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Tax planning is essential for two very important reasons.  The first reason is to ensure you take advantage of opportunities BEFORE the year is over.  The second is that you are informed well in advance of April 15th of what your potential tax liability will be so that you can begin to plan for the cash outlay.  Now is the time to take a serious look at your tax situation.  Tax planning holds equal importance for your business and you personally and we want to make sure you pay as little tax as legally possible.  Here are some tax planning ideas worth considering:

A big issue facing business owners today is determining if an individual should be hired as an employee or as an independent contractor. The government does not take this issue lightly. Misclassifying workers as independent contractors can result in large, unexpected tax bills along with penalties and interest. Furthermore, employers may pay penalties on employment taxes – Social Security, Medicare, and Federal and State Unemployment – in addition to incorrectly filing tax forms. Determining the correct classification requires an in-depth look at the circumstances surrounding the worker’s arrangements.

Whenever you sell business or investment property and you have a gain, you generally have to pay tax on the gain at the time of sale. IRC Section 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of a qualifying like-kind exchange. Gain deferred in a like-kind exchange under IRC Section 1031 is tax-deferred, but it is not tax-free.

The exchange can include like-kind property exclusively or it can include like-kind property along with cash, liabilities and property that are not like-kind. If you receive cash, relief from debt, or property that is not like-kind, however, you may trigger some taxable gain in the year of the exchange. There can be both deferred and recognized gain in the same transaction when a taxpayer exchanges for like-kind property of lesser value.

What are the benefits of exchanging v. selling?

• A Section 1031 exchange is one of the few techniques available to postpone or potentially eliminate taxes due on the sale of qualifying properties.
• By deferring the tax, you have more money available to invest in another property. In effect, you receive an interest free loan from the federal government, in the amount you would have paid in taxes.
• Any gain from depreciation recapture is postponed.
• You can acquire and dispose of properties to reallocate your investment portfolio without paying tax on any gain.

Who qualifies for the Section 1031 exchange?

Owners of investment and business property may qualify for a Section 1031 deferral. Individuals, C corporations, S corporations, partnerships (general or limited), limited liability companies, trusts and any other taxpaying entity may set up an exchange of business or investment properties for business or investment properties under Section 1031.

What are the different structures of a Section 1031 Exchange?

To accomplish a Section 1031 exchange, there must be an exchange of properties. The simplest type of Section 1031 exchange is a simultaneous swap of one property for another.

Deferred exchanges are more complex but allow flexibility. They allow you to dispose of property and subsequently acquire one or more other like-kind replacement properties.

To qualify as a Section 1031 exchange, a deferred exchange must be distinguished from the case of a taxpayer simply selling one property and using the proceeds to purchase another property (which is a taxable transaction). Rather, in a deferred exchange, the disposition of the relinquished property and acquisition of the replacement property must be mutually dependent parts of an integrated transaction constituting an exchange of property. Taxpayers engaging in deferred exchanges generally use exchange facilitators under exchange agreements pursuant to rules provided in the Income Tax Regulations.

A reverse exchange is somewhat more complex than a deferred exchange. It involves the acquisition of replacement property through an exchange accommodation titleholder, with whom it is parked for no more than 180 days. During this parking period the taxpayer disposes of its relinquished property to close the exchange.

What property qualifies for a Like-Kind Exchange?

Both the relinquished property you sell and the replacement property you buy must meet certain requirements.

Both properties must be held for use in a trade or business or for investment. Property used primarily for personal use, like a primary residence or a second home or vacation home, does not qualify for like-kind exchange treatment.

Both properties must be similar enough to qualify as "like-kind." Like-kind property is property of the same nature, character or class. Quality or grade does not matter. Most real estate will be like-kind to other real estate. For example, real property that is improved with a residential rental house is like-kind to vacant land. One exception for real estate is that property within the United States is not like-kind to property outside of the United States. Also, improvements that are conveyed without land are not of like kind to land.

Real property and personal property can both qualify as exchange properties under Section 1031; but real property can never be like-kind to personal property. In personal property exchanges, the rules pertaining to what qualifies as like-kind are more restrictive than the rules pertaining to real property. As an example, cars are not like-kind to trucks.

Finally, certain types of property are specifically excluded from Section 1031 treatment. Section 1031 does not apply to exchanges of:

• Inventory or stock in trade
• Stocks, bonds, or notes
• Other securities or debt
• Partnership interests
• Certificates of trust

What are the time limits to complete a Section 1031 Deferred Like-Kind Exchange?

While a like-kind exchange does not have to be a simultaneous swap of properties, you must meet two time limits or the entire gain will be taxable. These limits cannot be extended for any circumstance or hardship except in the case of presidentially declared disasters.

The first limit is that you have 45 days from the date you sell the relinquished property to identify potential replacement properties. The identification must be in writing, signed by you and delivered to a person involved in the exchange like the seller of the replacement property or the qualified intermediary. However, notice to your attorney, real estate agent, accountant or similar persons acting as your agent is not sufficient.

Replacement properties must be clearly described in the written identification. In the case of real estate, this means a legal description, street address or distinguishable name. Follow the IRS guidelines for the maximum number and value of properties that can be identified.

The second limit is that the replacement property must be received and the exchange completed no later than 180 days after the sale of the exchanged property or the due date (with extensions) of the income tax return for the tax year in which the relinquished property was sold, whichever is earlier. The replacement property received must be substantially the same as property identified within the 45-day limit described above.

Are there restrictions for deferred and reverse exchanges?

It is important to know that taking control of cash or other proceeds before the exchange is complete may disqualify the entire transaction from like-kind exchange treatment and make ALL gain immediately taxable.

If cash or other proceeds that are not like-kind property are received at the conclusion of the exchange, the transaction will still qualify as a like-kind exchange. Gain may be taxable, but only to the extent of the proceeds that are not like-kind property.

One way to avoid premature receipt of cash or other proceeds is to use a qualified intermediary or other exchange facilitator to hold those proceeds until the exchange is complete.

You cannot act as your own facilitator. In addition, your agent (including your real estate agent or broker, investment banker or broker, accountant, attorney, employee or anyone who has worked for you in those capacities within the previous two years) cannot act as your facilitator.

Be careful in your selection of a qualified intermediary as there have been recent incidents of intermediaries declaring bankruptcy or otherwise being unable to meet their contractual obligations to the taxpayer. These situations have resulted in taxpayers not meeting the strict timelines set for a deferred or reverse exchange, thereby disqualifying the transaction from Section 1031 deferral of gain. The gain may be taxable in the current year while any losses the taxpayer suffered would be considered under separate code sections.

How do you compute the basis in the new property?

It is critical that you and your tax representative adjust and track basis correctly to comply with Section 1031 regulations.

Gain is deferred, but not forgiven, in a like-kind exchange. You must calculate and keep track of your basis in the new property you acquired in the exchange.

The basis of property acquired in a Section 1031 exchange is the basis of the property given up with some adjustments. This transfer of basis from the relinquished to the replacement property preserves the deferred gain for later recognition. A collateral affect is that the resulting depreciable basis is generally lower than what would otherwise be available if the replacement property were acquired in a taxable transaction.

When the replacement property is ultimately sold (not as part of another exchange), the original deferred gain, plus any additional gain realized since the purchase of the replacement property, is subject to tax.

How do you report Section 1031 Like-Kind Exchanges to the IRS?

You must report an exchange to the IRS on Form 8824, Like-Kind Exchanges and file it with your tax return for the year in which the exchange occurred.

Form 8824 asks for:

• Descriptions of the properties exchanged
• Dates that properties were identified and transferred
• Any relationship between the parties to the exchange
• Value of the like-kind and other property received
• Gain or loss on sale of other (non-like-kind) property given up
• Cash received or paid; liabilities relieved or assumed
• Adjusted basis of like-kind property given up; realized gain

If you do not specifically follow the rules for like-kind exchanges, you may be held liable for taxes, penalties, and interest on your transactions.

Please give us a call if you are planning on selling a property and want to buy a new property. We can see if a Section 1031 Tax-Deferred Exchange is right for you.

Mark S. Gallegos, CPA, MST is the Tax Division Leader at Apex CPAs & Consultants, Inc.
P 630.584.4555 F 630.444.1798 mgallegos@apexcpas.com

The federal government is expanding its crackdown on offshore tax evasion and preparing numerous criminal cases against suspected offenders.

It has been four years since the agreement between the United States and Switzerland pierced a veil of banking secrecy by requiring Swiss bank UBS to turn over names of account holders to the IRS. Currently, more than 100 criminal investigations may be under way against suspected tax evaders. The U.S. government already has won approximately 50 criminal cases and collected at least $5.5 billion in connection with undeclared offshore accounts.

Now the Department of Justice has announced in a Jan. 8, 2013, news release that Mary Estelle Curran, a 79-year-old widow, best known for her volunteer work, pleaded guilty to criminal charges of filing false tax returns and evading approximately $668,000 in federal tax on $40 million her husband left her in a secret Swiss bank account at UBS. She agreed to pay almost $22 million in penalties. Curran is scheduled to be sentenced next month. She faces up to six years in prison.

Many tax attorneys believe that the Department of Justice wants to send a message that no one is too old or too rich, too poor or too sympathetic, to escape criminal prosecution.

If you are as concerned about the financial implications of the recent tax law changes as the majority of our clients are, then I hope you take a few minutes to read over our summary of the significant developments of the American Taxpayer Relief Act. Congress has been hard at work in an attempt at compromise. We hope you find it informative. Remember, we are here to serve you so please call with questions. We always like hearing from you!

Individual tax rates

All the individual marginal tax rates from the Bush-era are retained (10%, 15%, 25%, 28%, 33%, and 35%). A new top rate of 39.6% is imposed on taxable income over $400,000 for single filers, $425,000 for head-of-household filers and $450,000 for married taxpayers filing jointly ($225,000 for each married spouse filing separately).

Phase-out of itemized deductions and personal exemptions

The personal exemptions and itemized deductions phase out is reinstated at a higher threshold of $250,000 for single taxpayers, $275,000 for heads of household, and $300,000 for married taxpayers filing jointly.

Capital gains and dividends

A 20% rate applies to capital gains and dividends for individuals above the top income tax bracket threshold; the 15% rate is retained for taxpayers in the middle brackets. The zero rate is retained for taxpayers in the 10% and 15% brackets.

Alternative minimum tax

The exemption amount for the AMT on individuals is permanently indexed for inflation. For 2012, the exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers. Relief from AMT for nonrefundable credits is retained.

Estate and gift tax

The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012), but the top tax rate increases from 35% to 40% effective Jan. 1, 2013. The estate tax "portability" election, under which, if an election is made, the surviving spouse's exemption amount is increased by the deceased spouse's unused exemption amount, was made permanent by the act.

Permanent extensions

Various temporary tax provisions enacted as part of the Bush-era were made permanent. These include:

  • Marriage penalty relief (the increased size of the 15% rate bracket)
  • Child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one)
  • Expanded adoption credit and adoption-assistance program amounts
  • The exclusion for employer-provided educational assistance
  • The enhanced rules for student loan deductions
  • The higher contribution amount to Coverdell education savings accounts
  • The employer-provided child care credit

Individual credits expired at the end of 2012

The act extended certain credits that expired at the end of 2012 including:

  • The American opportunity tax credit for qualified tuition and other expenses of higher education was extended through 2017.
  • Child tax credit
  • The earned income tax credit

Individual provisions expired at the end of 2011

The act also extended through 2013 a number of temporary individual tax provisions, most of which expired at the end of 2011:

  • Deduction for certain expenses of elementary and secondary school teachers
  • Exclusion from gross income of discharge of qualified principal residence indebtedness
  • Parity for exclusion from income for employer-provided mass transit and parking benefits
  • Mortgage insurance premiums treated as qualified residence interest
  • Deduction of state and local general sales taxes
  • Special rule for contributions of capital gain real property made for conservation purposes
  • Above-the-line deduction for qualified tuition and related expenses
  • Tax-free distributions from individual retirement plans for charitable purposes

Business tax extenders

The act also extended many business tax credits and other provisions including:

  • Credit for increasing research and development activities is extended through 2013
  • Section 179 Deduction in 2013
  • Deduction Limit = $500,000 / Limit on Capital Purchases = $2,000,000
  • Bonus Depreciation in 2013 = 50%

Other business provisions extended through 2013, and in some cases modified, are:

  • Temporary minimum low-income tax credit rate for non-federally subsidized new buildings
  • Housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds
  • Indian employment tax credit
  • New markets tax credit
  • Railroad track maintenance credit
  • Mine rescue team training credit
  • Employer wage credit for employees who are active duty members of the uniformed services
  • Work opportunity tax credit
  • Qualified zone academy bonds
  • Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements
  • Accelerated depreciation for business property on an Indian reservation
  • Enhanced charitable deduction for contributions of food inventory
  • Election to expense mine safety equipment
  • Special expensing rules for certain film and television productions
  • Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico
  • Modification of tax treatment of certain payments to controlling exempt
  • Treatment of certain dividends of regulated investment companies
  • Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Tax Act
  • Extension of subpart F exception for active financing income
  • Look through treatment of payments between related controlled foreign corporations under foreign personal holding company rules
  • Temporary exclusion of 100% of gain on certain small business stock
  • Basis adjustment to stock of S corporations making charitable contributions of property
  • Reduction in S corporation recognition period for built-in gains tax
  • Empowerment zone tax incentives
  • Tax-exempt financing for New York Liberty Zone
  • Temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands
  • American Samoa economic development credit

Energy tax extenders

The act also extends through 2013, and in some cases modifies, a number of energy credits and provisions that expired at the end of 2011:

  • Credit for energy-efficient existing homes
  • Credit for alternative fuel vehicle refueling property
  • Credit for two- or three-wheeled plug-in electric vehicles
  • Cellulosic biofuel producer credit
  • Incentives for biodiesel and renewable diesel
  • Production credit for Indian coal facilities placed in service before 2009
  • Credits with respect to facilities producing energy from certain renewable resources
  • Credit for energy-efficient new homes
  • Credit for energy-efficient appliances
  • Special allowance for cellulosic biofuel plant property
  • Special rule for sales or dispositions to implement Federal Energy
  • Regulatory Commission or state electric restructuring policy for qualified electric utilities
  • Alternative fuels excise tax credits

Foreign provisions

The IRS to apply a withholding tax to gains on the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent, and the amount is increased to 20%.

New taxes

In addition to the various provisions discussed above, some new taxes also took effect Jan. 1 as a result of 2010's health care reform legislation.

Additional hospital insurance tax on high-income taxpayers. The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer's spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of SECA tax on self-employment income in excess of the threshold amount.

Medicare tax on investment income. Starting Jan. 1, imposes a tax on individuals equal to 3.8% of the lesser of the individual's net investment income for the year or the amount the individual's modified adjusted gross income (AGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins.

For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is $125,000; and for other individuals it is $200,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.

Medical care itemized deduction threshold. The threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer's spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.

Health flexible spending arrangement. Effective for cafeteria plan years beginning after Dec. 31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for any plan year is $2,500.

Please give us a call so we can talk, plan and help you navigate through the American Taxpayer Relief Act of 2012.

Mark S. Gallegos, CPA, MST is the Tax Division Leader at Apex CPAs & Consultants, Inc.

P 630.584.4555 F 630.444.1798 mgallegos@apexcpas.com

Previously Illinois created the Small Business Jobs Creation Tax Credit that was a pilot program created to help reverse the trend of high unemployment in Illinois and to help spur the economy to recovery, by assisting and encouraging small businesses in the creation of local, sustainable, new jobs.

Due to the overwhelming positive response to the pilot program that ran from July 1, 2010 to June 30, 2011 the Small Business Job Creation Tax Credit was re-enacted and extended by the Illinois General Assembly.

What businesses are eligible for this tax credit

  • Small businesses with 50 or fewer full-time employees on July 1, 2012. The determination of whether an employer has 50 or fewer employees on July 1, 2012, includes all employees in every location, which includes both in Illinois and out of state employment totals.
  • Any-sized business that hires a 2010 "Put Illinois to Work Program" worker-trainee
  • The small business must be located within the State of Illinois and must be engaged in interstate or intrastate commerce

How much is the tax credit worth

  • For small businesses under 50 full-time employees: The credit is for $2,500 per job (that can be carried forward) and it must be applied against their Illinois withholding tax. The employer is entitled to a one credit ($2,500) if the position is filled for one year.
  • For any-sized businesses hiring "Put Illinois to Work" worker-trainees: Employers in this category are entitled to one-half of the credit ($1,250) allowable if that employee is employed for at least 6 months after the date of hire. The employer is entitled to the other half of the credit ($1,250) if that employee is employed for at least 12 months after the date of hire
  • The credit is taken against a company's withholding tax liability
  • The program is capped at $50 million worth of credits issued

Credit Guidelines

  • The position must have been created between July 1, 2012 and June 30, 2016
  • The position must pay no less than $10.00 per hour or the equivalent salary for a new employee for a minimum of $18,200 annualized
  • For small businesses: Eligibility for the credit does not require that a particular individual employee be retained for one year, only that a new, full-time Illinois job be created and sustained for one year
  • The credit may be claimed for an hourly employee working an average of 35 hours per week or for a full-time salaried employee, but not for a partner or an independent contractor
  • The position cannot be filled for any individual who has a direct or indirect ownership interest of at least 5% in the profits, capital or value of the business

How will companies apply for the credit

  • Eligible companies must register that they have created new position online at JobsTaxCredit.illinois.gov
  • Approximately one year after filling the new position, the business will provide supporting data as requested online in order to be issued its tax credit certificate(s). The start of the issuance of tax certificates will be July 1, 2013

If you are a small business and create and hire employees, then give us a call so we can discuss your current situation and make sure you benefit from this Illinois Tax Credit.

Rumors are circulating that all real estate transactions, including sales of personal residences, will be subject to a new 3.8 percent federal sales tax beginning in 2013.

These rumors are false.

The rumors resurfaced after the Supreme Court upheld the constitutionality of most of the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010 - collectively referred to as "Obamacare."

Here are the facts:

Beginning Jan. 1, 2013, a new 3.8 percent Medicare tax on unearned income will take effect. As a result, a small number of people will pay an extra tax on gain from the sale of their principal residence.

The new tax applies to single individuals with modified adjusted gross income (MAGI) in excess of $200,000 ($250,000 for married couples). The tax is equal to 3.8 percent of the lesser of net investment income or the amount by which MAGI exceeds the threshold amount.

When you sell your home, you may owe the tax if all of the following circumstances apply:

  • Your modified adjusted gross income exceeds the applicable threshold.
  • You sell your home at a gain.
  • Your gain exceeds the excluded amount ($250,000 for single taxpayers and $500,000 for joint returns).

Only the portion of the gain that is not excluded will be subject to the 3.8 percent tax.

For example, you and your spouse file a joint return in 2013. Before considering the sale of your home, you have MAGI of $325,000 and no other investment income.

Many years ago, you had purchased your home for $350,000. In 2013, you sell the home for $900,000, realizing a gain of $550,000. After excluding $500,000 as "gain from the sale of a personal residence," you are left with $50,000, which is considered investment income.

Since your MAGI ($325,000 + $50,000) is $125,000 over the tax's threshold amount for married couples filing jointly, the lesser amount of $50,000 is subject to tax. At 3.8 percent, you owe $1,900 of Medicare tax, plus a capital gains tax on your $50,000 gain (at whatever rate is in effect for 2013).

Sometimes the IRS gives you a second chance.

That was the case in a private letter ruling the IRS issued to an unnamed partnership. But remember that private letter rulings cannot be cited as authority for anyone other than the taxpayer to whom it was issued.

When the partnership filed its original return, it elected not to deduct the 50-percent and 100-percent bonus depreciation deductions to which it was entitled. The tax professional charged with preparing the partnership return erroneously believed that one of the partner's deductions would be limited by the passive activity rules. Under that limitation, the partner would not benefit from the enhanced depreciation deductions.

After filing two years of partnership returns on which the bonus depreciation was not claimed, the preparer discovered that the partner in question actually met the material participation standards with respect to the partnership. That partner would not be subject to the passive activity rules.

Finding that all partners would benefit from bonus depreciation, the partnership sought to amend its returns. In many cases, you can change a position you have taken on a filed tax return simply by filing an amended return within the next three years.

However, the tax law specifically provides that the election to claim or not to claim bonus depreciation can be changed only if the IRS consents to the change. In this case, the IRS granted its permission (PLR201230011).

While the situation worked out well for the partners involved, the IRS could have refused to allow the change.

Shareholders or employees of a corporation often lend it funds - expecting to be repaid.

If the loan does not get repaid, a bad debt deduction can be claimed. However, the tax treatment is different for "business" bad debts and "nonbusiness" bad debts.

A business bad debt results in an ordinary loss. A nonbusiness bad debt is treated as a short-term capital loss. In addition, for nonbusiness bad debts, a deduction is allowed only if the debt is wholly worthless, while a business bad debt loss is allowed for partial worthlessness.

If you lend money to a corporation that provides your primary means of employment, you may be able to show that the main purpose of the loan is to protect your trade or business as an employee. In that situation, business bad debt treatment should be available.

But if your primary motivation for the loan is more as an investment in the corporation, nonbusiness bad debt treatment is the result.

If you are both a shareholder in the corporation and an employee, the primary motive for making the loan may be difficult to prove. This difficulty was highlighted in a recent Tax Court case (Harry R. Haury v. Commissioner, TC Memo 2012-215, July 30, 2012).

Harry Haury was a software engineer who developed software and licensed it to NuParadigm Government Systems, Inc. and NPS Systems, Inc. Haury owned 48.3 percent of NuParadigm and 49.2 percent of NPS. He received compensation from NuParadigm but not from NPS.

To reduce cash-flow problems, Haury lent the companies almost $435,000 and claimed a business bad debt deduction when the loans were not repaid. Although the court agreed that the loans were worthless, it concluded:

The dominant motivation for making the loans was not petitioner's trade or business as an employee of the companies. … Petitioner designed the software used by the companies and invested a significant amount of time and money to ensure the success of the companies. Protection of petitioner's investment interests in the companies, rather than protection of his salary, was the dominant motivation for the loans.

When lending money to any business in which you are involved, you should be sure to document both the terms of the loan and the reasons for making the loan.

As demonstrated in several recent court cases, the IRS is taking an aggressive position in issues involving valuations of noncash charitable contributions.

Rather than challenging the value placed on the asset, the IRS is challenging whether the valuation is supported by a "qualified appraisal," as that term is defined in the regulations.

One taxpayer recently asked the Tax Court to reconsider its previous decision to deny the deduction.

Steven and Rory Rothman purchased a four-story townhouse located within a historic district. Several years later, the Rothmans contributed a historic preservation facade easement on their residence to the National Architectural Trust (NAT).

The Rothmans retained the services of a real estate appraisal firm to value the contribution. The appraisers estimated the property's fair market value at $2.6 million without the easement and concluded that the easement would decrease the property's value by approximately $290,000.

The Rothmans claimed a noncash charitable contribution deduction. They attached a copy of the appraisal and Form 8283, Noncash Charitable Contribution, to their return. On audit, the IRS disallowed the deduction based on the Rothmans' failure to establish the easement's value and failure to meet the qualified appraisal requirements of the regulations.

The first time it heard the case, the Tax Court ruled that the appraisal submitted by the Rothmans was not a qualified appraisal under the regulations (Rothman v. Commissioner, TC Memo 2012-163). The court found that, among other defects, the appraisal lacked a method and specific basis to determine value. The appraiser did not use the income, cost or replacement-cost approach to extrapolate the fair market value of the subject property as encumbered by the easement.

After that decision was rendered, the U.S. Court of Appeals for the Second Circuit, reversing and remanding a Tax Court decision in a different case, held that an appraisal using a method similar to that used by the Rothmans to value a facade conservation easement met the requirements of the regulations (Scheidelman v. Commissioner, 682 F.3d 189 (2d Cir. 2012).

On reconsideration, the Tax Court again concluded that the Rothmans' appraisal was not a qualified appraisal. While agreeing that the Scheidelman decision settled the issue of whether the Rothmans' appraisal included a method and a specific basis for the valuation, the court noted that the qualified appraisal regulations impose 15 distinct requirements and that the Rothmans' appraisal still failed to satisfy eight of those 15 requirements (Rothman v. Commissioner, TC Memo 2012-218, Aug. 1, 2012).

Before making a noncash charitable contribution, you should retain the services of a qualified appraiser and a tax adviser who will help you assure that the appraisal is qualified under the regulations.

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