Every Monday through April 18, local tax experts will answer selected questions this tax-filing season.
To be included in the following weeks, please use the form at the right side of this page to submit your questions.
Julie Smith, Baltimore: Parents are divorced and have joint custody of one child. Parents have a divorce decree stating they may claim [the] child on alternating tax years. One parent claims child on the tax year they were not allowed to without the other parent's permission. What can be done in this situation?
Wilhelm: Julie, in general, a dependency exemption is available to the custodial parent. This is the parent who has custody for the greater part of the year. In order for the noncustodial parent to claim the dependency exemption for the child, he/she must attach one of two documents to his/her current year federal tax return:
A copy of the divorce decree or separation agreement made after 1984 stating which years the custodial parent will allow the noncustodial parent to claim the child as a dependent. This document must be signed by both parties and must state that the noncustodial parent may claim the child as a dependent regardless of any other conditions, such as support.
Form 8332, Release of Claim to Exemption for Child of Divorced or Separated Parents. This form must be signed by the custodial parent and attached to the noncustodial parent's return each year in which they claim the exemption.
In a situation in which one parent claims the child as a dependent in the wrong year (as stipulated by the divorce decree), the other parent should still claim the dependency exemption and attach the necessary documentation in support of his/her claim. It is likely that the first return to be filed with the IRS will receive the exemption and a notice will be sent to the second parent. If a notice is received, the parent should provide copies of any documents supporting their right to the dependency exemption for the current year. The IRS will look at the documentation provided and decide on the appropriate course of action.
If the relationship between the parents is amiable, the parent who has the right to the exemption may want to advise the other parent to amend their return to avoid an IRS inquiry.
Joe Treadwell, North York Borough, Pa.: The local borough charges a per capita tax. If I am using Schedule A, what line do I include this tax on?
Wilhelm: Joe, the per capita tax that you are referring to is generally levied to everyone over the age of 17 living in your jurisdiction during a given billing cycle (the calendar year). It is not based on property ownership or the amount of income earned during the year, but simply on the fact that you were a resident for any part of the billing cycle. Lines 5 through 8 of Form 1040, Schedule A are reserved for various state, local and foreign taxes paid by individual taxpayers during the tax year.
Other types of taxes are reported on line 8. This is where you should report the per capita tax that you paid in 2004. Please bear in mind that you can only deduct what you paid in 2004. Many jurisdictions send out the per capita tax bill in late January for the preceding year. Any amounts paid in 2005 for the 2004 tax year will not be deductible until you file your 2005 tax return.
Robert Thomas, Fredericksburg, Va.: I have a rental house I sold in 2004 for a gain of about $100,000. I put the money into a tax-free exchange and it is in the escrow account of the intermediary. But, I cannot find a suitable property in which to reinvest the money, so I may just pay taxes on it. In which year do I owe the money -- 2004, when it was sold, or 2005, when I actually received the money?
Wilhelm: Robert, under the tax-free exchange rules, you have 45 days to identify the property you intend to purchase, and 180 days to acquire the property. Both time periods begin when the original property is given up. When the 45-day identification period ends, assuming all other facts you provided remain the same, will determine when you will recognize the gain on the sale of your rental home.
If the 45-day period ended in 2004, you will realize the gain in 2004, even if you didn't receive the money until 2005. Most intermediaries hold the money in escrow for the full 180-day period. You may, however, consider the sale an installment sale, subject to the installment sale and depreciation recapture rules. In this case, you will need to file Form 6252, Installment Sale Income, for 2005 and each subsequent year a payment is received. This will allow you to recognize the gain as you receive the actual payment(s).
If the 45-day period ended in 2005, you may report the gain in 2005, since your intention was to acquire a like-kind property, and the money was being held by an intermediary, where you did not have access to or benefit from the exchange proceeds. This section of the Internal Revenue Code is quite technical and we'd recommend a professional review these issues for you.
One final thought, given the amount of gain you are facing. If you cannot find suitable replacement property, you might consider a planning strategy that involves the exchange of real property for indirect interests in REITs. This strategy can allow for tax deferral, avoid the work required when acting as a landlord and diversify your real estate holdings.
To be included in the following weeks, please use the form at the right side of this page to submit your questions.
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Jim Wilhelm, a partner with SC&H Group, leads the income tax department, providing tax compliance and consulting services to private and public companies throughout the region. -
Nicole M. Harrell, a certified public accountant, is the principal of an accounting firm bearing her name in Baltimore. She is a graduate of Hampton University in Virginia and is a member of the Maryland Society of Accountants and the National Association of Black Accountants. - Property
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Wilhelm: Julie, in general, a dependency exemption is available to the custodial parent. This is the parent who has custody for the greater part of the year. In order for the noncustodial parent to claim the dependency exemption for the child, he/she must attach one of two documents to his/her current year federal tax return:
In a situation in which one parent claims the child as a dependent in the wrong year (as stipulated by the divorce decree), the other parent should still claim the dependency exemption and attach the necessary documentation in support of his/her claim. It is likely that the first return to be filed with the IRS will receive the exemption and a notice will be sent to the second parent. If a notice is received, the parent should provide copies of any documents supporting their right to the dependency exemption for the current year. The IRS will look at the documentation provided and decide on the appropriate course of action.
If the relationship between the parents is amiable, the parent who has the right to the exemption may want to advise the other parent to amend their return to avoid an IRS inquiry.
Joe Treadwell, North York Borough, Pa.: The local borough charges a per capita tax. If I am using Schedule A, what line do I include this tax on?
Wilhelm: Joe, the per capita tax that you are referring to is generally levied to everyone over the age of 17 living in your jurisdiction during a given billing cycle (the calendar year). It is not based on property ownership or the amount of income earned during the year, but simply on the fact that you were a resident for any part of the billing cycle. Lines 5 through 8 of Form 1040, Schedule A are reserved for various state, local and foreign taxes paid by individual taxpayers during the tax year.
Other types of taxes are reported on line 8. This is where you should report the per capita tax that you paid in 2004. Please bear in mind that you can only deduct what you paid in 2004. Many jurisdictions send out the per capita tax bill in late January for the preceding year. Any amounts paid in 2005 for the 2004 tax year will not be deductible until you file your 2005 tax return.
Robert Thomas, Fredericksburg, Va.: I have a rental house I sold in 2004 for a gain of about $100,000. I put the money into a tax-free exchange and it is in the escrow account of the intermediary. But, I cannot find a suitable property in which to reinvest the money, so I may just pay taxes on it. In which year do I owe the money -- 2004, when it was sold, or 2005, when I actually received the money?
Wilhelm: Robert, under the tax-free exchange rules, you have 45 days to identify the property you intend to purchase, and 180 days to acquire the property. Both time periods begin when the original property is given up. When the 45-day identification period ends, assuming all other facts you provided remain the same, will determine when you will recognize the gain on the sale of your rental home.
If the 45-day period ended in 2004, you will realize the gain in 2004, even if you didn't receive the money until 2005. Most intermediaries hold the money in escrow for the full 180-day period. You may, however, consider the sale an installment sale, subject to the installment sale and depreciation recapture rules. In this case, you will need to file Form 6252, Installment Sale Income, for 2005 and each subsequent year a payment is received. This will allow you to recognize the gain as you receive the actual payment(s).
If the 45-day period ended in 2005, you may report the gain in 2005, since your intention was to acquire a like-kind property, and the money was being held by an intermediary, where you did not have access to or benefit from the exchange proceeds. This section of the Internal Revenue Code is quite technical and we'd recommend a professional review these issues for you.
One final thought, given the amount of gain you are facing. If you cannot find suitable replacement property, you might consider a planning strategy that involves the exchange of real property for indirect interests in REITs. This strategy can allow for tax deferral, avoid the work required when acting as a landlord and diversify your real estate holdings.
