Paying Estimated Taxes - my CPA any Good?? - Posted by Frank Chin

Real Estate Investing Real Estate Law
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Posted by JHyre in TexOhio on May 22, 2001 at 07:26:30:

Related parties are not a big issue with real estate partnerships, at least not under the facts that you’ve described. The problem will be certain provisions of partnership capital accounting, partnership anti-abuse regulations and business purpose. One thing that could work for your brother- 704(c) allocations using the curative or remedial methods (just trust me on the jargon!). Say you contribute a property with low basis and high value and your relative(s) contribute cash. Let’s say the basis of the property (ignoring land for simplicity’s sake) is $10,000 and the FMV is $40,000. Therefore, the property has $30,000 of “built-in gain”. To make a long story short, each of your relatives could be allocated $10,000 of extra depreciation or other favorable tax items over time…BUT at your expense- you would effectively receive $20,000 of extra “phantom” gain over the same period. Assuming that you are in a lower bracket than they are and that other tax principles do not interfere, they can get high NPV of benefits. The problem: Few tax people truly and thoroughly understand these rules…though their complexity accounts for a VERY low audit rate on these issues as well. In fact, I’ve never seen someone get audited on these issues. REITs deal with these Code provisions daily.

John Hyre

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Paying Estimated Taxes - my CPA any Good?? - Posted by Frank Chin

Posted by Frank Chin on May 20, 2001 at 08:04:20:

I recently sold a property and got conflicting opinions from two CPA’s regarding the payment of estimated taxes:

1- WHEN to PAY ??

CPA #1 advised us to estimate the gain and pay Federal and New York State authorities by June 15 2001. He says amount NOT paid will be penalized at the rate of 8% per annum in the case of the Federal returns.

CPA #1 is a tax attorney and did my closing.

CPA #2 who was asked to do a pro forma calculation of the gain says the estimated amount due only has to equal 110% of last years tax payment on the Federal return. The rest is due next April 15 2002. If this is true, and our tax bill is six times what it was last year, we have a BIG lump of cash to play with till next year.

Is CPA #2 correct ?

2- WHAT to PAY ??

During the discussion of calculating the gains, CPA #2 mentioned that depreciation is recaptured at ordinary rates.

I told him I recall ordinary rates only apply to accelerated depreciation that exceeded straight line rates. Straight line depreciation is recaptured at a flat 25% from my recollection.

Capital gains rate of 20% then applies to the difference between the basis and the sale price.

Am I right? I was trying to find the info in IRS publication 544, but find it confusing.

3- CAPITAL LOSS OMMISSION

I mentioned to CPA #2 that I loss 15K playing some options back in 1994, and was waiting for major capital gains to offset. I recall capital losses can be carried forward SEVEN years.

CPA #2 asked if we deducted $3,000 per year. I said NO. Then he said the IRS may have a problem if I just decided to deduct it for year 2001. I then wondered out loud if we might refile the tax returns going back a few year. He then said we can only do it for three years but is not sure if its worth it.

CPA #2 says just to forget my 15K loss.

I was thinking I’ll just deduct the entire LOSS and let the IRS decide if I’m wrong ???

BIG QUESTION

On the way back home, the wife and I was wondering if CPA #2 is ANY GOOD. We only paid a $100.00 retainer, and its still early to try someone else.

CPA #1 is a tax attorney, but has little time to answer questions, and dropped the ball on us a few times.

Opinions ?? Look for CPA # 3 ??

Frank Chin

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Re: Paying Estimated Taxes - my CPA any Good?? - Posted by Monique

Posted by Monique on May 20, 2001 at 15:26:16:

Frank,

Good questions, Frank. I was glad the Johns responded, since I learned something new.

We interviewed two prospective CPAs to make a switch ourselves. It appears that CPA #2 may not have much experience with preparing returns for active real estate investors. The depreciation recapture should be a fairly straight forward thing. Does CPA #2 do any investing him/herself? If so, approximately how many properties does she/her purchase each year? And how many clients does he/she have that have a similar tax situation as you do? These are the questions I would ask to determine if I needed to find a CPA #3.

My $0.02!

Monique

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Re: Paying Estimated Taxes - my CPA any Good?? - Posted by JThompson

Posted by JThompson on May 20, 2001 at 09:14:16:

Hi Frank.

I am a CPA by trade during the day and a REI the rest of the time (working to make it happen!).

Here’s my take on the issue (my own opinion, not paid professional advice):

Question 1: It appears that CPA #2 is correct. The ‘safe harbour’ provision in the internal revenue code allows for payment of 110% of last year’s tax LIABILITY, not necessarily payment. This allows you to pay only as much as 110% of your 2000 tax by the time you file, then pay the balance due with your tax returnwithout penalty or interest.

Question #2: I may be wrong in assuming this, but it sounds like CPA #2 might try to classify you as a ‘dealer’, in which case you depreciate and recapture at ordinary rates. Need more info here.

Question #3: CPA #2 is correct. In taxation of individuals, net capital losses exceeding the annual limit of $3,000 that may be carried to succeeding years so as to offset capital gains or ordinary income. There is no limit on the amount of capital losses that may be used to offset capital gains in any one year, only on the amount of losses in excess of gains that may be used to offset income. Now, I don’t know where seven years came from; it’s actually fifteen (15) years. Also, #2 is correct in saying that you can only ‘amend’ the last three years of returns. Since your loss occurred in 1994, you technically have lost out on the loss. I would question the person who did your 1994 return and ask why they failed to disclose it in the return.

The reason CPA #2 says that it would be more trouble than it is worth is that since you did not show it on your 2000 tax return as a carryover, you can’t just stick it on 2001 for sake of getting audited (and this would be red-flagged by the IRS). He also runs a great risk by falsifying a tax return by knowingly showing it as a 2001 loss when it was a 1994 loss since he knows the circumstance.’

About the only thing you can do would be to amend the prior three years to possibly include the $3,000 maximum on losses exceeding gains, but that is definitely running a risk for audit.

If it were me, I’d pass on claiming a deduction or amending any returns. Use this as a learning experience, and definitely question the dude preparing your 1994 return (hopefully you didn’t prepare it yourself).

My $0.02 worth.

Good luck to all.

John

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Got the feeling the CPA not strong on RE - Posted by Frank Chin

Posted by Frank Chin on May 21, 2001 at 08:06:46:

Hi Monique:

Good Point.

My wife found CPA #2, and during the initial interview, he indicated that most of his clients are small businesses. He’s got a store front office several blocks from our house which we pass by all the time.

I must admit its not the best method for finding a CPA.

During the second meeting, after his misstatements regarding depreciation recapture, I asked him another question about RE partnerships. I said I recall I can enter into an arrangement among partners where the deprciation taken can be in a different proportion to the invested funds. I asked if its true that the one electing NO depreciaiton must take at least ONE percent.

His answer was “I’m not sure - that’s stuff on RE partnerships”.

He also gave me a blank look on 1031 exhanges. BUT CPA #1 who claimed to be a Commercial RE investor said he never done one either, and said he’s kinda busy when I asked about doing a reverse 1031 exchanges.

And I’m actually looking to do a reverse 1031.

I admit I’m a bit frustrated. Besides deciding on the future course of my RE, looking for contractors to do upgrade projects, I have to continue my search for a CPA with a good RE backgroud.

I just have the feeling that CPA #2 NOT that strong on RE.

Frank Chin

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Re: Paying Estimated Taxes - my CPA any Good?? - Posted by Irwin(ca)

Posted by Irwin(ca) on May 20, 2001 at 15:49:24:

Hi John,

I thought the regs only required paying 100% of previous year’s tax to avoid penalty or interest. Where did 110% come from?

Irwin

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Re: Paying Estimated Taxes - my CPA any Good?? - Posted by JHyre in Ohio

Posted by JHyre in Ohio on May 20, 2001 at 11:49:16:

Good, solid advice from John. He should be a great addition to this site. Let me add a few things. First, I WOULD amend to get $3,000 losses for previous three years. Increased chance of audit still means low chance of audit- like 3% instead of 1.2% chance. Repeated amendments would get more attention, but amending for simple error of omission is not a big attention getter. I assume that you’ve no reason to fear an audit…i.e.- no hyper aggressive positions or other issues. I rarely base a position on risk of audit. If I’m right, they can audit til the cows come home. It is a hassle and can be expennsive, but I don’t think amending because of a fairly straight-forward error is likely to attract attention. It could happen, but the odds are against it.

Sounds like your read of gain rates is correct, i.e.- 20% on long-term capital gains and 25% on depreciation recapture, assuming that this isn’t dealer property.

As a general rule, tax lawyers are better planners than accountants, while accountants are much better at compliance than lawyers. I have of course met exceptions to both rules.

John Hyre

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Thanks John - Posted by Frank Chin

Posted by Frank Chin on May 20, 2001 at 09:32:50:

I appreciate your taking the time to post. I wanted to make sure the CPA is giving me good advice.

I’ve been a long term holder of RE and definately NOT a dealer, as this is the first SALE in a number of years. The property in question was bought in 1983 and held for some 18 years.

I did a pro forma on Turbo tax myself for year 2001.

As to the 1994 tax returns I had a CPA doing it - but he quit the business and the wife did it since then.

I’ll skip the 15K loss as both of you suggest and just be happy that I finally made some good money instead of losing it.

Thanks again.

Frank Chin

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Re: Got the feeling the CPA not strong on RE - Posted by JHyre in TexOhio

Posted by JHyre in TexOhio on May 21, 2001 at 09:52:50:

In re depreciation allocations: You can allocate as you wish PROVIDED that the company follows the complex capital account rules of IRC 704. Having a business purpose for allocations helps as well. For a partner to recieve/give allocations to another, said partner must of course have a capital (as opposed to mere profits) interest in the partnership…1% is probably the minimum for the transaction to have economic substance. Generally, allocating any partnership tax items out of proportion to respective interests is not worth the cost of advice and the other transaction costs where small partnerships/LLCs are concerned. Making such allocations without good advice is admittedly less dangerous in terms of audit risk because the IRS has VERY few people that understand these rules…though if you get nailed the penalties are substantial. In general, small businesses should have tax allocations follow each owner’s respective percentage interest. These issues are more in the nature of partnership issues, as opposed to real estate issues. Few attorneys and even fewer CPAs are truly familiar with partnership capital account and allocation rules. Those of us that are tend to sell this advice to large companies for a hefty fee…I’ve never been paid to do this kind of work by a company worth less than a billion dollars. That’s why small business practitioners are usually unfamiliar with these rules…so I wouldn’t hold that particular point against anyone. Nevertheless, you do need a CPA that is more familiar with RE…#2 doesn’t cut it on the grounds already discussed here.

John Hyre

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Re: Paying Estimated Taxes - my CPA any Good?? - Posted by JThompson

Posted by JThompson on May 20, 2001 at 19:24:39:

Good point, Irwin. Please let me clarify:

Before changes under the Taxpayer Relief Act of 1999, the safe harbor with respect to the estimated tax payment requirement was based upon 100% of the prior year tax, provided the 1998 adjusted gross income did not exceed $150,000 ($75,000 for married filing separately). With respect to estimated tax payments relating to tax year 1999, the safe harbor for an individual, whose adjusted gross income exceeded $150,000 in 1998, was based upon 105% of the 1998 tax liability. The amendments under the Act increase the safe harbor amount for estimated tax payments from 105% to 108.6% of the prior year 1999 tax liability. The estimated safe harbor tax payments made with respect to the 2001 tax liability, based upon the prior year 2000 liability, increase further to 110%. The amendments made by this section apply with respect to any installment payment for the taxable years beginning after December 31, 1999.

I guess I assumed that Frank made in excess of $150,000. If that is true, then he will, under Safe Harbor provisions, need to pay 110% of his tax liability for 2000 by the time he files.

If he didn’t make $150,000 in 2001, then the provision is 100%.

Hope this clears it up. Have a great one.

John

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Thanks - questions on Depreciation Allocation - Posted by Frank Chin

Posted by Frank Chin on May 21, 2001 at 18:09:25:

Hi John:

Thanks for commenting on the depreciation question as well as my “loss ommission” mentioned earlier. It always amazes me that I can get accurate answers more quickly from pros such as yourself on this board than from expensive paid professionals locally.

I’m giving serious thought to the 15K ommission - it was a big ouch. My tax reporting’s been on the up and up - so there’s no fear of an audit.

As to the real estate allocation issue. My mother-in-law who’s retired invests in tax free municipals, tax free annuities, and considering doing real estate with my brother in law (her son), who’s a doctor.

Doing RE in San Francisco requires considerable cash investment which she can provide. But it also requires a willigness to absorb negative cash flow for an initial period, which suits my brother in law’s tax situation. So the idea is for her to share the down payment, but her son, the doctor, will absorb the tax writeoffs and handle landlording, with the eventual appreciation to be split proportionately.

Also in view of my mother-in law’s mostly tax free income, she cannot efficiently use the writeoffs. She’s also thinking of doing something along the same lines with us - hence the question on allocating depreciation, or negative cash flow for that matter.

We’ve haven’t done anything along these lines as yet. But we have reviewed the K-1 form, which requires some Partnership #, so I assume a RE partnership would have to be formed, and partnership agreement filed, in order to past IRS muster.

Guess I should get a good RE attorney and CPA. I heard of rules on “related parties” which I’m not sure will impact on this. If you can shed further light on this, or what to cover with the CPA/attorney, it would be most appreciated.

Frank Chin

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Thanks for the clarification. NT - Posted by Irwin(ca)

Posted by Irwin(ca) on May 20, 2001 at 22:13:24:

NT