Archive for February, 2014|Monthly archive page

Relief if You Paid Tax on a Short-Sale 2011-2013

Originally published in the Cedar Street Times

February 21, 2014

Hopefully we are nearing the end of the short-sale and foreclosure saga that has continued since 2008.  My litmus test based on tax return filings is indicating that things are much closer to being back on track.  Prior to 2008, it was all about 1031 exchanges.  Those turned off like a faucet when the markets crashed, and then short-sales and foreclosures took center stage.  I have seen those tapering off over the last couple years, and I am starting to see 1031 exchanges again.  The cycles continue!

But before we leave short-sales and foreclosures in the dust, there is a possible silver-lining handed down by the IRS and FTB in the last few months.  Taxpayers that generated income tax as a result of a short-sale in California on their principal residence, retroactive to January 1, 2011, may be entitled to a refund.

California Code of Civil Procedure Section 580b has been dubbed California’s “anti-deficiency laws” for years.  It had a positive effect on homeowners because it basically said if you had never refinanced your home and you lost it in a short-sale or foreclosure that you could not be pursued for the balance you still owed (the deficiency), and the remaining debt would not be taxable income to you because the debt was considered nonrecourse debt.

This, however, left many people out in the cold that had refinanced.  Suddenly, it was a different ball game if you had done a refinance (and who didn’t during the run of good years up through 2007!?), and the debts were then allowed by lenders to be treated as recourse debts and they could pursue your personal assets.  Alternatively they could cancel the debt if it was not worth pursuing, leaving you with taxable income for the amount cancelled.

Congress stepped in (and California generally conformed) during the housing crisis and enacted favorable legislation which said you could exclude cancellation of debt income generated by your personal residence.  The catch, however, was that the debt had to be “qualified debt.”  In short, if you lived off the equity in your house by refinancing to pull cash out and did anything with it other than improve the property, then you were not eligible for the exclusion on that portion and would still have to pay tax.

Then, a few years ago, California passed Senate bills 931 and 458 which were codified into law as California Code of Civil Procedure Section 580e as of January 1, 2011.  This resulted because some unscrupulous lenders were entering into short-sale agreements to allow sellers to go through with the sale of their property for less than the amount owed to the bank, but then still pursuing the seller for the remaining debt after the fact (often a big surprise to the seller).  California’s enactment of this law was good news for homeowners because it basically said, even if you had refinanced, but had entered into a short-sale agreement with a lender, then you could not be pursued for the remaining balance owed and that lenders would basically have to cancel the debt.  Of course, cancelling the debt could mean tax was owed, but that was still better than being pursued for the remaining balance!

Finally, in November 2013 a letter from the Office of the Chief Counsel at the IRS written to Senator Barbara Boxer, due to an inquiry from her, stated that the IRS would treat any debt pursuant to California’s 580e as nonrecourse debt!  The Chief Counsel’s office at California’s Franchise Tax Board followed up with their own letter a month later saying they will conform to the IRS interpretation.

This means that anyone who filed a tax return in 2011 or 2012, or even this year, and reported cancellation of debt income related to the short sale of a principal residence, should consider filing an amendment for a possible refund.  It is still possible to have income tax, primarily if you did not live in the house for two of the last five years prior to your short-sale.  The reason is that when a home is disposed of with nonrecourse debt, the total amount of debt outstanding at the time of the short-sale becomes the sales price of the home.  You then subtract your cost basis, and the difference is your gain on sale.  However, if you lived in the home for two of the last five years, then you get a $250,000 gain exclusion for filing as a single status, and $500,000 gain exclusion if married filing jointly, pursuant to IRC Section 121.

You need to act on this during the next year if your short sale was in 2011 as the statute of limitations expires three years after filing.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.

Advertisements

Aren’t All Tax Returns Created Equal?

Originally published in the Cedar Street Times

February 7, 2014

There is a belief by many people that a tax return is a bit of a commodity – basically you are going to get the same results no matter if you or anybody else prepares the return.  If that were true, your only goal would be to find the absolute cheapest tax preparer in town (or do it yourself).

A number of years ago Money magazine used to annually send out the same hypothetical family’s tax return to be prepared by 45-50 tax preparers across the country.  The surprising result was that it was rare in any year to have even two tax returns prepared the same way.  The most recent one that I could find resulted in only 25 percent of the preparers coming within $1,000 of the theoretical correct answer.  That means 75 percent missed the mark by more than $1,000.  This certainly speaks to the complexity of the tax code, and why you really need to have someone with as much relevant experience, education, and training as possible to navigate the tax terrain.  You may think you are being savvy by saving $200-$300 by getting a deal on your tax preparation, but what did you get?  Maybe you overpaid your tax by a $1,000 in the process of saving $300.  And how would YOU ever know.

When it comes to hiring someone to prepare your returns, credentials are not everything, but they certainly are a measuring stick of the education, training, testing, and commitment required.  Here are your options:

Do-It-Yourself Software (i.e. TurboTax) – Tax software, whether for professionals or amateurs is certainly a requisite tool to bring any measure of accuracy or efficiency to preparing a tax return.  Computers are quick at math and very accurate at crunching numbers (that is the part that is “guaranteed” to be accurate by do-it-yourself software providers), but if you provide the wrong input, or your software is not even programmed to ask you or accept all the variables you might need, then you will get a wrong answer every time (that part they don’t guarantee).

In addition, without an understanding of the forms and tax law, you will have no idea if there is a glaring error staring you in the face when you are ready to submit the forms.  I have seen countless returns butchered through the use of tax preparation software over the years.  I am currently amending three years of tax returns for a family that overpaid their taxes by $1,000 a year for the past twelve years due to a simple mistake that the software was not able to point out to them.  Unfortunately the statute of limitations has run out on the first nine years and they cannot get a refund at this point.

RTRP -“Registered Tax Return Preparer” – This is the current basic credential required by the IRS to prepare tax returns for pay.  There is no formal high school or college education required, no professional class and exam process to become licensed, and no continuing education requirement.  You just pay $65 to the IRS and you can prepare tax returns professionally!  This designation was created in the last few years with the intent of having a basic exam and some continuing education, but the testing and education requirements have been put on hold pending legal challenges to the requirements. RTRPs have limited practice rights before the IRS.

CRTP – “CTEC Registered Tax Preparer”– (CTEC stands for CA Tax Education Council) – This is the current basic credential required by California to prepare tax returns for pay.  Again, there is no formal high school or college education required.  There is a 60 hour professional class (equivalent to three or four semester units in college – one class) that is offered by many providers in person, on the internet or by self-study with an exam on the material covered.  There is 20 hours of continuing education each year, and a $5,000 bond.  This is the license that the vast majority of preparers hold in California at chains such as H&R Block, Liberty Tax Service, and Jackson Hewitt.  CRTPs also have limited practice rights before the IRS.

EA – “Enrolled Agent” – This is the highest of the two designations offered by the IRS, and EAs can practice in any state.  Again there is no formal high school or college education required, and there is no required professional class (although an intensive prep course is generally taken).  There is a 10.5 hour proctored three-part exam with 100 question each – one on individual, one on business returns, and one on practice procedures and ethics with essentially 24 hours of continuing education each year.  EAs have unlimited practice rights before the IRS.

CPA – “Certified Public Accountant” – Licensed by each state (although there is reciprocity to practice with nearly every state now).  California requires a college degree with 150 semester units (five years) including 24 semester units of accounting and 24 semester units of business related courses in taxation, economics, finance, management, etc., 10 semester units of ethics, and another 20 semester units of accounting studies which a masters of taxation or masters of accountancy would satisfy.  You must then work for a year under the direct supervision of a CPA.  If you want to be able to sign audit reports, you have to have 500 supervised audit hours.  You must also pass a 14 hour proctored four-part national exam and then a CA ethics exam.  California also requires a LiveScan background check and fingerprinting of all applicants.  There is essentially 40 hours of continuing education required each year for California CPAs.  CPAs have unlimited practice rights before the IRS.  Although CPAs are trained in, and can do a lot more than just your tax returns, most small CPA firms focus on tax preparation.

Attorney – Licensed by each state. We won’t discuss the requirements to become an attorney, as attorneys rarely prepare tax returns.  Some attorneys that specialize in tax will prepare tax returns, although most of those are focused on estate tax returns.  Attorneys that do prepare tax returns will often have obtained a CPA license also.  Attorneys have unlimited practice rights before the IRS.

Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950 and focuses on trust, estate, individual, and business taxation. He can be reached at 831-333-1041.