Lynn Brenner's Family Finance

How to Report a Capital Gain That Isn't Taxable

Q: My parents deeded land to me and my siblings 10 years ago, and reserved a life estate interest for themselves. Our last surviving parent died in November 2009. In an earlier post, you explained that  we wouldn't have a taxable gain when we sold the land if  the sale price was no greater than the land's market value when we inherited it.

My siblings and I sold the property in May of 2010. Now, as I start to prepare information for my income tax return, I'm not sure how to show that no capital gain is realized on my portion of the sale.

How do I file my tax return? I assume I need to show on the tax return that the transaction took place, even though no tax is due. Is that correct? –KF, via email

 A: Yes. You report the sale on your tax return, and show that there was no taxable gain.

As I explained in the earlier post, you inherited the land at its market value.  

After the sale, you should have received a Form 1099-S stating the amount that was paid to you at the closing. This form might have been sent to you by the mortgage company, or the bank, or the purchaser's attorney, or even the title company. The same firm also sent a copy of Form 1099-S to the Internal Revenue Service, reporting the amount you received.

You report the sale on Schedule D of Form 1040, says Alan E. Weiner, senior tax partner emeritus at Holtz Rubenstein Reminick in Melville NY.

'Date of purchase' in this case is the date of your last parent's death in November of 2009 -- the date you inherited the land.

‘Date of sale’ and ‘Sale Price’ are self-explanatory.

‘Cost or other basis’ is the land's market value at the date of your second parent's death, plus whatever expenses you incurred in selling the property.

The last column on Schedule D is 'Gain'.

If there is a capital gain, it will be a long-term gain even though you sold the property less than 12 months after inheriting it.  "Anytime you inherit property and sell it, it's automatically a long-term transaction," Weiner explains. (To make sure the IRS computer doesn't mistakenly flag a sale of inherited property as a short-term transaction, you can simply write 'INHERITED' on Schedule D instead of setting down a date of purchase, notes Barry C. Picker, a Brooklyn NY tax accountant.)  

If the land’s market value at the date of death is the same or lower than the sale price, there is no gain. In the current environment, that seems more than likely! Still, it’s a good idea to get an appraisal of the date-of-death market value as back-up in case you're ever audited. 

You don't have to spend several thousand dollars on a formal appraisal unless this is a major financial transaction, Weiner says.  You probably don’t need more than a letter from a local real estate broker estimating the land's value at your late parent's death. Keep that letter as documentation.

This is all quite straightforward if you and your siblings each received a Form 1099-S stating his/her share of the proceeds. But it’s possible that only one Form 1099-S was issued for the entire sale proceeds. Let’s say that's what happened -- and that the 1099-S for the whole amount has your name and Social Security number on it.

Of course, the property belongs to all of you and you shared the proceeds equally. But you mustn't confuse the IRS computer by reporting a different amount from the one on the 1099-S, says Weiner.

Here's what you do:

Report the full sales price on Schedule D, as it appears on the Form 1099-S. On the next line, write, "See note, attached."

On Schedule D, subtract the amount you're not responsible for. For example, if the total sale was for $300,000 and your share is $100,000, under ‘Sale Price’, you write '$300,000’ and under that you write ‘minus $200,000'.

In a note attached to the return, explain the situation. For example:

Keith Franklin, Paul Franklin, and Mary Franklin inherited X acres of land at Y location, on November 12, 2009. They sold it on X date 2010. The Form 1099-S was issued only to Keith Franklin. Paul Franklin and Mary Franklin are two-thirds owners, and they have reported two-thirds of the sale proceeds on their tax returns. Your note should include Paul and Mary's Social Security numbers and addresses.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

 

Retirement Plan Rules Say I Must Withdraw My Account at 70 and a half. Will I Have to Pay Taxes on It?

Q: I'm a 68 year-old with zero tax deductions who is still working. I'm maxing out on my contributions to my Thrift Savings Plan retirement account, plus doing my over 55 catch-up contribution to reduce my taxable income. I'm considering withdrawing about $60,000 from my account to pay off my mortgage. I owe about $26,000 on the house at 6.75%. I'd convert the rest into my Roth IRA. I do have funds to pay the taxes on this withdrawal.

I have two questions. First, what's the most I could withdraw without going into a higher tax bracket? Second, I've heard that if you take a withdrawal while still working, when you do retire and turn 70 and a half, you must withdraw the whole account. That would mean a big tax bill. If this is true, is there a way around it? --RC, via email

 

A: You should take the first question to your tax accountant. Even a tax professional can't tell you how much you can withdraw without being bumped into a higher tax bracket without more information about your situation.

But you don't have to worry about the second question. You won't be hit with a big tax bill at 70 and a half.

Let's make things clear to other readers by explaining that the Thrift Savings Plan (TSP) is the defined contribution plan for federal government employees. In many respects, it resembles a 401(k) plan -- but not in all respects.

For example, 401(k) plans only permit pre-retirement withdrawals under very specific conditions of financial hardship. By contrast, the TSP allows its participants to do a one-time pre-retirement transfer of money to an IRA after turning 59 and a half.

This is called an 'in-service age-based withdrawal'. That's what will let you withdraw $60,000 from your account. (To comply with the rule, you'll probably have to transfer the entire $60,000 to the Roth IRA, and then use $26,000 to pay off the mortgage.)

The same TSP rule that permits this type of pre-retirement withdrawal says that if you use it, you must take the rest of your money when you retire.

But that doesn't mean you'll have to pay taxes on the entire amount. All you need to do to preserve its tax-deferred status when you retire is transfer it from the TSP into a traditional IRA.

By April 1 of the year after you turn 70 and a half, you must start taking minimum annual withdrawals from your tax-deferred retirement accounts. (This is true whether your money is in the TSP, a 401(k), or a traditional IRA). But only the amount you withdraw is taxable. The balance remains tax-deferred.

You're never required to take withdrawals from your Roth IRA; but any withdrawals you do take are tax-free after you're 59 and a half and have owned the account for five years. The five year clock starts on January 1 of the year you open your first Roth IRA, and that date applies to all your subsequent Roth IRA contributions to that account, as well as to Roth IRA accounts you open later. (As far as the Internal Revenue Service is concerned, you have only one Roth IRA, no matter how many accounts it's divided in.)

Your $60,000 withdrawal will be subject to income taxes since you're not going to transfer it into a traditional IRA. Even so, using this money to pay off the mortgage can make financial sense:

You say you have zero tax deductions. In other words, you aren't deducting the 6.75% interest you're paying on the mortgage. (Your mortgage is almost paid off, which means the interest portion of your payment is very small. The interest is probably less than your standard income tax deduction, says Barry C. Picker, a Brooklyn NY tax accountant.)

Since you aren't getting a deduction for that interest, using $26,000 to pay off the mortgage is like investing the money at a risk-free 6.75%. You can't beat that these days!

One suggestion: Convert the withdrawal into a new Roth IRA. Don't put this money in an existing Roth IRA. Here's why:

If you do a Roth IRA conversion in 2010, you have until October 15 2011 to change your mind and move some or all of the converted amount back into the tax-deferred retirement account it came from. (This is called 'recharacterizing' the conversion.)  It's much, much simpler to do this if you haven't commingled the converted money with an existing Roth IRA.

After the recharacterization deadline has passed, you can always consolidate your Roth IRAs if you wish. Even if you don't, the five year clock that started with your first Roth IRA will apply to the new one too.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

 

 

Here's Why Everybody Should Name Contingent 401(k) Beneficiaries

Q: My wife passed away two years ago and left a hefty 401(k) plan. She did not have a will, so the money was ordered to me, and is currently in an IRA in my name. I'd like to transfer the money to her three siblings without taxes, penalties, etc. Any advice would be greatly appreciated. -- BC, via email

A: As a brother-in-law, you win the generosity sweepstakes! But unfortunately for your late wife's siblings, the tax law isn't as magnanimous. You can't do a tax-free, penalty-free transfer to them.

You'll owe income taxes on any money you take money from your IRA to give to your in-laws, plus a 10% early withdrawal penalty if you're under 59 and a half years old.

And that's not all. Gifts are subject to gift taxes, which are always paid by the donor, says Barry. C. Picker, a Brooklyn tax accountant and IRA expert.

Whether you actually owe a gift tax depends on the amount involved. You can make annual $13,000 gifts to as many people and charities as you want, without incurring any gift tax. And in addition to those 13,000 annual gifts, you can give away up to $1 million free of gift tax in the course of your lifetime.

It's a shame that your wife didn't name her siblings as her contingent 401(k) beneficiaries. Had she done so, you could have passed them the money without any tax or penalty:

An heir always has up to nine months to disclaim an inheritance. Had you disclaimed the 401(k) within nine months of your wife's death, the legal effect would be the same as if you had predeceased her. Her 401(k) would then automatically have passed without any tax consequences to her contingent beneficiaries, and they could have transferred it into IRAs of their own.

Everyone should name contingent IRA beneficiaries for the same reason.

In fact, it's important to name your secondary heirs as contingent retirement account beneficiaries, even if they're ultimately sure to inherit this money anyway as part of your estate.

Let's say you and your spouse have named each other as sole IRA beneficiaries, and you die in a common accident. Your IRAs will be paid to your estate. That means your kids will ultimately inherit them, along with the house and the stamp collection. But they'd get much more favorable tax treatment on this money if they inherited the IRAs as the named contingent beneficiaries. (For more about that, see this earlier post.)

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c) Lynn Brenner, All Rights Reserved

 

Help! Nobody Told Me I Must Take Distributions From an Inherited IRA. Will the IRS Waive the Penalty?

Q: I was the beneficiary of my mother's IRA. I didn't know I was supposed to continue taking distributions, and I'll be penalized for not taking them. Is there a way I can ask the IRS to waive this penalty? I honestly didn't know, and Fidelity -- which was the IRA custodian -- didn't inform me. -- AM, via email

 

A: You can indeed ask the IRS to waive the penalty, and you should do that -- and take those distributions out of the IRA -- without delay. Chances are that they'll settle for a sincere apology.

Here's the rule you didn't know: As your mother's IRA beneficiary, you had to start taking minimum annual withdrawals based on your life expectancy by December 31 of the year following her death. (You calculate the minimum amount you must withdraw every year using an IRS actuarial table called 'Single Life Expectancy Table for Inherited IRAs'. You'll find it in IRS publication 590, which you can download at www.irs.gov).

The penalty for failing to take annual required distributions is really steep. It's 50% of the amount you were supposed to take, but didn't. So if the required distribution was $1,000 and you took nothing, the penalty would be $500. (In tax jargon, it's called a 50% excise tax on your 'excess accumulation' in the IRA.)

Bear in mind, however, that you have no problem if 2009 was the only year you missed taking a distribution. Nobody was required to take a minimum IRA distribution in 2009. (There was a special one-year exemption so that people wouldn't be forced to take taxable distributions from retirement accounts that had been decimated by the 2008/2009 financial meltdown. )

If you failed to take the required minimum distributions in other years, take them now -- and immediately use IRS Form 5329 to report the excise tax you owe. Don't worry:  the instructions for filling out Form 5329 also tell you how to ask that the penalty be waived because you made an honest mistake.

Or as IRS Publication 590 puts it:

" If the excess accumulation is due to reasonable error, and you have taken, or are taking, steps to remedy the insufficient distribution, you can request that the tax be waived. If you believe you qualify for this relief, attach a statement of explanation and complete Form 5329 as instructed under Waiver of tax in the Instructions for Form 5329."

You can download that form and the instructions for completing it at www.irs.gov.

Please send your questions to Lynn@LynnBrennersFamilyFinance.com.  I'm sorry I can't respond personally to every email. Questions are only addressed online.

(c:) Lynn Brenner, All Rights Reserved