The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood. Please call us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.
Home and Investments
Couple couldn’t deduct mortgage interest added to principal. In a recent case involving a negative amortization loan, a couple was denied a mortgage interest deduction for the unpaid interest that was added to principal. Since they reported their taxes using the cash method of accounting, the couple couldn’t deduct this interest because they did not pay it. The IRS also wanted to impose a penalty on them, but the Tax Court refused to do so. It found that the husband credibly testified that he reported the interest deduction using what he thought was stated on the Form 1098, Mortgage Interest Statement, received form the lender.
Aaron’s Take: The tax code only allows deduction based on “Qualified Acquisition Debt.” The addition of principal to a loan based on a negative amortization mortgage does not qualify as Acquisition Debt. Also, just because a number shows up on a 1099 or 1098 does not mean it is correct!
Partner couldn’t report sale of unrealized receivables under the installment method. The Tax Court has held that an individual couldn’t use the installment method to report the portion of the proceeds from the sale of her partnership interest that was attributable to the partnership’s unrealized receivables. Income from an installment sale is taken into account under the installment method; that is, a portion of the total gross profit from an installment sale is included in income in each year in which the seller receives payment. The amount received by a transferor partner in exchange for the part of his partnership interest attributable to unrealized receivables of the partnership is treated as an amount realized from the sale or exchange of property other than a capital asset.
In a recent case, a taxpayer sold her interest in a partnership that had unrealized receivables and reported the sale on the installment method. She reported the gain over the years as capital gain, which is taxed at lower rate than ordinary income. The IRS went after her, and the Tax Court held that she couldn’t use the installment method for the portion of the gain allocable to the unrealized receivables. Rather, this portion of the gain had to be reported in the year of the sale and as ordinary income. The Court did allow her to reduce the amount she had reported as capital gain by the amount she had to report as ordinary income.
Aaron’s Take: Receivables have never been an asset eligible for installment sale. The taxpayer’s loss is was a position inconsistent with tax law.
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