Tax Q&A

Answers to your tax questions

• Life insurance proceeds • Recaptured depreciation • Rollover to Roth IRA • Investment loan interest

By Lawrence Farber, Senior Editor

Q:How do I determine whether I owe any tax on the money I received from cashing in a life insurance policy last year?

A: Any proceeds that exceed the cost of the policy count as income. In general, your cost (technically, your "investment in the contract") equals the total of premiums paid, less any rebates, reinvested dividends, or policy loans you made but didn't repay. The company should send you a Form 1099­R showing the total proceeds and the taxable part. Report these amounts on lines 16a and 16b (pensions and annuities) of Form 1040.

Q: We sold our home at a $100,000 profit in July 2000, after living in it since 1993. My wife used 10 percent of the house as a business office from 1994 through 1996 and took depreciation deductions on our returns for those three years. Do we owe any tax on our gain?

A: No. You meet the qualifications for excluding up to $500,000 of gain, because you used the entire house as your residence for at least two of the five years prior to the sale. It doesn't matter that you claimed depreciation; the 25 percent tax on recaptured depreciation applies only to deductions taken after May 6, 1997.

Q:Toward the end of last year, I took $25,000 from a traditional IRA, intending to roll it over to a Roth IRA, but the transaction wasn't completed until after Dec. 31. Did I violate the rules?

A: Not if the Roth account received the money within 60 days after you withdrew it. In that case, you're considered to have made the conversion in 2000, as you intended. Otherwise, the money is subject to a penalty as an invalid Roth contribution. Either way, you must report the $25,000 as a taxable distribution on your return for 2000.

Q: I've sent in Form 4868 to request a four-month extension to file my return. But what if I'm still unable to file when that runs out?

A: You can apply for an additional two months either by writing a letter to the IRS or by filing Form 2688. Unlike the earlier extension, this one isn't automatically granted. You'll need to give a good reason for your request, such as illness or lack of critical information to compute your tax. Be sure to file for the extra extension well before Aug. 15, when the original extension ends, so that the IRS will have enough time to consider your application. If you're turned down, you'll have to file by Aug. 15, or within 10 days of the date of the notice of disapproval (the notice will clarify, if that's the case).

Q:In 1998, I paid my brother $17,000 for a lot he'd originally bought for $20,000. Last year, I sold it for $25,000. He says I can save on capital gains tax, because he wasn't able to claim his $3,000 loss on the sale to me. Is that true?

A: Yes. Losses on sales to blood relatives or spouses generally aren't deductible, but you can subtract your brother's $3,000 loss from your taxable profit on the resale. Although you actually gained $8,000 ($25,000 minus $17,000), you'll owe tax on just $5,000.

Q:I bought a high-interest bond last year for more than its face value. The issuer sent me a Form 1099 that includes an amount labeled "original issue discount" (OID). Do I have to pay tax on this?

A: No. If you'd purchased the bond when issued, you'd have paid less than face value and would owe tax annually on a portion of the discount. Since the bond was selling at a premium when you bought it, the OID amount isn't taxable. However, you should report it with your other interest income on Schedule B, then subtract it from the total and mark it "OID adjustment."

Q:I borrowed from my pension plan last year and used the money to buy stocks. Can I include the interest I'm paying on the loan in my deduction for investment interest?

A: Not if you're a key employee of your practice. You're a key employee if you owned more than 1 percent of the practice and earned more than $150,000 in 2000, or if you owned more than 5 percent of the practice regardless of earnings. Meeting one of several other criteria could also make you a key employee—for instance, if you were one of the 10 largest owners and earned more than $30,000. If none of the key employee tests apply and the loan can't be secured by your elective deferrals to a 401(k) or tax-sheltered annuity, you can treat the loan interest as investment interest and deduct it, up to the amount of investment income you have.

Q:I invested in a one-year certificate of deposit last March. Interest is credited to my account monthly, but I can't withdraw it until the CD matures. Do I owe any tax for 2000?

A: No. The tax on the interest income from a savings certificate with a term not exceeding one year is deferred until the year you're able to collect it without being charged a substantial penalty by the bank. If your CD's term were longer than a year, you'd have to report the interest credited last year as income on your return for 2000.

Q:The owner of a property on which I held a mortgage couldn't make the payments. Last year, he transferred the property to me and I canceled the debt. How do I handle this on my tax return?

A: Assuming the property's fair market value is greater than the mortgage debt plus unpaid interest, the difference is a capital gain, and you owe tax on it for 2000. If it's the other way around, you have a capital loss.

Q:Last March, I bought $10,000 worth of shares in a mutual fund and paid a 5 percent ($500) load in addition. By May, the value of the shares had declined to $9,000, so I swapped them for those of another fund. Because it was in the same family, the sponsor waived the 5 percent load on the new shares—$450. How do I figure my loss on the swap?

A: Because you made the exchange within 90 days, you must transfer $450 of the $500 load to your cost basis for the new shares. Therefore, the basis of your old shares was $10,050. They were worth $9,000 when you made the swap, leaving you with a loss of $1,050.

 

Lawrence Farber. Answers to your tax questions. Medical Economics 2001;4:92.