Towne v. Eisner & the Definition of Income

Income Tax Rule Gain Financial

Income Tax

As counter-intuitive as it may seem, many of the most basic terms in tax law were being argued and debated as recently as one century ago. We tend to think of many terms in tax law – particularly very elementary terms such as “property” and “income” – as things which simply emerged with fixed definitions, presenting little or no controversy since their inception. Here at HTW, we know better: in fact, oftentimes the most elementary terms have been fraught with the greatest level of uncertainty. The average person may not realize it today, but the clarity of many of our essential tax law concepts is the result of an immense amount of mental energy on the part of our legal and political establishment.

The case of Towne v. Eisner (1918) is one example of such mental energy being expended to settle a seemingly simple term. In this case, the full breadth of the term “income” came under contention when a shareholder challenged the tax authorities on the issue of the taxability of stock dividend transactions. This case is significant for a number of reasons, but one reason for its significance stands out among others: through this case, the basic principle that income places someone in an advantageous position was firmly pinned down. This “principle of advantageous position,” to coin a phrase, is still at the heart of our definition of income today.

Let’s look at the (relatively simple) factual scenario of this case in greater detail.

Facts

After a company transferred $1.5 million in profits to its capital account, the taxpayer received a stock dividend consistent with his preexisting ownership stake in the company. The newly received stock had a value of roughly $417,450. The authorities contended that this stock dividend was income within the meaning of the tax law of 1913 – and that this construction of the term “income” within the tax law of 1913 was also consistent with the construction of the same term in the sixteenth amendment – and assessed a tax liability on the taxpayer. Though the taxpayer received additional shares, he did not take a cash dividend, and so the question before the court was whether a valid tax liability could be assessed given that the taxpayer was not actually placed in a financially superior or advantageous position following the stock dividend.

Law

The applicable law was the Revenue Act of 1913. This act contained an income tax provision which was freed from the traditional rule of apportionment present in previous eras. The taxpayer claimed that stock dividends fell outside of the definition of “income” as construed within this act.

Ruling

The court (the Supreme Court of the U.S.) ruled in favor of the taxpayer and threw out the tax liability assessed by the tax authorities. The court cited several earlier cases involving corporate stock dividends in its decision; the essential fact which decided the matter was that the taxpayer was not placed in a financially superior position by way of the transaction. What had occurred was merely a reissuing of stock certificates in order to properly reflect the proportional interests of the shareholder. The taxpayer did not actually “gain” anything from the transaction, he was not placed in a more advantageous position, and so the court ruled that it would be incorrect to say that the taxpayer had received taxable income.

As mentioned above, this basic principle has endured up to the present day and continues to inform our conception of taxable income. This principle informed the construction of the term “income” in various other contexts as well; for instance, the provisions of section 1031 of the tax code follow from the idea that gain should not be taxable if it were merely theoretical rather than actual. Again, though we may see this principle as self-evidently true today, this was not always so, and the case of Towne v. Eisner contributed mightily to the development of this principle.

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Cuts to Benefit Programs Indispensable to Trump’s New Budget Plan

Trump Budget Tax Plan Cuts Spending Benefit

Trump’s Budget Plan

As we discussed in our feature article on Trump’s tax reform proposal, President Trump’s plan is to consolidate the existing tax bracket structure by reducing the number of brackets from seven down to three. This consolidation will positively impact very high earning Americans and negatively impact many middle earning Americans; those at the top will receive a cut, while many in the middle will be faced with a somewhat higher tax burden than they would have previously under the seven bracket structure.

As it turns out, the tax reform proposal is just one part of a larger plan to alter the entire existing financial landscape of our country. Trump’s aim is to tackle our massive national debt and restore our overall financial health; toward this end, he has developed a comprehensive budget plan which has proved highly controversial and is currently facing significant difficulties in the Congress. The question remains whether the budget plan can successfully pass through without being transformed into something unrecognizable in comparison to its original form.

Let’s look at some of the major provisions of the plan and then go over some of the controversy surrounding it.

Major Cuts to Benefit Program Spending

Certainly the most controversial aspect of Trump’s budget proposal is its management of funds dedicated to benefit programs. The new plan aims to slash approximately $200 billion of benefit program spending from the federal budget immediately; the plan also aims to slash funding for Medicare, Medicaid and the Obama health law. Overall, Trump’s plan will cut approximately $5.4 billion from the budget over the course of the coming decade. By 2027, the goal is to turn our current national annual deficit into a small surplus.

Cuts Provoke Philosophical Debate

Unsurprisingly, Trump’s budget plan has provoked strong opposition from Democrats. Progressive legislators haven’t been shy to claim that the budget plan’s large cuts are politically unworkable as well as socially undesirable given the effects they will have on broad segments of the population. Aside from political objections, the budget plan has also raised deeper philosophical issues among politicians both in Washington, D.C. and throughout the entire country. The plan brings up complex questions about the proper role of government in civic life: what responsibility does the federal government have to effectively “gift” resources to citizens? And, assuming the federal government does have such a responsibility, how much is each citizen entitled to receive?

We will have to watch and see whether Trump’s plan will be enacted without significant modifications. What is perhaps most fascinating, however, is the way that Trump’s budget is calling upon pundits and political leaders to reevaluate some of the most foundational questions of our political life. It’s probably safe to say that the Trump administration will leave a very lasting imprint on our civic life as it will compel us to look in the mirror and carefully examine the features which make us who we are.

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A Few Thoughts on Seattle’s New Tax on the Wealthy

Seattle City Income Tax Wealthy Residents

Seattle’s New Tax on Wealthy Residents

On Monday, July 10, the Seattle City Council unanimously approved a new city income tax targeted toward Seattle’s highest-earning residents. The new tax will collect 2.25 percent on incomes above $250,000 for individuals and $500,000 for married couples filing jointly. Expectedly, the measure has received a great amount of both positive and negative feedback.

As our regular readers will know, here at HTW it is almost unheard of for us to take a strong stance on any controversial issue. By design, our material is intended to provide readers with helpful information so that they can more capably navigate the complex worlds of tax and accounting. In other words, our aim is to confer tangible benefits, not push political agendas. Consistent with this aim, we’d like to look carefully at this new city tax and provide a balanced opinion of its usefulness and likelihood of success. Whether it be upheld or struck down, our one unswerving hope is that this new tax creates a more just environment for Seattle residents of all socioeconomic backgrounds.

Intense Reactions

As mentioned, the tax has sparked intense responses on both sides of the debate. Supporters point to a number of facts which seem to bolster the tax’s desirability. Seattle imposes one of the heaviest tax burdens on low-income families in the nation; on the other end of the spectrum, high earners in Seattle enjoy one of the lightest local tax burdens. Supporters also insist that the additional funds generated by the tax are necessary to improve local conditions.

Opponents of the tax, on the other hand, have put forth several arguments against the tax. For one, they contend that this new city income tax could be a slippery slope, and if left unchecked it could lead to a statewide income tax which would affect Seattle residents of all income levels. Adversaries also argue that the city’s targeting of wealthy residents is unfairly discriminatory and is tantamount to punishing success.

It seems likely – practically certain – that the divide will persist well into the distant future. What’s also nearly certain is that opponents of the new city income tax will file a legal challenge against the measure.

Legal Objections

Opponents claim that the new tax may be undermined on several different grounds. For one, the state constitution of Washington provides that taxes must be uniform within a “class of property” to be upheld. This new income tax possibly violates this rule by selectively targeting wealthy residents. Furthermore, an active 1984 state law forbids cities from taxing net income; Washington also has a requirement that cities must receive approval from the state capital before they can impose new taxes.

At present, no one of these objections appears the most likely to be invoked. But there’s practically no room for doubt that at least one of these objections will be raised against the new tax in the near future.

Closing Thoughts

Certainly, not one of those who count themselves among Seattle’s wealthiest residents can argue against the desirability of improving local conditions and raising the living standards of Seattle’s entire population; the need to improve our city, as well as the need to address local poverty, is something all Seattle residents can agree upon. But whether this new city income tax be the proper method to address city financial issues is something which remains to be seen. On the one hand, there is no getting away from the fact that Seattle’s tax treatment of wealthy residents is comparatively very gentle; but how can proponents of the new tax be certain that changing this state of affairs won’t cause a mass of socioeconomic flight to other areas of the country? What if imposing the tax inadvertently leads to a financial situation for Seattle which is worse than it was before? Only time will provide the clarification we need.

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Helvering v. Brunn & the Issue of Taxable Gain

Taxable Gain Income Tax Amendment

Taxable Gain

After a great deal of suspense, drama and record-breaking levels of nail-biting on the part of our readers, Huddleston Tax Weekly is proud to announce that we will be picking up our XVI Amendment series. We will contribute a few more articles to this series before we move on to other things. The purpose of our XVI Amendment series is twofold: firstly, our aim is to show how important this political act was to American society; and secondly, by examining some of the issues which were sparked by this amendment, our other goal is to provide our readers with a sense of the complexity of tax law as a field. This latter goal, if realized, should confer significant benefits to our readers: if you’re familiar with some of the essential issues in the field of tax law, the likelihood is strong that you’ll be more effective in how you handle your own tax situation.

One of the things which makes tax law such a fascinating field is that it forces you to formally analyze many terms which are casually – and often carelessly – used in everyday conversation. In common parlance, terms such as “income,” “gain” and “property” are understood intuitively and require little or no clarification. But tax law does not operate in this same way. In tax law, these terms, along with many others, have much more narrow and occasionally shifting meanings which must be carefully examined in whatever context they originally appeared in order to produce a sustainable legal result. Though they may appear simple, these terms can create all sorts of complexity in tax litigation.

The case of Helvering v. Brunn (1940) is a good example of a case which involved formal analysis of a term which is typically grasped very rapidly. The judicial officers had to determine whether the events which occurred in the case could be construed as “taxable gain.” The XVI Amendment only removed the restrictions on the taxing power of Congress, it did not contribute to the issue of what constitutes taxable gain. The case of Helvering v. Brunn explored this issue, and it added an important layer to our understanding of taxable gain. In a sense, it helped to clarify the full scope of the amendment by showing what can – and what cannot – be taxed.

Let’s look at this case more closely to get a sense of its full significance.

Facts

The respondent (a landowner) executed a lease with a tenant which provided, among other things, that any improvements or buildings added to the land during the time of the lease would be surrendered back to the respondent when the lease expired. The tenant destroyed an existing building on the land and then developed a new building in its place. The difference in value between the old building and the new one was approximately $51,434.25. The tenant forfeited the lease when he was unable to keep up with rent and taxes. Subsequently, the IRS claimed that the respondent realized a gain of $51,434.25 as a consequence of the new building which had been added to the land. The respondent disputed this claim and contended that any value conferred by the new building did not qualify as taxable gain under the prevailing construction of this term.

Law

The prevailing definition of “gross income” derived from the Revenue Act of 1932. The central question of the case was whether the value conferred by the new building should be treated as a taxable gain under the bounds established by this act.

Ruling

The court (the Supreme Court of the U.S.) ruled that the respondent had in fact realized a taxable gain when the tenant added the new building to the land. The respondent highlighted the importance of transferability (or exchangeability) to the definition of taxable gain in certain contexts. The new building was not “removable” or “separable” from the land in the sense that it could not be taken off the land and still maintain its current market value. The respondent argued that this lack of transferability made the value bestowed by the new building nontaxable. In support of this of position, the respondent cited a number of cases which apparently held that transferability was a key component of taxable gain in stock dividend transactions. The court stated that the logic underlying the importance of transferability was limited to those types of transactions and did not apply to the present situation.

The key point to gather from Helvering v. Brunn is that gain can be taxable even outside of a traditional business transaction. And the gain needn’t be transferable, at least not in most contexts. Taxable gain can be triggered whenever value has been added or an event places someone in a financially superior position. Forgiveness of a liability or exchange of property, for instance, can trigger taxable gain even though cash isn’t involved and no sale has occurred.

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Owning real estate often brings up tax issues. If you’re a current or future real estate owner and you’d like to learn about the tax perks of real estate ownership, check out our presentation on this topic by our CPA, Jessica Chisholm

Gregory v. Helvering & the Old Roots of Modern Financial Duplicity

Stock Shares Financial Accounting Tax Income Dividend

Creative Finance

I know we promised that the last article would be the final installment of Huddleston Tax Weekly before the return of our XVI Amendment series. Surprisingly, we fibbed a bit. We’d like to sneak in just one more – and now we really promise, just one more – article prior to our return to that series. If this frustrates you, that’s understandable, but hopefully whatever frustration comes to the surface will immediately dissolve after you know what topic to which this article will be devoted: the important case of Gregory v. Helvering (1935). Though not the most well-known financial case, this Great Depression-era piece of litigation is fascinating for a number of reasons. Perhaps the most notable reason for its appeal is its relevance to more modern financial scandals.

In 2017, we have become accustomed to seeing all sorts of financial scandals. Some of these scandals, like the Enron scandal, can be very elaborate and involve complex accounting fraud, insider trading and other kinds of high-brainpower underhandedness. Every trend, no matter its size or significance, can be traced to a single source, and the case of Gregory v. Helvering stands as a legitimate candidate for the forerunner to much of the financial trickery present in recent decades. And this is not necessarily because the taxpayer in Gregory v. Helvering aimed to abuse the law in a nefarious way; the facts of the case, as they’ve come down to us, do not allow for such a conclusion. But in this case we do see an attempt to transact in such a manner that the form of the law is obeyed but its spirit is ignored. And this creative maneuvering is something that we see again and again in the modern era.

Let’s look at the details of this case to get a better sense of why it foreshadows many recent financial scandals.

Facts

The taxpayer owned a company – United Mortgage Corporation – and this company held 1000 shares of another company’s stock (Monitor Securities Corporation). The taxpayer wished to sell this stock but also wished to minimize (or ideally eliminate) the potential tax liability of such a sale. Toward this end, the taxpayer established a new company, Averill Corporation, and then transferred the 1000 shares of Monitor to Averill. The taxpayer then transferred the 1000 shares of Monitor to herself, and then quickly dissolved Averill. The Averill entity clearly had no other function aside from acting as a conduit through which to distribute the shares to the taxpayer. The taxpayer contended that the series of actions which occurred fell under section 112 of the Revenue Act of 1928 as a corporate “reorganization.” If what occurred were in fact reorganization under section 112, the gain realized by the taxpayer would not be taxable.

Law

The relevant subsections of 112 were (g) and (i). Subsection (g) stated that distributions of stock on reorganization to a shareholder in a corporation which was a party to the reorganization will not result in gain (to the receiving shareholder). Subsection (i) lays out a definition of reorganization.

Ruling

The court (Supreme Court of the U.S.) ruled that a legitimate reorganization had not occurred and that the deficiency assessed by the IRS was correct. Even though the taxpayer had apparently satisfied every element of section 112, the court reasoned that section 112 did not apply because the Averill Corporation was clearly a “dummy company” in the sense that it served no other purpose than to eliminate the tax liability which would have normally followed the stock distribution. Hence, though the taxpayer took steps to fall under section 112, what had actually occurred was a dividend, because there was no substance underlying the creation of the Averill Corporation.

What we have here, therefore, is a fascinating early example of creative business maneuvering. The taxpayer either received expert counsel on section 112, or was familiar with section 112 by way of independent research, and the taxpayer established the dummy company for the specific purpose of falling within the meaning of this statute. And even though the steps taken by the taxpayer would seemingly bring the transaction under section 112, the court was not willing to let this type of trickery slide under the judicial radar. In some ways, Gregory v. Helvering represents the embryonic form of more heinous modern trickery, such as the kind perpetrated by Enron’s CFO, Andrew Fastow.

Although what happened here is dwarfed by comparison to modern scenarios, it’s still interesting to see the roots of what goes on around us today.

Image credit: Investment Zen

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Readers who enjoyed this piece should consider viewing our presentation on business formation. This presentation was given by our principal and founder, John Huddleston

Kornfeld v. Commissioner and the Step Transaction Doctrine

Step Transaction Doctrine Legal Theory Tax Deduction

The Step Transaction Doctrine

We will look at one more case before returning to our article series on the sixteenth amendment. This is a case every HTW reader should become very well acquainted with: Kornfeld v. Commissioner (1998). Though it’s primarily an income tax case, it contains a plethora of other important topics and subtopics, and it presents a message which every HTW reader should commit to memory.

In the past, we’ve learned that whether a transaction be taxable is dependent on its substance, and that courts apply the “substance over form” doctrine to determine the true nature of a business transaction. The substance over form doctrine is not the only tool utilized by courts to review a transaction, however; the so-called “step transaction doctrine” is another tool commonly used by courts to clarify the nature of a transaction for tax purposes. Under the step transaction doctrine, multiple “steps” may be classed together and regarded as a single transaction; in this way, steps which may have been taken simply for the specific goal of altering tax liability can be overturned. The step transaction doctrine does not exist to create tax liabilities where none should exist, but to assess tax liability properly by viewing a transaction with the greatest level of accuracy.

In other words, the step transaction doctrine imposes a sort of coherence to a multistep transaction so that it can be properly adjudicated. This is very common in law: legal theories often condense or codify reality so that it can be interpreted using preexisting categories. But the rationale for theories such as the step transaction doctrine is not only about simplicity; there is also the aim of viewing a matter according to its true nature. Even though the step transaction doctrine may “condense” things for the sake of simplicity, many contend that this theory (and other similar theories) portrays matters in a more accurate way, that it provides a clearer sense of what actually occurred. Let’s look at the details of the Kornfeld case to get a better sense of this doctrine and its rationale.

Facts

The facts of this case are a bit complicated. Kornfeld, a highly experienced tax attorney, established a revocable trust which he intended to use to purchase bonds. He entered into an agreement with his daughters in order to claim an amortization deduction on the bonds; the agreement was that Kornfeld would transfer funds (from the trust) to the bond issuing institution equal to the value of a life estate in the bonds and then the daughters would pay the balance on the bonds. The agreement also held that Kornfeld would deliver checks to the daughters for the exact amount which they paid to cover the balance.

Kornfeld and his daughters executed this initial agreement and Kornfeld obtained the bonds. Subsequently, the tax code was changed so that the amortization deduction sought by Kornfeld was made unavailable in situations involving related parties. In response, Kornfeld and his daughters made another agreement which included Kornfeld’s secretary; the second agreement held that the daughters would take a second life estate interest in the bonds following Kornfeld’s death, and that the secretary would have the final remainder interest upon the death of the daughters. Importantly, Kornfeld used IRS valuation tables to create his estimates for the value of his life estate interest. Kornfeld claimed amortization deductions on the bonds and then the IRS assessed a deficiency after they declared that the transaction had failed to produce a genuine life estate in the bonds.

Law

Under U.S. code – specifically section 167 – taxpayers may claim a depreciation deduction of a reasonable amount based on wear and tear for property held primarily for the production of income (such as a bond). IRC subsection 167(d) pertains to life tenants and beneficiaries of trusts. Under these rules, life estate interests in bonds – or “term interests” or limited interests – are considered amortizable (or depreciable) and thus taxpayers may claim a deduction for such an interest. Also see 26 CFR 1.167(a)-1.

Ruling

Applying the step transaction doctrine, the court rejected the argument made by Kornfeld that the payments made to his daughters (and secretary) had no real connection to the bond transaction, and that a genuine life estate interest had been created for tax purposes. The court based its decision on the fact that the seemingly disparate actions of the case were patently interdependent and all served to produce a single, underlying purpose. Kornfeld thought that he had devised a near foolproof scheme to completely avoid any tax liability on the bond transaction, but the court realized that a genuine limited interest had not been created and that Kornfeld had acquired total ownership of the bonds.

The Kornfeld case is a prime example of the step transaction doctrine at work. All HTW readers need to be aware of how the step transaction can affect their tax liabilities; if you aim to acquire a particular kind of tax treatment, you need to understand that your actions preceding any given transaction, as well as your actions which occur after a given transaction, can impact the tax treatment you ultimately receive. In the future – after a few more installments on the sixteenth amendment – we will look at a few more examples of how the step transaction doctrine has been used to alter the tax classification of a series of events.

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A Few Thoughts on the New Seattle Soda Tax

Soda Tax Seattle Drink Council City

Seattle Soda Tax

On Monday, June 5, 2017, the Seattle City Council passed a motion which will implement a tax on sugary soft drinks (soda). This new “soda tax” is designed to reduce statewide obesity rates, particularly among children, and to raise additional funds for public projects. Expectedly, the passage of the soda tax has been met with both surprise and opposition as it raises issues regarding personal freedom and the role of government in the marketplace. Let’s look at the basic provisions and purposes of the tax and then discuss some of the arguments both in favor and against it.

Basic Facts

The soda tax was passed by a margin of 7-1; Lisa Herbold was the sole councilmember to vote against the tax. The city will collect 1.75 cents for every ounce of “sugary” soda, such as regular Coca-Cola, Pepsi and so forth. The tax will not be collected on diet sodas and sodas made by smaller distributors.

The tax is set to take effect on January 1, 2018. This date could be pushed forward, however, in the event that a legal challenge or other type of motion takes place in the interim. Prior to the vote on the tax, councilmember Herbold proposed several amendments which she claimed would mitigate some of the potential negative consequences of the tax. All of Herbold’s amendments failed except for her proposal that some of the tax proceeds be used to fund local food banks.

Pros and Cons

The chief architect of the tax, councilmember Tim Burgess, argued that the tax will make a positive impact on state obesity levels. Though the tax may (indirectly) encourage healthier eating habits, many opponents could argue that this tax represents an undesirable incursion by the state on the free market. Regardless of the price, people have a choice to purchase sugary soft drinks, and the tax on soda could easily be interpreted as a financial penalty on personal freedom. The soda tax, therefore, brings up the recurring issue of what role the government should play in preventing certain behaviors in the interest of the wider public good.

When viewed in this fashion, the soda tax acquires a rather lengthy pedigree. Sin taxes, such as those imposed on tobacco and liquor, have been relatively common throughout American history. In the 1920s (and early 1930s), we used Prohibition to guard against the supposedly toxic influence of alcoholic beverages; today, historians almost all concur that Prohibition was a failed experiment, but the issue of what level of responsibility the state has for promoting public health remains hotly contested. Here at HTC, we think it prudent to avoid a definitive stance on the issue; after all, we are not dealing with a ban or severe financial burden, only a small incentive to avoid sugary drinks. HTC is certainly very curious about the impact of the tax and we look forward to seeing hard numbers on whether the tax lives up to its expectations.

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Top Areas for Future Home Buyers in the Greater Seattle Region

Seattle Real Estate Property Value Market

Seattle Real Estate Market

Though many of our clients are homeowners, quite a few of our clients are currently in the market (or plan to be in the market) for a new home. For this reason, in our present article we’d like to take a moment to highlight some of the hottest areas for real estate purchases in the greater Seattle metropolitan region. These areas offer plenty of perks to residents: pleasant scenery, easy access to downtown, safety, economic opportunities and many other benefits. If you are hoping to buy a house, condo or townhome in the near future, you should give serious consideration to a place in one of these areas.

And once you count yourself among the crowd of homeowners, be sure to keep coming back to HTC as we’ll be able to assist you with all of the tax-related issues homeownership can bring up.

Downtown Bothell

Though the economic recession of 2008-2009 slowed Bothell’s growth a bit, the city has managed to bounce back very well and has seen substantial development in the most recent few years. Multiple residential and commercial properties have been added to the city and more projects are on the horizon. The city boasts several important biotech and high-tech employers and also hosts the Bothell campus of the University of Washington. The median home value currently stands at $427,900 and the expected rate of appreciation is 5.2 percent.

Ravenna

Conveniently located very close to the University of Washington’s main campus and Seattle Children’s Hospital, the small town of Ravenna is an excellent choice for someone looking to acquire a stylish property in an urban setting. The town is receiving a large influx of tech professionals from California and elsewhere who are attracted to the stylish craftsmanship which characterizes Ravenna homes. Well-paid UW personnel and medical professionals are also flocking to the town given its location and pleasant community. The median home value is approximately $666,900 and the rate of appreciation is 7.1 percent.

Kirkland

Frequently regarded as Bellevue’s little cousin, the city of Kirkland is an easy choice for the most desirable real estate markets in the greater Seattle area. Between 2015 and 2016 the city saw a rise in home values of 11.7 percent and, though the exact rate will fluctuate, more good appreciation appears to be in store. Given its waterfront location and easy access to downtown Bellevue, Kirkland will likely continue to attract ambitious and affluent home seekers throughout the coming years. Kirkland Urban – the massive, mixed-use residential and commercial property which will host a movie theater, restaurants, bars, etc. – has an expected completion date of November, 2018 and play a considerable role in increasing Kirkland’s desirability.

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Trump’s New Tax Proposal Could Have Substantial Impact on Seattle Homeowners

Trump Real Estate Deduction Seattle Tax Property Mortgage Interest

Trump’s Plan & the Seattle Market

President Donald Trump has developed a proposal to rewrite the tax code in such a way that it may render the mortgage interest deduction meaningless for all but a small minority of wealthy homeowners. Opponents argue that this provision would take away an important incentive of homeownership; supporters contend that the change benefits the majority of Americans and would expand homeownership opportunities for middle income earners.

Let’s examine Trump’s proposal in greater detail and highlight how the changes could impact the Seattle real estate market.

Proposed Revisions

The proposal contains a number of changes; perhaps the most important one is the raising of the standard deduction from its current level of $12,700 (for married couples filing jointly) to $24,000. On its face, Trump’s proposal does not eliminate the mortgage interest deduction, but its goal of substantially raising the standard deduction would mean that millions would cease to itemize their write-offs and consequently fail to deduct the interest from their home loan.

Trump’s plan also modifies existing deductions for state and local taxes, including property taxes. Opponents contend that the property tax deduction is another important perk of homeownership which should not be removed.

The Trump administration states that the changes will actually stimulate home purchases for low to middle income Americans because the higher standard deduction will enable greater savings. The proposal is also likely to trigger a measurable decline in average home pricings across the country which will increase access to homeownership.

Possible Impact

Currently, the Seattle real estate market has a median home price of approximately $722,250. This figure undoubtedly places Seattle among the most expensive real estate market in the country. Assuming the Seattle buyer puts down twenty percent, this median price means that the typical Seattle homeowner will pay roughly $2,735 per month in mortgage costs over a 30-year loan. Given its status, there’s no question that the Seattle real estate market will be impacted by the Trump proposal very heavily. A large number of our homeowners will suddenly be in a situation in which itemizing will no longer make financial sense. Trulia – the well-known property data provider – determined that the number of households eligible for the mortgage interest deduction in Seattle would drop from 56 percent down to 26 percent.

Whether Trump’s changes increase or decrease homeownership across the country obviously remains to be seen; what is certain is that the real estate industry as a whole is lined up in opposition to Trump’s proposal. Supporters and opponents both appear to have facts and figures which bolster their respective positions. Perhaps only a fair trial will determine whether Mr. Trump’s plan will be beneficial to the nation.

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To learn more about the mortgage interest deduction and other tax benefits of homeownership, see this presentation by our CPA Jessica Chisholm

Investment Property & the Personal Residence Exclusion

Vacation Home House Property Investment

Investment Property

Contrary to what many may suppose, the initial purpose underlying the acquisition of a property does not necessarily bar future invocation of the principal residence exclusion (under IRS section 121). As we’ve discussed earlier, Section 121 of the Internal Revenue Code allows homeowners to exclude up to $250,000 ($500,000 for married couples filing jointly) of gain from the sale of a “principal residence” (as defined by the code). What we haven’t mentioned yet, however, is that property may be converted from its original purpose — say, for investment — into a primary dwelling specifically to take advantage of the principal residence exclusion. This is an extremely useful piece of information for many real estate owners. In many cases, a person will acquire real property as an investment — a vacation rental house, for example — and then later decide to use that same property as a personal residence. As long as the property is used as a “principal residence” — meaning that the owner has used the property as a residence for at least two years out of the most recent five-year period — the owner may utilize the exclusion provided by section 121.

Converting Your Investment (Rental) Property into a Principal Residence

Perhaps the most common instance of “converting” a property initially used for investment purposes into a property eligible for the exclusion provided by section 121 is the conversion of rental property. If they have access to the requisite funds, many real estate owners choose to invest in rental property in order to generate regular supplemental income. They may decide to acquire a vacation house and then rent this property out to tenants. It may become financially beneficial (or financially necessary) for the real estate owner to eventually convert this investment rental property into a primary dwelling at some point in the future; once the owner satisfies the time requirements of the provisions of section 121, they can then sell the property and exclude as much of the gain as the section allows.

Converting investment property into a primary dwelling for the purpose of invoking section 121 of the IRC is just one piece of expertise that the team at HTC is familiar with. As promised, we will return to the sixteenth amendment very soon, but before we do we thought it helpful to draw attention to this little gem of tax knowledge. Stay tuned for more gems in the future!

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If this article grabbed your attention, you should view our presentation on real estate tax advantages by our resident CPA Jessica Chisholm

Huddleston Tax CPAs of Seattle & Bellevue
Certified Public Accountants Focused on Small Business

(800) 376-1785
40 Lake Bellevue Suite 100, Bellevue, WA 98005

Huddleston Tax CPAs & accountants provide tax preparation, tax planning, business coaching, Quickbooks consulting, bookkeeping, payroll and business valuation services for small business. We serve Seattle, Bellevue, Redmond, Tacoma, Everett, Kent, Kirkland, Bothell, Lynnwood, Mill Creek, Shoreline, Kenmore, Lake Forest Park, Mountlake Terrace, Renton, Tukwila, Federal Way, Burien, Seatac, Mercer Island, West Seattle, Auburn, Snohomish and Mukilteo. We have a few meeting locations. Call to meet John Huddleston, J.D., LL.M., CPA, Tawni Berg, CPA, Jennifer Zhou, CPA, Jessica Chisholm, CPA or Chuck McClure, CPA. Member WSCPA.