This Article is designed to be of general interest. The specific techniques and information discussed may not apply to you. Before acting on any matter contained herein, you should consult with your personal legal adviser.

On July 22, 1998, the President signed the new tax law for the restructuring of the IRS. Although there are some significant changes in this law, most of it is more flash than substance.

First, the important items:

The long-term Capital Gains period for sales after 1/1/98 is reduced to 12 months. The 1997 Act had created 3 holding periods: short-term (less than 12 months); mid-term (between 12 and 18 months); and long-term (more than 18 months). Now the Republicans have prevailed and eliminated the mid-term category. [For 1997, the more complicated system remains the law.]

As previously reported on our web site, the new law fixed an error in the 1997 Tax Act regarding the Exclusion for the sale of a Principal Residence. If the 2 year use and ownership tests are not met, and a sale occurs (1) before 8/5/99 or (2) due to special circumstances (health, job, etc.), the exclusion is pro-rated.

If Bob owned a home for only 1 year and was eligible for the "reduced exclusion," if his profit was $80,000, a strict reading of the 1997 Tax Act required taxation of $40,000 (50% of his gain). Now the 1997 law has been retroactively corrected to allow Bob to exclude 50% of his $250,000 exclusion amount and pay no tax on any gain up to that amount.

IRS Restructuring
Attacking the IRS has become a favorite political bandwagon. The horror stories in the recent Congressional Hearings show how an out-of-control IRS can abuse taxpayers.

Our personal experience is that most of these horror stories are due to taxpayers' failure to respond to the IRS. If the IRS writes to a taxpayer:

• who moved without sending a change of address form to IRS; or
• who fails to respond; or
• whose response is not properly received by IRS,

Innocent Spouse status has been expanded. Formerly, an ex-wife who enjoyed a high standard of living and filed a joint return with her crooked husband had no chance of relief, since she enjoyed the benefits of his tax crimes.

Now Innocent Spouse qualification has been greatly expanded.

Now, innocent divorced or separated taxpayers may be responsible only for their share of the tax liability in certain circumstances.

Both of these new rules apply to tax liabilities arising after the date of this brand new law, or to taxes still owed now.

Last year if each side presents equal evidence in Tax Court, the case is a tie and the Taxpayer lost because he did not meet the burden of proof. On the other hand, if the Taxpayer's case is just a smidgen better than the IRS's case, the Taxpayer won.

Now, under the new law if the case is a tie, the Taxpayer wins (if he cooperated at audit).

In real life, this means little as very few cases end up in a tie.

Also, there has been some simplification made to the Family Business Exclusion for estate taxes.

Triple Net Leases
[This is not a change in the law, but an interesting technique worth considering.]

In a tax deferred "Starker" exchange (also known as a "like-kind exchange," or more properly a §1031 exchange) taxation on the sale of the "old property" is postponed if a new property is acquired within the timeframes allowed by §1031 of the Internal Revenue Code.

Many clients thinking about selling discard the like-kind exchange option because they are tired of being landlords. They have had too many worries about drain problems, evictions, damage, rent control....

In a §1031 exchange for real estate, any (US) real estate qualifies, even if the owner is not actively involved in the management or operation of the property. A good example is a triple net lease.

Tom wanted to sell and cash out, even if it meant he would pay tax. He was TIRED of the headaches of being a landlord. His profit on the sale would be $400,000. If he had to pay tax, he would owe over $100,000. He could invest the balance in bonds and get income of $16,000 each year, guaranteed, with no headaches.

Instead he did a §1031 exchange and bought a property upon which a national chain built a hamburger outlet. Although it is owned by a local operator, the national chain guaranteed the lease terms.

The tenant pays all expenses, including repairs, insurance, and property taxes. Tom gets a check every month, automatically deposited into his account.

If the guy who flips the burgers calls in sick, Tom does not even know about it. If the local operator goes broke, the national chain will pay the monthly rent to Tom.

With no headaches, and no taxes to pay on the sale of the old property, Tom has a much bigger income than if he had sold and paid tax. Unlike other options to postpone tax (installment sale, Charitable Trust, etc.), Tom's heirs will receive a step-up in basis allowing them to sell the property tax free at Tom's death.

Using a triple net leased property acquired in a §1031 exchange makes life much simpler, and hopefully more profitable, for people who want to get rid of the problems of owning real estate, yet postpone the taxation. This works extremely well for senior citizens who have owned one or more investment properties for years, with large built in profits.

Custodial Account Reminder
I am constantly amazed at the financial experts who do not understand the following 2 items:

If the Donor (of a gift to a minor) is the Custodian under the Uniform Transfers to Minors Act, at the Donor's death the Custodial account is part of the Donor's taxable estate.

A simple example illustrates this.

Dad puts $10,000 a year into a Custodial account for Junior. Dad is Custodian. The account grows, and when Dad dies is worth $100,000. The entire $100,000 is part of Dad's taxable estate, because Dad was both the Donor and Custodian.

If Grandpa puts $10,000 a year into a Custodial account for Junior with Dad as Custodian, the account is not part of Grandpa's taxable estate, because Grandpa was not both the Donor and Custodian; it is also not part of Dad's taxable estate, because Dad was not both the Donor and Custodian.

Custodianship accounts terminate by California law at one of 3 points:

1. If the gift was made during the Donor's lifetime, it may last until the minor reaches age 21 IF that age is specified at the time the account is opened; if no specification is made, the child gets the account at age 18!

2. If the gift was made at the Donor's death, it may last until the minor reaches age 25 IF that age is specified at the time the account is opened.

3. If no specification is made, the child gets the account at age 18!

While Custodial accounts are easy to set up, when a child comes of age they create risks of unwise use of the funds.

A "Minor's Trust" may be a better solution because it may last until any age.

Finally, either device should be evaluated against the general college aid requirement that a student must spend 35% of his assets for college.