Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: MONDAY, April 10, 1995 TAG: 9504110001
SECTION: BUSINESS PAGE: A8 EDITION: METRO
SOURCE:
DATELINE: LENGTH: Long
Q: I lent my son and his wife $22,000 to help complete a new house they had started. This loan is secured by a deed of trust.
How do my son and his wife report this interest as a tax deduction, and how do I report it as interest received? Which forms and what information?
A: The interest from the loan that you described would meet the criteria for "qualified residence interest" of a home acquisition indebtedness. This is defined as any debt that is (1) incurred in acquiring, contracting or substantially improving any qualified residence of the taxpayer and (2) secured by such residence.
Your son and his wife would deduct the interest paid to you on line 11 of Schedule A. You would record the same amount as interest income on Schedule B.
|-Answered by David Wright of Anderson & Reed
Q: My parents are interested in cutting their tax liability. In particular, they are concerned that the state and/or federal government will place a great tax burden on the home they own as well as some farmland they also own.
Is it possible for them to quit-claim the home and the farmland to their children, or to use some other legal means while the parents are still living, in order to avoid state and/or federal taxes?
A: Further inquiry with you reveals that your parents are in their early 70s, that their combined estates will be over $600,000, and that their home and farmland are in different states. Since the farmland is rented to others, a special use valuation does not appear to be available.
Assuming that the properties have appreciated in value since the parents acquired them, gifting them to the children during the parents' lifetime would not be prudent as the parents' low tax basis would follow to the children. On the other hand, inherited property received a step-up in basis to the fair market value at the date of the decedent's death.
Probably the most important planning tool is the maximum utilization of the $600,000 exemption equivalent amount (the unified credit) available to each parent. This is usually accomplished by the implementation of a "credit shelter trust." The objective of such an arrangement is to assure that $600,000 of property passes to the next generation without being included in the taxable estate of the decedent or the surviving spouse.
This is achieved by structuring the trust so that the surviving spouse does not have such property and income rights which would cause the trust assets to be included in his or her estate. For example, the trust can provide for income and corpus distributions to the surviving spouse subject to an ascertainable standard, with the remaining income distributed to the children. Then, at the time of the surviving spouse's death (or at some later time) the trust would be terminated, with the property being distributed to the children.
When the value of the combined estates is in excess of $600,000 (one exemption equivalent) but less than $1.2 million (twice the $600,000 exemption equivalent), the planning objective is to use the unified credit in both estates. This amount should be placed in the credit shelter or bypass trust, with the result that the assets are not taxed either on the first spouse's death or at the death of the surviving spouse.
However, the surviving spouse may be the beneficiary of that trust and continue to have the economic benefit of those trust assets. At the subsequent death of the surviving spouse, another $600,000 exemption will be available to protect from taxation the assets included in that spouse's gross estate.
If one spouse has a significantly smaller estate than the other, consideration should be given to tax-free "inter vivos" gifts between the spouses, from the more wealthy to the less wealthy spouse. This can accomplish the objective of the maximum use of each spouse's unified credit.
Where the combined estates exceed $1.2 million (two exemption equivalents), estate tax savings may be achieved by the use of a credit shelter trust in the estate of each spouse, coupled with a marital deduction upon the death of the first spouse.
The effect will be the use of two $600,000 exemption equivalents in transferring the assets to the next generation. Some federal estate tax will be due upon the second spouse's death, assuming that the spouse's estate has not been reduced below the $600,000 exemption equivalent by gifts, consumption or a decline in asset value.
Of course, the parents can also systematically reduce their estates during their lifetimes by use of the annual $10,000 per donee gift tax exclusion. Husband and wife can deem a gift to be a joint gift (regardless of which actually owned the gift), thus permitting them to make annual gifts of $20,000 per donee.
Obviously, this technique works much better when the estates are highly liquid in nature (cash, marketable securities, etc.) and does not work as well when the estates consist primarily of non-liquid assets (real estate, closely held business interests, etc.).
The foregoing discussion is certainly not intended to be all inclusive; there are other tax saving techniques available to competent estate planners. With the federal rates on taxable estates ranging from 37 percent to 55 percent, this is not a "do-it-yourself" field. Competent professionals (banker, CPA, attorney and planner) should be consulted, especially when the combined estates exceed $1.2 million.
-Answered by James B . Taney of Anderson & Reed
Q: The only income my daughter had last year was approximately $1,000 in unearned income, with no taxes deducted. She is over 21 and lived at home for the entire year 1994.
My wife and I intend to carry her on both federal and state tax forms.
Is my daughter required to file tax returns and, if so, what exemptions and deductions would she be allowed?
A: Your daughter is required to file a federal income tax return and pay tax on a portion of the $1,000 of unearned income. She is entitled to a standard deduction of $600 but cannot claim an exemption for herself since you and your wife are claiming her. Her federal taxable income would be $400, which results in a tax liability of $62.
No Virginia income tax return is required for single taxpayers when income is less than $5,000.
-Answered by William Brumfield of Foti, Flynn, Lowen & Co.
Q: My fiance and I will soon be married, and he will be moving into my house. He plans to assume payments on my house and change the deed to show joint ownership. The house has a mortgage of approximately $60,000, somewhat less than half the house's value.
When he sells his house, he hopes to roll over his gain - about $20,000 - into the purchase of his half of my house. Is that legal for tax purposes? When we change the deed from my name to joint ownership, am I "selling" the house and liable for tax?
A: Gain from the sale of a personal residence can arise when married taxpayers individually contribute less to the purchase of a new home than the adjusted sales price (the sales price less selling expenses) they individually received from the sale of an old residence, and the title to the new home is held in a different way than it was held in the old residence. A special "consent" election permits married couples to treat themselves as a unit to avoid such gains in most instances.
In your case, if your new husband could not invest the adjusted sales price of his old residence into your home when joint ownership is taken, the gain on the sale of his home could still be postponed (meaning not currently taxable) if you both sign a special consent statement that says: "We agree to reduce the basis of the new home by the gain from selling the old home." The statement can be made in the bottom margin of IRS Form 2119 - Sale of Your Home - when filed with your tax return. The consent is available only if both the old and the new home are each used as a principal residence.
The effect of this consent is to reduce the basis of the home, now jointly owned, by the husband's gain from his old residence. For example, if the husband's home cost $80,000 and his adjusted sales price was $100,000, he would have a $20,000 gain on the sale, and he would have to invest $100,000 in his wife's home to avoid tax consequences. Assume the husband could not invest the full adjusted sales price of his home ($100,000), and that the wife's home cost $120,000.
By filing the consent statement, the husband would postpone his $20,000 gain, and the basis in the wife's home (now jointly owned) would be reduced to $100,000 ($120,000 cost, less the husband's deferred gain of $20,000). In addition, if title in the wife's residence is changed to joint ownership with her new husband after the couple is married, it is considered a transfer between spouses and not taxable to the wife.
The husband is still bound by the "two year replacement period" rule governing the sale of residences, which obligates him to invest in their joint home within the period beginning two years before and ending two years after the sale of his old home.
If the above consent is not filed, then the husband would recognize a taxable gain on the sale of his former home to the extent that his adjusted sales price exceeds his contribution to the cost of his wife's home.
-Answered by Melissa M. Dupuis of Lucas & Boatwright
Q: We intend to roll over a mutual fund IRA to a certificate of deposit. Is it possible to withdraw the dividend and any capital gains portions and do the income taxes in this tax year? Our income is below that which requires filing a return normally, and we wish to get past that complicated tax return.
A: An owner of an Individual Retirement Account (IRA) may receive a distribution or any amount from it and within 60 days roll that amount, or any part of that amount, over into any other individual retirement plan. If your current IRA account is with a mutual fund, you may establish another IRA account with a bank, transfer the rollover proceeds and invest the amount transferred in a certificate of deposit. Amounts distributed from an IRA and not timely rolled over are generally taxable as income in the year received. A 1995 IRA distribution could not be included in income for 1994.
IRA distributions are generally taxable regardless of their source. However, if an IRA owner made voluntary nondeductible contributions to an IRA, then a portion of the annual distributions would be considered nontaxable. Income earned within an IRA such as dividends, interest and capital gains loses its identity when distributed from an IRA.
Distributions from an IRA to the owner before the owner reaches age 591/2 are considered premature distributions and subject to an additional tax equal to 10 percent of the amount distributed and included in gross income in the tax year.
Even if your gross income, including the IRA distribution, falls beneath the filing requirement (that is, for 1995, married filing jointly with gross income under $11,550), the 10 percent premature distribution penalty will have to be paid. The penalty can be avoided if the IRA recipient is disabled or causes the distributions to be made in a series of substantially equal periodic payments in accordance with IRS regulations.
If you do not have to file Form 1040, but owe the 10 percent tax for a premature distribution, you may simply file Form 5329, include your address on page 1 and your signature and date on page 2. Enclose a check payable to the Internal Revenue Service for the taxes due. Include your Security number and "1994 Form 5329" on the check.
Answered by Stan Boatwright of Lucas & Boatwright
by CNB