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How to Make a Family Home Loan Interest Deductible

It is not uncommon for individuals to loan money to relatives to help them buy a home. In those situations, it is also not uncommon for a loan to be undocumented or documented with an unsecured note, and the unintended result that the homebuyer can’t claim a tax deduction for the interest paid to their helpful relative. The tax code describes qualified residence interest as interest paid or accrued during the tax year on acquisition indebtedness or home equity indebtedness with respect to any qualified residence of the taxpayer. It also provides that the term "acquisition indebtedness" means any indebtedness that is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and is secured by such residence.


There are also limits on the amount of debt and number of qualified residences that a taxpayer may have for purposes of claiming a home mortgage interest tax deduction, but those details are not covered in this article, which focuses on the requirement that the debt be secured.

Secured debt means a debt that is on the security of any instrument (such as a mortgage, deed of trust, or land contract):

(i) that makes the interest of the debtor in the qualified residence-specific security of the payment of the debt,

(ii) under which, in the event of default, the residence could be subjected to the satisfaction of the debt with the same priority as a mortgage or deed of trust in the jurisdiction in which the property is situated, and

(iii) that is recorded, where permitted, or is otherwise perfected in accordance with applicable state law.

In other words, the home is put up as collateral to protect the interest of the lender.

Thus, interest paid on undocumented loans, or documented but unsecured notes, is not deductible by the borrower but is fully taxable to the lending individual. The IRS is always skeptical of family transactions. Don’t get trapped in this type of situation.

Take the time to have a note drawn up and recorded or perfected in accordance with state law. In California it’s pretty easy. You can usually have the note created and recorded by escrow and/or title companies and they’re very inexpensive.

Finally, the terms of the note between family members should be at arm’s length, what a non-related lender would offer/provide to the borrower. For example, if the going mortgage interest rate based on the borrower’s credit score, down payment and finances is 5% but the family member is charging 2%, there could be a tax issue. This is beyond the scope of this article.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him at david@saacpa.com or visit www.saacpa.com or www.SilkRoadRealtyInc.com. Thank you.

New Reporting Requirement for Individuals with Foreign Financial Assets

Each U.S. person who has a financial interest in or signature or other authority over foreign bank accounts, securities accounts or other financial accounts must file a Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts or FBAR) if the aggregate value of the accounts exceeds $10,000 at any time during the calendar year.

A “foreign financial account” is a financial account located outside the U.S. An account maintained with a branch of a U.S. bank that is physically located outside of the U.S. is a foreign financial account. A financial account includes a securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution. A financial account also includes a commodity futures or options account, an insurance policy or annuity policy with a cash value, and shares in a mutual fund or similar pooled fund. In addition, a debit card account is a financial account, and a credit card account may be treated as a financial account under certain circumstances.

The FBAR is due by June 30 following the calendar year for which it applies. Thus, FBARs for the 2011 calendar year must be filed on or before June 30, 2012.

The penalties for failure to file a FBAR are onerous. The civil penalties for a non-willful violation may not exceed $10,000 per violation. Civil penalties for a willful violation may not exceed the greater of $100,000 or 50% of the amount in the account at the time of the violation. The criminal penalty for willful violations is a fine of not more than $250,000, or imprisonment for not more than five years, or both.

In addition and new for 2011, is a requirement for any individual who, during the tax year, holds any interest in a “specified foreign financial asset” to complete and attach Form 8938 to his or her income tax return if a reporting threshold is met.

The reporting threshold varies depending on whether the individual lives in the U.S. and files a joint return with his or her spouse. For example, someone who is not married and doesn’t live abroad will need to file Form 8938 for 2011 if the total value of his or her specified foreign financial assets was more than $50,000 as of December 31, 2011, or more than $75,000 at any time during 2011. For married taxpayers filing a joint return and living in the U.S., the threshold amounts are doubled, $100,000 or $150,000, respectively. The thresholds also are higher for taxpayers residing abroad.

For purposes of the reporting requirement for individuals with foreign assets a “specified foreign financial asset” is:

1. Any “financial account” maintained by a “foreign financial institution” or

2. Any of the following assets which are not held in an account maintained by a “financial institution”:

a. Any stock or security issued by a person other than a U.S. person,
b. Any financial instrument or contract held for investment that has an issuer or counterparty that is other than a U.S. person, and
c. Any interest in a “foreign entity”.

What is interesting is any interest in a “foreign entity” is subject to reporting. Therefore, one could imply, that if you own a business or real estate in a foreign country through a foreign entity, it needs to be reported.

However, no disclosure is required for interests that are held in a custodial account with a U.S. financial institution.

The penalty for failing to report specified foreign financial assets for a tax year is $10,000. However, if this failure continues for more than 90 days after the day on which the IRS mails notice of the failure to the individual, additional penalties of $10,000 for each 30-day period (or fraction of the 30-day period) during which the failure continues after the expiration of the 90-day period, with a maximum penalty of $50,000.

To the extent the IRS determines that the individual has an interest in one or more foreign financial assets but he or she doesn't provide enough information to enable the IRS to determine the aggregate value of those assets, the aggregate value of those assets will be presumed to have exceeded $50,000 (or other applicable reporting threshold amount) for purposes of assessing the penalty.

No penalty will be imposed if the failure to file the 8938 is due to reasonable cause and not due to willful neglect. The fact that a foreign jurisdiction would impose a civil or criminal penalty on the taxpayer (or any other person) for disclosing the required information isn't reasonable cause.

In addition, if it is shown that the individual failed to report the income from the foreign financial account on his or her income tax return, a 40% accuracy-related penalty is imposed for underpayment of tax that is attributable to an undisclosed foreign financial asset.

Furthermore, if you have received a large gift or bequests during the tax year from “non-U.S. persons” you also have a reporting requirement.

If the value of aggregate foreign gifts that you receive during any tax year exceeds a threshold amount, you must report each foreign gift to the IRS. A foreign gift is any amount you receive from a non-U.S. person which you treat as a gift or bequest. A non-U.S. person is any person other than a citizen or resident of the U.S. or a U.S. partnership or corporation. The term non-U.S. person also includes a foreign estate. Foreign gifts don't include qualified tuition or medical payments made on behalf of the recipient, or gifts which are otherwise properly disclosed on a return under the separate requirements applicable to amounts received from foreign trusts.

For purposes of determining whether the receipt of a gift from a foreign person is reportable, different reporting thresholds are applied for gifts received from nonresident alien individuals, and foreign estates, and for gifts from foreign partnerships, and foreign corporations.

So, a U.S. person is required to report the receipt of gifts from a nonresident alien or foreign estate only if the total amount of gifts from that nonresident alien or foreign estate is more than $100,000 during the tax year. Once the $100,000 threshold has been met, the one who receives the gift must separately identify each gift which is more than $5,000, but doesn't have to identify the donor.

A U.S. person must report the receipt of purported gifts from foreign corporations and foreign partnerships if the total amount of purported gifts from all such entities during the tax year is more than $14,723 for tax years beginning in 2012 and $14,375 for tax years beginning in 2011. Once the threshold has been met, the gift recipient must separately identify all purported gifts from a foreign corporation or foreign partnership, and provide the name of the donor.

If you fall within these reporting rules, you have to file Form 3520, Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts. The form is due on the date that your income tax return is due, including extensions. The form must be sent to the IRS at the address shown on the IRS website (irs.gov).

Where appropriate, I may be able to recommend planning approaches which may allow you to avoid the reporting requirements. For example, if you are expecting a gift of $120,000 from a nonresident alien individual or foreign estate, it may be possible to arrange for the gift to be paid over two years, so that in neither year does the gift exceed $100,000. If the split gift is the only foreign gift you receive each year, you will avoid the reporting requirement. Alternatively, if we can arrange for part of the gift to be made in the form of qualified tuition or medical payments, the rest of the gift may be reduced enough to avoid the reporting requirement.

The penalty for not reporting a foreign gift that must be reported is 5% of the amount of the gift for each month the failure to report continues, up to a maximum of 25%. The penalty will be excused if reasonable cause for the failure to report can be established.

Finally the gift that you receive is not income to you. There is no federal or state tax liability associated with it. Therefore, you should report it.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com or www.SilkRoadRealtyInc.com. Thank you.

Big Changes Coming for Investors in 2013

Long-Term Capital Gains Rates Increase – Taxpayers have enjoyed reduced long-term capital gains rates for several years as a result of the Bush era tax cuts. However, without Congressional action, which is not expected, those reduced rates will return to the higher rates in effect prior to 2003. The table below compares the current long-term capital gains rates to the anticipated rates for 2013 and subsequent years.

Taxpayer’s Regular Long-Term Capital Gains Rates
Tax Bracket Current Anticipated for 2013

15% and below 0% 10% (1)
Above 15% 15% 20% (2)

(1) 8% if held over 5 years
(2) 18% if held over 5 years

Taxpayers with unrealized long-term capital gains may wish to review their holdings and consider whether it is appropriate to sell during 2012 at the lower rates or whether to continue to hold for additional increases in value. This includes real estate as well. Where future increases in value are anticipated, a taxpayer could sell and realize existing gains in 2012 and then repurchase the investment for future anticipated increases. Investment strategies depend on a variety of issues, including existing capital loss carryovers, growth potential of individual investments, and other factors related to each individual, and should be carefully analyzed before taking action.

Regular Tax Rates – In addition to lower long-term capital gains rates, the regular marginal tax rates have been declining since 2001. However, without Congressional action, those reduced rates will return to higher rates in effect prior to 2001. The table below compares the current marginal individual tax rates to the anticipated rates for 2013 and subsequent years.

Year Regular Marginal Tax Brackets (%) Currently 10.0 15.0 25.0 28.0 33.0 35.0
Expected for 2013 15.0 15.0 28.0 31.0 36.0 39.6

These increased rates will apply to all varieties of ordinary income including interest, dividends, short-term capital gains, employment income, etc. Marginal tax rates increase as a taxpayer’s overall income increases, taxing the first block of income received at the lowest rate and each subsequent block at ever-increasing rates until the maximum rate is reached. As with assets eligible for the long-term capital gains rates, it may be appropriate for some taxpayers to accelerate ordinary income into 2012 to take advantage of the lower rates.

Surtax on Investment Income – Depending upon what the Supreme Court ultimately decides about the Health Care Law, starting in 2013 a new surtax, called the Unearned Income Medicare Contribution Tax, will be imposed on individuals, estates, and trusts. For individuals, the surtax is 3.8% of the lesser of:

The taxpayer’s net investment income or The excess of modified adjusted gross income over the threshold amount ($250,000 for a joint return or surviving spouse, $125,000 for a married individual filing a separate return, and $200,000 for all others).

Thus, this surtax will only impact higher income individuals. “Net” investment income is investment income reduced by allowable investment expenses. Investment income includes:

Income from interest, dividends, annuities, and royalties, Rents (other than derived from a trade or business), Capital gains (other than derived from a trade or business),

Trade or business income that is a passive activity with respect to the taxpayer, and trade or business income with respect to trading financial instruments or commodities.

For surtax purposes, the net investment income does not include excluded items, such as interest on tax-exempt bonds, veterans' benefits, and excluded gain from the sale of a principal residence.

For planning purposes, existing law favors tax-exempt bond interest, which avoids both the surtax and the regular income tax. However, you should be aware that President Obama’s tax plan would also tax the income from “tax-exempt” bonds for higher-income individuals at generally the same threshold as this surtax kicks in.

It is not too early to start planning for the 2013 tax increases. Prudent planning can significantly reduce the tax bite. At the same time, keep a watchful eye on Congress. Since this is an election year, tax changes are most likely to come after the November elections.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com orwww.SilkRoadRealtyInc.com. Thank you.

How Long Should You Keep Your Tax Records

Generally, we keep “tax” records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns; and (2) to keep track of the tax basis of our capital assets so that the tax liability can be minimized when we actually dispose of the assets.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25% of the income reported on a tax return. And, of course, the statutes don’t begin running until a return has been filed. There is no limit on the assessment period where a taxpayer files a false or fraudulent return in order to evade tax.

If an exception does not apply to you, for federal purposes, most of your tax records that are more than three years old can probably be discarded; add a year or so to that if you live in a state with a longer statute.

For example: Sue filed her 2011 tax return before the due date of April 17, 2012. She will be able to dispose of most of her records safely after April 15, 2015. On the other hand, Don files his 2011 return on June 2, 2012. He needs to keep his records at least until June 2, 2015. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with discarding records indiscriminately for a particular year once the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. They need to be separated, and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into this category:

• Stock acquisition data — If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

• Stock and mutual fund statements — Many taxpayers use the dividends that they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gains when the stock is finally sold. Keep statements at least four years after the final sale.

• Tangible property purchase and improvement records — Keep records of home, investment, rental property or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com or www.SilkRoadRealtyInc.com. Thank you.

Employing a Family Member

A way to reduce the overall family tax bill is by employing family members through your business, which allows you to shift income to them and provide them with employment benefits.

· Employing your Spouse. Reasonable wages paid to your spouse entitle you to a business deduction. Although the wages are subject to income and FICA taxes, your spouse may qualify for Social Security benefits to which he or she might not otherwise be entitled. In addition, your spouse may also be entitled to receive coverage under the qualified retirement and health plans of your business, allowing you to obtain business deductions for contributions to your spouse’s retirement nest egg and health insurance premium payments made on behalf of your employed spouse. While maintaining the same family medical care coverage, you increase your business deductions by providing your spouse with family health insurance coverage as an employee.


· Employing your child. By employing your child, the income tax advantages include obtaining a business deduction for a reasonable salary paid to that child, thus reducing your self-employment income and tax by shifting income to the child. Since the salary paid to your child is considered earned income, it is not subject to the “Kiddie Tax” rules that apply to children under the age of 19, as well as some older children. The maximum standard deduction available to your child in 2013 is $6,100 (up from $5,950 in 2012) if he or she has at least that amount of earned income. Therefore, the standard deduction eliminates all tax on this income if you pay your child $6,100 (2013) in compensation. If your business is unincorporated, wages paid to your child under age 18 are not subject to social security taxes. Not only are there significant income tax advantages to employing your child, you may also provide him or her with fringe benefits such as group-term life insurance and qualified pension plan contributions.

Any type of business such as medical, professional, real estate and etc. can hire a family member and any entity as well such as a sole proprietorship, an LLC, partnership, a S or C corporation or a trust.

Your child may also make deductible contributions to an IRA of the lesser of earned income or the annual limitation. These contributions can offset earned and unearned income. As example, in 2013 your child could receive $11,600 gross income ($6,100 earned and $5,500 unearned) by combining the IRA deduction ($5,500) with the standard deduction ($6,100) and pay no tax. You should consider giving him or her part or all of the money needed to fund the IRA (as part of your $14,000/$28,000 annual exclusion for gifts) if your child does not want to use his or her earned income to fund an IRA contribution.

Your child can then withdraw money from his or her IRA account to pay for his or her college expenses. The money that he or she withdraws from their IRA account will be taxable but will not be subject to the early withdrawal penalty. However, most likely your child will not have any other source of income while going to school. Therefore, the amount that is taxable will first be offset by your child’s standard deduction and perhaps their personal exemption. Then any amount over those two deductions will be taxable and most likely at the lowest federal and state tax rates.

It is actually a great way to save for your children’s college expenses and get a tax deduction for it too.

Please keep in mind that, when you employ a family member through your business, the wages should be reasonable for the work performed and that the services performed are necessary to the business. Please call this office for additional information.

The above technical reference is provided as a courtesy to the reader by David Silkman, CPA, MST, Broker, Silkman & Associates Accountancy Corporation and SilkRoad Realty, Inc. The information is technical in nature, may not include all the details on a particular subject and may require review of the reader’s circumstances by a professional. You should consult with your tax advisor.

David S. Silkman is a CPA, has a Masters in Taxation (MST) and is a licensed real estate broker. He specializes in real estate tax laws and accounting. If you have any questions, please do not hesitate to call him at 310.479.7020 x301, email him atdavid@saacpa.com or visit www.saacpa.com orwww.SilkRoadRealtyInc.com. Thank you.