January, 2002 FAQs: Tax Accounting Period; U.S. Residency Rules; Non-Public Worthless Stock Issues; and Tax Consequences of Abandoning Stock.

Note: Due to computer difficulties, I am using the old format for FAQs.

Copyright © 2002  Robert L. Sommers, all rights reserved.

Question 1: I intend to sell my rental property and pay off the mortgage on my principal residence with the proceeds. Should I sell before or after April 15, 2002?

Answer 1: If you sell your property at any time during 2002, you'll owe tax as of April 15, 2003. It does not matter whether you sell before or after April 15, 2002. Typically, you'll pay federal long-term capital gains at 20% (unless you are in the 15% tax bracket, then you would pay tax on the gains at 10%). There is a federal recapture rate of 25% that applies to any depreciation taken on the property. Review state tax law regarding state income taxes payable, if any, on the transaction.

Question 2: A Colombian executive has been traveling in the United States for the past five years on business as well as for pleasure. For year 2001 he was allowed to stay only 118 days to avoid being classified a US resident for tax purposes (based on tables issued by the IRS). He overstayed the allowable days and wants to know if he has to file tax returns. He works in Colombia and earns a US salary too, owns a house in the US, has his vehicles registered here, and belongs to a country club. Does he have to provide information to prove these facts?

Answer 2: I have the rules regarding residency on my webpage under Foreign Taxpayers. Generally, if he was in the U.S. beyond the number of allowable days, but less than 183 days and can show a closer connection with Columbia than with the, he is not considered a resident. The closer connection test looks at subjective factors such as residency, where his family resides, where his business and social contacts are, where his children attend school.

Question 3: I exercised options and hold common stock in a non-public company that is still in business but has created a new class of preferred shares that have diluted the common stock to virtual worthlessness. Is it possible to formally "abandon" the shares (I hold the certificates) and take an ordinary income loss deduction for the year in which I abandon the shares (under section 165)? What would be the procedure to fix the abandonment of these shares?

Answer 3: No. There is no ordinary loss provision unless the stock was Sec 1244 stock ( a very narrow provision dealing with the first $1,000,000 of common stock issued). It sounds like you have a short-term or long-term capital loss. It may be relevant when you exercised your stock options.

Question 4: Thanks for the quick reply [to question 3]. Does the attached article change your opinion of my situation? The stock does not qualify as small business stock.

Answer 4: I've read the article and other tax treatises on the subject. The article is merely speculation by an accountant and is unsupported by the Echolsdecision. Note: The case deals with legal issues and accountants are not trained as lawyers, so they do not have the necessary education to interpret and give opinions on legal issues.

Abandonment and worthlessness in the Echols decision refer to timing issues: Specifically, in what year was the taxpayer entitled to a deduction; when he abandoned the property? – a subjective test of the taxpayer's intent; or when the company became worthless? – an objective test involving the company's finances. IRC Sec. 165(g) covers stock and there are no cases that support the accountant’s musing that an ordinary loss might be available for the abandonment of public stock. In your case, it sounds like the stock is worthless anyway so the worthless rules would pertain. In any event, the alternative minimum tax would greatly decrease, or could eliminate, any benefit from claiming the worthless stock loss deduction, even if it was available under the regular tax system.

If you decide to claim an abandonment ordinary loss, remember, a tax article is not considered substantial authority to support your position and you could get tagged for negligence penalties in addition to the taxes and interest owed on the transaction.