Old Slip May Escape IRS Scrutiny
Q: My only income is from rentals and investments. In 1986, I opened two individual retirement accounts at separate brokerages for a total of $2,000. Neither told me that, because my income was passive, I was ineligible for an IRA. I didn’t find out for several years. Now my tax preparer says I should let the matter slide because the Internal Revenue Service won’t catch it. Is this good advice? Will I get in big trouble when I withdraw the money when I turn 59 1/2 ? -- J.M .
A: We’ll let you decide what to do. Here are your choices:
To be absolutely within the strict bounds of the law, you should withdraw the funds in those ineligible IRA accounts, pay a 6%-a-year excise tax for excess contributions and a 10% penalty for early withdrawal, plus ordinary income taxes on the full amount of the withdrawal. Then, carefully clutching the few dollars you have left, you can rest assured you have made full amends to the government for your $2,000 mistake.
On the other hand, you could just forget the whole matter and let the funds stay where they are. At age 59 1/2, simply withdraw the money and pay the appropriate income taxes on the disbursement. After all, you might reason, the IRS didn’t catch the contribution when it was made eight years ago. Further, our experts note that, assuming you have not made additional contributions to the accounts in subsequent years, the statute of limitations on the initial deposits has elapsed.
What does the IRS say? A spokesman said that officially, the agency can only recommend the first choice above. Unofficially and anonymously, he said chances are pretty good that the IRS won’t come looking for you. Besides, he noted: “Let’s be reasonable. We’re talking peanuts here.”
Where to Write Off Quake Business Loss
Q: I own a small retail business that suffered considerable, uninsured inventory damage during last month’s earthquake. May I write off my loss on Schedule C of my tax return and thereby reduce my self-employment tax? May these losses be carried forward or back to another tax year? --J.E.L .
A: Business inventory casualty losses should be listed on Schedule C. And, because self-employment taxes are based on your net business income, those losses would affect the amount of self-employment tax you must pay. Excess losses may be carried back for up to three years or forward as far ahead as 15 years. For more information on casualty losses to businesses, see IRS Pub. 536. To order it, call (800) 829-3676. This number is staffed from 7 a.m. to 5 p.m. in most time zones.
By the way, the Jan. 30 column on the replacement period for casualty losses needs amplification. Taxpayers whose principal residences are in a federally designated disaster area have up to four years to use insurance settlements to replace lost homes. This provision of the 1993 tax law covers only principal residences and is retroactive to Sept. 1, 1991.
Business owners with real estate casualty losses from a natural disaster or another type of involuntary conversion have three years to replace that property. The replacement period for all other assets, including a residence not in a federal disaster area, is two years.
The clock on the various limits begins running on Jan. 1 of the year following the tax year in which the involuntary conversion occurred. For taxpayers affected by the recent Southern California earthquake, the replacement period clock starts ticking on Jan. 1, 1995.
Figuring Tax Status on Foreclosed Deed
Q: We acquired a property at foreclosure last year on which we had held the second trust deed. The previous owner had defaulted on our note, and we had advanced money on the first trust deed to avoid foreclosure by that lender. What is our tax basis in this property? -- I.M.
A: According to our experts, your basis now is your original tax basis from the second trust deed plus any money you spent to bring the note current (including back taxes and payments) to avoid foreclosure, plus the balance due on the remaining note. The appraised value of the property is irrelevant to this calculation.
‘Reverse Mortgages’ Are Not for Everyone
Q: Can you help me get information about reverse mortgages? We are senior citizens who need cash and would like to remain in our home. J.R.S.
A: An increasing number of older people whose primary asset is appreciated real estate are opting for what are called reverse mortgages. Under this program, the homeowner borrows against the equity in his house to gain additional money for living expenses. Since these programs tend to deplete the equity in a home quickly, they are best suited to people who are in their late 70s or older and have substantial equity.
You should talk with your accountant, lawyer or other trusted professional adviser to determine if this program suits your long-term needs. For more information about reverse mortgages in your area, send a postcard asking for “Home-Made Money” to the American Assn. of Retired Persons Home Equity Information Center, 601 E St. N.W., Washington, D.C. 20049. Delivery takes six to eight weeks. Or telephone the AARP at (800) 424-3410.
CORRECTION: The phone number for consumer service counselors at the Resolution Trust Corp. was misprinted in last week’s Money Talk column. The correct number is (800) 842-2970, ext. 67470. Counselors at this number are prepared to tell you if the RTC holds your mortgage. Be prepared to give the name and address of the thrift that originated your note and the loan number.
