Tax & Financial Monthly Newsletter - September 2008

Tax Planning Strategies
New Tax Credit for First-Time Homebuyers
A New Twist For Home Sales

General Information
Mortgage Workouts - Tax-Free for Many Homeowners

Briefs
IRA Withdrawals for College Education
Property Tax Deduction for Non-Itemizers

Due Date Reminders
September 2008

TAX PLANNING STRATEGIES

New Tax Credit for First-Time Homebuyers

Now is a good time to purchase a home and there are a lot of good deals awaiting those with a down payment to facilitate a purchase. Congress has come up with a novel way to help first-time homebuyers afford the down payment on a home.

For home purchases made after April 8, 2008 and before July 1, 2009, a first-time homebuyer can receive a refundable tax credit equal to 10% of the purchase price of the home, but capped at $7,500 ($3,750 for married taxpayers filing separately).

But before you get too excited, you should know that the credit is essentially an interest-free loan that must be paid back over a 15-year period. Beginning the second year after the year of the credit, the taxpayer must begin repaying the credit in installments equal to 6.67% of the amount of the original credit. The payback will be in the form of an additional tax amount on the homeowner’s federal tax returns. If the home is sold or no longer used as a primary residence before the end of the 15-year period, the balance of the un-repaid credit must be repaid in the year the home is sold or no longer used as the taxpayer’s primary residence. However, the credit repayment amount can't exceed the gain from the sale of the residence to an unrelated person, and no repayment is required in a year after the death of the taxpayer.

The law includes a liberal definition of a first-time homebuyer: it is a taxpayer (or spouse if married) who had no present ownership interest in a principal residence in the U.S. during the 3-year period before the purchase of the home to which the credit applies.

To make sure this credit is not used by wealthy taxpayers, the credit is phased out for individual taxpayers with incomes between $75,000 and $95,000 and between $150,000 and $170,000 for joint filing taxpayers.

Taxpayers with a purchase in 2009 that qualifies for the credit can elect to claim the credit on their 2008 tax return and not have to wait until 2010 when they file their 2009 return to get the credit.

The credit is not allowed to non-resident alien taxpayers, homes that are financed with tax-exempt mortgage bonds or property purchased from a related party. There are also special rules to deal with divorce, casualty losses, involuntary conversions, etc.

To see how this credit can help your unique situation, please give our office a call to schedule a planning appointment.


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A New Twist For Home Sales

With the advent of the home sale gain exclusion back in the 1990s, taxpayers have been using that provision of the law in a popular strategy to exclude gain not just from their primary residence but also from rentals and second homes as well.

They do that by moving into the rental or second home and making it their primary residence for two years, then selling it and excluding the gain, up to $250,000 ($500,000 for joint filers).

To qualify for the exclusion, each taxpayer must own and occupy the home as their primary residence for two of the five years prior to the sale and must not have utilized the exclusion in the two years immediately preceding the sale. Thus, with careful planning, taxpayers could employ this technique on multiple properties.

Apparently, this strategy became too popular and Congress included a provision in the recently-enacted Housing Assistance Act of 2008 to curtail gain exclusion attributable to periods of ownership when the property was not the taxpayer’s primary residence. The new law accomplishes this by prorating the home sale gain between qualified and nonqualifed use periods and allowing the home gain exclusion to apply only to gain from qualified periods.

Example: An individual taxpayer purchases a home on 1/1/09 and rents it. On 1/1/11, he occupies the property as his primary residence and then sells the home in 1/1/13 for a $200,000 gain. Prior to this law change, the entire $200,000 could have been excluded. However, under the new law taking effect after 2008, the taxpayer would have to apportion the gain between the periods when it was a rental and when it was a personal residence. In this example, he owned it four years, of which time use for two years was nonqualified. Thus, 50% of the gain ($100,000) would be attributable to a nonqualified use period and would not be excludable. As a result, the taxpayer would be able to exclude only $100,000 of the $200,000 gain. Note that had the taxpayer used the home as a second home instead of a rental, the results would have been the same.

The law does provide a pretty liberal definition of nonqualified use. A period of nonqualified use means any period during which the property is not used by the taxpayer or the taxpayer's spouse or former spouse as a principal residence, except as noted below. For purposes of determining periods of nonqualified use, do not include any period:

o Before January 1, 2009,

o After the last date the property is used as the principal residence of the taxpayer or spouse (regardless of use during that period), and

o Not to exceed two years that the taxpayer is temporarily absent by reason of a change in place of employment, health, or, to the extent provided in regulations, unforeseen circumstances.

If your planning strategies include employing multiple sales, each qualifying for the home sale exclusion, you should carefully analyze the impact of this new law on your plans. Please call this office if you have any questions.

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GENERAL INFORMATION

Mortgage Workouts - Tax-Free for Many Homeowners

There is now tax relief for struggling homeowners. If your mortgage debt is partly or entirely forgiven during 2007, 2008 or 2009, you may be able to claim special tax relief.

Normally, debt forgiveness results in taxable income. But under the Mortgage Forgiveness Debt Relief Act of 2007, you may be able to exclude from tax up to $2 million of debt forgiven on your principal residence. The limit is $1 million for a married person filing a separate return.

Debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure, may qualify for this relief. The debt must have been used to buy, build or substantially improve your principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.

Debt forgiven on second homes, rental property, business property, credit cards or car loans do not qualify for this special tax-relief provision. In some cases, however, tax relief based on insolvency or other special provisions of the tax law may be available.

If your debt is reduced or eliminated, you will receive a year-end statement (Form 1099-C) from your lender. By law, this form must show the amount of debt forgiven and the fair market value of any property given up through foreclosure.

The information included on the 1099-C is not always correct and it may be necessary to notify the lender immediately if any of the information shown is incorrect. Of primary importance is the amount of debt forgiven (Box 2) and, if the 1099-C relates to a foreclosure, the value listed for your home (Box 7).

If you have debt or mortgage relieved during the year, you are encouraged to contact this office so we can determine its effect on your tax liability and explore any mitigating options before the year’s end.

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BRIEFS

IRA Withdrawals for College Education

Generally, when funds are withdrawn from an IRA before a taxpayer reaches age 59-½, the distribution is taxable and an early withdrawal penalty tax of 10% of the distribution will also apply. Penalty-free withdrawals are permitted if the funds are used to pay qualified higher education expenses. Qualified "higher education” expenses include tuition at a qualified educational institution, as well as related room, board, fees, books, supplies and equipment. The expenses can be for the taxpayer, spouse, taxpayer's or spouse's children and grandchildren. Caution: Even though the penalty may not apply, the distribution itself is still taxable.

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Property Tax Deduction for Non-Itemizers

For 2008 only, those who take the standard deduction instead of itemizing deductions may claim an additional standard deduction for State and local property taxes paid (but taxes written off as business deductions don't count). The maximum deduction is $1,000 for joint returns and $500 for all other filers (or actual property tax paid, if that is less).

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DUE DATE REMINDERS

September 2008

September 10 - Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during August, you are required to report them to your employer on IRS Form 4070 no later than September 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

September 15 - Estimated Tax Payment Due

It’s time to make your third quarter estimated tax installment payment for the 2008 tax year. Our tax system is a “pay-as-you-go” system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the “pay-as-you-go” requirement. These include:

• Payroll withholding for employers;
• Pension withholding for retirees; and
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is 2% higher than the prime rate and the penalty is computed on a quarter-by-quarter basis.

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than the $1,000 de-minimis amount, no penalty is assessed. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

• The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of what is owed in the current year, you can escape a penalty.

• The second safe harbor is based on the tax owed in the immediately preceding tax year. This safe harbor is generally 100% of the prior year’s tax liability. However, for higher-income taxpayers whose AGI exceeds $150,000 ($75,000 for married taxpayers filing separately), the prior year’s safe harbor is 110%.

Example: Suppose your tax for the year is $10,000 and your prepayments total $5,600. The result is that you owe an additional $4,400 on your tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception.

However, in the above example, the safe harbor may still apply. Assume your prior year’s tax was $5,000. Since you prepaid $5,600, which is greater than the 110% of the prior year’s tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. If you have questions regarding your safe harbor estimates, please call this office as soon as possible.

CAUTION: Some state de-minimis amounts and safe harbor estimate rules are different than those for the Federal estimates. Please call this office for particular state safe harbor rules.

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