Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Archive for January 21st, 2006

Free Scam-Buster DVDs

Posted by taxguru on January 21, 2006

Our friends at the US Postal Service have five free educational DVDs available on various scams that seem to be luring in more and more people.  This is one more deal I learned about from TechBargains

The titles include:

Dialing For Dollars – On telemarketing fraud

Work at Home Scams

Identity Crisis – on identity fraud

Long Shot Foreign Lottery Scams

Web of Deceit – on internet scams

I ordered a copy of each and will check them out when they arrive. Since they are probably going to send them for free via the US Snail, it may be quite a while. 

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Posted by taxguru on January 21, 2006

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REITs Not Like Kind For Real Property

Posted by taxguru on January 21, 2006


Subject: Exchange Question
I have funds from the sale of investment real estate sitting in an exchange fund.   Can I have the trustee buy shares in a REIT?



What is most disconcerting is why, in the middle of an exchange, you are asking this critical question of a stranger.  Both your personal professional tax advisor and your exchange facilitator could very easily tell you that shares in a REIT are not eligible like kind replacement property for real estate.  They are essentially equivalent to shares of stock in a corporation, another non-like kind asset.

If you are doing this exchange without the services of both a professional tax advisor and an independent exchange facilitator, you have probably screwed things up with your exchange; and should consult with some competent professional advisors ASAP to see if it can be salvaged.

Good luck.

Kerry Kerstetter


As you may be aware you can get multiple answers from multiple people.  Your answer was affirmed by an article in the June 2005 NY CPA Journal.



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Pro-Rated Tax Free Exclusion

Posted by taxguru on January 21, 2006

Note:  This is the email exchange to which I referred in my item on the Tax Gap and how people intentionally overpay their taxes rather than risk IRS hassle.



Subject: Property sale

Dear Mr. Kerstetter,

I had written to you once about a year ago regarding the sale of primary residence with under 2 years occupancy.  You said that it sounded like I had a good case if I chose to sell my house under 2 years.

I am in the Marines and was transferred to Yuma, Arizona in February 2004.  I signed a contract to build a house in December 2003 which was completed 15 August of 2004.  When I purchased this 4BD/2BA 1768 sq ft home, it was with in mind that only my domestic partner of 2.5 years and myself would be residing there full time with occasional visitations from our children.  We each have a son and daughter from previous marriages for a total of 4 children. 

After moving to Yuma, Arizona in February of 2004 my son came to live with me at the demand of his mother in March 2004.  In June 2004 both of my domestic partners kids came to live with us full time and we moved into the house on 15 August 2004.  A custody battle arose over my son and daughter in August of 2004 due to the mother wanting my son back and both kids wanting to live with me due to an unstable and hostile home at their Mother’s.   I was granted temporary custody of my son at that time until the custody hearing was completed. 

With 3 children living with us full time now and my daughter coming for visitations it quickly became apparent the house was going to be crowded with all 4 children living there, only 1 bathroom between them, and my son needing his own room now that he was a teenager. 

In February of 2005 (This was about the time in which I e-mailed you before.) I signed another contract to build a house 5BD/2.5BA 2261 sq ft. to be completed in December 2005.  The final hearing was in May of 2005 and I was granted custody of both children beginning June 2005. 

I sold the old home 23 November 2005 and closed on the new house on 9 December 2005.  (I resided in the house I sold for 15+ months.)

I bought the first house for $147,000, owed $130,000, and sold it for $269,900.  Gross gains = $122,900.  I left the money with the title company until closing on the new house.

I bought the new house for $265,000.   I at first was going to finance $130,000 and put all the proceeds from the 1st house into the new house, but thought best to finance another $20,000 for possible capital gains tax.  $115,000 from the old house rolled right into the new house at the title company I never touched it and I received a little over $20,000 back from the title company due to financing more to cover taxes just in case.

I received a 1099 from the Title company for gross amount of $269,900.

My question is; does this still sound like a good case for a pro-rated exemption under “unforeseeable circumstances”?  Should I request a private letter ruling or am I just wasting my time and money? (Apparently there is fee of $200 or ?more? to do a request.)

I have consulted the military base tax center, done exhausted reading online, and even called the IRS 1 (800) number and am even more confused than I was before.  I appreciate any help or guidance that you can provide.

Thank you,




It still sounds as if you would qualify for the pro-rated exclusion, which any properly experienced tax professional should be able to confirm.

It’s not necessary to get prior approval from IRS.  Just attach a statement of the facts to your 1040.

The residence sale rules don’t have any restriction on use of the cash or requirement to reinvest anything.  That’s only required for 1031 exchanges of business and investment properties.

The fact that you did buy a larger house to accommodate the unexpectedly larger family should be included in your explanation of why you qualify for the pro-rated exclusion.

Good luck.

Kerry Kerstetter


Thank You for responding to my letter Mr. Kerstetter.

I was close to just surrendering and paying the capital gains tax to avoid having to pay any penalties or fees.

I just have one more question if you have the time to respond.

If the IRS finds that I do not qualify for a pro-rated exclusion and it’s after the 15th of April or even 2 years later will I have penalties or be fined more money?

Thanks again,




In the extremely unlikely (perhaps one in a thousand) chance that IRS questions your eligibility to use the pro-rated tax free exclusion, it’s not an automatic requirement to pay the additional taxes.  You and your representative will have plenty of opportunity to present more information to convince them that you are correct.  Worst case scenario, if you are unable to convince them and don’t want to drag it on, you would have to pay the extra Federal and Arizona taxes and interest on those taxes.  Penalties are negotiable, and it shouldn’t be hard to have them waived in a situation like yours.

 If, on the other hand, you choose to not take any chances and pay those taxes with your original returns, there is absolutely zero chance that IRS will come back and tell you that you didn’t need to.  It is also the case that if you pay the taxes and then later change your mind, it will be practically impossible to get that money back.  IRS will use your  original self assessment of tax as an admission that you owe it, and it will be a hundred times more difficult to change that after the fact.  It’s the same as a murderer trying to recant a confession.

Your case is a perfect example of why I have long contended that, contrary to popular opinion that everybody is a tax cheater, more people intentionally or accidentally overpay their taxes than underpay.  Millions of people are just like you, looking for 100% assurance that their position is sound and will not ever be questioned by IRS.

As I have said for decades, tax law is at most 10% black and 10% white, with the other 80% as gray as can be.  My position has always been that things falling into the gray area should be interpreted in favor of the taxpayer.  Unfortunately most other tax preparers and taxpayers themselves prefer to interpret the gray areas in favor of the IRS in the hope that this will buy them some safety from attacks. I have many cases over my career where people have still been attacked by IRS, even though they intentionally overpaid their taxes by several thousands of dollars; so that scenario isn’t a guarantee of safety. 

It’s obviously your choice which way to treat this.  I hope I’ve given you some food for thought before you send in your 1040.

Good luck.

Kerry Kerstetter


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Matching Federal & State Tax Info

Posted by taxguru on January 21, 2006


Mr. Kestetter,
I ran across your Web site and was hoping you could answer a question for me. In 2003 I filed a federal tax return but did not file an arkansas state income tax return. I moved out of the state in 2004. But I recently recieved a notice of non-filing from the dfa.
Here’s my question: on my federal return I took a lot of deductions and am thinking twice about taking them again with the state as I do not want to get audited. With just a standard deduction I will be due a refund. But I’m wondering if I just use the short form with the state and take the standard deduction, will that raise any red flags with the IRS because my returns will be different? Also, is my state return likely to recieve heavier scrutiny because it is being filed late?
I would really appreciate your help.



IRS and DFA do share tax data; so I would keep the Ark. numbers in synch with what you reported to IRS. You could open a can of worms for yourself if you try to submit different figures.

Filing the return late doesn’t increase its audit potential. 

DFA doesn’t do the kinds of audits that IRS does.  The only time they will hold up processing a return is if you forget to attach various documents, such as W-2s, 1099s, and Federal schedules.

A qualified tax pro should be able to help you stay in compliance with the DFA.

Good luck.

Kerry Kerstetter


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Set Up Exchange Beforehand

Posted by taxguru on January 21, 2006


Subject: Exchange Question
If an exchange was declined at closing of escrow and the property has been sold, can the seller still decide to purchase a home, invest the money into a new property and still get tax even though an exchange was not established?


The answer is no.

The exchange has to be set up before the sale leg closes.  It is also critical that you never touch the money. 

Kerry Kerstetter


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Proper 1099 Forms

Posted by taxguru on January 21, 2006


Subject: 1099 forms
Kerry – The web site where I have been getting the 1099 & 1096 forms say you can no longer use these off their site because they are in red and there is a penalty if you use them.  Can you tell me where I can get these forms?  I’ve call the Post Office and the Library…they don’t have any.  Thanks,



Actually, nothing has changed in regard to the 1099 forms

The copies you need to give to your payees by January 31 can be of the regular black and white variety as produced through QuickBooks or that you can download or photo-copy.  Those are super easy to prepare.

The hassle is with the copies that are to be sent to IRS by February 28.  They do have to be printed on a special scan-able red-ink form that is a pain in the butt to line up properly in laser printers.  You can buy these forms at most office supply stores.  You should buy a few more than you will actually need because the first test ones will probably be messed up.

Good luck.



It’s also time for my annual reminder that it’s best to not rush the 1099 and W-2 forms in to IRS and SSA.  They are not due to the government until February.  It will make everyone’s life much less complicated if you give your payees time to review their copies and notify you of any errors before you send in the government’s copies.  


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Posted by taxguru on January 21, 2006

Woman leaves entire $1.1 million estate to pay down national debt – The big difference between this woman’s estate plan and what happens to most others is that hers was voluntary.  For others, the government and probate attorneys confiscate part of their estates instead of allowing them to pass their accumulated wealth to whomever they want to. 


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