December 12, 2014
Posted by Chris Manes

LEAVING YOUR CALIFORNIA LLC BEHIND - How California Taxes The Sale of Business Interests by Nonresidents

California residents who plan to move to another (by definition lower income tax) state, either to retire or for business purposes, often face the problem of how to handle their business interests situated in California. Mostly these interests are LLCs, the preferred entity for most modern business operations. The taxpayer often wants to hold onto the LLC interests and continue to get the income stream until some later date after the move. The question that arises is, what are the California income tax consequences of selling a California LLC interest after the taxpayer changes residency to another state?

I'm assuming the business owner has already weighed the risk of retaining his California business interests while disentangling himself from California by reducing his contacts here and establishing residency elsewhere. Obviously any continued contacts with California are red flags for California's taxing authority, the Franchise Tax Board, which determines residency in part through a "contacts test," evaluating which state the taxpayer has the most contacts with. Business interests are just the type of substantial contact that can weigh heavily in determining residency, and can trigger a costly residency audit. In addition, unless the circumstances are very unusual, the income allocated from the LLC to the taxpayer will be California source even after the taxpayer leaves the state. That means the former Californian will have to file nonresident tax returns with Sacramento (the Form 540NR), and the FTB will know about his global income. If the income is high, it again sends up a red flag that could lead to a residency audit.

But assuming that this decision has already been made, and the taxpayer decided to keep his California business interests despite the risks of an audit, the next issue is planning for the eventual sale of the interest as an out-of-state resident.

On its face, the rule is relatively simple. California generally taxes all income that has its source within the state. The fact that the taxpayer moved to another state doesn't alter that result. With businesses, the state they operate in is called their "situs." It follows that an LLC set up, located and operating in California has a California business situs, and its income is California source. But California LLC interests have special business situs rules when it comes to sales. Income for the sale of intangible interests (stocks, bonds, notes, and LLCs) is not considered derived from California sources unless the intangible property itself has a business situs here. Clearly LLCs that operate in California have a situs here for purpose of their income taxes. But the ownership interest itself takes on the residence status of the owner. Thus, an LLC interest owned by a nonresident is generally deemed a "non-California situs intangible interest" even if the business is set up, located and operates in California. So while the income from LLC operations in California paid to the nonresident is usually California source and is subject to California income taxes, the income from the sale of the LLC interest itself is not.

Unfortunately this rule gets more complex in practice.

Business owners often have more than just a passive relationship to LLCs they have equity in. Often they not only invest in the LLC, but use their interest to leverage other investments. And that often involves pledging the LLC interest as collateral for loans. And in many cases, a control group of investors own related LLCs, and the loans are used to keep the related operations afloat or pay their debts. This can lead to the nonresident unwittingly creating a business situs for his intangible ownership interest in a California LLC, which otherwise could be sold free of California taxation.

The regulations give the classic example of a nonresident who pledges intangible personal property in California as security to pay indebtedness or taxes related to a California business. This is the LLC owner who takes out a loan to pay the debts or otherwise capitalize a related LLC, and the LLC interest is pledged as collateral. In that case, the intangible property acquires a business situs in California. It is no longer "non-California situs intangible property." When the interest is sold, California can tax the gain, even though the owner is a nonresident.

Nonresidents can also get into trouble if they buy and sell LLC interests in California (or place orders with brokers in this state to buy or sell such intangible property) so regularly, systematically, and continuously as to constitute doing business in California. In that case the sales themselves are deemed California source.

So while the rule seems simple when it comes to nonresidents selling their California LLC interests, they need to realize that the application often requires considerable analysis.

November 4, 2013
Posted by Sanger & Manes, LLP

Do Yesterday's Registered Domestic Partners Now Count as Today's Same-Sex Married Couples For IRS Purposes? A Palm Springs Attorney Discusses....

In Revenue Ruling 2013-17, the IRS has now had the opportunity to delve further into the question of what now since the fall of the Defense of Marriage Act? The IRS proceeded to answer a series of questions, but the most question I found addressed in RR 2013-17 was the following: Whether, for Federal tax purposes, the terms "spouse," "husband and wife," "husband," and "wife" include individuals (whether of the opposite sex or same sex) who have entered into a registered domestic partnership, civil union, or other similar formal relationship recognized under state law that is not denominated as a marriage under the laws of that state and whether, for those same purposes, the term "marriage" includes such relationships." In other words, since for years the biggest commitment same-sex couples could make was entering into a "registered domestic partnership", does the IRS now consider registered domestic partners as being married couples for tax purposes? Or do those couples now have to go actually get married to be deemed married for federal tax law? Let's take a look at that question, and a couple others brought up by the revenue ruling.

Issue One- Are same-sex couples Who Have Actually Married Considered Married for the IRS Purposes?

Well, we know the answer to this one already. If the same-sex couple is married in any state where same sex marriage is legal, no matter what state their domicile is, they are considered married for federal tax purposes (and that's great for estate planning, where the unlimited spousal deduction is now available for same sex spouses).

Issue Two- Are a Same-Sex Couple Who Married in a State Which Permits Same-Sex Marriage Still Considered Married for Federal Purposes if They Live in a State Which Does Not Permit Same-Sex Couples?

Well, we know the answer to this one too. State of ceremony (where the marriage occurred) is all that matters, not the state of domicile. Get married in California, live in Oklahoma, all that matters for federal tax purposes is that you were married in California, and that California permits gay marriage.

So let's get to the question which is breaking new ground...

Issue Three- Whether, for Federal tax purposes, the terms "spouse," "husband and wife," "husband," and "wife" include individuals who have entered into a registered domestic partnership, civil union, or other similar formal relationship recognized under state law that is not denominated as a marriage under the laws of that state>

So you couldn't get married for a long time in California, and you chose to be viewed as a registered domestic partner. Marriage is now legal, but you haven't gotten around to getting married in California yet. Can you, as a registered domestic partner, be considered married for federal tax purposes (which will get you, amongst other things, a spousal deduction on the death of the first spouse (to avoid the estate tax))? This time the IRS does not help. For federal tax purposes, the term marriage does not include registered domestic partners (or civil unions). So, if you want to be considered married for federal tax purposes (which usually, but now always, is a benefit financially to a couple), you have to go get married- registered domestic partners (even though that may have been all that was available for years), will not suffice for this purpose.

September 10, 2013
Posted by Sanger & Manes, LLP

Palm Springs Law Firm Discusses The New Tax Implications for Same-Sex Spouses, Part I

We've held off a little starting our same-sex tax blog, because until the IRS finally chimes in on the impact of the post-DOMA world, there really wasn't much more to do other than speculate on the impact. But with the first pronouncement from the IRS since DOMA's demise, we finally have some concrete rules from which we can advise our clients. On August 29th, the IRS issued Revenue Ruling 2013-72 which gives us the IRS' perspective (the Federal perspective, not the state of California's perspective) on what the fall of DOMA means. In this first part of this series, let's take a look at the IRS' rules on what constitutes a marriage:

Rev. Rul. 2013-72 Says That The IRS Will Recognize Your Same-Sex Marriage As Long as You Were Married in a State Which Recognized Same-Sex Marriage.

So what is the IRS saying here? They're saying, as long as you are actually married in a state where same-sex marriage was legal at the time of the marriage (i.e., the state which issued you the marriage license, where the service was) then the IRS will view you as legally married for IRS (federal) purposes (the significance of this we will discuss later posts on this topic). If a same-sex couple was married in California, but lives in Oklahoma (the couple's "domicile"), the IRS does view the Oklahoma couple as legally married for its purposes.

Will the IRS Recognize Your Same-Sex Marriage if You Were Registered Domestic Partners Prior to the Fall of DOMA?

Of course, many same-sex couples at this point could not have been married in a given state, because same-sex marriage (prior to 2013) has only been legal in a handful of states. But maybe a same-sex couple instead for many years have been registered domestic partners in a given state. However understandable this situation might be, it does not matter in the eyes of the IRS. If you want to be treated by the IRS as married for tax reasons (and again, we'll digest why you might in short order), you're going to have to now go get married. Registered Domestic Partners and Civil Union Partners are not deemed by the IRS to be spouses.

Lastly, if I Get Married in a State Which Permits Same-Sex Marriage, but Live in Another State (which does not Permit Same-Sex marriage), Where am I permitted to get divorced?

Of course with marriage, there must be an avenue for divorce. So the final issue to address in Part I is the issue of divorce. In Part 2, we'll get into the advantages and disadvantages of being deemed a married couple in the eyes of the IRS. So what happens now if a same-sex couple gets married in California, but lives in Oklahoma, and then wants to get in divorce? Oklahoma isn't going to honor a divorce, it didn't honor the marriage. The IRS honored the marriage because it was performed in California. Well, as you might expect, the IRS will honor a divorce entered into back in California, the same state the marriage took place. All the couple must do is show that the state of domicile (Oklahoma) will not grant the divorce, and California becomes eligible as a divorce jurisdiction which will be honored by the IRS.

January 14, 2013
Posted by Sanger & Manes, LLP

I'm Selling Real Estate in 2013 (Let's Say in the Palm Springs Area), Help Me Understand the New 3.8% Surtax on the Sale (Part 2)...

Nothing brings a new law home like some examples, let's take a look:


1.) A single individual with a salary of $210,000, which exceeds the $200,000 threshold, could be subject to the 3.8% tax IF he also has "net investment income."

2.) A married couple with a combined income of $275,000, which exceeds the $250,000 threshold, could be subject to the 3.8% tax IF they also have "net investment income."

3.) A married couple have an Adjusted Gross Income (AGI) of $175,000, less than the $250,000 threshold, but have a "net investment income" of $100,000. Their Modified Adjusted Gross Income (MAGI) (MAGI = Adjusted Gross Income + "net investment income") is $275,000 ($175,000 + $100,000), exceeding the $250,000 threshold, making them subject to the tax.

4.) A married couple have an AGI of $240,000. Their total "net investment income" is $6,000, $2,000 of interest and $4,000 of dividends. The 3.8% tax would not apply even though they have "net investment income" as their MAGI 0f $246,000 ($240,000 + $6,000) is below the $250,000 threshold. But if they have the same interest and dividends plus a $10,000 capital gain, their MAGI would be $256,000. The excess of MAGI over the applicable threshold amount of $250,000 would be $6,000 ($256,000 - $250,000) and their "net investment income" is now $16,000 ($2,000 of interest, $4,000 of dividends and $10,000 of capital gains). Since $6,000 is less than $16,000, and the tax is calculated on the lesser, the 3.8% tax would be applied to the $6,000 and the tax would be $228 ((3.8% x $6,000).

5.) A married couple, purchased their primary residence 20 years ago for $100,000 and have lived in it since that time. Today, it is worth $700,000. If they sold it their profit would be $600,000. The first $500,000 of profit for a married couple selling their primary residence and meeting the ownership and occupancy tests would be tax-free, because of the couples federal home sales profit tax exemption of $500,000. The remaining $100,000 profit ($600,000-$500,000 exemption) would be "net investment income." The question would then be are they subject to the new 3.8% tax? That depends.
If their AGI was $175,000, the $100,000 "net investment income" capital gain profit would then be added to their AGI for a MAGI of $275,000 ($175,000 + $100,000). If the MAGI totaled less than $250,000, the new tax would not apply although they would still have to pay the capital gains tax on $100,000 profit. In this example, as the MAGI is $25,000 greater than the $250,000 threshold ($275,000 - $250,000), the new tax would apply. The new 3.8% tax applies to the lesser of the "net investment income," in this case $100,000, or the $25,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $25,000 is less than $100,000, the additional tax would be $950 (3.8% of $25,000).

6.) A married couple sold their principal residence for $525,000. They originally purchased it for $325,000. Their gain is $200,000, but they satisfy the ownership and occupancy requirements for the $500,000 couples federal home sales profit tax exemption of $500,000) and after applying the exclusion they have no capital gain and there "net investment income" is zero. Even though they have $300,000 of AGI, they are not subject to the new 3.8% tax as they have no "net investment income."

7.) A married couple inherited stocks and bonds that they liquidated. The sale
of these assets generated a capital gain of $120,000. Their AGI is $140,000 and their MAGI is $260,000 ($120,000 + $140,000). The excess of MAGI of $260,000 over threshold $250,000 is $10,000 ($260,000 - $250,000). The new 3.8% tax applies to the lesser of the "net investment income," in this case $120,000, or the $10,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $10,000 is less than $120,000, the additional tax would be $380 ($10,000 x 0.038).

8.) A married couple have total investment income from bonds, CD's, dividends, and capital gains of $145,000. Their AGI is $190,000 and their MAGI is $335,000 ($145,000 + $190,000). Their excess MAGI over the threshold of $250,000 is $85,000 ($335,000 - $250,000). The new 3.8% tax applies to the lesser of the "net investment income," in this case $145,000, or the $85,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $85,000 is less than $145,000, the additional tax would be $3,230 ($85,000 x 0.038).

9.) A married couple own a vacation home they purchased for $275,000. They have never rented it to others. They sell it for $335,000 and their second home sale capital gain is $60,000 ($335,000 - $275,000). The home sale profit exemption does not apply to second homes. In the year of the sale their AGI is $225,000 and their MAGI is $285,000 ($225,000 + $60,000). Their excess MAGI over the threshold of $250,000 is $35,000 ($285,000 - $250,000). The new 3.8% tax applies to the lesser of the "net investment income," in this case $60,000, or the $35,000 that their MAGI exceeds $250,000 for a couple filing a joint return. As $35,000 is less than $60,000, the additional tax would be $1,330 ($35,000 x 0.038).

January 8, 2013
Posted by Sanger & Manes, LLP

I'm Selling Real Estate in 2013 (Let's Say in the Palm Springs Area), Help Me Understand the New 3.8% Surtax on the Sale (Part 1)...

Beginning January 1, 2013, a new 3.8% unearned Medicare income tax will be levied under IRS Section 1411(a)(1) on some "net investment income." This tax is designed to raise an estimated $210 billion to help fund Medicare and health care reform. The tax will apply to the lesser of "net investment income" or the dollar excess of "Modified Adjusted Gross Income over the applicable threshold amount". The 3.8% tax applies in addition to any other taxes that otherwise would apply to the associated income.

It is not true, as some frightening emails have suggested, that the new tax is a sales tax on the total sale price, nor is it true that it will affect all home sales or even most home sales. It is not true, as the emails have reported, that it would cost an additional $3,800 (3.8% x $100,000) in taxes to sell a $100,000 home.

What is Net Investment Income?

The first test for determining the amount of income subject to the 3.8% tax is determining the "net investment income," which includes income from capital gains (less capital losses), rentals (less expenses), dividends, annuities, and royalties. It also includes income derived from a passive activity such as real estate investing and from income derived from a net gain attributable to the sale of property including a home. Income associated with a normal business in which the individual materially participates is not subject to the tax. Also, distributions from a retirement plan are not subject to the tax.

What is the Modified Adjusted Gross Income over the applicable threshold amount?

The second test for determining the amount of income subject to the 3.8% tax is the dollar amount of Modified Adjusted Gross Income (MAGI) greater than the applicable threshold amount. For an individual filer the applicable threshold amount is $200,000 and for a married couple filing jointly the threshold is $250,000. Modified Adjusted Gross Income (MAGI) = Adjusted Gross Income + "net investment income." Home sale profits are capital gains and are considered to be investment income.

What About Code Section 121, Which Permits an Individual to Exempt $250,000 in Capital Gains from the Sale of a Primary Residence?

If certain ownership and occupancy requirements are met, capital gains from the sale of a primary residence less than $250,000 for an individual and less than $500,000 for a couple filing a joint return are currently exempt and will continue to be exempt from taxation. The vast majority of home sellers will not be subject to the new 3.8% tax. In July 2012, the median sales price for existing homes was $181,500. Homes that sold for more than $500,000 accounted for only 11% of home sales. To qualify for the home sale profit exemption, the sale home must be a primary residence which the seller owns and has lived in for two-of-the-last-five years prior to the sale. Husbands and wives can each claim a $250,000 exemption on a joint tax return if both spouses meet the two-of-the-last-five year occupancy test, although only one spouse need meet the ownership test. Two co-owners not married to each other who meet the ownership and occupancy tests can each claim up to $250,000 tax-free home sale profits. Those homeowners who cannot meet the full ownership and occupancy requirements for capital gain exclusion may qualify for a partial exclusion equal to the fraction of the time that the ownership and occupancy requirement are met.

Note, the home sale profit exemption does not apply to second homes or to property owned solely for investment purposes. In those cases, the usual ordinary income or capital gains rules apply.

Are Canadians or Other Non-US CItizens Subject to the New 3.8% Tax?
Canadians, or other foreign nationals owning a second home in the U.S. would not qualify for the exemption, but nor are they subject to the new 3.8% tax.

What About Estates and Trusts?

The new 3.8% tax will also apply to estates and trusts. For estates and trusts, the tax is equal to the lesser of the estate's or trust's undistributed net investment income, or the excess of the estate's or trust's Adjusted Gross Income (AGI) over the dollar amount at which the highest tax bracket begins for such taxable year.


We'll run through some examples, in Part 2....

October 22, 2012
Posted by Sanger & Manes, LLP

Indian Wells, Rancho Mirage Tax Attorneys comment further on: RELOCATING SERVICE CONTRACTS (for purposes of avoiding the California state tax...Part 2)

...To evaluate this, the distinction between Rule #1 (California income taxes incurred due to residency), as opposed to Rule #2 (California income taxes incurred due to sourcing) is extremely important. Taxpayers are more or less in control of their residency; they can pull up stakes and move. However, the source of income is not as easily controlled. In many cases, the operations that bring in the income rely on California's market, which is often the market the owner knows and understands. There is no point in moving out of state to avoid the application of Rule #1, if Rule #2 is still going to apply. The tax is the tax is the tax.

But let's look at the nuts and bolts. It's not unusual for a business owner to have a corporation and several related tax pass-through entities, such as limited liability companies or limited partnerships, which produce income by providing goods or services here in California. The corporation often provides the LLCs with administrative services, and charges accordingly. Generally, the owner will hold the corporate stock in a family trust. In case like this, creative relocation can have worthwhile tax benefits. Here's how.

First, remember Rule #1. Since the point of most business enterprises is to get money into the pockets of the owner, if the owner remains a California resident, relocating the corporation won't help a bit by itself. Assuming all the income from operations passes through the entities (including the trust) to the owner, it will be taxed by California because of Rule #1. All of a resident's income is taxable by California. So in situations like this, if a strategic relocation is in the cards, step one is for the owner to change residency to a lower tax or non-income tax state. Obviously that's a big step. It means major change. But if reducing state income taxes is the goal, it's the sine qua non.

Second, remember Rule #2: moving out-of-state won't change anything if the source of the income derives from California. The premise here is that the owner's market is in California, so he can't move the operations. Paying California income taxes on that is the price we pay for benefiting from the Golden State's large market. That said, what doesn't have to be performed here is the administrative services: the management, accounting, etc., that the corporation carries out for LLCs. The source of income from personal services is the location where the services are performed, and not where the nonresident lives, the location where the contract for services is entered into, or the place of payment. Cal. Code Reg §18662-5. Therefore, if the services aren't performed in-state, it's not California source.

Thus step two involves creating a new entity in a lower tax or non-tax state (or the owner can perform those services upon changing residency) to provide the administrative services. In that situation, neither Rule #1 nor Rule #2 applies to the fees charged by the corporation. The services are not rendered in California, so they are not California source. Neither the entity nor the owner are residents, so their global income isn't subject to California taxation.

Now, there are complexities with this, as with any tax situation.

The rule about location of performance is strict. If even some of the work is performed in California (say by the owner coming to California to inspect the business), the payment, or a portion thereof, will be deemed California source under special allocations rules. Cal. Code Regs.18 18662-2. Indeed, if the entity is performing other services in-state, or otherwise doing business in California, all the income from the services may be taxable by California. In the Matter of the Appeal of William-Sonoma, Inc., and Subsidiaries (June, 26, 2012). Therefore, to avoid the application of Rule #2, it is very important to "wall-off" any nonresident entity or person from doing any business in California.

Furthermore, new (and somewhat complex) rules went into effect in 2011 regarding what constitutes "doing business in California" for entities. Partnerships and LLCs are considered doing business in this state if they have general partners or members in this state. Likewise, partners and members are considered doing business in this state if the partnership or LLC is doing business in this state. Further, if a partnership or LLC has employees working in California, it might result in the entity being deemed doing businesses in California, even if most of its operations have nothing to do with California. The point is, depending on how the owner's entities are interrelated, one or all of them might be deemed "doing business in California" for taxation purposes. Therefore, relocators need to carefully scrutinize those relationships to insure none of them can be used to impute "doing business in California" to the nonresident entity.

It's also noteworthy that any equity distributions from the California entities to the out-of-state entity or the owner (and presumably they will be significant) derives from operations in this state. California applies a source-based concept of taxation for full-year nonresident partners. Appeal of Lore Pick, 85-SBE-066; (June 25, 1985), Appeal of George D. Bittner, 85-SBE-111 (October 9, 1985), Appeal of Estate of Marion Markus, 86-SBE-097 (May 6, 1986); FTB Legal Ruling 2003-1. Essentially, California requires owners of pass-through entities to treat items of income, deduction and credits earned by such entities as if the items were earned by the owners at that time.

Similarly, nonresident shareholders are taxed on the portion of their distributive shares of an S corporation's income or loss, which are derived from sources within the state. Valentino v. Franchise Tax Board (1993) 25 Cal.Rptr. 282; Rev. & Tax. Cd, §17951. This is a bright-line rule that can't be avoided. (Dividend income from C-corps is treated differently and generally is sourced not to operations but to where the recipient resides, but that's another story).

So, in my scenario, while you may be able to free service contracts from California taxation, the same isn't true for the profits of the companies engaged in operations.

October 8, 2012
Posted by Sanger & Manes, LLP

RELOCATING SERVICE CONTRACTS: THE RESIDENCY TAX PITFALLS (Part I)

It's no secret that California has a high state income tax rate. In fact the Golden State competes with New Jersey and New York for the highest rate in the nation. Nonetheless, despite somewhat overblown media reports, most Californians aren't in a position to tear their businesses up by the roots and transplant them to low or zero income tax havens like Nevada and Florida. Often those businesses have to operate in California, since that's where the market for the product or service is, and typically for small businesses, the owner has to be present here in state for the enterprise to grow.

But that's not always the case, especially when a taxpayer owns numerous entities and some of the income derives from service contracts (usually for management work) among the entities or between the entities and the owner. In that case, some strategic use of out-of-state entities can result in large tax savings that might make the major step of relocation worthwhile.

But before we can address the benefits and pitfalls of relocation, we need to first give an overview of California's income tax system relating to residency. California taxes residents with respect to their "global" income. This means that for a California resident, income from whatever source - whether in-state or out-of-state - is subject to California taxation. There may be credits for payment to other states, and there may be other mitigations of the taxes due. But leaving that aside, California residents generally must pay significant state income taxes on all the income they make, from whatever source. Let's call this Rule #1: taxation of all income based on the California residency of the taxpayer.

In contrast, nonresidents only have to pay California income taxes to the extent that the income is "California source." If a nonresident has no California source income, the taxpayer isn't liable for any California income tax. California source income means income derived from a business or real property with a situs in California, or from work performed here. That income is subject to taxation by California, even if the taxpayer is not a resident. Let's call this Rule #2: taxation based on the source of the income being situated within California.

The rules relating to who is a resident and who isn't get very complex and fact specific. I won't get into them here. See Christopher Manes' A GUIDE TO SUCCESSFUL (TAX-FREE) SNOWBIRDING and THE PART-TIME RESIDENT TAX TRAP, on the Sanger & Manes website. Suffice it to say that if a taxpayer follows the necessary steps, he can change residency to a lower tax state. The issue is, when is such a major relocation worthwhile? We'll review question that in Part II.

September 17, 2012
Posted by Sanger & Manes, LLP

Coachella Valley Residents, as 2012 Draws Nearer to a Close, So Does Your Opportunity to Utilize The Large Estate/ Gift Tax Exemption (Probably)

As 2012 draws nearer to a close, we should all keep in mind that the opportunity for maximum estate and tax planning may also be drawing to a close. What are we talking about? Let's look at the estate and gift tax changes which are scheduled to change at the end of 2012:

1) The $5,000,000 lifetime estate and gift tax exemption amount (actually $5,120,000) in 2012 is scheduled to revert to $1,000,000 in 2013.

2) The highest estate tax rate is 35% in 2012, which is scheduled to revert to 55% in 2013.

There's no guarantee the estate/gift tax exemption will be $1,000,000 in 2013, or that the highest rate of estate tax will be 55% in 2013. But these are what's scheduled, and absent an agreement from Congress, this is what we're getting,

So how we can take advantage of what is scheduled to occur?

Suggestion 1- Make Gifts This Year (2012)

Obviously we're talking about very wealthy people here. But if you have millions of dollars, you want to take advantage of every dime of that high $5,120,000 2012 exemption before it goes away. How do you do that? Recall that the estate tax exemption and the gift tax exemption basically operate in unison. So what the affluent person can do now is make a gift (let's say to a relative but it could be to anybody). So the affluent individual makes a gift to his daughter (that's probably who would inherit much of his estate anyway) in 2012 in the amount of $5,120,000. Now the wealthy individual has lowered his estate by $5,120,000 by giving that amount to the person to whom it was going to go to upon his death anyway. And because he did it in 2012, with a high estate/gift tax threshold, he was able to do it with no tax consequences. Imagine, on the other hand, if he didn't make the gift in 2012, but instead held on to the money and then passed away in 2013. Upon his death the $5,120,000 still goes to his daughter (under the Will), but under this scenario (with only $1,000,000 in the estate tax exemption in 2013), $4,120,000+ is subject to the estate tax (which is taxed at maximum of 55% in 2013= over $2,000,000 in estate tax). So by not making the gift to daughter in 2012, the wealthy individual's estate lost over $2,000,000 to the IRS.

Suggestion 2- If you Have Loans Outstanding to Family Members in 2012- Consider Forgiving Them (This Year)

Somewhat in line with Suggestion 1, if you are an affluent individual who has loans outstanding to you children, consider forgiving the loans (and making them gifts to your kids). Again, for the affluent, 2012 is potentially a very good year to make gifts to family members.

Suggestion 3- Put the Gifts For the Family Members into a Trust First

Again, it's a good year for gifts to individuals who would inherit from you anyway. Why put the gifts in a trust 1st? Well, for starters, if the individual's daughter has trouble with creditors (or if the individual's daughter gets divorced and we don't want the ex-husband getting any of the gift) those gifts (to the family members) are protected (unlike the outright gift). Also, this allows the wealthy individual to pay the tax on the growth (the interest/income component) instead of the daughter.

Other really interesting gift opportunities exist when gifting an interest in an LLC or partnership, where the gifts can actually be well above the $5,120,000 and still exempt (due to the discounting of interests in entities due to lack of marketability and for minority interests).

Last Question- Any Chance 2012 Gifts of $5,000,000+ Will Be Deemed Not Exempt in Later Years?

This is the question of the clawback. $5,120,000 is the exemption amount in 2012, but will the IRS retroactively deem that the $5,000,000 gift of 2012 was not entitled to the full exemption? There is no indication this will occur (although some practitioners do worry about it). For now, we say gift away, at least for the rest of 2012!!!

September 6, 2012
Posted by Sanger & Manes, LLP

I Own a House in Palm Springs, California, But I Really Live in Illinois. How Do I Avoid Being Deemed a California Resident (Part 2)?

So we're on to Part 2 on this topic. Here, we're talking about a US citizen who owns a California home (maybe in Palm Springs), but lives in Illinois.

Presumptions Generally

Let's review the FTB's presumptions on time spent in California. If you spend more than 9 months (in a calendar year) in California- you are presumed to be a California resident that year (but you can rebut it by going to the checklist). You can find this presumption in Cal Rev. & Tax Code §17016. There is also a lesser presumption (found in regulations as opposed to the Cal Rev and Tax Code) which provides if you are present in California less than 6 months a year, you are presumed to not be a California resident. This "lesser" presumption is found at 18 Cal. Code of Regs. §17014(b). I consdier it a lesser presumption since it comes from the Cal tax regs and not the Code (unlike the 9 month presumption). There is no presumption if you are present in California between 6 months and 9 months. But in all events, you still must go back and review the checklist.

Make Sure to RE-Review the Checklist

We must re-review the checklist of items the FTB looks at from Part 1 of this topic (e.g., location of your spouse/RDP and children; location of your principal residence; where your vehicles are registered; where you maintain your professional licenses, etc.). The FTB may still deem the American from another state (Illinois) a California resident if they have enough checks in the wrong category, even though that person does not spend more than 6 months a year in California.

What Does it Mean For the American From Another State to Be Deemed a Resident of California?

It's significant. It means that California will tax the individual up to 9.3% of the income they earn anywhere in the world.

What Taxes Must the American Who Is Not Deemed a Resident of California Still Pay to California?

Here were talking about owing tax to California solely on California source income. So what are we talking about here?

Gain From the Sale of California Real Property- A big one. You sell your California vacation house, you owe tax in California. Count on 9.3% of the gain on the property (i.e, buy for $300,000, sell for $500,000, its 9.3% x $200,000= $18,600 in tax to the state of California). You're still going to owe tax to the IRS on top of this. By the way, upon the sale of your house, the buyer must withhold from you (the out of state seller, or the in state seller for that matter) either: 3.3% of gross sales price ($500,000 x 3.3%= $16,500); or 9.3% of the gain ($18,600), and send it in directly to the FTB. You, as the seller, can choose the withholding amount (you should choose the lower amount).

We'll talk about the tax on other sources of California income in Part 3 of the series.

August 20, 2012
Posted by Sanger & Manes, LLP

I Own a House in Palm Springs, California, But I Really Live in Another State. How Do I Avoid Being Deemed a California Resident?

We next start a detailed series on the consequences of, and how to avoid, being deemed a California state resident for state income tax purposes. We will track this discussion on our Canadian Snowbird blog.

General Rules on California State Taxes

Let's start with some general principles of California state taxation:

Residents of California- are taxed on ALL income, including income from sources outside California. A California resident is any individual who meets any of the following:
• Present in California for other than a temporary or transitory purpose.
• Domiciled in California, but outside California for a temporary or transitory purpose.

Domicile means the place where you voluntarily establish yourself and family, not merely for a special or limited purpose, but with a present intention of making it your true, fixed, permanent home and principal establishment. It is the place where, whenever you are absent, you intend to return.

Nonresidents of California- are taxed only on income from California sources. A nonresident is any individual who is not a resident.

Part-year residents of California- are taxed on all income received while a resident and only on income from California sources while a nonresident. A part-year resident is any individual who is a California resident for part of the year and a nonresident for part of the year.

California Has a High State Income Tax

Individuals from other states and other countries will want to avoid being deemed a California State Tax Resident. Why? Because California state taxes are not low. For 2102, the highest rate of tax (for individuals earning over $98,000 approximately) is 9.3%. That's in addition to the federal income taxes (with a high rate of 35%). So this is a high state income tax, no question.

How Does the FTB (the California Franchise Tax Board) Determine Whether an Individual is a California Tax Resident?

It applies the "Closest Connection Test." This refers to the state with which a person has the closest connection during the taxable year. For the FTB, this literally means counting all the California contacts a person has and comparing that number with the non-California contacts. Of course, some contacts simply weigh more than others.

Factors to consider are as follows:
• Amount of time you spend in California versus amount of time you spend outside California.
• Location of your spouse/RDP and children.
• Location of your principal residence.
• State that issued your driver's license.
• State where your vehicles are registered.
• State in which you maintain your professional licenses.
• State in which you are registered to vote.
• Location of the banks where you maintain accounts.
• The origination point of your financial transactions.
• Location of your medical professionals and other healthcare providers (doctors, dentists etc.), accountants, and attorneys.
• Location of your social ties, such as your place of worship, professional
associations, or social and country clubs of which you are a member.
• Location of your real property and investments.
• Permanence of your work assignments in California.

So a determination of residency, at first instance, is a balancing test. Again, not all factors are created equally. A job or real estate ownership indicates a closer tie than merely enjoying a country club membership.

There's a lot more to discuss regarding California income tax, including how nonresidents are subject to tax on their California source income, in our next post....

August 14, 2012
Posted by Sanger & Manes, LLP

I'm Not Happy About My Riverside County Property Tax Bill, How Do I Appeal It?

As a California property owner, you have the right to appeal the amount of your property taxes. You can use an attorney to represent you in your appeal, or you can do it yourself. Property taxes are assessed (and appealed) on a county-wide basis in California, so for those of us in Riverside, Banning/Beaumont and the Coachella Valley (Palm Springs, Rancho Mirage, Palm Desert, Indian Wells, etc.), our appeals are handled in Riverside County.

Am I really Challenging The Amount of My Taxes?

Actually no, what you are really challenging is the Riverside County Assessor's enrolled value of your property.

Appeals Generally

First of all, there is a chance (maybe unlikely) you can change your assessed value without even appealing. You can try contacting your Assessor and make the case informally. Absent a glaring mistake or omission by the Assessor, that's probably not going to work. So you can file an appeal with your local appeals board (for us in the Palm Springs area, this means the Appeals Board of Riverside County). Again, an attorney is not required, but property tax appeals frequently include legal issues, and attorneys are used to the appeals process (they do many of these), so it's not the worst idea. And by the way, the appeals process (with the Riverside Board) is going to take a while, in fact you can count on months (maybe 6 to 8 months until your hearing).

What Kind of Appeal Do You Want to File?

Decline in Value Appeal- Very common. You believe your property is no longer worth as much as the assessed value. If you are filing a decline in value appeal, you must file your appeal as follows:

If you received your assessment in the mail by August 1- you must file your appeal between July 2 and September 15.

If you did not receive your assessment in the mail by August 1 (you received it later)- you must file your appeal between July 2 and November 30.

Base Year Value Appeals- A little different than a decline in value appeal. Here, what you're auguring is that there should be a change in your property's "base year value", because (for example) a change in ownership of the property occurred, or perhaps there has been a change to the structure of the property (you added a garage). The concept of a base year value, of course, stems from California's Proposition 13. Under Proposition 13, once a base year value has been established (for example, when you buy a previously owned house, the property has now undergone a change in ownership, and a new base year value is established), the property value (for tax purposes) can only go up a small percentage each year. We'll speak more of Prop. 13 in detail in later blog posts.

Calamity Reassessment Appeal- A natural disaster has affected the value of your property (so a reassessment is required).

What Kind of Evidence Can You Present?

Obviously, most people will want to show evidence that their property is not worth what the assessor believes. The best evidence will be sales of houses which are comparable to yours (e.g., in your area, of like size, etc.). While the Appeals Board will consider this evidence, the only "comps" which generally count for their purposes are the sales that occurred between January 1 and March 30 of the year in question (sales prior to Jan 1 can be considered as well, but must be adjusted for elapsed time). You may wish to consider getting a formal appraisal (although evidence of three comparable sales of home sales in your area (within one mile radius of your home), of (generally) the same size and condition, will generally suffice.

For more information on the Riverside County Property Tax Assessment Appeals Process, give us a call.

July 23, 2012
Posted by Sanger & Manes, LLP

Dual US (and Foreign Country) Citizens Who Don't Owe Tax in The US, It's Easy to Get Compliant with IRS Now. For the Other US Citizens With Foreign Accounts and Who do Owe US Tax, You Need to Consider the 2012 FBAR Amnesty Program

IR-2012-65 allows Dual Citizens who Don't Owe Tax in the US a Pain-Free Way to Become Compliant

First of all, which dual citizens don't owe tax in the US? As a general matter, a dual citizen who have been living in a foreign country and been paying that country's tax (as appropriate) probably does not owe much tax in the US (if any). The US taxes its citizen's income no matter where they earn it anywhere in the world. But the US also works in cooperation with almost every country in the world (except for countries such as Cuba, Iran and Yemen...i.e., countries we have no relations with). If you are an American citizen living in France (you might also be a French citizen), and you have been paying your appropriate French tax for the money you earn in France, odds are you will not owe tax in the US. Why is this so? Most foreign countries have higher tax rates than the US. So as long as the income is of a type which we recognize (such as wages for services, or gains for stock sales, or rental income, or dividends, etc), the US will credit income earned in France by the dual French/US citizen. Thus, after the credit, the US citizen probably owes $0 US tax or very little US tax, on the amounts he earns in France. And the same goes for that US citizens with most every other country.

Now let's not confuse the issue of whether the dual citizen owes any US tax with the obligation of the dual citizen to: (a) file US tax returns; and (b) file FBARs annually if they have bank accounts outside the US with over $10,000 at any point in the calendar year. Those obligations generally exist whether the person owes US tax or not. But for those people the new guidance is terrific. Those individuals must complet their past-due tax returns (at least 3 years) and delinquent FBARs (at least 6 years), and they'll probably have no penalty to get compliant provided you don't owe significant US Tax. A great deal.

Now if you haven't been paying the appropriate tax in France (or whatever foreign country), and you probably haven't been paying the appropriate tax in the US if you haven't been completing your tax returns here, then (provided you have bank accounts in the foreign country over $10,000) you need to go through the 2012 FBAR amnesty program (review our prior posts for a description of the OVDP).

Let's point out some important factors of the new amnesty program.

More Notes about the 2012 FBAR Amnesty Program

The 2012 FBAR amnesty program is currently underway. There is no deadline for the program. The program could be pulled by the IRS at any time, or the IRS could raise the current amnesty FBAR penalty (27.5% of the highest (aggregate) overseas balance in the highest year with a bank account abroad) at any time. Again, for those going through the amnesty program, you really have strongly consider taking the 27.5% penalty if you did not check the box on the Schedule B of the Form 1040 (asking the taxpayer to check the box if he or she had any foreign bank accounts). For those who don't go into the amnesty and eventually get caught, the penalties can be enormous. They can wipe you out, no question. Also, in really egregious circumstances, jail is a possibility. And, as we understand it, foreign countries (like Switzerland) are feeling little option but to turn over bank account records to the US government (either presently, or soon).

The IRS clearly draws a distinction between those taxpayers who come in voluntarily, and those who are caught. If you are a US citizen or resident and have overseas bank accounts and you owe tax in the US on those amounts (maybe because you haven't paid the appropriate tax in the foreign country at issue), you probably should consider the 2012 amnesty program soon.

July 16, 2012
Posted by Sanger & Manes, LLP

US Citizens and Residents of the Coachella Valley, Have You Failed to Report Your Foreign Bank Accounts? IRS Offers a 2012 Amnesty Program (and Now has Released Detailed Information About the 2012 Amnesty Program), But its Tricky (Part III)

So a few months ago on this blog we informed you that the IRS offered a new FBAR amnesty program (now the 3rd program it's offered), but that it only had released the broad stokes of the program (see our entry from February 16, 2012, for our last discussion of this topic). Since then, the IRS has established new procedures for dual citizens who have foreign bank accounts but who have paying the appropriate tax on the amounts in the those accounts in the foreign country at issue. Taxpayers with this situation can resolve it rather easily without having to go through a formal amnesty program (see our post from July 5, 2012, discussing this new option). However, that program won't be available for everyone, and for the rest there is now the 2012 Overseas Voluntary Disclosure Program (the "OVDP"). On June 26, 2012, the IRS issued a set of Frequently Asked Questions and Answers (this is new guidance to assist taxpayers under the 2012 OVDP).

Background

Again, recall US tax citizens or residents must file a "FBAR" (a "Report of Foreign Bank and Financial Accounts") annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States. The term financial account includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1, by June 30 of the year after the US citizen or resident had a non-US account.


So What Are Broad Strokes of the 2012 OVDP?

Largely, we've already discussed basics of the 2012 OVDP in our prior posts, since the amnesty program remains very similar to the 2011 amnesty program. Taxpayers going through program will have to make a very important decision.

Option One- No Questions Asked. The taxpayer chooses pay a one-time penalty of 27.5% of the highest aggregate overseas account(s) balance in the highest year. So if the aggregate overseas account balance in the highest year (of all the years when the individual did not file a FBAR) was $2,000,000 (and by the way, when we say highest aggregate overseas account balance we are including the value of overseas assets- such as a house- plus the value of overseas accounts), the taxpayer is volunteering to pay a penalty to the IRS of $550,000 (27.5% x $2,000,000), plus the unpaid income tax (if any), plus penalties for failure to file or pay income tax (if any). That stings, no question.

Option Two- Roll the Dice for a Lesser Penalty. The taxpayer asks for a lower penalty than the 27.5% general amnesty penalty (which required a payment of at least $550,000 for a $2,000,000 overseas aggregate account balance above). But this is a gamble with big stakes. If the IRS agrees that the taxpayer is entitled to a lesser penalty based on the facts of the case, then great. But if the IRS doesn't agree, the taxpayer can lose big. In fact, if upon review the IRS believes that the taxpayer's failure to file a FBAR was "willful", they can take EVERYTHING in the foreign accounts (maybe more). The taxpayer cannot elect option two and roll the dice if the facts of his case have even the whiff of a willful failure not to file FBARs. So what factors suggest to the IRS a taxpayer willfully failed to file a FBAR???

How Do I Know if the IRS will Consider My Failure to File FBARS a Willful Failure, so That I Better Take the 27.5% No Questions Asked Penalty?

So this is really where the rubber meets the road on the 2012 OVDP FBAR amnesty. I need to know whether my case is too risky to ask for the opt-out, and just accept the 27.5% one-time penalty. I must accept the 27.5% penalty if there is a decent chance the IRS will deem my failure to file FBARs as willful. What is a willful failure to file? While there are no concrete answers to this, here are some factors (which come both from the 2012 OVDP Q&A guidance and from our own discussions with the IRS):

1) If the taxpayer has large, unreported taxable gains attributable to the overseas account(s), this is a negative factor (e.g., you got a Swiss account which you haven't filed a FBAR for and you trade stocks in the account and had some major gains and a lot of tax due in the US from these gains...you should probably take the 27.5% amnesty deal...see Q&A 51.2 of the new ODVP guidance).

2) You failed to check the box on Part III of the Schedule B of the Form 1040 that states you had foreign bank accounts. It's one thing not to file FBAR's annually, but it's another thing to fail to state on your personal income tax return that you had any foreign bank accounts. That is not a good factor for someone looking for the opt-out deal.

3) You failed to pay the appropriate tax in the foreign country at issue. It looks better if while failing to file FBARs and paying tax in the US, you were at least tax compliant in the foreign country at issue. Note that if you paid the correct tax overseas, it's quite possible (due to the tax credit system) that you have $0 US tax owed. If you paid the correct tax to the foreign country at issue, that's a very positive factor.

Make a Calm, Objective Decision on Whether to "Opt-Out"

In our experience, there is natural inclination for clients not to want to accept the 27.5% (of the highest aggregate foreign account balance(s) in the highest year) penalty. This is understandable. But again, you need to calmly and objectively assess your case before you make the critical decision of whether to opt-out of the no questions asked 27.5% penalty. The stakes are huge (you could lose the entire value of these accounts if you're wrong). If you haven't declared your overseas bank accounts yet, and you are increasingly worried about the IRS and the Department of Justice discovering them, we strongly recommend you give us or a competent tax attorney a call to review your case.

We'll talk about how long the new FBAR 2012 Amnesty Program is expected to last, and other features of the program, in our next post.

July 5, 2012
Posted by Sanger & Manes, LLP

IRS Makes It Dramatically Easier (and less costly) For US Citizens Living In Another Country to Catch up on Past-Due Tax Returns and FBARs

On June 26, 2012, the IRS announced a new initiative to help US citizens living in another country (very likely dual citizens) catch up with their unfiled US tax returns and FBARs.

Background

In our law office in Palm Springs, we regularly see clients who may be Americans by birth, but who live in (and are also probably a citizen of) another country (usually Canada). While the dual American/Canadian may enjoy visiting Indian Wells three months a year, she really lives in Vancouver. But since she was born in Seattle, she has a social security number, she is a US citizen, and (whether she wants one or not) she has an obligation to file a US tax return every year (even though maybe she's never filed one in her life). Plus, since she has bank accounts outside the US in Canada with more than $10,000 in them, she has an annual FBAR filing requirement as well.

Before the Recent Announcement, This Was a Big Problem for the Dual Citizen Living Abroad

Dual citizens living (permanently) in a country other than the US did not know what to do. Was our Seattle-born dual US/Canadian citizen living permanently in Vancouver supposed to file 25 years of back taxes? Wouldn't that lead to possibly thousands of dollars in back taxes and interest and penalties to the IRS? And as for the delinquent FBARs, isn't the failure to file penalty for an FBAR $10,000 per each year going as far back as the FBAR program has been in existence (it started in 2003)? Our Vancouver resident might think it would be nice to get straight with the IRS because she doesn't like the specter of unpaid income tax and past due FBARs hanging over her head, but it's certainly not worth the $300,000 in back taxes and interest and FBAR penalties she will have to pay for coming clean.

IRS New Procedure Offers Significant Relief For Dual Citizens Living in a Foreign Country Who Have Not Filed US Tax Returns or FBARs in Years

Under the new procedure, taxpayers will be required to file delinquent tax returns for the past three years and file delinquent FBARs for the past six years. All submissions will be reviewed, but for those taxpayers presenting low compliance risk, the review will be expedited and the IRS will not assert penalties or pursue follow-up actions. How do we know if a taxpayer has a "low risk" case where there may be no penalties imposed? Absent unique factors, if the submitted returns show less than $1,500 in tax due in each of the reviewed years, they will be treated as low risk.

So the Dual Citizen Who Hasn't Done a US Tax Return in 20 Years Can Do the 3 Most Recent Tax Returns, and 6 Most Recent Past Due FBARs, and Maybe Have No Penalties and Now Have a Clean IRS History?

The answer is yes! And it's easier than you might think. If our Vancouver resident, born in Seattle (and with a vacation home in Indian Wells) has been paying proper taxes in Canada all these years, due to the tax cooperation between the US and Canada (and the tax credit system), she very possibly owes $0 in past due US taxes for the reviewed years (easily below the $1,500 per year threshold). And the same goes if she was born in New York City and now lives in France (or almost any other country). No failure to file income tax return penalty, and no $10,000 per year failure to file FBAR penalty!!! This is great news for the dual citizen living abroad who just wants to clean their US tax record.

See IR-2012-64 for more details, or call our office.

May 14, 2012
Posted by Sanger & Manes, LLP

How Do I Sell My House, Buy Another, and Not Pay Tax?...Let's See Some Examples:

Let's do some basic (and not so basic) 1031 examples. Again, before we start, remember that in addition to a rising real estate market (no sure thing the last few years, although in the Palm Springs area we might finally be turning the corner), in order to qualify for 1031 you need property either: held for (a) investment or (b) productive use in a trade or business.
Also remember vacation homes are unlikely to qualify as either: held for (a) investment or (b) productive use in a trade or business, unless the owner or the owner's family uses the vacation house not more than 14 days a year. A property used as rental property will qualify for Section 1031 because the IRS deems rental properties as held for productive use in a trade or business.

Basic 1031 Examples

Here's a basic example (1): Tom purchases a Palm Desert house in 2001 for $500k. Tom sells it in 2006 for $1,000,000. Shortly thereafter in 2006, Tom purchases an Indian Wells home for $1,000.000. In 2012, Tom sells the Indian Wells home for $1,250,000. Assuming the Section 1031 requirements met, Tom's taxable income in 2006 is $0, and Tom's taxable income in 2012 is $750,000.

When the taxpayer receives cash in the transaction, the taxpayer must recognize gain (at least to the extent of the cash received).

Basic example (2):
Tom exchanges real estate held for investment (i.e., the general rule is he or his family uses it not more than 2 weeks a year), which he purchased in 2000 for $500,000 which now (in 2012) has a fair market value of $800,000, for other real estate (to be held for productive use in a trade or business) worth $600,000, and $200,000 in cash. The gain from the transaction is $300,000 (Tom bought a property for $500,000 and is now exchanging it for a new property worth $600,000 plus $200,000 in cash), but the $300,000 gain is only recognized to the extent of the cash received: $200,000. Tom must recognize $200,000 in 2012 when he engages in the exchange.

And let's do one more example (with a little more complexity, including two assets transferred (only one of which qualifies under 1031)), plus the question of what is the basis in the new property:

Basic example (3): In 2007, Tom transfers real estate he used exclusively as a rental property which he purchased in 2002 for $1,000,000 in exchange for other real estate (to be held as rental property) which has a fair market value of $900,000, an automobile which has a fair market value of $200,000, and $150,000 in cash. Tom realizes a gain of $250,000 (bought property in 2002 for $1,000,000 and sold it in 2007 for property plus a car plus cash all worth $1,250,000). Tom must recognize (ie pay tax on) the entire $250,000 gain because he received items other than another real property (the car plus the cash) worth a total of $350,000. The basis of the new rental property received in exchange is the basis of the transferred real estate ($1,000,000) decreased by the amount of money received ($150,000) and increased in the amount of gain that was recognized ($250,000), which results in a basis for the property received of $1,100,000. This basis of $1,100,000 is allocated between the automobile and the real estate received by Tom. The basis of the automobile must remain its fair market value at the date of the exchange- $200,000, with the basis of the real estate received being the remainder: $900,000. So at the end of the transaction, the basis in new property is only $900,000 ($100,000 less than the basis in the old property).