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TAX TIPS FOR INDIVIDUALS

Hit by the NJ Exit Tax on Sale of Real Estate? You Can Recoup Your Money

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The New Jersey “Exit Tax”, which became law in 2007, requires the real estate seller to file a GIT/REP form

Exiting NJ?

(Gross Income Tax form) in order to record a Deed for  the transfer of his property.

When a non-resident sells property, New Jersey will withhold this income tax in the amount of either 8.97 percent of the profit or 2 percent of the total selling price, whichever is higher. Therefore, even if the property is sold at a loss, tax must be withheld to fulfill the two percent requirement.

What Can I do?

It’s important to realize that while the Exit Tax requires a substantial withholding, it doesn’t have any impact on the actual tax liability. If the seller files a NJ tax return he is refunded the difference between what was withheld and what is owed. This recovery can be very significant when one factors in the selling costs and original purchase price, both of which reduce the taxable gain.

Estates Should Pay Special Attention

The recovery is often even greater in the case of real estate sold by an estate, as there is a step up in cost basis which would typically minimize a gain on the sale, often resulting in full recovery of the entire withholding. To quickly expedite the recovery of the excess withholding, it would be prudent to timely file Form NJ1040 NR (individual) or NJ1041 (estate/fiduciary).

How do I know if I am considered a “non-resident”?

So who’s considered a “resident” and who’s a “non-resident” with regard to this tax? The law defines a resident taxpayer as one of the following:

  • An individual who is and intends to continue to maintain a permanent place of abode (home, residence) in New Jersey on/after the day of transfer
  • An estate established under the laws of New Jersey
  • A trust established under the laws of New Jersey

A nonresident is simply defined as “any taxpayer that does not meet the definition of resident taxpayer.”

Tax Court Hammers Home the Need to Document Your Mortgage Interest Expense

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 An individual who wishes to claim a home mortgage interest deduction has to be able to document his equitable ownership interest in the property, a U.S. Tax Court ruled earlier this year. The opinion, which was handed down in Dolorosa Luciano-Salas, Petitioner v. Commissioner Of Internal Revenue, Respondent appears to provide some useful guidance when it comes to claiming a mortgage interest and other deductions.

The Taxpayer’s Disputed Deductions

On her 2008 federal income tax return, California resident Luciano-Salas claimed a deduction for $24,144 of home mortgage interest on Schedule A, Itemized Deductions; and she also took a deduction for a rental real estate loss of $25,000 on Schedule E, Supplemental Income and Loss. 

But the IRS disallowed $24,144 of the $25,717 deduction for mortgage interest that she claimed on Schedule A, as well as the $25,000 deduction (rental real estate loss) that she claimed on Schedule E. The IRS said Luciano-Salas had failed to show that the duplex was used as a rental property or that she was otherwise entitled to the disallowed deductions. 

When is Interest Expense Deductible? 

Although personal interest expense cannot generally be deducted by an individual taxpayer, the tax code generally does allow a deduction for interest paid on a mortgage that is secured by a qualified residence. The mortgage, however, “must be the obligation of the taxpayer claiming the deduction, not the obligation of another,” although there is an exception if the individual paying the mortgage is the “legal or equitable owner,” even if he or she is not directly liable upon the bond or note secured by such mortgage, according to the Tax Court. 

There was no dispute that, at the time of her tax filing, Luciano-Salas lived in a Van Nuys duplex that had been purchased by her sister, who bought the property with a first and second mortgage. The sister later obtained a third-mortgage loan that was secured by a recorded “short form deed of trust” granting the lender a security interest in the duplex and the power to sell the property. 

Can You Legitimately Claim an Ownership Interest? 

Despite this, Luciano-Salas said that she was the true owner of the duplex—and was eligible to take the interest deduction and the loss on rental activity. Luciano-Salas said that her sister, who allegedly lived with her husband in Arizona, owned the property “in name only.” Luciano-Salas also said that her own credit rating was poor, so her sister agreed to help her out by acting as the purchaser of the property. 

There was a hitch, however. Luciano-Salas did not present a written agreement memorializing the supposed arrangement. Additionally, she was unable to present a reasonable paper trail showing that she, and not her sister, had made the mortgage payments. Adding to the confusion, she was unable to document the use of the duplex as a rental property. To top it off, in 2009 when Luciano-Salas’ sister declared bankruptcy, all the documents filed in connection with the matter indicated that she, not Luciano-Salas, was the legal and equitable owner of the duplex, according to Tax Court records. 

The Ruling 

“There is no objective evidence, however, that Ms. Hileman [the sister of Luciano-Salas], the legal owner of the duplex, entered into an agreement vesting petitioner with any ownership interest in the property. There is no evidence that petitioner had any duty or obligation to maintain or insure the property or that she was responsible for real estate taxes,” noted the Tax Court. “We have disallowed a deduction for mortgage interest where the taxpayer is unable to establish legal, equitable, or beneficial ownership of mortgaged property.”

 

Our recommendation: to reduce the likelihood of trouble, maintain adequate documentation for income and expense positions, and consult with your accountant.

New Options for Foreign Bank Account Owners

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What is the Offshore Voluntary Disclosure Program?
Since 2009, the IRS has announced various initiatives for taxpayers with unreported foreign assets. The Offshore Voluntary Disclosure Program (OVDP) requires filing 8 years amended tax returns and 8 years of Foreign Bank Account Reports (FBAR). In addition to paying 8 years of taxes, taxpayers must pay a 20% “accuracy” penalty on the tax plus interest. Taxpayers must also pay a 27 ½ % “FBAR-related” penalty on the highest balance of their foreign assets in the 8 year period (includes investments other than bank accounts).

What are the Changes?
On June 18, 2014 the IRS announced major changes to the OVDP which results in three possible “routes”: First, U.S. residents who did not report foreign income or assets but who certify that their non-compliance was not “willful”, do not need to enter the OVDP, but are now able to address the issue by filing only 3 years amended returns and 6 years of FBARs. No income tax penalty and only a 5% “FBAR-related” penalty are due.

Second, those who cannot certify that their non-compliance was not “willful” can still join the OVDP. The June 2014 changes create a third category of those who enter the program after it becomes public that their foreign bank is under investigation by the IRS or Dept. of Justice. For these taxpayers, the June 2014 changes increase the 27 ½ % penalty to 50% of the highest balance (of the taxpayer’s foreign assets during the preceding 8 years). This 50% penalty can be avoided only by completing the detailed preclearance filing procedures before August 3, 2014.
For those who can’t certify non-willful non-compliance, the OVDP is the only way to cap their civil tax exposure and to avoid criminal prosecution and possible jail time.

What are the Risks?
For those who choose to certify that their non-compliance was not “willful”, be aware that there is NO protection against criminal prosecution if the IRS finds the Taxpayer’s certification of non-willful conduct not to be true. Furthermore, the taxpayer will then be considered ineligible to participate in the OVDP.

What Should I Do Now?
Taxpayers need to ask themselves some hard questions in order to determine if they are eligible to claim that their non-compliance was “non-willful”. Non-willful conduct is defined by the IRS as conduct that is due to negligence, inadvertence or mistake or conduct that is the result of a good faith misunderstanding of the requirements of the law.

Time is Running Out
The 2014 OVDP does not have a final end date. However, the IRS has reserved the right to end the program at any time. We work with several law firms who specialize in this area. Together with your legal counsel we can help you evaluate the most suitable alternative.

Israel now Taxing US Trusts with Israeli Beneficiaries

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If you have family living in Israel for whom you set up an irrevocable trust, Israel now wants its share. Until 2014, irrevocable trusts settled by foreign residents in favor of Israeli resident beneficiaries weren’t taxed by Israel unless the beneficiaries exercised “control or influence” over the trust. This is no longer the case.

Beginning January 1, 2014, Israel is taxing any trust anywhere in the world that has an Israeli resident beneficiary. There are two types of Israeli Beneficiary Trusts.

A Relatives Trust (or Family Trust) is a trust where the settlor is the parent, spouse, child, grandchild or grandparent of the beneficiary.

A Non-Relatives Trust is all other Israeli Beneficiary Trusts.

If the trust is a Relatives Trust, the trustee must choose between two possible tax regimes. Israel will impose a tax rate of 30% of income distributed to beneficiaries. Alternatively, it’s possible to elect to be taxed at a rate of 25% on annual trust income regardless of distributions.  An irrevocable election must be made by June 30, 2014 to choose the tax regime.

An exception applies to new and senior returning residents (who lived abroad 10 years) who arrived after 2006. They enjoy a 10-year Israeli tax holiday regarding overseas income, gains and asset reporting.

Thinking about excluding Israeli resident beneficiaries? It’s not so simple. The new 2014 rules impose Israeli tax on all trusts that ever had Israeli resident beneficiaries since inception. Consultation with qualified and competent U.S. and Israeli tax professionals is critical to deal effectively with the new tax liability.

 

 

How Does the IRS Find Foreign Account Owners?

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Do you have income overseas you forgot to report? Did Grandpa leave you his foreign bank account when he passed away? If you have foreign bank accounts holding more than $10,000 in the aggregate anytime during the year, you are required to file an FBAR (Report of Foreign Bank Accounts) by June 30th of the following year. It doesn’t matter whether the foreign accounts generate income or not; just owning them, or having signature authority, requires you to file. (For more information regarding the FBAR, click here: Foreign Asset Reporting)

If the thought has crossed your mind to not file and hope for the best, think again. With the increasingly aggressive tactics being taken by the U.S. Treasury and Justice departments, this has become a very risky proposition. The U.S. is entering into settlements with many foreign banks that provide for fines in exchange for nonprosecution agreements for banks that facilitated American tax evasion.  As part of these settlements, the foreign banks hand over the names of their U.S. customers. Moreover, in July 2014 the Foreign Account Tax Compliance Act (FATCA) will go into effect, requiring international financial institutions to turn over all the information on their US account holders.

In 2009, as the IRS became aware of increased offshore tax abuse, it initiated the formal Voluntary Disclosure Program for offshore accounts. While making a voluntary disclosure doesn’t guarantee immunity from prosecution, taxpayers making truly valid disclosures are rarely, if ever, prosecuted.

It’s important to realize that the Voluntary Disclosure Program essentially sets up a race between you and the IRS. In order to avoid criminal prosecution you must come forth before the IRS comes knocking. A growing number of foreign banks are sharing American accountholder information with the IRS, so time is of the essence.

While the current voluntary disclosure program is currently running indefinitely, the rules can change at any time. The FBAR penalty has been raised in 2012 to 27.5% of the largest balance during the period covered by the voluntary disclosure. Sounds like a steep price to pay? The penalties are far greater if you don’t “get with the program” and then get caught. In addition, disclosing now allows you to transfer the money to your American accounts as well as to implement gifting and many other estate planning strategies.