Theft loss for Trust Scam Fees, Strike Pay, Foreign Parent as Joint Tenant

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, June 14, 1998

Copyright 1998 Robert L. Sommers, all rights reserved.

Question: May I deduct the fees paid to a promoter if my business is placed in a trust which is subsequently ruled fraudulent by the IRS? Note: The IRS is challenging abusive trust arrangements (trust scams) in which taxpayers transfer businesses and personal assets to a series of trusts designed to evade income taxes. These are not the lawful estate planning trusts used to reduce estate taxes and avoid probate.

Answer: No. Unlike legitimate business expenses, payment to form these trusts is not an ordinary or necessary business expense and, therefore, is not deductible. Your best bet is to claim you were criminally defrauded by the promoter and claim a theft loss, which is an itemized deduction used to offset your income (Form 1040, Schedule A, line 19). To establish your claim, file a criminal complaint with your district attorney.

Note: A California Appellate Court held that advertising the benefits of a trust scam (called a "pure" trust) to avoid income taxes amounted to false and deceptive advertising practices; the trust promoter was later convicted for criminal fraud.

Question: I received a Form 1099 for strike pay. Do I include these payments as income? May I claim any deductions?

Answer: Strike benefits paid to a worker from union dues are considered income, unless the facts clearly demonstrate that the union intended the payments as gifts. If you incurred ordinary and necessary expenses in conjunction with the strike, you may deduct them as miscellaneous itemized deductions (Form 1040, Schedule A, line 20). These deductions are limited to the amount that exceeds 2% of your adjusted gross income. As with any deduction claims, you should retain receipts and cancelled checks to document your expenses.

Question: Is interest paid on a second home mortgage deductible and, if so, how much?

Answer: Generally, interest paid on mortgages (or deeds of trust) securing a first or second home (collectively homes) is deductible up to $1,000,000, to buy, build or improve your homes ("acquisition debt"). In addition, you may deduct the interest on "home-equity debt" (secured by your homes), provided the total principal amount does not exceed the lesser of $100,000 or the excess of the home’s fair market value (FMV) over the acquisition debt.

For example, if you purchase a $500,000 home with $50,000 down and a mortgage of $450,000, you may deduct the interest on the $450,000 of acquisition debt. If your residence has a FMV of $500,000, the interest deduction on a subsequent home-equity loan is limited to $50,000 of principal (the difference between the FMV less the acquisition debt).

Note: Unlike acquisition debt, home-equity debt may be used for any personal purpose (education, automobile purchases, debt consolidation, business or financial ventures).

Question: My father, a non-resident alien (NRA) sent $100,000 directly to the title company for the down payment of my house. After escrow closed, I made him a joint tenant. When we refinanced the house, with his consent, I removed him from the title. We are considering placing him back on the title. My real estate agent assured me there are no tax consequences to these transactions. Is this true?

Answer: No. Your agent was probably referring to Proposition 13 property tax reappraisals. While principal residence transfers between family members usually do not trigger a property tax reappraisal, the federal gift tax rules do apply to your transfers. California law permits a joint tenant to sever the tenancy and convert that property to a "tenant in common" (thereby owning his share of the property outright). Therefore, you have made a gift to your father by placing him on title as a joint tenant.

Previously, your father made a taxable gift to you of U.S. real property when he transferred $100,000 into escrow to fund your purchase. A second gift occurred to your father when you placed him on title as a joint tenant. According to the gift tax laws, when you took him off title, he gifted back his share of the property to you. Consequently, your father made two separate taxable gifts to you and you made one taxable gift to him.

Note: An NRA is not entitled to the Unified Estate and Gift Tax Credit (currently worth $625,000) to off-set his gift tax liability. However, he may use the Annual Gift Tax Exclusion (currently worth $10,000 per year, per beneficiary) to reduce $10,000 of the gift’s value.

If your father had transferred those funds without restriction and later you independently decided to use the money to purchase the property, his gift to you would have been non-taxable.

The lesson: Adding and removing owners on title of real estate are considered federal gift tax transactions, every time they occur. To avoid taxation, an NRA should make gifts of cash directly to an individual without any strings attached. Then, in a separate and independent transaction, the individual may purchase the real estate.


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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**