Avoiding Tax Return Miscalculations in Property Re-Development - BRUCE SCAMBLER : CPA CFF FCMA
A CPA with proven experience in forensic accounting, taxation and consulting services. Experience covering many different cases, including insurance, SEC, oil and gas and corporate malfeasance investigations concluding in litigation support and other engagement
Real Estate ‘asset’ (re-)development property (whether for
commercial properties or domestic homes) as a
subject topic of the tax code, comprises some of the most complex in the Tax Code, with
thousands of applicable rules and regulations.
At the same time, if you follow the rules accurately, it can be one of
the most favorable areas for the tax payer.
Here is one of the rubs, re-developers and designers with
creative brains, do not think at all
like that of an accountant or CPA. They
are not experts in all these rules. Many
such taxpayers were also left ‘without normal available accounting help due to
covid’, and are struggling to comply through 2021 and 2022 return periods. Taking care of the bookkeeping to prepare tax
returns for property development is a skilled service. We can advise on how to get the most in tax avoidance,
applying the more favorable aspects, while ensuring you of being in compliance.
Providing you get us accurate
information, or what you have we can apply forensic tests to get returns
prepared.
Here are some of the opportunities, and following are a sample of the tax preparation rules and checks required to cover these projects, and report them most favorably in your tax returns. If you would like a more in-depth discussion please email or call.
1)
Importance of Accurate
Bookkeeping and Records
It is very important to keep accurate records,
for each project separately, and over the whole life to the conclusion and
disposal of the project. Given the accounting
and tax analysis for extended property developments can cover multiple years, (many
run one to five (1-5+) or more years) you need to have comprehensive recording
systems and record keeping. The re-development
and re-design needs careful budgeting, detailed record keeping, accurate and
timely bookkeeping and accounting. From
these records and accounts highly complex tax reviews and calculations need to
be performed and completed.
Property development is an area that the IRS review
frequently. High on the list is to
ensure that mortgage and loan allowances are not exceeded, and that “primary”
residence rules are in compliance.
Failure to keep accurate records can lead to IRS examinations and then a
531 Notice of deficiency leading to US Tax Court.
If you have not kept accurate accounting records
you could be at a disadvantage to avoid the deficiency tax payment. The Tax Court is not the appropriate forum to
try to take up valuable Court time in reviewing low level multiple transactions
and reconciliations. If you are in a
poor records situation, consider using forensic accounting to recover the
records and recompile. We can perform
forensic accounting to ensure you have accurate records. If you are in Tax Court, then with
forensically recompiled numbers you can argue matters of law, settle disputes get
to a favorable resolution. This article stresses
how to get to accurate records, even if you suffered a loss, flood or fire, and
avoid paying tax deficiencies on the basis of inaccurate records.
2)
Compilation of Accurate Records
The property development sector does need
accurate records, and there are times after floods, hurricane storms, tornadoes,
fires, earthquakes and other disasters where forensic work is required to
recompile lost or damaged records.
This area of the tax code and subject matter of
real estate asset development property is some of the most complex (with
thousands of applicable rules) in the Code.
At the same time it is one of the most favorable for the tax payer.
Here
is what we are covering:
(i)
Outlining the scope of the
records required
(ii)
Detailing compilation, tests
and other work to prepare the property tax parts of income tax returns
(iii)
Reaffirming obligation to file
Amended Returns and
(iv)
Dealing with the effect of the
limited time allowed by the IRS -Service.
(i)
Outlining the scope of the Real
Estate Accounting and records required
Likely the last thing as a real estate developer you
want to bother with is to track your numbers metrics and financial and keep
accurate records. You may dream of
avoiding all of this, but in reality, you need to get support, software and
services to do this. You must stay
compliant with income tax reporting requirements. The other benefits include understanding the
current profitability (or losses) of the projects, prepare reports to attract
investors or obtain financing, and frankly sleep better at night. Not having IRS examinations and audits is a
lot more restful. You need to ensure you
approach real estate to include accounting, and understand that this improves your
ability to run your business successfully.
Real estate accounting is quite complex. There are a lot of different factors and
parts, not found in standard retail sales or marketing businesses. As a developer, we recommend for you as a
client, to think of this as a dash-board or scorecard. The real estate accounting process requires
you to manage multiple costs and constantly identify strategies for savings.
For example, you may want to find ways to reduce costs in the vendor
procurement process. You can keep a better
eye on the situation if you use a seven (7) factor balancing scorecard. This will help you run your business more effectively.
1. Set up optimal key accounts
Make sure you get best advice when you set up your
real estate accounting, whether you use generic or real estate specific software.
The most important part here is to ensure that you identify
the accounts that give you the most efficient insights into your development
operations.
Another example, a commercial building developer should
set up accounts for accounts payable, banking cash, construction-in-progress
(CIP), work-in-progress (WIP), account receivables, investment, loans and equity,
identifying all loan rates and terms whether long-term debt, or short-term debt
(less than 1 year), retainage, and many others.
By contrast a landlord who rents out property will
after the property is rented no longer track CIP/WIP, but they may need to add
accounts that allow them to track specific expenses related to their rental
operations.
2. Focus on the key measures for your reports
When you are driving, you need speed,
distance, lane control, gas remaining, cruise control and mpg to get optimum
and safe driving. The key measure reports
for real estate focus on similar aspects.
The key measure reports you need can vary, based on what objectives and
type of project’s in progress.
If you are a home investor who plans to buy
a property at a low cost, develop and flip you will typically focus on the project
profitability. You need accurate
original and rework costs, labor and vendor costs and amounts owed. You need a
report which provides an overview of the development’s profitability based on
the you ‘assets and liabilities’, what you have in the project, and what you
owe. Added time taken will increase your
interest on loans so you need to measure whether you are on time.
If your project is to re-develop the
house to make a rental or AB&B, you will need during the reworks, accurate
original and rework costs, labor and vendor costs and amounts owed. When the property is rented you need a report
which provides an overview of the development’s profitability based on what you
have in the project, and what you owe, which
will generate rental income, reports and records should focus more closely on
the profit-and-loss (P&L) report, which helps you see the expenses versus
revenues during any time period.
In both of these examples good
accounting will allow you to generate the right reports where your real estate
activities will dictate which key measure in reports you should review most
carefully. We can advise.
3. Track Cost of Goods Sold (COGS)
A
real estate developer needs to be somewhat like a manufacturer and track the Cost
Of Goods Sold (COGS). When you set up
the accounts these are items that change as your property sales value
changes. Not indirect expenses, but
direct on the real estate sales. COGS covers
all direct expenses involved in developing your property. We advise putting direct labor in this
category, including paying contractors, electricians, architects, obtaining permits, and buying
building materials. Where you can get smarter with software and better records
is to break down COGS line items per square foot, or use numbers to create
profitability ratios. This will let you to compare the profitability of
different development projects. The fact
is that the better you understand your costs, and the dash board the more
effectively you will be able to generate profit for this and make projections
and estimates for future projects. Limit
indirect expenses, to more fixed costs like paying someone to run the office
for your real estate development firm, office electricity, company insurance,
but not project insurance, or direct project and interest.
4. Cross analyze to identify hard or soft costs
In addition to Direct and Indirect Costs (COGS),
real estate developers need to separate and identify hard and soft costs. This is an advanced layer technique. Tracking hard or soft expenses separately
helps you better understand how these different element types affect the
overall budget and final outcome of your project.
Hard costs are the physical tangible construction parts
of the project, which includes labor, materials, environmental, hazardous
materials abatement, and equipment such as scaffolding, cranes, trash systems
or slips.
Soft costs, are the rest, so not the physical
building. They include consultants, architects, permits, inspection fees, and
financing costs.
Where hard or soft identification matters, is that
each different project can vary. Doing
multiple same projects should give you a general rule of thumb, where you can
allocate soft costs over several projects.
Hard costs may in a housing development make up 90% to 95% of a
project’s budget. For one off projects soft
costs may be higher and make up 20% to 30%.
Having these parts identified can help you better identify your
profitability.
5. Compiling a Budget, Tracking and Making Financial Projections
For the more experienced developers you are aware
that real estate accounting starts long before you buy the land. Before you ever ‘break ground’ on a project,
you need to have made your best estimated financial projections. Making prospective property development
includes data on acquisitions, market data, construction costs, and your
proposed work schedule. You need a budget, and a plan and write out assumptions.
This plan details the sources and use of funds from your initial cash
requirements through works out to the end of the project.
While the project proceeds you will need to track actual
costs and liabilities while also continuing to make estimates and projections
about the future. Key to your dash board
is your burn rate. Get help if you need
it to create rolling cash flow
projections so you can be up to date in identifying potential shortfalls early
and make a plan to avoid them.
6. Use Financial Projections to refine development decisions
There is nothing worse than wasting time comparing
actual to old budgets. As new and better
information comes in revise the budget and financial projections. But, mind you review the reasons as your project
moves forward. The updated information
will allow better decisions to find a ‘balance’. We term this the balanced scorecard
report. It balances between your design development
and what you can afford per your revised budget/forecast. We believe best practice means that during the
project, you to produce numerous revised budgets. At each revision you need to refine your development
design choices to stay in line with these forecasts. This information is designed to let you strike
a balance that allows you to minimize both delays and cost increases while
maintaining the quality of your project, and maximizing profits,
7. Use Specific Real Estate software to refine development decisions
Real estate ‘accounting’ software helps you stay on
top of your projects. These seven (7) elements
should help you analyze everything. You
need to get good reports, get above line-item variances to aggregate costs and
up to a balanced scorecard or “dashboard report”. We have consultants who know how to implement
and utilize real estate accounting software. It can be very challenging. You may want to work with a consultant specialist. There is nothing worse than wasting time getting
an implementation wrong. Get to understand
how to use accounting software, this is a critical part of this process.
(ii)
detailing compilation, tests
and other work to prepare the property tax parts of income tax returns
Our
clients have a range of different processes and software to prepare accounts. Whichever is used, we apply standardized
tests to these calculations and compilations.
We go through extensive checklists and tests, to check we have applied
the relevant tax rules correctly. To
give you an idea of what is required and performed, the detailed tests are set
out below. It may seem dry read to anyone not involved in real
estate accounting and taxation. It is
however what is necessitated by the complexity and extensive Code
compliance. To relate to these tests the
following scenario has been created.
Scenario (based on real life)
You
are a property developer of a multi-unit development. You are selling units when they are ready,
and renting some units that are slow in selling. Revenue inflows are from multiple sources, the expenditures are posted through
multiple accounts. You have multiple
bank accounts, and multiple funding equity partners, and different bank and
private loans. Your bookkeeper got long
term Covid and has not updated the QuickBooks for several months. With so many bank accounts going, you can not
keep separate track of what was what in one project account or another. You are paying in and out from which ever account
had enough money to cover the expense, accounting for everything through one
‘bucket’. There were also issues with
contractors who stole tools, took decorations, billed for work that was
sub-standard and required redo-over, and worse billed for work not
completed. There were some insurance
claims (erroneously booked to income).
Primarily due to Covid, accounting was a mess and that part made it very
difficult to maintain profit and cost center accounting. Like many sole proprietors during Covid, developer
had to manage 'no-shows', find replacement contractors to be on site, when they
could be found. Keeping all transactions
posted was as best as could be done in the circumstances. Developer was working super hard to stay
afloat. It seems the coding suffered,
and the loan receipts were not identified as loans. Your replacement tax preparer booked your
loans and equity deposits to income, and filed your taxes without telling you
about it. Go figure what do you do?
Scenario Review
What
the developer was doing was Property Development and Interior Design. This project design, work-wise, with
building, renovating building and operating the rental business on the
property. This is a summary of the compilation,
tests and other work to rectify the practitioner errors,
The developer’s
starting point, upon being informed of the error(s) by the IRS examiner, was to
engage a forensic CPA. To show the scope
of the work required, covering several years below are a summary of the
forensic CPA work and procedures. These
test details are those performed per checklists that included the following
checks and procedures to review the Resort and other projects:
Checklist
of Review Tests
(1) Review
the acquisition purchase contract and purchase closing statement, check postings
to ledgers
(2) Review
purchase position when the property was acquired and examine any photos to see
how it was. (put copy on file) Determine if vacant, a run - down or other
condition.
(3) Review
available budgets and plans.
(4) Review
income and receipts in the bank statements, and perform proof of cash.
(5) Review
available expense receipts and expense postings, from purchase to date.
(6) Review
the credit card statements as available, from purchase to date.
(7) Compile
income reconciliations and detail out loans, and apply use of funds to proof of
cash, from purchase to date.
(8) Determine
the project scope of circa ‘gross budget’ for ‘n’ years, contractor works and
amounts expended in excess of the net sales prices, from purchase to date.
(9) Review
the initial budget expectation to renovate it to get it to “operation” within
the realm or neighborhood of budget,
(10) Schedule
out loans and compile basis.
(11) Determine
the adjusted basis of business property back when it was acquired, from
purchase closing documents. (Adjusted Basis
includes not just the cost of the asset, determined under Section 1012).
(12) Determine
any exchanges, barters or trades where taxpayer can also rely on a substituted
basis if the property was in part acquired in any exchange transaction (Section
358(a)(1) and Section 1031(d)).
(13) Compile
the cost basis (including cash payments for property plus the fair market value
of noncash property given in payment, and costs directly related to the
acquisition of property) which all must be included in its initial basis (include
freight, purchase commissions, title fees, transfer taxes, and sales taxes
(Regs. Sec. 1.263(a)-2(f)).
(14) Review
expenses for cost basis, to includes any costs incurred to get the asset ready
for its intended use (Section 263 and Regs. Sec. 1.263(a)-2), including
installation, Interior Design, renovations, implementations, and showing or
testing costs.
(15) Review
real property taxes apportioned to or owed by the seller and paid by the
purchaser which can also be included in the purchaser's tax basis (Regs. Sec.
1.1012-1(b)).
(16) Review
the amount of any liability incurred by the taxpayer Petitioner to acquire the
property included in basis (Regs. Sec. 1012-1).
(17) Review
transactions borrowing money. Identify traditional
mortgage loans and others. Review to ensure loans all based on prevailing
commercial terms.
(18) Review
application of rule of Section 1231 (allows where a net combined result of all
sales and exchanges of Section 1231 assets during the tax year(s) is a net
loss, the loss is an ordinary loss (Section 1231(a)(2))). Where the result is a net gain, the gain is
treated as a long-term capital gain (Section 1231(a)(1)). (This asymmetric rule offers the best of both
worlds to the business taxpayer Petitioner - ordinary loss or capital gain on
the sale of operating assets). With this
preferential rules result the application ordinary losses are fully deductible
in computing taxable income, whereas capital losses are subject to limits on
deductibility. All else equal, capital
gains are preferred to ordinary gains; ordinary losses are preferred to capital
losses.
(19) Compile
computation for Section 1231 netting process (critical to determining the
ultimate impact of Section 1231 gains and losses on taxable income). The tax result of a Section 1231 asset sale
cannot be fully determined until after year-end of the year in which project
sale occurs, after application of the netting process. This was running through to Resort sale in
2021.
(20) Perform
such adjustments applicable to business property, where basis was increased for
expenditures property chargeable to a capital account. (Such expenditures
include those improvements capitalized under Section 263(a)). Where basis was reduced by depreciation
deductions allowed or allowable in computing taxable income compute the basis
reduction for depreciation as the greater of amounts allowed as deductions in
computing taxable income or the amount allowable, even if not claimed as a
deduction.
(21) Review
all the “Lenders” who were contracted for the loans with terms albeit some were
personal friends
(22) Review
basis computation to include debt assumed by the owner of property and debts to
which the property continues to be subject after the acquisition, including
nonrecourse debt.
(23) Complete
a review compilation of all loans, apply Regs. Sec. 1.1001-2, where the amount
realized from a sale or other disposition of property includes any amount of
liabilities from which the seller is discharged as a result of the sale or
disposition. (i) Debt discharge is generally included in
amount realized whether the liability is recourse or nonrecourse. Review requires detailed document reviews to
see if the owner of the property could have been held personally liable. (ii) Alternatively, identify nonrecourse liability
(where the lender can look only to the property securing the debt in
satisfaction of the liability). The
extent of complexity in these circumstances includes that the amount of debt
included in the property's tax basis must be determined under either the
original issue discount OID rules of Section 1274 or the unstated interest
rules of Section 483. The OID rules are
extremely complex. Consider Section 1274 applies to debt instruments issued as
consideration for the sale or exchange of property when there is not adequate
stated interest or, if there is adequate stated interest, the instrument's
stated redemption price exceeds the stated principal amount. Review needed to identify any instruments are
excluded from these requirements, including (i)
instruments with terms less than six months, (ii) instruments from sales
of personal residences, (iii) instruments from sales involving total payments
of $250,000 or less, and publicly traded instruments. These instruments
excluded from Section 1274 are subject to Section 483.
(24) Complete
a review of Section 1274 applicability, (where the amount of a debt instrument
included in amount realized equals the issue price of the debt). If the debt instrument bears adequate stated
interest, the issue price equals the stated principal amount. Otherwise, the
issue price must be determined by calculating an imputed principal amount. The
goal of the imputation process is to separate payments to be received under the
debt instrument between principal and interest using an applicable federal rate
instead of the stated interest amount.
(25) Review
loans to apply Section 1274, (where the imputed principal amount will be less
than $x million); this lower amount will be included in amount realized on the sale.
As payments are received on the note, a portion of such payments will be
treated as interest for tax purposes, taxed to Petitioner at the time accrued
or received under its method of accounting.
Computing the imputed principal amount being the sum of the present
value of all payments to be received under the debt instrument, determined as
of the date of the property disposition.
Present value is computed using the applicable federal rate, compounded
semiannually. (Applicable federal rates are those published monthly by the
Treasury and vary depending on the term of the debt instrument).
(26) Make
a compilation of the imputed principal amount, including comparing to the
stated principal amount to determine if the debt instrument bears adequate
stated interest. Ascertain if the
imputed principal amount is greater than or equal to the stated principal
amount, wherefore there is adequate stated interest, and the issue price equals
the stated principal amount. Ascertain
if not, the issue price (and the amount included in amount realized on the
disposition of the property) is equal to the imputed principal amount. Amounts
paid in excess of the issue price are considered interest, recognized over the
life of the debt instrument.
(27) Review
the debt instruments if subject to the unstated interest rules of Section 483
instead of Section 1274. Determine the debt amount included in amount realized
under Section 483. (Apply similar test
to the approach applied under Section 1274).
Note: Section 483 applies only to sales and exchanges not covered by
Section 1274, where any payments are due more than one year after the sale or
exchange. Section 483 exempts sales for $3,000 or less, certain sales of
personal property, and sales of patents with contingent payments.
(28) Review
Real property taxes apportioned to or owed by the seller and paid by the
purchaser also have to be included in the seller's amount realized (Section
1001(b)(2)). Real property taxes apportioned to the purchaser but paid by the
seller, for which the seller receives reimbursement, are not included in amount
realized on the sale. Such taxes related to periods subsequent to the purchase
are typically deductible by the purchaser, either as ordinary and necessary
business expenses (Section 162) or as an itemized deduction (Sections 63 and
164). (Note that effective January 1, 2018 an itemized deduction for state and
local income or sales tax and property tax is limited to $10,000 (or $5,000 for
married taxpayer Petitioners filing separate returns).
(29) Apply
Section 61(a)(3) which specifies that gross income includes "gains derived
from dealings in property." Conversely, Section 165(a) allows a deduction
for "any loss sustained during the taxable year and not compensated for by
insurance or otherwise." In combination, these two rules require taxpayer
Petitioners to include gains and losses from property transactions in the
computation of taxable income.
(30) Apply
Section 1001, where realized gain or loss from a disposition of property is
computed as: Amount realized on disposition - Adjusted tax basis of property =
Realized gain or (loss) From prior computations apply the realization principle
of accounting. (Increase or decreases in
the value of assets which are not accounted for as income). Such unrealized gains or losses are
considered after an asset is converted to a different asset through an external
transaction with another party.
(31) Review
all loans to see is a party received any purchaser debt instrument as part of
the consideration for a property disposition, the amount of such debt included
in amount realized is generally the issue price of the debt. For the amount of debt included in the
property's tax basis determined under either the Original Issue Discount
(herein “OID”) rules of Section 1274 or the unstated interest rules of Section
483. The OID rules are themselves extremely complex. Their application here is
detailed only to the extent necessary to explain their impact on the cost basis
of the acquired assets.
(32) Review
Section 1274 application to debt instruments issued as consideration for the
sale or exchange of property when there is not adequate stated interest or, if
there is adequate stated interest, the instrument's stated redemption price
exceeds the stated principal amount. Review instruments which are excluded from
these requirements, including (i) instruments with terms less than six months,
(ii) instruments from sales of farms for
less than $1 million, (iii) instruments from sales of personal residences, (iv)
instruments from sales involving total payments of $250,000 or less, and
publicly traded instruments. These instruments excluded from Section 1274 are
subject to Section 483.
(33) Perform
compilation review tests to check for debt instruments which per Code are subject
to the unstated interest rules of Section 483 (instead of Section 1274). The
test approach used to determine the debt amount included in amount realized
under Section 483 (similar to the approach used under Section 1274). The tests sought to see if there were any
sales and exchanges (not covered by Section 1274), where any payments are due
more than one year after the sale or exchange.
(NB: Section 483 exempts sales
for $3,000 or less, and some sales of personal property).
(34) Test
and identify any Real property taxes apportioned to the purchaser but paid by
the seller, for which the seller receives reimbursement, are not included in
amount realized on the sale. Such taxes related to periods subsequent to the
purchase are typically deductible by the purchaser, either as ordinary and
necessary business expenses (Section 162) or as an itemized deduction (Sections
63 and 164). Effective January 1, 2018 an itemized deduction for state and
local income or sales tax and property tax is limited to $10,000 Petitioner).
(35) Review
capital improvements made to the business property, (accounted for in the Amended returns)
checked to provisions of Section 263(a) which requires that the cost of such
improvements be capitalized to the tax basis of the asset.
(36) Review
Grubb accounting on an item-by-item basis capitalized amounts, (which can't be
ignored as they were by the previous CPA preparer) critical to computing
allowable cost recovery of business assets.
Review for application and depreciation effects. When the Resort property was sold in 2021,
the adjusted tax basis of the property determined the resulting gain or loss on
sale. Petitioner, having been apprised
of these relevant professional capital gain/loss filed Amended Returns (Profit (net of losses) on the sale or
exchange of a capital asset or Sec. 1231 property, is subject to favorable tax
rates, and loss on such sales or exchanges (net of gains) deductible against
$3,000 of ordinary income per Section 1231 netting process.
(37) Compute
inclusion of debt instruments for the amount of such debt to be included in the
tax basis of the property. (The complexity
here is to apply on a loan-by-loan basis criteria to determine under the OID
rules of Section 1274).
(38) Apply
Section 1274, the amount of a debt instrument included in amount realized
equals the issue price of the debt.
However, per rule only if the debt instrument bears adequate stated
interest, the issue price equals the stated principal amount. Alternatively, the issue price must be
determined by calculating an imputed principal amount. The imputation process is a detailed
calculation, to separate payments to be received under the debt instrument
between principal and interest using an applicable federal rate instead of the
stated interest amount.
(39) Review
all debt instruments, schedule stated principal amounts for adequate stated
interest, wherein the issue price the entire amount of which is included in
amount realized on the sale of the building, applying Section 1016 required
adjustments to tax basis. These basis
adjustments are applied to the initial basis of the property, whether a cost or
substituted basis. (Practitioner notes:
there were exceptions where a few of the debt instrument had low interest. In these cases, the annual installment
payments required by the debt instrument, even though characterized as
principal, economically represent both a repayment of borrowing (principal) and
a payment for the use of the borrowed funds (interest). Under Section 1274, the imputed principal
amount will be less than; this lower amount will be included in amount realized
on the sale. As payments are received on the note, a portion of such payments
will be treated as interest for tax purposes, taxed to Petitioner at the time
accrued or received under its method of accounting).
(40) Review
imputed principal amount as the sum of the present value of all payments to be
received under the debt instrument, determined as of the date of the property
disposition. Present value was computed
using the applicable federal rate, compounded semiannually. (Applicable federal rates were those as are
published monthly by the Treasury and vary depending on the term of the debt
instrument). The imputed principal
amount was compared to the stated principal amount to determine if the debt
instrument had adequate stated interest. When the imputed principal amount was
greater than or equal to the stated principal amount, then adequate stated
interest existed. Then the issue price
equals the stated principal amount. When
lower than the stated principal amount, the Debt ‘issue’ price (and the amount
included in amount realized on the disposition of the property) was set as
equal to the imputed principal amount.
Amounts paid in excess of the issue price were considered interest,
recognized over the life of the debt instrument.
(41) Apply
provisions of Section 61(a)(3) which specifies that gross income includes
"gains derived from dealings in property." Conversely, Section 165(a) allows a deduction
for "any loss sustained during the taxable year and not compensated for by
insurance or otherwise." In
combination, these two rules require taxpayer Petitioners to include gains and
losses from property transactions in the computation of taxable income.
(42) Under
Section 1001, realized gain or loss from a disposition is computed as: Amount realized on disposition - Adjusted tax
basis of property = Realized gain or (loss).
This computation is complex requiring use of the realization principle
of accounting. Under this principle, increases or decreases in the value of
assets are not accounted for as income. Such unrealized gains or losses are not
considered until an asset is converted to a different asset through an external
transaction with another party.
(43) Review
transactions from purchase. Where the
market value of the asset has increased, estimate gain as not reported any of
the accrued economic gain on tax returns.
(The issue is in most (but not all) cases, realization is a necessary
prelude to recognition of gains and losses on the tax return. Therefore, the
realization principle gives Developer control over the timing of gain or loss
recognition. Owners of devalued property
can accelerate the deduction of loss and the related tax savings by disposing
of the property as soon as possible. The amount realized on a disposition of
property is defined in Section 1001(b) includes the following items all of
which need to be reviewed)
i. Cash
received.
ii. Fair
market value of noncash property received.
iii. Relief
of seller liabilities (Regulation Section 1.1001-2).
iv. Issue
price of purchaser debt issued in exchange for the property (Regs. Sec.
1.1001-1(g)).
(iii) obligation
to file Amended Returns
(iii)
reaffirming obligation to file
Amended Returns
In
nearly all cases, given the complexity of the code, forensic review will
identify revisions to income, expenses and overall tax liability. You will need to report this change. The standard method to make a change is to file
an amended return. You are obliged to do this if there's a change to Income,
Deductions, Credits, Tax liability.
Correcting an over-assessment, or an over-payment of taxes for error is
a good reason to file Amended Returns.
The
IRS or ‘Service’ has a policy of encouraging voluntary disclosure. Although
voluntary disclosure creates no substantive or procedural rights for taxpayers,
you are entitled to correct and avoid Tax Court litigation and penalties. Not all Service examiners are the same. Do not anticipate your voluntary disclosure
will guarantee acceptance and correction; historically taxpayers used to have
to face a potential hazard of filing an Amended return with a tax controversy
pending. Some forty (40) years ago the US Supreme Court, stated in Badaracco v.
Commissioner, 464 U.S. 386 (1984), that amended returns are "a
creature of administrative origin and grace." The Service view was that a taxpayer who
is already under ‘audit’ or ‘review’ could be considered as revealing the
semblance of being considered an admission of the taxpayer.
A
more current view is that preparation mistakes, especially during Covid years,
are very common place. Preparers working
at home often filed returns remotely without obtaining all the necessary
information from taxpayer clients. Correcting
these mistakes is a necessity. It is most prudent to get the record
straight. You need to file an Amended
income tax return. Amended returns are
mentioned in Treasury Regulation §§ 301.6211–1(a), 301.6402–3(a),
1.461–1(a)(3)(i). Section 6213(g)(1) and Section 1.451-1(a)) that require Amended tax returns to be
filed.
Treasury
Regulation 1.451-1(a), does provide an obligation to file an amended
return:
§
1.451-1 General rule for taxable year of inclusion.
(a)
General rule. Gains, profits, and income
are to be included in gross income for the taxable year in which they are
actually or constructively received by the taxpayer unless includible for a
different year in accordance with the taxpayer's method of accounting. Under an
accrual method of accounting, income is includible in gross income when all the
events have occurred which fix the right to receive such income and the amount
thereof can be determined with reasonable accuracy (all events test).
Therefore, under such a method of accounting if, in the case of compensation
for services, no determination can be made as to the right to such compensation
or the amount thereof until the services are completed, the amount of
compensation is ordinarily income for the taxable year in which the determination
can be made. Under the cash receipts and disbursements method of accounting,
such an amount is includible in gross income when actually or constructively
received. Where an amount of income is properly accrued on the basis of a
reasonable estimate and the exact amount is subsequently determined, the
difference, if any, shall be taken into account for the taxable year in which
such determination is made. To the extent that income is attributable to the
recovery of bad debts for accounts charged off in prior years, it is includible
in the year of recovery in accordance with the taxpayer's method of accounting,
regardless of the date when the amounts were charged off. For treatment of bad
debts and bad debt recoveries, see sections 166 and 111 and the regulations
thereunder. For rules relating to the treatment of amounts received in crop
shares, see section 61 and the regulations thereunder. For the year in which a
partner must include his distributive share of partnership income, see section
706(a) and paragraph (a) of § 1.706–1. If a taxpayer ascertains that an item
should have been included in gross income in a prior taxable year, (s)he
should, if within the period of limitation, file an amended return and pay any
additional tax due. Similarly, if a taxpayer ascertains that an item was
improperly included in gross income in a prior taxable year, (s)he should, if
within the period of limitation, file claim for credit or refund of any
overpayment of tax arising therefrom.
There are many reasons
to file an Amended return. Avoiding
Service 'prosecution' litigation should be a good reason. Consider an example, where an inexperienced
bookkeep during Covid, Working From Home (‘WFH’) booked all receipts on the bank
statements to income. Unfortunately some
of those transactions (fifteen (15)) were where the receipt was of personal loan
funds, which looked much like payments from private clients project work. When
these were incorrectly booked to income (in error), income was overstated over
one million (1,000,000.00) dollars. The
taxpayer only found out this error had occurred after the Service local
examination concluded, due to Covid. per
Treasury Regulation 1.451-1(a), (s)he should, (if within the period of limitation
which it was), file “claim for credit or refund of any overpayment of tax
arising therefrom” for which the correct form is “an Amended Return”.
(iv)
dealing with the effect of the
limited time allowed by the IRS -Service.
The service do not grant and examination extended
time in many instances. Examinations are
pushed along, which explains why the time it takes to perform the error
correction review, after it has been discovered, can be longer than
allowed. If the records on hand are not
accurate it can take a little longer than the limited time allowed by the
Service. The sooner we can be engaged
the more we can accomplish/
This is a really complex area of code. In making the
corrections, if we do not have enough time, there will not be time to lay out
detailed litigation presentation reconciliation schedules. When the Service ends the local review, there
may not be time for schedules to be produced.
If they are required more time has to be allowed to provide such
information to the Service. It is
important to try and ensure the Service does not ‘close’ the normal review
channels for such detailed discussion, closing local review and instigating
these proceedings.
Please
call if you require assistance.
B. J. Scambler CPA CFF FCMA
CPA Tax Counselors P.L.L.C.,
Certified Public Accountants
Tel Cell/Mobile 405
820 2711
Tel Office 405 608 2700
Email:
bruce@cpataxcounselors.com
Address
190
Kauger Street (Box 35)
Colony
OK.
73021
Counseling: guidance towards
Prosperity and
Affluence©
Other
Emails scamblerbj@msn.com
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