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How Do I Report the Sale of an Inherited House?

Happy Memorial Day. Keeping in mind all the hot dogs and beer you're going to have (already had?) this weekend, we'll keep things simple. We'll deal with inherited property, Keogh contributions, spinoff stock and a beginner's mutual fund tax issue.

Keep sending your questions, along with your full name, to taxforum@thestreet.com.

I Sold Inherited Property

How do I report the sale of inherited residential real estate? I did receive a 1099-S -- Proceeds from Real Estate Transactions. The property was not my personal residence nor was it converted to a rental property. It was just held until sold. The property was appraised on the date of death and sold 11 months later at a loss. Can the loss be used to offset personal income?

-- Jeanette Johnson

Jeanette,

When you inherit property, your basis -- or cost -- in the property becomes the fair market value of the property on the date of death, says Bill Fleming, director of personal financial services for PricewaterhouseCoopers. So if you sold the house on the same day you inherited it, there should be no gain or loss.

But what often happens is you end up with an overall loss on the sale, thanks to broker fees and selling costs. "You're pretty much guaranteed to lose money on an inherited house," notes Fleming. Whether you can take that loss on your tax return depends on whether the house was a personal asset, investment asset or rental property.

If you used the home at all, then most likely it would be considered a personal asset. This is the only situation in which you cannot take the loss on your tax return. Only gains on the sale of personal residences are reportable.

If you rented the home out, it would be treated as a trade or business. So you could use losses -- and related costs -- to reduce your taxable income.

Since you say that the home was not used personally or converted to rental property, then the inherited property can be considered an investment asset. You can report the loss on investment property on Schedule D -- Capital Gains and Losses.

Investing in a Keogh

I have a duplex apartment that I rent out. Can any portion of the rental income be invested in a Keogh? Most of my income comes from a salary from my incorporated business (not related to real estate).

-- Cheryl Wingate

Cheryl,

A Keogh is a self-employed person's pension plan. The amount you can contribute to it is based on a percentage of your self-employed net earnings. It doesn't matter where the money comes from.

"But net is the magic word in determining your contribution level," notes Fleming. Your net income is what's left after expenses and self-employed income tax. You can contribute 13.043% of that net number.

Basis in a Spinoff

Can you shed some light on the issue of calculating the cost basis of a stock after spinoffs for tax purposes?

-- Susan Katz

Susan,

Most companies today will do this spinoff calculation for their shareholders. But, in general, the cost basis of the original stock is proportionally allocated between the new stocks using the fair market value on the date of the spinoff.

Here's an example:

Let's say a few years ago you purchased one share in Company A for $9. Yesterday, Company A spun off a division. Now you have two shares of stock.

After the spinoff, the main company's stock trades at 40 a share, and the spinoff division trades at 20. Your total post-spinoff investment is $60.

Two-thirds of that $60 is in the main company's stock. So two-thirds of your original (pre-spinoff) cost basis is allocated to the main company's stock. That means your new basis in that stock is $6. The spinoff share, one-third of your $60 investment, will get the remaining one-third of your original investment. The basis in your spinoff share is $3.

If the company decides to calculate things differently, it should let you and the other shareholders know.

Options Trader

As a full-time options trader, can I mark to market my option trades? What if I don't own any options on the last day of the year? Would I be marking to market the hundreds of trades I made throughout the year even though I own nothing on that last day? None of the options I traded still existed on that last day; they all expired.

-- Greg Ray

Greg,

Mark to market is a tax technique that allows taxpayers to report certain trades as if they were sold on the last day of the year -- even if they're still in the portfolio. But if you don't have any open positions at year-end, you don't have to worry about marking your trades to market, notes Ted Tesser, a certified public accountant in Boca Raton, Fla., and author of The Trader's Tax Survival Guide. As you point out, there is nothing to mark to market.

Your completed trades would have been accounted for as realized transactions. Same goes for the options that expired worthless, notes Tesser. So mark to market is not an issue for you.

Mutual Fund Taxes 101

I just invested in a non-retirement mutual fund. Will I have to pay taxes on both dividends and capital gains? Also, will the fund company report those earnings to me on an annual basis?

-- Larry Young

Larry,

Here's a basic rule of thumb: Any income you receive is probably taxable. More specifically, all dividends and capital gains are taxable.

Even if you elect to reinvest your dividends and capital gains, you still owe tax on those amounts. "But I don't ever see that money," you say. I know. Think of it this way. The fund made a dividend distribution. You got a check, so you now owe taxes. Then you decide to put that distribution right back into the fund. When a mutual fund company has a reinvestment program, it just cuts out the middle steps for you. It does not cut out the taxes owed.

A mutual fund is a pass-through entity for tax purposes. That means any income the fund generates must be passed on to its shareholders. So a fund does not report earnings. It's not supposed to have any.

But mutual fund companies are required to send annual and semiannual statements to their shareholders detailing performance and holdings, says John Collins, spokesman for the Investment Company Institute, the mutual fund trade organization. They are not required to forewarn you about upcoming distributions, though.

For more on the mutual fund basics, check out our How to Get Started at Mutual Fund Investing series by TSC Contributing Editor Brenda Buttner.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.

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