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Be aware of NYS gains tax audits.

Be aware of NYS gains tax audits

Taxing authorities at all levels have been increasing the frequency of audits of various types of taxes in recent months. Among the more vigorous of these examinations are those involving the New York State Real Property Transfer Gains Tax (Gains tax").

There are few taxes that have as high a rate of examination as the Gains tax. While most taxes are audited on a selected basis, the state attempts to examine as many Gains tax returns as possible. In addition, virtually all significant refund claims are audited. With co-op and condominium conversions, since the statute of limitations extends three years beyond the date of transfer of the last unit, most of these filings will be audited during their sellout period or within three years thereafter. Furthermore, pre-transfer audits have become more frequent, with the state requesting more information and documentation before the property transfer rather than upon subsequent examination.

The approach taken by New York State is revenue-driven. Accordingly, real estate developers should be ready for thorough and tough examinations. Any costs claimed which reduce the gain subject to tax will be subject to close scrutiny. Unlike a Federal income tax examination, where a sampling of invoices is examined, New York State auditors will often request and review substantiation for virtually all of the costs claimed. This is especially troublesome when a property was acquired or improved many years ago, at a time when the taxpayer had no need to indefinitely retain bills and other records. Often such a documentation problem can be avoided by providing tax returns or possibly accountants workpapers, but there is no guarantee of success. It usually depends on the nature and amount of the cost claimed.

Owners and developers should be aware that many adjustments proposed by auditors are a result of the application of "office policies," which are based on the New York State Tax Department's interpretation of the Gains tax law. These policies are unwritten, and familiarity with them is obtained only through the handling of audits.

A sampling of frequently encountered issues:

* Brokerage fees -- In computing gain subject to tax the sales price of a property may be reduced by any customary brokerage fee relating to the transfer, if paid by the transferor. If the fee paid by the transferor is in excess of what the state considers customary, a disallowance of the excess will be proposed. Generally on a co-op or condo conversion, the State will allow somewhere in the range of 6-7.

* Interest on construction loans -- Where the proceeds of a loan are used to make capital improvements to real property, the interest costs paid during the construction period may be included as a capital improvement reducing the gain subject to tax. Proposed adjustments will often occur because of the difficulty in determining the construction period. This often arises in a rehab situation where there is no certificate of occupancy obtained which would signify the approximate end of the construction period.

* Rehab expenditures are closely scrutinized to determine the extent of normal maintenance and repairs included in these costs. The Gains tax law is specific in that expenses incurred to repair and maintain the property in a condition of fitness and/or safety, or to preserve such condition, are not allowable.

Additional tax arising from a Gains tax examination is accompanied by interest and, more often than not, penalty. The penalty is assessed at 10 percent of the tax, plus 2 percent per month, not to exceed 25 percent. Therefore, the maximum penalty, which is not tax deductible, is 35 percent. The penalty may be abated when it can be determined that the failure to pay the tax was due to reasonable cause and not due to willful neglect. Owners and developers should be aware that the burden of proof is on the taxpayer to show that the penalty is not justified. The state auditors are extremely strict in this area and will not readily settle the penalty issue, leaving the taxpayer to resolve the penalty assessment through a conciliation conference.

If confronted by a Gains tax examination, the taxpayer should be wary and seek qualified representation at the earliest stage possible.

Larry Weiser, a partner in Friedman Alpren & Green, specializes in the tax and accounting aspects of residential real estate ownership, development and conversion. He is significantly involved with all aspects of the New York State Real Property Transfer Gains Tax.
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Title Annotation:Taxing Situations; New York State
Publication:Real Estate Weekly
Date:Jun 26, 1991
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