Archive for the ‘carryovers’ Tag

Back to Basics Part XXVI – Form 8606 – Nondeductible IRAs

Originally published in the Cedar Street Times

October 30, 2015

If you have traditional or Roth IRAs, you owe it to yourself to understand what is meant by having “basis in your IRA.”  This is especially important for people that have switched tax preparers over the years or prepared returns themselves, as they may not have transferred or tracked the amounts properly from year-to-year, or preparer-to-preparer.  Failure to understand this concept could result in oversights that cost you thousands or tens of thousands of dollars in tax when you start withdrawing and using the money from those accounts.

Having basis in your IRA means that you have made a contribution to your IRA at some point over the years for which you did not receive a tax deduction when you made the contribution.  Since you did not get a tax deduction when you contributed the money, you should not have to pay tax when you withdraw the money.  Roth contributions, by nature, are those for which you receive no tax deduction when you put the money in, so all contributions create basis.  With traditional IRAs, you create basis when contributing if your income is too high and you are therefore disallowed from taking the tax deduction.  Having high income would not prohibit you from making the contribution to the account, but you would just not be allowed to take the tax deduction on the tax returns.

If you are unfamiliar with the related calculations and forms and do not review them carefully or discuss them with your return preparer (or just plain have no interest in doing so!), you could easily assume you are getting a deduction when you are not.  Financial advisors generally have no idea if you have basis in your IRAs because they do not typically obtain copies of your tax returns and verify the deductions each year – it is just not part of their job description.  Basis to them generally means, what did you pay for the stock, bond, or mutual fund (a different concept of basis relevant for regular brokerage accounts).

And you do not really need a lot of income to be phased out from the deduction; it is not just a problem for the rich.  For tax year 2015, people filing single or head of household that also contributed to a retirement plan through their work during the year (even if a trivial amount) or were eligible for a pension, are allowed to take the deduction in full until they reach only $61,000 of income.  Then the deduction starts to phase out and is completely phased out once they have $71,000 of income.  For married couples filing jointly, the combined income (of both spouses) phase out range is only $98,000 to $118,000 when determining the deductibility of a contribution when both spouses participates in a work plan.  In situations where one spouse participates in a work plan, and the other does not, the phaseout range for the deductibility of the contribution by the spouse that does not participate in a work plan is a combined income (of both spouses) of $181,000 – $191,000.  If neither spouses participates in a work plan during the year, there is no income phase out for the deduction that year.

The other way people get basis in their IRAs is if they are inherited.  Since IRAs do not get a step-up in basis upon the death of a decedent, you receive the basis the decedent had in the IRA (if any).  So it becomes very important to make sure you know what this is and hopefully have some documentation supporting it.

When you start withdrawing money out of your IRAs, the tax preparer determines the tax free portion of your withdrawal by dividing your total historical IRA basis by the total year-end values of all your SEP, SIMPLE and Traditional IRAs and multiplying that ratio by your IRA withdrawal amount.  If you or your past preparer(s) did not carefully track and pass this basis number on over the years, then your current preparer will generally assume there is no basis.  As such you have just set yourself up to be double taxed – once when the money was put in and you did not get the deduction and now again, when you take the distributions.

Sadly, I regularly see new clients come through my doors whose basis is missing, drastically lower than it should be, or at least suspect of being low; the client often has no idea why it even matters, has not kept records, and has changed investment advisors and tax preparers several times.  It becomes time consuming and expensive to recreate, if it can be done at all, or is even noticed in the first place.  Unless a nondeductible contribution is made during the year, the Form 8606 used to track the nondeductible contributions, is not filed and therefore not part of the return you may hand to your new preparer.  That individual has to have the presence of mind to ask about these carryovers.  I see these problems mostly with do-it-yourself and discount tax service chains.  Those options certainly have a right place and serve a need, but as a consumer, you need to understand the more you have at stake, the more detrimental is a mistake.

As mentioned before, with Roth IRAs, basis is created with every contribution.  What becomes important to track with Roth IRAs is the total amount of direct contributions made to the Roth versus Roth conversions and rollovers from traditional IRAs.  If you take any distributions before reaching age 59 1/2, or are over 59 1/2 but have had a Roth IRA for less than five years, these amounts become critical in order to calculate if a portion of your distribution is taxable.  There is a specific ordering method for withdrawals which is favorable.  As with traditional IRAs, Roth IRA basis is often forgotten about over the years.

The Form 8606 – Nondeductible IRAs does several things: 1)  it is used to calculate and track nondeductible contributions to traditional IRAs, 2) it is used to calculate the taxability of SEP, SIMPLE, and traditional IRA distributions when there is basis, 3) it is used to calculate the tax on Roth conversions, and 4) it is used to calculate the any possible tax on Roth distributions.  Part I of the is used for items 1) and 2) above.  Part II of the form is used 3), above and part III of the form is used to calculate item 4).

The instructions to the form also explain how to handle recharacterizations – this is where you  contribute money to an IRA and then later for that same tax year decide you want to “recharacterize” it as a contribution to a Roth IRA instead, or vice versa – it’s like a “do-over.”  In addition the instructions explain how to handle excess contributions or a return of contributions made during the year.

Even though the taxing authorities have theoretically received all your 8606s since 1987 when nondeductible IRAs were first permitted, I have never seen them point out to a taxpayer that he had basis in the past that was overlooked.  In fact, in the instructions to the form the IRS puts the burden on the taxpayer to retain the supporting documents from inception of your IRAs until your retirement accounts are fully distributed (plus at least three years for audit possibilities).

They ask that for the purpose of proving your basis in IRAs, you keep the first page of all 1040s, keep all Form 8606s,  keep all Form 5498s from your custodian showing the amounts contributed each year, as well as all 1099-Rs showing any distributions.  Now you know why, when people ask me how long I suggest keeping tax returns, I say, “Forever.”  I actually have scans of every one of my personal tax returns dating back to when I was 16, mowing greens, raking bunkers, and driving tractors in the summer for a golf course.

If you have questions about other schedules or forms in your tax returns, prior articles in our Back to Basics series on personal tax returns are republished on my website at .

Travis H. Long, CPA, Inc. 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.

Home Office Part I – New Option for 2013

Originally published in the Cedar Street Times

July 26, 2013

In January, the IRS issued Revenue Procedure 2013-13 which discusses a new option for calculating the home office deduction.  (You may want to clip this article and put it in your tax file as a reminder.) Instead of tracking the actual expenses of operating your home office such as water, utilities, garbage, repairs and maintenance, depreciation, etc., you can now elect a safe harbor $5 per square foot of qualified office space, up to 300 square feet ($1,500).  It is kind of like taking a standard mileage deduction on your car instead of tracking gas and repair receipts, and calculating depreciation expense.  Unlike vehicles, however, you can switch methods back and forth from one year to the next.

There are a few interesting provisions that will make it a good option for some people, and a bad option for others.  In other words, when preparing your return you will need to analyze the short and long term impacts, and determine which method is best each year. Since the $5 per square foot figure is not adjusted by region or for inflation, individuals living in high cost states like California are at a disadvantage.

If there is more than one person in the house, such as a spouse or roommate, they can each use the safe harbor as long as they are not counting the same space.  If one person has more than one office in the home for more than one business, the person can either use actual expenses for all the businesses, or the person must use the safe harbor for all the businesses.  However, the maximum deduction allowed is still $1,500 for all the businesses in the home combined, which may have to be allocated pro rata to the businesses based on square footage used by each. If one person has qualified home offices in more than one home, the person can use the safe harbor for one home, but must use actual expenses for the other home.

When claiming the safe harbor deduction, you are allowed to take your property taxes and mortgage interest in full as itemized deductions on Schedule A as well as claiming the safe harbor deduction.  On the surface this sounds like a plus, but for self-employed individuals you are effectively converting expenses that used to be on your Schedule C reducing self-employment taxes to itemized deductions which do not reduce self-employment taxes, and perhaps do not even reduce income taxes if you do not itemize.

Another big difference when claiming the safe harbor deduction is that no depreciation expense is allowed to be taken.  Traditionally, any depreciation expense taken on your home is required to be recaptured at the time you sell your house, and you must pay tax on it.  Even the section 121 exclusion ($250,000 tax-free gain for single/$500,000 for married couples) when living in the house for two out of the last five years will not exempt you from recapture taxes.  Occasionally that can produce negative results, but it is usually helpful because it often helps people avoid income AND self-employment tax which are typically higher than recapture rates.  Nonetheless, I regularly see tax returns where no depreciation was taken on a home office, to “avoid recapture.”  This is incorrect as recapture rules require you to recapture any depreciation “allowed or allowable.”  It does not matter whether you took the deduction or not, you are technically still on the hook for the recapture.

One other notable exception in the 15 pages of new rules explaining the safe harbor is that carryover expenses are not allowed for safe harbor years.  Ordinarily, if your business produces a loss, you are not allowed to create a bigger loss from business use of home expenses with the exception of the portion of mortgage interest, property taxes, or casualty losses which would have been allowed as itemized deductions even if you had no business.  The rest of the expenses get carried over to future years until you make a profit and can use the losses.  Using the safe harbor, any loss generated by the safe harbor disappears forever.  You would be better off in these years using actual expenses in order to preserve the losses for the future.

At the end of the day, you might as well just continue to track the actual expenses, and let your tax professional figure out which method will give you the best benefit each year.

In two weeks, we will go over the basic requirements in order to claim a home office deduction.

Prior articles are republished on my website at

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.

Foreclosures and Short-Sales – Part V – Insolvency

Originally published in the Pacific Grove Hometown Bulletin

August 17, 2011

The last four issues I went over the basic concepts of foreclosures and short-sales, an overview of ways to exclude the resulting taxable income, the effects of recourse/nonrecourse debt, and the principal residence exclusion. If you missed these articles they are re-published on my website at This issue I will specifically discuss the exclusion available when you are insolvent.

Insolvency means your liabilities are greater than the fair market value of your assets – essentially you have a negative net worth. In such cases, the IRS may allow you to exclude cancellation of debt income, created as a result of losing a home or rental property, to the extent that you are insolvent. This insolvency calculation is performed based on your assets and liabilities the moment before your debts are discharged.

Let us assume you are losing a second home with recourse loans so the principal residence exclusion does not apply to you. You have a house worth $300,000 and the value of everything else you own – cars, savings, retirement plans, household items, etc. is $100,000 for a total of $400,000 in assets. Then assume your home loan was $550,000 and you have you have $50,000 in credit card debt and car loans for a total of $600,000 in liabilities. You are insolvent by $200,000. If your home was foreclosed, you would have cancellation of debt income of about $250,000. You can exclude $200,000 of the $250,000, from income, leaving you with only $50,000 of taxable income.

When calculating your insolvency, do not forget to include the fair market value of pension plans, annuities, etc. If you have a plan such as CalPers, for instance, that pays you a monthly retirement benefit, you need to call your plan administrator and ask for an actuarial calculation of the value of your plan. Some people are surprised to learn that that pension can easily be worth $500,000 or $1,000,000, and would drastically change your insolvency calculation!

After determining how much debt can be excluded, you then have to reduce any tax attributes you may have. In exchange for excluding the $200,000 of income as in the above example, you then have to reduce or eliminate tax benefits that may have been useful to you in the future, or defer tax to a later date through basis reductions in items you may sell later. There is a specific order, method, and timing for doing this, but items such as carryovers of net operating losses, general business credits, minimum tax credits, and capital losses; basis in depreciable and nondepreciable property; passive activity loss carryovers and foreign tax credit carryovers are all on the chopping block. If after all these rules are applied and you still haven’t traded enough to equal your exclusion, then you are off the hook!

Oh, and you still have to calculate the gain or loss on the disposition of the property. We will not discuss that in this issue.

It is possible for the insolvency exclusion to be used in conjunction with other exclusions, and there are ordering rules to the exclusions themselves. This is just a summary of some of the key provisions. There are many other circumstances and specific rules that could affect you, and you need to consult with a qualified professional to review your situation. Consult as soon as you can foresee the possibility of losing a home in order to plan the most tax efficient way to lose it.

If this exclusion does not help you completely, and you are losing a rental property, you may be eligible for the qualified real property business indebtedness exclusion – next issue’s topic!

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, Pacific Grove, CA, 93950. He can be reached at 831-333-1041.

Lost in Transition

Originally Published in the Pacific Grove Hometown Bulletin

March 16, 2011


In my experience in the tax profession and from my vantage point as a Certified Public Accountant, I can tell you stories that will make your heart sing.  I can also tell you stories that will make you shudder like you just heard a bad contestant on American Idol.  The stories that make you cringe are usually caused by moments of stupidity by other tax preparers, or sadly, by people losing at a game of Tax Return Russian Roulette1.  I like to think the stories of hearts singing involve me riding in on a metaphorical white horse to save the day, heralding a banner “To correct stupidity and promote safety locks on roulette guns…”  I grant you, it is an unusual banner.

If I may spare you some pain, dear reader, I would say be mindful of transitions between tax preparers (including yourself) – particularly if you are “downgrading” the type of preparer you use.  Over the years I have seen countless returns where valuable tax attributes from prior returns were not carried forward to the next year’s returns by a new preparer (effects ranging from hundreds to several hundred thousand dollars in tax).  Some of you may be under the impression that your tax returns each year are distinct; this is rarely true.

Let us look at a simple example and suppose that you bought or inherited some mutual funds in 2007 worth $11,000; you sold them in 2009 for $6,000 resulting in a $5,000 loss.  There is a good chance you would have been limited to using $3,000 of this loss in 2009 and the other $2,000 would have been a capital loss carryover to your 2010 returns that could save you $500 or more in tax.  Of course, if you switch preparers and the new preparer does not have the training or presence of mind to find the Schedule D from 2009 and look for any unused capital losses, the cost of your new tax preparer just went up by $500.  Sadly, you probably would never know a costly mistake was made.

There are many areas similar to the above item including: carryovers of net operating losses, basis in retirement contributions and depreciable assets, state tax payments or refunds, office-in-home expenses, charitable contributions, rental property expenses (passive activity losses), alternative minimum tax (AMT) credits, foreign tax credits, general business credits, etc.  Often there are different amounts for the federal and state returns, and perhaps even AMT amounts for each of those if you are or may become subject to AMT.  Unfortunately these are scattered throughout forms in the return, and just because your new preparers show you comparative figures in a tax summary when you pick up your returns, does not mean they entered any of the carryovers in their software.

You do not have to be rich or have a complicated return to be affected by a number of these.  However, it does generally hold true, that the more money you make and the more types of activities you are involved with (rental properties, investments, etc.) the more heavily you are affected.

If you are doing the returns yourself with tax software for the first time, look carefully through the returns for hints of the above mentioned items, and be very diligent in answering the tax software questions.  Also, be wary of deleting items you think you no longer have, as they may have carryover or suspended items attached to them.  One of your big challenges is to know what the returns are supposed to look like when you are through.  If you are switching preparers, make sure the new preparer is qualified.  You may want to ask what specific carryover information was picked up from the old returns.

Let it be said of you, “You have chosen…wisely.”  I hope I do not have to saddle up my white horse on your behalf, as I still prefer a regular appointment.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950.  He can be reached at 831-333-1041.


Tax Return Russian Roulette – noun – a form of legalized gambling with generally poor odds whereby untrained participants willingly subject themselves to cruel and unusual punishment in the form of self-tax preparation, risking thousands of dollars in order to save hundreds.