“DEEMED ELECTION” TO REPLACE PROPERTY INVOLUNTARY CONVERTED

WHEN A DISASTER STRIKES… BE CAREFUL… DON’T FORGET YOUR IRS REPORTING responsibilities

BEWARE OF THE PITFALLS

 “DEEMED ELECTION” TO REPLACE PROPERTY INVOLUNTARY CONVERTED

This is part of a series of articles emphasizing several ways taxpayers can be trapped by problems in dealing with the tax reporting obligations resulting from a major casualty loss event.

The IRS regulations include, deep into §1.1033 covering replacement assets in disaster gain situation regulation at §1.1033(a)-2(c)(2) the following sentence in this part:

“Failure to report the transaction in the return of the year the gain arises is deemed to be an election to defer the gain even though the details in connection with the conversion are not reported in such return.”

Failure to report is, in itself, is an election.

In some ways it protects taxpayers, in other ways it creates responsibilities and limitations on the taxpayer.

If, in the year the “event finances” turn the catastrophic loss into a gain (which results when the reimbursement exceeds the cost basis of the assets lost or damaged) the taxpayer can elect to pay the tax from the gain or formally elect to defer the gain and repair or replace the property within the required statutory replacement period. If the taxpayer elects to report the gain as a taxable event, the taxpayer can, within statutory period, reverse the election and claim a refund for taxes paid. If the taxpayer elects to defer the gain, then the property must be repaired or replaced and if not completed, then the taxpayer must wait until the expiration of the replacement period and file an amended return for the year the gain was realized incurring two to four years of interest.

If nothing is done, the election has been made according the above IRS regulation.

The regulation does not discuss the implications or responsibilities of replacement property reporting. This is where FSA 200147053 issued by the IRS in 2001 comes into the mix of concerns tobe dealt with in the recovery process.

If the taxpayer makes no election and does not report a gain, the regulation makes the deferral election for you. Now if there is no gain, it may not seem significant.

The neglected IRS Field Service Advice FSA 200147053 Is the only direction provided for taxpayers who have not take any formal reporting. It can be argued that FSA 200147053 has many problems, but it is definitive on its conclusions. The FSA clarifies the IRS position on the “Deemed Election” sentence in §§1.1033(a)-2(c)(2).

The IRS does not back away from its regulation, including the benefits of the “Deemed Election.” But, the Service makes it clear that the “Deemed Election” does not exonerate the taxpayer from formally notifying the IRS of the election decision. The decision regarding the actual replacements must still be reported to the IRs in the years they are made and they must be made within the statutory replacement period. The replacements, to be valid, must be made in response to a formal deferral election to replace. According to the IRS, not reporting a replacement is an election that the acquisition is not to be counted as a qualified replacement. Additionally, the IRS position is that without a formal deferral election, the Statute of Limitations does not start to run on the transaction. Once the statutory replacement period expires and no replacements have been reported the gain is taxable, but must be reported in the year the gain arose, subjecting the taxpayer to interest and penalties.

This brings us to a recommendation regarding reporting replacement expenditures even in a loss situation. Report all the replacement expenditures in a disclosure for the year they arise as they might later need to be applied against gain proceeds not known  at the time of filing the original “loss report” tax return.

In the event that a loss turns into a gain, and the taxpayer has made investments in qualified replacement property, if those replacements have been reported in the years that they occurred, they count toward the qualified replacements. But, if there is an assumption that the loss will never turn into a gain, and replacements are not reported, the otherwise qualified replacements are never allowed as qualified replacements. The replacements will be counted as cost basis for the property while it is not counted as “absorbing” the reimbursement proceeds for income tax deferral purposes.

The article has not covered the implications of all the ways that a taxpayer can create a new disaster by not paying proper attention to the details. A tax professional, knowledgeable in the tax reporting of casualties and disasters can assist the taxpayer with the details.

Remember, every dollar saved in taxes can go toward recovery.

JOHN TRAPANI assists both taxpayers directly and advises taxpayers’ tax professionals.

This material was contributed by John Trapani. A Certified Public Accountant who has assisted taxpayers since 1976, in analyzing and reporting transactions of the type covered in this material.  

© 2015, John Trapani, CPA,

All rights to reproduce or quote any part of the chapter in any other publication are reserved by the author.

	JOHN TRAPANI
	Certified Public Accountant
	2975 E. Hillcrest Drive, #403
	Thousand Oaks, CA 91362
	(805) 497-4411       E-mail John@TrapaniCPA.com
	Website: www.TrapaniCPA.com
	Blog: www.AccountantForDisasteRrecovery.com
	It All Adds Up For You

Tax Advice Disclaimer

Any implication of accounting, business or tax advice contained in this material is not intended as a thorough, in-depth analysis related to your specific issues. It is not a substitute for a formal opinion including a discussion or your specific situation. It is not sufficient to avoid tax-related penalties. If desired, John Trapani, CPA would be pleased to perform the requisite research, specific to your facts and circumstances and provide you with a detailed written analysis. Such an engagement would be the subject of a separate engagement letter letter that would define the scope and limits of the desired consultation services.

This material was completed on the date of the posting

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