No Point Fighting Over Loss Due to IRS Error

Q: A recent audit by the Internal Revenue Service resulted in no change to my filing. I later learned that the audit was called because someone in the IRS had simply failed to turn the page of my return to see that I had properly reported some investment income. The audit cost me hours of lost time and 25% of my take-home pay for a month. I feel harassed and cheated, and take no joy in knowing that the accountant’s bill is a tax deduction. Isn’t there any other recourse for me?-- T.D.

A: No, you have no other recourse. And, furthermore, and this is really nasty news, you may not even have a tax deduction. Remember, accountants’ bills fall into that great catch-all category of miscellaneous deductions, which aren’t deductable at all until they exceed 2% of your adjusted gross income.

According to our advisers, the only time taxpayers stand a chance of winning money from the IRS is when a case goes to court and the court decides not only that the IRS is wrong, but that it had taken an unreasonable position. This doesn’t happen very often.

Attorney Can Unsnarl Mortgage Situation

Q: My sister and I inherited our mother’s house with the stipulation that our stepfather could live in it as long as he wished. The house was left in her trust estate, and my sister and I are making the mortgage payments ourselves. Our stepfather pays the taxes. Are we allowed a tax deduction for the interest we are paying on the mortgage? -- N.M.

A: Quite honestly, this is not a question to which our experts felt comfortable giving a straight, unequivocal answer. Too many possibilities. Too many players. In short: too messy. Their advice? Consult a competent attorney before making any moves.

However, since this column never sends its readers away empty-handed, we’ll explain why you need personalized professional help before you do anything that could put you on the wrong side of an IRS audit.

The problem, as our experts see it, is the fact that while you and your sister are paying the mortgage interest, you are not living in the house. Therefore, you don’t qualify to deduct the interest you are paying as your mortgage interest. (Neither, by the way, does your stepfather, who’s paying only the property tax bill.)

Now that the categories of deductible interest have been severely streamlined, your challenge is to find a category that fits your situation. One possible fit, our experts say, would result from declaring your inherited home an “investment” and the mortgage interest you’re paying “investment interest.” The law, however, is unclear on this, hence the advice to consult a competent professional.

How to Find Right Section of Tax Code

Q: In a recent column you said transferring a personal residence to one’s spouse or children would not trigger a reappraisal of that property for tax purposes. Can you please give me a citation for that law so I may obtain a copy? -- D.P.

A: The applicable laws are detailed in Sections 63 and 63.1 of the California Revenue and Taxation Code.

Keogh Plans Differ Slightly From 401 (k)

Q: You talk frequently about 401(k) plans. What exactly are they? Is a Keogh plan a 401(k) plan? May I have a Keogh plan through my second business as well as a 401(k) plan through my employer? -- C.L.F.

A: Simply stated, a 401(k) plan is a type of tax-deferred retirement program that meets the specifications of Section 401 (k) of the Internal Revenue Code. The key feature of these plans--and the reason for their popularity--is the simple fact that employers contributing to these plans are allowed to declare these contributions as tax-deductible business expenses the year the contributions are made. However, employees do not pay taxes on the funds until they actually withdraw the money, usually some time after turning age 59 1/2.

A Keogh plan is not a 401(k) plan. It may talk and walk like one, but it’s actually a 401(d) plan. Still, most people think of it anyway as a 401(k) for the self-employed. And, essentially, that is what it is.

A taxpayer may make contributions to both a 401(k) and a 401(d) plan in any year according to the rules and limitations of the programs. Employers, using federal guidelines, set the tax-deferred contributions levels for 401(k) plans. The maximum contribution levels for Keogh plans are detailed in the Internal Revenue Code.

Market Value at Time of Death Is the Key

Q: My aunt was a life tenant in a home she purchased in 1974 for $29,500. She died last year. My sister and I are the “remaindermen” of the house, which has been appraised at $190,000. For tax purposes, what should we give as the cost basis of the house? -- J.R.L.

A: Your tax basis in the house is its fair market value on the date of your aunt’s death. The key fact here, say our experts, is that your aunt purchased the house for herself. If this is so, then, as her heirs, you and your sister are entitled to set its value as of her death. If the house had been left to your aunt by another member of your family, and she had just been given a life tenancy there, you would not be entitled to the same treatment. In this case, your tax basis would be the price of the house when originally purchased, plus any improvements.