passive activity. The limit on home equity indebtedness is also a limit on the amount borrowed. $100,000 - not indexed for inflation.

Now suppose you buy a $2,000,000 house putting 20% down. That would give you a mortgage of $1,600,000 and to make the math easy lets say it is at 5%. Further assume that you have no other debt. How much of your $80,000 of interest expense can you deduct ? So you don't have to get a calculator I'll give you two choices - $50,000 or $55,000.

I have to admit that I always thought the answer was $55,000. I thought it was clear enough that I never really looked any further. It turns out, however, that there is a reading of the Code to the effect that interest on home equity indebtedness up to the $100,000 limit is deductible regardless of how the money was spent unless it was spent to purchase a residence. My inability to see that reading must have come from my falling into the "That doesn't make any sense" trap. So what if it doesn't make any sense it is what it is.

There are two tax court decisions with this holding. I went and looked at them and noted that in at least one the taxpayer had made himself obnoxious in nine ways till Sunday so they might have been trying to throw the book at him. Regardless, the Service in this ruling is saying that it will not follow the two tax court decisions on this issue that it won. So if you purchase a house with a mortgage of more than $1,000,000, $100,000 of the excess can be counted as home equity indebtedness.

Investment Interest Relief

PLR 201016032

This was originally published on PAOO on July 30th, 2010.

If you are someone who invests on margin PLR 201016032 might be of interest to you (pardon the unintentional pun). Back in the good old days interest used to be just deductible. Yeah they got upset if you used it to buy tax exempt bonds, but other than that it was cool. It hasn't been that way for quite a while. Interest expense falls in several different classes. In general which class the interest falls under is determined not by how the money was borrowed, but by what it was spent on. There are fairly mind numbing regulations, that tell you how you are supposed to trace borrowed money. If a residence is involved it can be important as to how the debt is secured.

Investment interest is deductible as an itemized deduction, but only to the extent of your investment income. If the interest exceeds investment income it is carried over to the next year. The carryover never expires. A problem, though, is that the definition of investment income does not include long term capital gains or qualified dividends. I will overcome my reticence on commenting on logic having anything to do with taxes to point out that capital gains and qualified dividends are taxed at a preferential rate. What if the only investment income you ever have is long term capital gain and qualified dividends ? You are allowed to elect to treat that income as investment income. The cost of the election is that you don't get the preferential treatment on the income you reclassify. The election has to be made on a timely filed return.

The taxpayer in the ruling managed to find a preparer who wasn't aware of the election. Neither was the taxpayer until contacted by the preparer - light having dawned on Marblehead - two years later. The Service allowed the taxpayers sixty days from the date of the ruling to amend their return and make the election.

If you invest on margin or otherwise have investment interest ( You may for example have received a debt financed distribution from a partnership which you deposited into your brokerage account), take a look and see if your return has Form 4952 attached. On Part III Line 7, there may be a number showing your carryover of investment interest. If that number is a NUMBER, you may want to discuss with your preparer whether you might benefit from the election in the future. If it is REALLY A NUMBER, it may be worth amending even if you have to request permission for a late amendment.