ROANOKE TIMES
Copyright (c) 1996, Roanoke Times
DATE: Monday, March 25, 1996 TAG: 9603270005
SECTION: MONEY PAGE: 6 EDITION: METRO
COLUMN: tax questions
Q: The employee stock purchase plan where I am employed was terminated in 1995. I received a stock certificate and a check for the fractional share. This was an after-tax purchase. The company contributed a percentage toward the plan.
How is the amount for the fractional share handled on my 1040 form?
A: Any cash you receive for fractional shares under such a plan is treated as an amount realized on the sale of the fractional shares. Because these fractional shares do represent stock, you must report your gain or loss and report it as a capital gain or loss on Schedule D of your Form 1040.
Your gain or loss is the difference between the cash you receive for the fractional share and your basis in the fractional shares sold.
Your basis in that fractional share can be affected by several transactions. Your basis in these shares is your original purchase price as you and your employer made contributions, plus any dividends paid on the stock if those dividends were used to purchase more stock within the plan.
Where stock dividends are paid to the plan or dividends are paid to the plan and then reinvested in stock, your basis in those purchases is arrived at by taking your basis in the existing stock and allocating some of that to the stock dividend based on the fair-market value of the existing stock as it compares to the stock dividend.
Assuming you held the stock more than one year, the gain on the stock would be a long-term capital gain. Unless the share sold can be specifically identified as to when it was purchased, the IRS requires you to go back and use the basis of the first stock purchased as your basis.
-Answered by F. Fulton Galer of McLeod & Company
Q: I have a house which I have used as rental property since 1985. At that time, I did not depreciate the house. I did begin depreciating it about four years ago. I am not sure that I used the correct method.
I plan on returning to live in the house in about eight years, at which time I will be 60 years old. I have never lived in the house since I started renting it out.
(1) If I used the wrong method, or a method that is not beneficial to me, can I change it now?
(2) Which depreciation method should I use?
(3) Can I recoup the years in which I did not depreciate it?
A: The tax code contains very specific rules for depreciating property. Generally, the depreciation rules in effect at the time property is placed into service must be followed and used for the entire time an asset is owned.
The tax code prescribes ``asset lives'' - the period over which the cost of an asset may be recovered. It also determines ``depreciation conventions'' - the date at which the property is considered placed in service. Finally, the code sets out ``depreciation methods'' - how to compute the rate of depreciation.
For example, a rental house placed in service during 1995 is assigned a life of 27.5 years, a mid-month depreciation convention and a straight line method of depreciation. See IRS Publication 534, ``Depreciation,'' for more information.
A taxpayer should ensure that she is following these rules for a very important reason. If, in an earlier year, you did not claim depreciation you were entitled to deduct, you must still reduce your basis in the property by the amount of the depreciation you should have deducted.
Also, you cannot ``catch up'' and claim the prior periods' depreciation (unless you file amended tax returns to claim depreciation for the years where the statute of limitations is still open). IRS Publication 527, ``Residential Rental Property,'' explains this rule at page 8. It also explains at page 11 what amount of a rental unit is depreciable.
I would advise you to seek the help of a tax preparer who can determine the current basis of your property and assist you in computing your future depreciation deductions.
-Answered by Mary Anne M. McElmurray of Brown, Edwards & Company
Q: I need advice about how to handle taxes on a transaction, which was handled through an investment company.
In June 1991, I purchased 300 shares of stock in Cellular Communications Inc. at $32.25 a share at a cost of $9,772.78.
By the end of 1991, it had become 300 shares of Cellular Communications Red Part Conv pfd; 50 shares (now 75 shares) of Cellular Communications Intl Inc.; and 50 shares (now 66 shares) of OCOM Corp. (now Intl. Cabletel). Now it also includes 62 shares of Cell Com Puerto Rico.
On Oct. 30, 1995, I participated in a reorganizational buyout by Cellular Communications Red Part conv pfd in which they purchased back 117 shares at $60 a share for $7,020. I still have 183 shares.
I have always done my own tax returns, but this seems complicated to me and I really do not know where to begin.
A: A reorganization of Cellular Communications Inc. (CCI) in which you purchased stock in June 1991 resulted in your receiving 300 shares of preferred stock of that company plus stock of two related companies. These were not taxable to you, and the values per share of each at that time were CCI $37.87 1/2, CCI Intl $4.50 and OCOM $4.62 1/2.
On Feb. 18, 1992, your reorganized company (CCI) made a non-taxable distribution of 50 shares of stock of a third related company, CC of Puerto Rico. The values per share at that time were CCI $37.62 1/2 and PR $15, according to information secured from the company.
The cost of your initial 300 shares of CCI ($9,773) is allocated among CCI and the first two related companies in proportion to the fair-market value of each at the date of the transaction.
Fair-market value is determined by the value per share multiplied by the shares received. The total fair-market value of the three is then allocated - 96 percent to CCI and 2 percent to each of the other two. This results in $9,382 of the $9,773 cost being assigned as the basis of the 300 shares of CCI.
For the Feb. 18, 1992 transaction, the reallocated basis to CCI, $9,382, is allocated between CCI and PR in proportion to the fair-market value of the two. This results in 94 percent of the reallocated basis of $9,382, or $8,819 to CCI and 6 percent or $563 to PR.
Your long-term capital gain is computed as follows: Selling price of 117 shares of CCI or $7,020, less the basis ($8,819 divided by 300 or $29.40 per share) of $3,440. Your long-term capital gain is $3,580.
The increase in the number of shares you now own in the related companies results from stock splits by these companies.
-Answered by William R. Brumfield Jr. of Foti, Flynn, Lowen & Company
Q: My broker calls me a couple of times during the year, and we make changes in my stock portfolio. Sometimes there is a gain and sometimes a loss.
In December, we usually make final transactions for the year. I never know until the end of the year whether I will have an overall gain or loss. If I sell stocks for a gain during the year, do I have to pay tax immediately? What if I sell other stocks at a loss later in the year?
A: Unfortunately, the federal income tax is a pay-as-you-go system. The government wants its share of your money each quarter as it is earned or it assesses you an underpayment penalty. But with proper planning you may be able to avoid the penalty and postpone paying tax on these stock gains until April 15 of the following year.
When your income is on the rise, as in your situation, the best strategy is to take advantage of a special exception that negates the underpayment penalty. If you pay withholdings or estimated tax payments quarterly in the current year that, in total, equal the total tax on your return last year, the underpayment penalty will not apply. By doing this, you not only avoid the penalty, but you also can earn interest on the deferred tax until April 15 of the following year. If your adjusted gross income was over $150,000, then the exception is 110 percent of the prior year's tax.
It may not be in your best interest to pay the prior year's tax, such as when your income is substantially less than last year and you have reduced your withholdings or estimated tax payments accordingly. In this situation, you should pay estimated tax on the stock gain in the quarter you sell it. If subsequent stock sales result in a loss, your withholdings and estimated tax payments should be reduced to compensate in the following quarters.
Another important factor to consider is that the underpayment penalty is basically interest charged on the difference between what you paid in and what you owe each quarter. The interest rate varies but is currently 9 percent. If your investments are yielding in excess of 12 percent, your economic gain may be greater by investing the funds rather than paying the estimated taxes. The interest rate spread results from the nondeductibility of penalties versus taxable investment income.
Remember, if you get a large refund on your return, it is not the best tax planning unless you enjoy giving the government an interest-free loan or you treat withholdings as a disciplined savings plan.
-Answered by C.J. King of Cole & King.
Q: I loaned my daughter $25,000 in June 1995. I understand that the IRS becomes involved in any loan over $10,000.
I have a letter from my daughter showing the amount of loan, date repaid and amount of interest paid. If I send a copy of this letter along with my form 1040 tax return, will this be sufficient, or is there another form I need to attach to my return?
I have tried repeatedly to call the IRS in Richmond but never get through.
A: From the facts stated in your letter, you and your daughter have treated the transaction as a bona fide loan; you loaned a sum of money for which you received an adequate amount of interest, and later the loaned amount was repaid to you. On your 1995 tax return you need only report the interest income on Schedule B.
You are correct in that the IRS is interested in loans between related persons. However, the IRS is only interested if a gift element is involved (you make a loan for which you are not fully repaid), or if the loan does not bear an appropriate interest rate.
-Answered by Mary Anne M. McElmurray of Brown, Edwards & Co.
Members of the Roanoke chapter of the Virginia Society of Certified Public Accountants are answering tax-related questions from our readers. This feature runs every Monday on the Money Page through April 8, but questions must be received no later than Wednesday, March 27. Please send your questions before that deadline to Tax Questions, The Roanoke Times, P.O. Box 2491, Roanoke 24010.
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