Mexican Land Trust / Fideicomiso

A U.S. person typically owns Mexican real estate near the coast or the border through a Mexican Land Trust (a.k.a., fideicomiso).  It was widely believed that the IRS considered a Mexican Land Trust to be subject to the foreign trust information filing requirements, such as IRS Forms 3520 and 3520-A.  In a recent ruling (Rev. Rul. 2013-14), the IRS has officially acknowledged what seemed obvious to many tax experts: there is no “trust”.  Just because something is called a “trust” (“fideicomiso”) doesn’t mean it is taxed as a trust.  Under U.S. income tax law, a trust is an arrangement created by a declaration (will or trust document) where one person (fiduciary or trustee) takes ownership of property in order to protect or conserve it for another person (beneficiary).  Where the Mexican fiduciary, usually a Mexican bank, has no rights or obligations beyond simply holding title to the property in place of the U.S. person, there exists no trust under U.S. income tax law, so there are no foreign trust reporting requirements for the fideicomiso. 

© Michael Fitzsimmons, CPA, San Diego, CA http://fitz-cpa.com/

Don’t Claim Depreciation?? Part V: Depreciation Recapture

This final installment in the series on whether to claim depreciation on a rental property or home office clarifies the term depreciation recapture. Since depreciation is an ordinary expense, without depreciation recapture a taxpayer could get an ordinary tax deduction in one year and then sell the asset in a later year and pay capital gains tax on the income that results from the basis reduction from depreciation. In addition to shifting income to a later year, this converts ordinary income into capital gain. This a great deal for the taxpayer. To prevent this, the depreciation recapture rules say that the portion of the gain that results from depreciation is taxed as ordinary income instead of capital gain. However, this is yet another area of the tax law where real estate investments really shine. Unlike other business assets, only the real property gain attributable to depreciation in excess of straight line depreciation is recaptured. Since real estate put into service after 1986 generally must be depreciated using the straight line method, there is typically no depreciation recapture on real property. However, there is unrecaptured Section 1250 gain, which is similar to depreciation recapture but uses a special “capital gains” tax rate not to exceed 25%. Since this is a capital gains rate, it is not technically depreciation recapture. While 25% is not as good as the capital gains rates for most assets, it sure beats paying tax at an ordinary rate of up to 35%.

© Michael Fitzsimmons, CPA, San Diego, CA http://fitz-cpa.com/

Don’t Claim Depreciation?? Part IV: Passive Activity Rules

Continuing the discussion of whether to claim depreciation on a rental property or home office… The passive activity rules can suspend the deduction for depreciation so that it is not immediately available to offset ordinary income from such items as salary, interest, non-qualified dividends, self-employment earnings, and retirement/pension. Since rental losses are passive, it will still offset other passive income, either from the same property, other properties, or a flow-through entity such as a partnership, limited liability company (LLC), S-corporation, estate, or trust. But any suspended deduction is carried forward until adjusted gross income drops below $150,000, or positive passive income is realized, or the property is sold. So even if the depreciation deduction is suspended under the passive activity rules, you are almost always no worse off than if you did not claim the depreciation, and will usually be much better off.

Automobile Mileage Tax Deduction – Mileage Logs

A recent court case illustrates the importance of automobile mileage logs. A self-employed salesperson did not keep a mileage log and instead tried to prove his business use of automobile by such means as a random sampling of invoices and odometer readings at beginning and end of year. This evidence fell far short of the strict record-keeping requirements for business use of automobile tax deductions, which require the date, location, business purpose, and number of miles for each trip. Douglas A. Royster v. Commissioner, (2010) TC Memo 2010-16. IRS standard mileage rates provide deductions for business use of an automobile of $0.55 per mile for 2009 and $0.50 for 2010.

Don’t Claim Depreciation?? Part III: Time Value of Money

Previous installments of this series discussed depreciation concepts for rental real estate property owners and taxpayers claiming the home office deduction, including “allowed or allowable” and capital gain vs. ordinary tax rates. Another reason to claim the depreciation when allowed is the time value of money. If you claim a depreciation deduction now and offset your salary or other ordinary income, but you don’t pay tax on the related capital gain until you sell the property, maybe 10 years or more in the future, you effectively earn interest or an investment return on the amount of deferred tax during the interim. This is a basic wealth-building concept that should be employed whenever possible. To take it one step further, you may use a Section 1031 exchange to defer the capital gain indefinitely or use the ultimate tax strategy: die while still owning the property and get a step-up in basis for your heirs so that the tax gain just disappears.

How is a the Income of a Decedent’s Estate Taxed?

Many people know that the estate tax applies only to estates of several million dollars, but that doesn’t mean that an estate has no tax obligations. An estate must file an income tax return and, depending on the timing of distributions, pay income tax. Typical items of taxable income include interest, dividends, and capital gains. An estate reports income and deductions similarly to a complex trust on IRS Form 1041. However, there are some important differences, such as choice of fiscal year, quarterly estimated tax payments, and rental real estate losses. Often a person dies with assets held in a revocable trust and some or all of the trust becomes irrevocable upon death. Typically this results in the creation at death of two taxable entities, the decedent’s estate and the irrevocable trust. If proper procedures are followed, income tax law allows these two entities to be combined for income tax return purposes. This usually results in more favorable tax rules, and, since only one income tax return is required per year, saves on professional tax preparation fees.

Business Use of Cell Phone Record-Keeping Required

Cell phones are used all the time in business. What many people don’t know is that tax deductions for business use of cellular phones are not guaranteed. Since cellular telephones are "Listed Property" under Internal Revenue Code Sections 274 and 280F, the IRS can require taxpayers to produce detailed records to justify the business tax deductions. Tax regulations require evidence of the amount, date/time, and the business purpose of each business use of a cellular phone. Most expenses other than the purchase of the phone will be listed on your cellular phone bills, which will provide the dollar amounts and dates/times of usage. However, the law technically requires taxpayers to prove the business purpose of each call. Although this is an unreasonably burdensome record-keeping requirement, it is the letter of the law. Luckily, this may change this year. Commissioner of the IRS Douglas Shulman recently stated that he is optimistic that Congress will pass a law this year so that personal use of employer-provided cell phones is not taxable.