TaxTalk tips: repair vs. maintenance, "tax-free" distributions and more.

• Author: Williams, Leonard W.
• Position: CaliforniaTax

A common occurrence among partnerships that own appreciated property is refinancing the property, then distributing the proceeds to the partners.

The question that occasionally has been posted on TaxTalk is whether or not anything special has to be done with the interest on the increased indebtedness.

The answer is, yes. The interest attributable to the money from the refinancing that was distributed to the partners has to be stated separately on the K-1s. It is not an operating expense to be reflected in the amount shown as net rental income on line 2 of Form 1065-K-1.

Nor is it to be entered on line 9 of the Form 8825, Rental Real Estate Income and Expenses of a Partnership or S-Corporation, that feeds into the K-1.

The proper disclosure is: "Interest attributable to a debt financed distribution." The partners will determine the deductibility of their individual portions and that will be a function of how they used the money. (Notice 89-35, 1989-1, CB 675. See Part V.A., "General Allocation Rule.")

Just in Time

The widow of a Vietnam veteran came to a member's office many years ago with a form letter from the Department of Defense she found among her late husband's papers. The letter told him that because he was in a combat zone, a certain amount of his W-2 could be excluded.

She appeared at the member's office the day before the statute of limitations was to expire. He had never seen the woman before, and neither of them had copies of the returns involved.

Our hero prepared a Form 1040X, showing the exclusion on line 1, col. B, and with all other lines labeled "unknown."

He attached an explanation, and a copy of the form from the Department of Defense, had the widow sign the 1040X, and submitted it.

He figured the worst that could happen would be a denial. But the refund check arrived a few months later.

A 'Roof Job' on a Rental Property

In common parlance, the term "roof job" means that the work consists of stripping off the old roof material and replacing it with new material. There may be some peripheral replacement of boards where appropriate.

The IRS position always has been that this is not a repair, but must be capitalized and depreciated.

The tide is starting to turn against the IRS because it has lost two Tax Court cases on this question--Northern v. Comm., TCS 2003-113, in which a $98,616 roof replacement was held to be a repair; and Campbell v. Comm., TCS2002-117.

Although these are summary decisions and can't be cited as...