FTB Audit Issues – First in a Series
Over the next few months, we will publish articles that focus on common audit issues for both individual and business entity taxpayers. This month, we focus on individual taxpayers.
Some of the most common tax audit issues currently affecting personal income taxpayers are:
- Sale of property through Internal Revenue Code (IRC) 1031 exchanges.
- Schedule D securities transactions.
- Rental real estate losses.
- Head of Household (HOH).
Sale of Property Through an IRC 1031 Exchange
We continue to identify IRC Section 1031 tax issues (Like-Kind-Exchange) including erroneous boot calculations, improper property identifications, and "drop and swap transactions.”
Schedule D Securities Transactions
Common audit issues involving Schedule D securities transactions include overstated stock basis, unreported option premium income, and regulated futures contracts.
Rental Real Estate Losses
Generally, losses from passive activities, including rental real estate, may be deducted only up to the amount of income from passive activities. Any excess loss is carried forward to the following year or years until the interest in the activity is disposed in a fully taxable transaction. In some cases, a taxpayer may classify rental activities as nonpassive for federal purposes. However, for California purposes rental activities are generally considered passive, with a few exceptions.
We continue to audit residency issues. The determination of a taxpayer's residency status is a facts and circumstances issue. In making this determination, we consider where the taxpayer has the closest connections and whether or not they receive substantial benefits and protection from California.
HOH Filing Status
We continue to see adjustments where the qualifying individual's income exceeds the gross income test of $3,700. We also see inconsistent reporting of HOH for Registered Domestic Partners (RDP). For tax years 2007 and later, RDPs must file their California income tax returns using either the Married/RDP filing jointly or Married/RDP filing separately filing status. An RDP may qualify to use the HOH filing only if the requirements are met to be considered not in a registered domestic partnership.Accurately reporting the filing status for your HOH clients could prevent future correspondence or adjustments.