Audits, Education Expenses, Residence-to-Rental Conversions & More

By Marianne K. Kingman, J.D., LL.M.

If you have an idea for a rookie article for the series, please share it with

The information below is for your reference. Remember: Always recommend that your clients seek competent tax counsel when considering issues that may affect their tax liability

1. First-Time Homebuyer Credit

If your client claims the credit on their 2009 or 2010 original or amended tax return, they cannot file electronically. In addition, they must attach the following documentation regarding their main home as applicable: a copy of their settlement statement showing all parties’ names and signatures, the property address, the contract sales price and the date of purchase. Their settlement statement typically is their properly executed HUD-1. The IRS encourages the buyer to sign the settlement statement prior to attaching it to the tax return.

If the date purchased is after 04/30/10 and before 07/01/10 and they entered into a binding contract before 05/01/10 to purchase the home before 07/01/10, attach a copy of the pages from a signed contract to make a purchase showing all parties’ names and signatures, the property address, the purchase price and the date of the contract.

If they are claiming the credit as a long-time resident of the same main home, attach copies of one of the following: mortgage interest statements, property tax records or homeowner’s insurance records. These records should be for five consecutive years of the eight-year period ending on the purchase date of the new main home.

2. Social Security Tax Exemption and Credit

The 6.2% Employer Social Security Tax exemption applies to previously unemployed individuals hired after 02/03/10 who have worked less than 40 hours during the 60-day period prior to employment and whose 2010 earned wages after 03/18/10 and before 01/01/11 do not exceed $106,800.

A $20,000 assistant hired on 05/01/10 saves an employer about $800 in taxes. Delaying the hiring until 09/01/10 would reduce the savings to about $400.

Employers will receive an income tax credit, which is either $1,000 for each qualifying worker hired after 02/03/10 and employed for at least 52 consecutive weeks or 6.2% of wages paid to the assistant over the 52-week period, whichever is less. Wages during the last 26 weeks must be at least 80% of wages paid for the first 26 weeks. Any new hire must certify by signed affidavit that they have not been previously employed for more than 40 hours during the prior 60-day period.

Neither the exemption nor credit is permitted if a person is hired to replace another employee unless such other employee is separated from employment voluntarily or for cause.

3. Personal Residence Conversion into Rental Creates Loss

A taxpayer purchased a home in Phoenix in 2005 for $250,000. $50,000 represented the cost of the land. They lived in the home until 2008 when they moved out of state. Rather than sell the house, they converted it to a rental property. The property’s fair market value (FMV), including the land, on its conversion to rental property was $150,000. The basis for depreciation in 2008 is $100,000—the FMV excluding land at the time of conversion—since it is less than the original purchase cost excluding land (or $250,000 less $50,000).

In 2009, the taxpayer sold the property for $125,000.
Original purchase cost: $250,000
FMV on conversion date: $150,000
Depreciation since conversion date: $7,272
Basis for tax loss: $150,000 minus $7,272 or $142,728
Basis for tax gain: $250,000 minus $7,272 or $242,728
Sale price: $125,000
Tax loss: $142,728 minus $125,000 or $17,728

The taxpayer has an allowable tax loss of $17,728 because the value of the property continued to fall after the conversion date.

4. IRS Audit Representation and Other Options

The Internal Revenue Service (“IRS”) accepts most federal income tax returns as filed; however, the IRS audits some returns for accuracy. IRS auditors are instructed to close audits within 28 months of the date that the taxpayer filed their 2009 tax return or the date it was due, 04/15/10, whichever is later. The IRS legally has until 04/15/13 to conduct an audit.

The taxpayer does not have to accept an audit report findings. The report can be appealed by sending a letter to the IRS within 30 days after the receipt of the audit report. The taxpayer can also file a petition in tax court if the appeal fails. A REALTOR® should consult with a competent tax attorney or CPA for help .

An installment agreement can be a reasonable payment option for those taxpayers who cannot resolve their tax debt immediately. Installment agreements allow for the full payment of the tax debt in smaller amounts. A taxpayer still qualifies for an installment agreement if they owe more than $25,000 in combined tax, penalties and interest; however, a Form 433-F will need to be completed.

The IRS has been known to accept considerably less than the amount owed on a tax bill if the taxpayer qualifies for something known as an Offer in Compromise (“OIC”). Submitting an OIC to the IRS is a formal process. One starts by completing IRS Form 656.

There is no legal right to have a valid tax bill reduced by the IRS. It is entirely a matter of the IRS’ discretion. Most OICs submitted are rejected by the IRS. The taxpayer does have the right to take a rejected OIC through the appeals process.

5. Tax Credit for Educational Expenses

The Hope credit for tax years beginning in 2009 or 2010 is amended. The modified credit is referred to as the American Opportunity Tax Credit. The credit is up to $2,500 per eligible student per year for qualified tuition and related expenses, such as books and equipment, for each of the first four years of the student’s post-secondary education in a degree or certificate program, which includes training to be a real estate agent. The modified credit rate is 100% of the first $2,000 of qualified expenses and 25% of the next $2,000.

The qualified tuition and related expenses must be incurred on behalf of the taxpayer, his spouse or dependent. The credit is available with respect to an individual student for four years, provided he has not completed the first four years of post-secondary education before the beginning of the fourth tax year. The credit is phased-out for taxpayers with modified adjusted gross income between $80,000 and $90,000—or $160,000 and $180,000 for joint filers.

Marianne K. Kingman received her J.D. from Boston University School of Law in 1997 and her LL.M. degree in taxation from the University of Washington School of Law. In 2005, she began the tax services firm of Kingman Winslow, LLC, the only tax services firm in the nation to specialize exclusively on real estate agents and brokers for their tax accounting needs.

About the Author

Michelle Lind

K. Michelle Lind, CEO of Arizona REALTORS®, is also an attorney, State Bar of Arizona board certified real estate specialist, and the author of Arizona Real Estate: A Professional’s Guide to Law and Practice. Please note that this article is of a general nature and may not be updated or revised for accuracy as statutory or case law changes following the date of first publication. Further, this article reflects only the opinion of the author, is not intended as definitive legal advice and you should not act upon it without seeking independent legal counsel.