Archive for Friday, October 14, 2005

Honesty pays when dealing with IRS

October 14, 2005


Q: I purchased my first rental property in June, and the tenants have been paying me in cash instead of using a check. When tax season comes, will I have to report all their payments as "income"? It seems to me that the IRS would have no way of knowing how much money I actually collected from the rental.

A: The Internal Revenue Service requires that all rental proceeds be declared as income. Period.

I can see where you might be tempted to fib to the IRS because all the rental income you have been collecting has been paid in cash. But if you get caught in the lie through an audit (or an anonymous tip to the tax man from a disgruntled tenant or neighbor), you would not only owe back taxes on the undeclared income but also get hit with stiff penalties.

It's worth noting that the risk of an IRS audit generally ends three years after a tax return is due. But if a taxpayer underreports his or her income by 25 percent or more, Uncle Sam can then go back six years in its hunt to collect back taxes and penalties.

Worse, if the IRS can prove that you intentionally committed fraud, it can review every single return that you have ever filed in its effort to collect more money and might even try to throw you in jail for tax evasion.

If you're still undeterred by the ethical and legal consequences of failing to report all your income, consider this: If you don't declare any rental earnings, you won't be allowed to take all the hefty tax deductions that the IRS showers upon landlords.

More than likely, it would make better financial sense to declare all the rental income in order to qualify for the full package of tax breaks than it would to lie to the IRS and thus forgo the special deductions that only landlords can take.

Honesty has its awards. By being truthful on April 15, you'd probably save more money, avoid future tax problems and maybe even sleep better at night by knowing that you did the right thing.

Asbestos disclosure

Q: We own a vacation home that was built in the 1960s, and there are large asbestos tiles under both the linoleum floors and carpet. We are selling now and our agent is urging us to tell the buyers about the tiles, but we don't see any reason to because none of the asbestos is actually exposed. We're also afraid that the buyers will cancel the deal if we mention the asbestos. What should we do?

A: Real estate disclosure laws vary from state to state. Your letter doesn't tell me where your vacation property is located, so I can't tell you whether you're legally obligated to tell the buyers about the asbestos tiles under your linoleum and carpets.

Nonetheless, it would be a good idea to inform the buyers about the asbestos even if such a disclosure isn't required by state law.

The type of asbestos tiling you have was widely used under various types of flooring until the 1970s, when the government determined that certain types of asbestos products can lead to serious health problems. The tiles aren't dangerous unless they become exposed and their microscopic fibers can be breathed into the lungs.

Although the tiles don't currently present a danger, they certainly might if the buyers eventually decide to rip up the old flooring and replace it. By disclosing the presence of the asbestos now, the buyers can take appropriate safety precautions if they remodel later, and your own "exposure" to a future lawsuit will be limited.

Trust costs

Q: I am interested in creating a living trust so my property can pass quickly to my heirs instead of getting tied up in probate court. How much do lawyers charge to create a trust?

A: Many lawyers and estate planners will prepare a basic living trust for less than $1,500, and some will do it for as little as $500.

Make sure that any prices you are quoted include both the cost of initially creating the trust and the cost of transferring your home and other assets from your name into the trust's name. Some attorneys and planners get new customers by offering to create a living trust for only a few hundred dollars, but then charge an arm and a leg for handling the actual transfer of assets.

- David W. Myers is a 20-year veteran of the newspaper and magazine business, having previously covered real estate for the Los Angeles Times and Investor's Business Daily.


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