Financial Services Industry

Practical tax tips: pension plans, "trading" partnerships, reviewing tax forms and more - California tax

California CPA, Sept, 2003 by Leonard W. Williams

Which Keogh/IRA/Pension Plan Custodians Will Handle Real Estate investments?

Although it doesn't come up very often, clients sometimes will want to invest their retirement funds in trust deeds or realty ownership. Most banks, stock brokerage firms or mutual funds, however, won't handle such situations.

A potential tax pitfall in realty ownership by an IRA or qualified plan is that it must be free of indebtedness. If there is a mortgage, then the IRA or qualified plan will have to pay unrelated business income tax (UBIT).

Several TaxTalk listserve participants offered names of custodians that will handle such investments, and shortly thereafter, similar information appeared in the July 23 edition of The Wall Street Journal.

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The WSJ article listed the following custodians: Lincoln Trust of Denver; Pensco Inc. of San Francisco; and Sterling Trust of Waco, Texas. IRA Resource Associates in Washington and Arrowhead Trust Inc. in Irvine weren't mentioned in the WSJ article, but appeared in an April 2003 Los Angeles Times article.

Records Retention

For some reason, clients act like records retention is a big imposition. But retaining records is usually to their advantage.

Johanna Sweeney Salt has a good general letter to clients on this topic and will send it to CPAs who request it. Her e-mail is j.saltcpa@verizon.net.

A TaxTalk participant suggested that any such letter include a disclaimer that the retention advice is limited to what is needed for income and other specified tax purposes. And that another paragraph cover keeping records for all gifts and inheritances, including tracing all transactions related to those assets until they have been spent to zero.

A couple of examples were given of records retention paying off.

One CPA's client had purchased a "lifetime" roof for her house. Twelve years later some of the roof tiles began to disintegrate. There was a class action lawsuit, and because of the client's records, she received a refund of 75 percent of the roof's cost and a patch job on the defective tiles.

Another CPA said a client, about 75 years old, had kept meticulous records of the gifts and inheritances she received, the reinvested dividends and money earned and spent since she was 16. The records were invaluable in computing the cost basis of stock sold, determining her separate property and withstanding IRS audits.

How is a "Trading" Partnership Categorized for the Purpose of Applying the Rules Pertaining to Limited Partnerships?

The operative authority is Temp. Reg. Sec. 1.469-1T(e)(6), which says that a "trading" partnership is not a passive activity for its partners. There also is FSA (Field Service Advice): 200111001, available at www.irs.ustreas.gov/pub/irs-wd/0111001.pdf.> The tax attributes passed through from a trading partnership are neither passive nor portfolio income. Thus the operating expenses, for example, management fees and rent, are deducted ms if it were a "trade or business" activity (above the line with no phase-outs), but the limitation on investment interest applies and goes on Schedule A, unless the partner materially participates.

Tax Administration by Booby Trap (Example #MMMDDDCCCLLLXVI)

One Tax Talk participant pointed out that California's EDD has a late filing penalty of 5 percent of the tax shown on the DE7, Annual Report. That's not 5 percent of the amount of tax due when filing the DE7, but 5 percent of the total tax shown on the form before payments.

There is a maximum penalty of $1,000, plus interest from the date the form was due.

A TaxTalk member suggested that one consider filing a request with the Taxpayer Advocate's office for a waiver of the penalty whenever it is assessed.

Does Sec. 121 Apply to the Sale of a Life Estate in One's Primary Personal Residence?

A TaxTalk participant called the IRS and asked the above question of a contributors to the new Sec. 121 regulations.

The answer she received:

Per Reg. 1.121-4(e)(1), if a taxpayer sells a life estate first, then the remainder second, they both are eligible for the Sec. 121 exclusion. Only one exclusion per person, but if they are owned by different people, then two exclusions.

However, if the remainder interest is sold first, then one may not use the exclusion against the life estate, according to her interpretation of Sec. 121(d)(8).

Do You Review Taxpayer Prepared Returns Prior to the Taxpayer Filing It?

Most of those who participated in this discussion felt uneasy about merely reviewing a return that a taxpayer had prepared. Consequently, most will not do it.

Circular 230 is clear that one must sign as a preparer if rendering advice on any significant part of the return, but one is playing with fire to conclude that the advice given wasn't a significant part of the return.

Thanks to the following CPAs for their insights, which produced this material: Keith Plottel, Ed Melia, Ed Zollars, Johanna Sweany Salt, Charleen Daefield, Steve Kramer, Michael P. Melland, Jim Counts and Glen Hammill.

Leonard W. Williams, CPA is a Sunnyvale-based sole practitioner, A member of CalCPA's Committee on Taxation, the AICPA Tax Division and a former Peninsula Chaper president, you can reach him at williams@/wwilliamscpa.com.