199A Deduction. Part I. Overview Of 199A. Final Regs. published 1/18/2019 2

Transcription

1 199A Deduction Part I Overview Of 199A Final Regs. published 1/18/2019 2

2 Final Reg. Effective Dates Generally apply to TYs ending after 1/18/2019. However, tapayers may rely on final regulations, in their entirety, or on the proposed regulations, in their entirety, for taable years ending in calendar year Certain anti-abuse rules in the final regulations apply to TYs ending after 12/22/2017. The new trust anti-abuse rule applies to TYs ending after 8/16/ T-Bs of Partnerships* S Corporations* Sole Proprietorships Eligible Tapayers Individuals Trusts Estates Ag. Cooperatives * Applied at the Partner or S shareholder level 4

3 Maimum 199A Deduction 199A Ded. Qualified Business Income () + Qualified REIT Div. (QRD) + Qualified Publicly Traded Partnership Income (QPTPI) 199A(a) Ag. Coops.: 9% Qualified Production Activity Income (QPAI) 199A(g) 5 Qualified Business Income (detail below) Must be a 162 T-B (not 212). Ordinary income (Sch C, K-1, etc.) Cannot be capital gain (LT or ST). Cannot be a dividend (ecept REIT Div). CAN be negative. 6

4 Capital Gains and Losses To avoid any unintended inferences, the final regulations remove the specific reference to section 1231 and provide that any item of short-term capital gain, shortterm capital loss, long-term capital gain, or long-term capital loss, including any item treated as one of such items under any other provision of the Code, is not taken into account as a qualified item of income, gain, deduction, or loss. To the etent an item is not treated as an item of capital gain or capital loss under any other provision of the Code, it is taken into account as a qualified item of income, gain, deduction, or loss unless otherwise ecluded by section 199A or these regulations. (Final Reg. Preamble) 7 Maimum Reduction in Effective Ta Rate = 7.4% Single H of H MFJ Indiv. Bracket Rate on <$9,525 <$13,600 <$19,050 10% 8% <$38,700 <$51,800 <$77,400 12% 9.6% <$82,500 <$82,500 <$165,000 22% 17.6% <$157,500 <$157,500 <$315,000 24% 19.2% <$200,000 <$200,000 <$400,000 32% 25.6% <$500,000 <$500,000 <$600,000 35% 28% >$500,000 >$500,000 >$600,000 37% 29.6% 8

5 Cannabis Business 280E: No deduction or credit shall be allowed for any amount paid or incurred during the taable year in carrying on any trade or business if such trade or business consists of trafficking in controlled substances. (emphasis added) 9 Taable Income T.I. Warning: when 199A mentions taable income (TI), it generally means TI without regard to the 199A deduction ( 199A(e)(1)). 10

6 Threshold Amount Taable Income of : $315,000 (MFJ) $157,500 (Other) (Inflation adjusted after 2018) 11 When T.I. is Above the Threshold: 1) 199 deduction phases-out for SSTBs 2) The W-2+UBIA limit applies. 12

7 Definition of SSTBs The term specified service trade or business means any trade or business (A) which is described as follows (in 1202(e)(3)(A)) any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, OR 13 any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its [employees or owners], OR (B) which involves the performance of services that consist of: investing and investment management, trading, or dealing in securities, partnership interests, or commodities. 14

8 SSTB Is like any other business if TI is: < $315,000 (MFJ), or < $157,500 (other). No 199A deduction if TI: > $415,000 (MFJ), or > $207,500 (other). Phase-out (of 199A deduction) range: $100,000 (MFJ); $50,000 (other). Reg A-5: Specified service trades or businesses and the trade or business of performing services as an 15 employee. Fully Phased-in W2+UBIA Limit If T.I. eceeds the threshold amounts: The 199A deduction is limited to the greater of: 50% of W-2 wages paid, or 25% of W-2 wages + 2.5% of unadjusted basis immediately after acquisition (UBIA) 16

9 W-2+UBIA Limit Complete tapayer relief from W2+UBIA limit if TI is at or below the threshold amount--$315,000 (MFJ) or $157,500 (other)). Fully-phased in W-2+UBIA limit applies if the tapayer s TI eceeds $415,000 (MFJ) or $207,500 (other). Tapayer is allowed to phase-in the W-2+UBIA limit over a $100,000 range (MFJ) or $50,000 range (Other). Reg A-2: Determination of W-2 Wages and unadjusted basis immediately after acquisition of qualified property. 17 W2+ UBIA Limit W2+ UBIA Limit First Net with Before W2+ UBIA Limit NO W2+UB Limit 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> Qualif. REIT Div. Qualif. PTPI 18

10 W2+UBIA Limit With Aggregation* NO W2+UBIA Limit 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> Qualif. REIT Div. Qualif. PTPI *Aggregation Is Done at the Partner or S Shareholder Level. 19 Form Pg. 2 The 199A deduction is from AGI and available to nonitemizers and itemizers. 20

11 S.E. Ta. The 199A deduction not allowed for SE ta purposes ( 199A(f)(3)). Negative T.I. The 199A deduction will never generate an NOL due to the overall T.I. limit. NOL Deduction. The 199A deduction must be removed from an NOL deduction ( 172(d)(8)). AMT. Is allowed for AMT purposes ( 199A(f)(1)(B)) 21 Final Reg. Clarification on 461(l) Generally, an NOL deduction under 172 does not reduce. An ecess business loss under section 461(l) is treated as a net operating loss carryover to the following taable year and does reduce in the subsequent taable year in which it is deducted. Reg A-3(b)(1)(v) 22

12 Other Business Deductions (per final regs.) For purposes of section 199A only, deductions such as o the deductible portion of the ta on selfemployment income under section 164(f), o the self-employed health insurance deduction under section 162(l), and o the deduction for contributions to qualified retirement plans under section 404 are considered attributable to a trade or business to the etent that the individual s gross income from the trade or business is taken into account in calculating the allowable deduction, on a proportionate basis to the gross income received from the trade or business. 23 Final Reg. Preamble Statement The Treasury Department and the IRS decline to address whether deductions for: unreimbursed partnership epenses, the interest epense to acquire partnership and S corporation interests, and state and local taes are attributable to a trade or business as such guidance is beyond the scope of these regulations. 24

13 Impact of Passive Loss Rules of 469 Passive income is eligible for the 199A deduction. The section 199A deduction is not based on the level of a tapayer's involvement in the trade or business (that is, both active and passive owners of a trade or business may be entitled to a section 199A deduction if they otherwise satisfy the requirements of section 199A and these proposed regulations). Preamble. 25 Suspended Losses Losses suspended under 469 (passive), 465 (at-risk), 704(d) (partner outside basis), and 1366(d)) (S shareholder stock and debt basis) do not reduce. o When freed-up, such losses reduce. Eception: Losses disallowed before o In chronological order from the oldest to the most recent on a FIFO basis (per final regulations). 469 PAL grouping rules do not apply to 199A. 26

14 Clarification in Re-Proposed Regs. In part to prevent confusion if the tapayer s section 469 groupings differ from the tapayer s section 199A aggregations, the 1/18/2019 proposed regulations under section 199A (REG ) treat previously suspended losses as losses from a separate trade or business for purposes of section 199A. 27 Impact on the NIIT The NIIT is 3.8% of the LESSER OF: 1) NII for the ta year, OR 2) The ecess of modified AGI over the threshold amount (250K MFJ or 200K Other) The 199A deduction does not reduce the NII. ( 199A(f)(1)(B)) Because the 199A deduction is from AGI deduction, it does not reduce modified AGI. A profitable rental, if a T-B, will generally be subject to the NIIT and eligible for the 199A deduction. 28

15 Lower Threshold for Substantial Understatement Penalty For any tapayer who claims a 199A deduction: A substantial understatement of income ta, is generally an understatement that eceeds the greater of 10 5 percent of the ta required to be shown on the return or $ 5,000. ( 6662(d)(1(A) modified by (d)(1)(c)) 29 Disregarded Entities An entity with a single owner (such as an SMLLC) that is treated as disregarded as an entity separate from its owner under is disregarded for purposes of 199A Reg A-1(e)(2) 30

16 199A Effective Date: ta years beginning after Dec. 31, 2017, and before Jan. 1, A is applied at the partner or S shareholder level. 31 Calendar year individual PTR in fiscal year PSP: PSP FY 2/1/2017 thru 1/31/2018. Is reported on PTRs 2018 Form PTR gets 199A deduction on all 12 months of (including 11 from 2017). Reverses in Bluebook nies any attempt to also claim prior law 199. Reg A-3(e)(2)(ii),, W-2 wages, and UBIA are all treated as having been incurred by the individual during the individual's taable year in which or with which such RPE taable year ends. (emphasis added) 32

17 Computation if T.I. is At Or Below The Threshold Amount -- Reg A-1(c) 33 Threshold Amount Taable Income of : $315,000 (MFJ) $157,500 (Other) (Inflation adjusted after 2018) 34

18 Recall: When T.I. is At or Below the Threshold: No need to pay W-2 wages No need for unadjusted basis. No difference between a specified service trade or business (SSTB) and any T-B. Irrelevant whether to aggregate T-Bs or not. 35 Overall T.I. Limit For all tapayers, the 199A deduction cannot eceed of T.I. in ecess of net capital gain. 36

19 1(h) Definition of Net Capital Gain (NCG) Net Capital gain (NLTCG NSTCL) ( 1222(11)) + Qualified dividend income. ( 1(h)(11)) 37 Formula 1) Total, plus 2) Qualified REIT Dividend, plus 3) QPTPI = The tentative 199A deduction General rule: The 199A deduction is the lesser of: a)the tentative 199A deduction or b) of taable income minus net capital gain. 38

20 Total Amount The net total qualified business income () from all trades or businesses (including share from RPEs) 39 Total Amount 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> QRD T-B #4 QPTPI * The 199A(a) deduction is the lesser of: (a) the combined amount or (b) taable income (TI) minus net capital gain. 40

21 Eample 2 A married couple (MFJ) owns two qualified T-Bs. Schedule C accounting practice profit of $200,000 in S2 is a 12% partner in a rental real estate partnership and S2 sells the partnership interest in 2018 for a long-term capital gain of $224,000. (Hint: LTCGs are not (detail below)). The disposition frees-up losses, previously suspended (pre-2018 so no reduction) under the 469 passive loss rules of <$100,000>. 41 Taable Income (Pre-199A) Sch. C Accounting Practice 200,000 LTCG on Sale of PSP Interest 224,000 Suspended Losses Freed-up <100,000> AGI 324,000 -Standard Deduction - 24,000 = Taable Income = 300,000 They are below the threshold T.I. of $315,

22 Sch C 200, QRD + QPTPI Sch C 200,000 None 44

23 QRD + QPTPI Tentative 199A Deduction Sch C 200,000 None 40,000* * 200,000 (200K () + 0 (QRD + QPTPI)) = $40, QRD + QPTPI Tentative 199A Deduction TI minus NCG** Sch C 200,000 None 40,000* 15,200** * 200,000 (200K () + 0 (QRD + QPTPI)) = $40,000 ** 76,000 (300,000 (T.I.) 224,000 (net capital gain) = $15,200 46

24 The Lesser of QRD + QPTPI Tentative 199A Deduction TI minus NCG** 199A Ded. Sch C 200,000 None 40,000* 15,200** 15,200 * 200,000 (200K () + 0 (QRD + QPTPI)) = $40,000 ** 76,000 (300,000 (T.I.) 224,000 (net capital gain) = $15, Causes of Lower Deduction Taable Income (Pre-199A) Sch. C Accounting Practice 200,000 LTCG on Sale of PSP Interest 224,000 Suspended Losses Freed-up <100,000> AGI 324,000 -Standard Deduction - 24,000 = Taable Income = 300,000 48

25 Total Amount 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> QRD T-B #4 QPTPI * The 199A(a) deduction is the lesser of: (a) the combined amount or (b) taable income (TI) minus net capital gain. 49 Eception One Net Negative If the total amount is negative, then the 199A deduction for is zero. Carryover. The net negative total amount carries over to the following year and is treated as negative from a separate T-B. 50

26 Net Negative Total Amount Carries Forward to Following Year and Offsets 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> QRD T-B #4 QPTPI 51 Eception Two: Net Negative QRD + QPTPI If the combined amount of qualified REIT dividends and QPTPI is negative, then the 199A deduction for that combined portion (QRD and QPTPI) is zero for the ta year. Carryover. The net negative is carried forward and offsets the combined QRD and QPTPI in the following year. 52

27 Negative [QRD + QPTPI] Carries Forward to Following Year and Offsets QRD + QPTPI 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> QRD T-B #4 <QPTPI> 53 E. 3: Multiple Businesses and a T-B Loss. Married couple filing jointly. S2 has W-2 wage income of $374,000 Qualified REIT Dividend of $40,000. Qualified PTP Income (QPTPI) of $60,000. Two qualified T-Bs: 1) McDonalds Sch. C Restaurant: o Net profit $200,000 in 2018 () 2) Rental real estate T-B (S1 is a REP): o Loss of <$350,000> (S1 materially participates) 11 54

28 Taable Income (Pre-199A) S-2 W-2 Wages Income 374,000 Sch. C McDonalds 200,000 Sch. E Rental Income (T-B) <350,000> (REP) Qualified REIT Dividend 40,000 QPTPI 60,000 AGI 324,000 -Standard Deduction - 24,000 = Taable Income = 300, Sch C 200,000 Rental <350,000> 56

29 Sch C 200,000 Rental <350,000> Total 0 57 Sch C 200,000 Rental <350,000> Total 0 <150,000> Carryover 58

30 QRD + QPTPI Sch C 200, ,000 Rental <350,000> Total 0 Carryover <150,000> 59 QRD + QPTPI Tentative 199A Deduction Sch C 200, ,000 20,000* Rental <350,000> Total Carryover 0 <150,000> * 100,000 ( 0 () + 100,000 (QRD + QPTPI) ) = $20,000 60

31 QRD + QPTPI Tentative 199A Deduction TI minus NCG Sch C 200, ,000 20,000* 60,000** Rental <350,000> Total Carryover 0 <150,000> * 100,000 ( 0 () + 100,000 (QRD + QPTPI) ) = $20,000 ** 300,000 (300,000 (T.I.) $0 (net capital gain) = $60, The Lesser of QRD + QPTPI Tentative 199A Deduction TI minus NCG 199A Deduction Sch C 200, ,000 20,000* 60,000** 20,000 Rental <350,000> Total Carryover 0 <150,000> * 100,000 ( 0 () + 100,000 (QRD + QPTPI) ) = $20,000 ** 300,000 (300,000 (T.I.) $0 (net capital gain) = $60,000 62

32 Draft Form Pg. 2 20, Form 1040 Line 9 Instructions Use the Deduction Simplified Worksheet (keep for your records ) if: 64

33 Recall Our Facts Taable Income (Pre-199A) S-2 W-2 Wages Income 374,000 Sch. C McDonalds 200,000 Sch. E Rental Income (T-B) <350,000> (REP) Qualified REIT Dividend 40,000 QPTPI 60,000 AGI 324,000 -Standard Deduction - 24,000 = Taable Income = 300, Form 1040 Inst. Worksheet 2018 Draft T-B #1 -- McDonalds T-B #2 Rental Loss EIN EIN 200,000 (350,000) Total Income or (Loss) from Line 1(c) (150,000) Qualified Business Carryforward Loss from Prior Year Total if zero or less enter zero Component: Line 4 Qualifed REIT and PTP Income or (Loss) Qualifed REIT and PTP Loss Carryover from Prior Year Total REIT and PTP Income -- If zero or less enter zero Line 8 100, , ,000

34 Deduction Before [T.I.] Limitation. Line [Taable] Income Before Deduction Net Capital Gains * Subtract Line 12 from 11. If zero or less, enter 0 [Taable] Income Limit. Line 13 Deduction: the smaller of Line 10 or 14 Qualified Business Loss Carryforward Qualified REIT & QPTP Loss Carryforward * 300, ,000 20,000 60,000 20,000 (150,000) 0 67 E. 4: Large Itemized Deductions married couple filing jointly. 12 Qualified dividend of $50,000. LTCG $60,000. Sch. C accounting practice profit of $200,000 in 2018 (). Due to large charitable contributions, itemized deductions are $60,

35 Taable Income (Pre-199A) Qualified Divided Income $50,000 Net Long-Term Capital Gain $60,000 Sch. C Accounting Practice $200,000 AGI $310,000 -Itemized Deductions - 60,000 = Taable Income = 250, QRD + QPTPI Sch C 200,000 0 Total 200,000 70

36 QRD + QPTPI Tentative 199A Deduction Sch C 200, ,000* Total 200,000 * 200,000 ( + QRD + QTPPI) = $40, QRD + QPTPI Tentative 199A Deduction TI minus NCG Sch C 200, ,000* 28,000** Total 200,000 * 200,000 ( + QRD + QTPPI) = $40,000 ** 140,000 (250,000 (T.I.) $110,000 (NCG)) = $28,000 72

37 The Lesser of QRD + QPTPI Tentative 199A Deduction TI minus NCG 199A Deduction Sch C 200, ,000* 28,000** 28,000 Total 200,000 * 200,000 ( + QRD + QTPPI) = $40,000 ** 140,000 (250,000 (T.I.) $110,000 (NCG)) = $28, Draft Form Pg. 2 28,000 74

38 Form 1040 Inst. Worksheet 2018 Draft T-B #1 Accounting EIN 200,000 Total Income or (Loss) from Line 1(c) 200,000 Qualified Business Carryforward Loss from Prior Year Total if zero or less enter zero Component: Line 4 Qualifed REIT and PTP Income or (Loss) Qualifed REIT and PTP Loss Carryover from Prior Year Total REIT and PTP Income -- If zero or less enter zero Line ,000 40, Deduction Before [T.I.] Limitation. Line [Taable] Income Before Deduction Net Capital Gains * Subtract Line 12 from 11. If zero or less, enter 0 [Taable] Income Limit. Line 13 Deduction: the smaller of Line 10 or 14 Qualified Business Loss Carryforward Qualified REIT & QPTP Loss Carryforward * 250, , ,000 40,000 28,000 28,

39 , Qualified REIT Dividends, and Qualified PTP Income (Reg A-3) 77 Qualified Business Income 78

40 Qualified Business Income () [The net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the tapayer. Not Qualified REIT dividends (QRDs) Qualified publicly traded partnership income (QPTPI). 79 Relevant Passthrough Entity (RPE) a partnership (other than a PTP) or an S corporation that is owned, directly or indirectly, by at least one individual, estate, or trust.. A trust or estate is treated as an RPE to the etent it passes through, W-2 wages, UBIA of qualified property, qualified REIT dividends, or qualified PTP income. Reg A-1(b)(10) 80

41 What is a T-B? 81 Qualified Trade or Business (T-B) Any T-B under 162 ecept: a T-B of performing services as an employee. Reg A-1(b)(14) 82

42 Employee versus Independent Contractor Employees do not get the 199A deduction. Employees are officers of a corporation and employees under the common law rules. Apparently, statutory employees full-time insurance salesperson, traveling or city salesperson, etc -- are eligible for the 199A deduction. (They receive a W-2, but use Sch C and social security and medicare withheld by the employer ) 83 Misclassified Workers. A worker misclassified by the employer as an independent contractor is is an employee notwithstanding. Rebuttable Presumption. An individual treated as an employee by the employer, and who is subsequently treated as an I.C. while doing substantially the same work, is presumed to be an employee. 84

43 What is a T-B? 162 v. 212 will distinguish a T-B from investment. 85 Rental Real Estate [T]he Treasury Department and IRS recognize the difficulties tapayers and practitioners may have in determining whether a tapayer s rental real estate activity is sufficiently regular, continuous, and considerable for the activity to constitute a section 162 trade or business. (Final Reg. Preamble) 86

44 Notice (Proposed Rev. Proc.) (1/18/2019) 87 Safe Harbor for a Rental Real Estate Enterprise Proposed Rev. Proc. Effective for Ta Years Ending After Dec. 31,

45 Notice Sec. 3 If the safe harbor requirements are met, the real estate enterprise will be treated as a trade or business as defined in section 199A(d) for purposes of applying the regulations under section 199A. RPEs may also use this safe harbor. Failure to satisfy the safe harbor does not preclude a tapayer from otherwise establishing that a rental real estate enterprise is a trade or business for purposes of section 199A. 89 Safe Harbor (Sec of Prop. Rev. Proc.) A rental real estate enterprise (RRE) will be treated as a trade or business if during the taable year : A) Separate books and records are maintained for each RRE. B) For TYB before 1/1/ or more hours of rental services are performed per year with respect to the RRE. C) The tapayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Recordkeeping rule won t apply to TYB before 1/1/

46 Safe Harbor for TYBA 12/31/2022 Instead of merely 250 hours per year : For TYBA December 31, 2022, in any three of the five consecutive taable years that end with the taable year (or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed per year with respect to the rental real estate enterprise. 91 Rental Services (i) advertising to rent or lease the real estate; (ii) negotiating and eecuting leases; (iii) verifying information contained in prospective tenant applications; (iv) collection of rent; (v) daily operation, maintenance, and repair of the property; (vi) management of the real estate; (vii) purchase of materials; and (viii) supervision of employees and independent contractors. Rental services may be performed by owners or by employees, agents, and/or independent contractors of the owners. 92

47 NOT Rental Services The term rental services does not include financial or investment management activities, such as: arranging financing; procuring property; studying and reviewing financial statements or reports on operations; planning, managing, or constructing longterm capital improvements; or hours spent traveling to and from the real estate. 93 Rental Real Estate Enterprise (RRE) [I]s defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. Tapayers must either treat each property held for the production of rents as a separate enterprise or treat all similar properties held for the production of rents (with the eception [described below]) as a single enterprise. Observation: A de facto aggregation option. 94

48 RRE Continued Commercial and residential real estate may not be part of the same enterprise. The individual or RPE relying on this revenue procedure must hold the interest directly or through an entity disregarded as an entity separate from its owner. Observation: Rev. Proc. doesn t apply to a partner s partnership interest in a rental real estate partnership (but such interests can be aggregated, if eligible, under Reg A-4). 95 Real estate used by the tapayer (including an owner or beneficiary of an RPE relying on this safe harbor) as a residence for any part of the year under section 280A is not eligible for this safe harbor. Real estate rented or leased under a triple net lease is also not eligible for this safe harbor. o o Ecluded from Safe Harbor For purposes of this revenue procedure, a triple net lease includes a lease agreement that requires the tenant or lessee to pay taes, fees, and insurance, and to be responsible for maintenance activities for a property in addition to rent and utilities. This includes a lease agreement that requires the tenant or lessee to pay a portion of the taes, fees, and insurance, and to be responsible for maintenance activities allocable to the 96 portion of the property rented by the tenant. (emphasis added)

49 Procedural Requirements for Safe Harbor A tapayer or RPE must include a statement attached to the return on which it claims the section 199A deduction or passes through section 199A information that the requirements in Section 3.03 of this revenue procedure have been satisfied. The statement must be signed by the tapayer, or an authorized representative of an eligible tapayer or RPE, which states: Under penalties of perjury, I (we) declare that I (we) have eamined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete. 97 When is rental real estate a T-B per case law? 98

50 A gross lease in which the landlord is responsible for the repairs and maintenance. Work by employees or agents of the landlord count as done by landlord. Links to my two articles in the Journal of Real Estate Taation are in the tet. Prop. regs. allowed deemed T-B treatment for self-rental to a 50% or more commonly controlled business (Reg A-1(b)(14). 99 Final Reg. Preamble Whether an activity rises to the level of a section 162 trade or business, however, is inherently a factual question and specific guidance under section 162 is beyond the scope of these regulations. The courts have developed two definitional requirements. o One, in relation to profit motive, is said to require the tapayer to enter into and carry on the activity with a good faith intention to make a profit or with the belief that a profit can be made from the activity. o The second is in relation to the scope of the activities and is said to require considerable, regular, and continuous activity. See generally Comm r v. 100 Groetzinger, 480 U.S. 23 (1987).

51 What Groetzinger Actually Said Is betting on greyhound racing a T-B? One also must acknowledge that Higgins, with its stress on eamining the facts in each case, affords no readily helpful standard, in the usual sense, with which to decide the present case and others similar to it. The Court's cases, thus, give us results, but little general guidance. We accept the fact that to be engaged in a trade or business, the tapayer must be involved in the activity with continuity and regularity and that the tapayer's primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement diversion does not qualify. 101 Groetzinger continued We do not overrule or cut back on the Court's holding in Higgins when we conclude that if one's gambling activity is pursued full time, in good faith, and with regularity, to the production of income for a livelihood, and is not a mere hobby, it is a trade or business within the meaning of the statutes with which we are here concerned. Respondent Groetzinger satisfied that test in Constant and large-scale effort on his part was made. Skill was required and was applied. He did what he did for a livelihood, though with a less than successful result. This was not a hobby or a passing fancy or an occasional bet for amusement. 102

52 Draft Pub 535 Instructions on What is a T-B? 103 Campbell v. Comm r, 5 TC 272 (1945) Tapayer inherited residential property in 1934 and tried to rent or sell it. Never used it as his residence. Attempted to rent it, until sold in 1941 at a loss. Campbell sought ordinary loss treatment on sale (v. capital loss) 104

53 The Ta Court Found a Trade or Business Same in Jephson v. Comm r, 37 BTA 1117 (1938), 105 In Hazard v. Comm. r, 7 T.C. 372 (1946), acq CB 3 A single family residential rental in Kansas City was viewed as a trade or business of the tapayer and thus produced an ordinary loss on sale under the predecessor to 1221(a)(2) and

54 Mr. Hazard lived in Pittsburgh (several hundred miles away) and devoted his entire time to his job as general counsel of a Pittsburgh company. 107 Grier v. U.S., 218 F.2d 603 (2nd Cir. 1955) (Rejected Hazard as not four-square with the precedent in Fackler) Grier required a broader activity than a single residential rental, long-term (14 years), to one tenant, with minimal repair activity. Ruled in the tapayer s favor that the rental was an investment activity (IRS sought T-B treatment) thus Grier was allowed a capital loss carryforward. 108

55 Judge Smith in Grier (in italics) The government relies heavily on Gilford, since the court held the sale there to constitute an ordinary loss where tapayer, not in the realty business, acquired under the terms of a will a fractional interest in a building containing stores and apartments. She, with the co-owners, placed the property in the hands of real estate agents who managed it and accounted for the income. The court was impressed with the "necessarily regular and continuous activity" involved in such a large management proposition involving the tapayer. It stressed the constant need to get new rentals, the supplying of services, and the keeping in good repair, citing Fackler and Pinchot, supra. [I]t is the etent of the regular and continuous activity of management involved in such multiple rental situations that impressed the court. That element is not present here In this case the activities with relation to this single dwelling, although of long duration, were minimal in nature. Activity to rent and re-rent was not required. No employees were regularly engaged for maintenance or repair. Lacking the broader activity stressed in Rogers v. U. S., D.C.Conn. 1946, 69 F.Supp. 8, and Pinchot v. C.I. R., Gilford v. C. I. R. and Fackler v. C. I. R., supra, the real estate in this case appears to partake more of the nature of property held for investment than property used in a trade or business.. 110

56 Greir references to broader activity: Pinchot (eleven commercial buildings in New York), Gilford (eight buildings in New York), Fackler (a si-story commercial building), and Rogers (sity-one properties). 111 The IRS has never revoked its acquiescence to Hazard. In GCM (7/27/81) IRS Chief Counsel rejected the IRS National Office audit division request for a reversal of the acquiescence to Hazard. 112

57 Chief Counsel in GCM In the typical case, the tapayer has offered evidence of the various activities involved in managing the rental property and the court has accepted this evidence as indicating that the tapayer was engaged in a trade or business Chief Counsel in GCM The problem that you raise is not with the legal standard applied by the courts, but with the relatively small amount of activity that the court have found to be indicative of a trade or business. In view of the number of cases that have been decided on this issue it is unlikely that the Service could now persuade the courts to take a more restrictive approach 114

58 But we have a split in the Circuits (not merely Ta Court v. 2 nd Circuit) 115 Reiner v. U.S., 222 F.2d 770 (7th Cir. 1955) The issue was whether the tapayer, living in the U.S. could carry back and forward her NOL resulting from the 1944 bombing raid on her rental property (former primary residence) in Austria during WW2 (confiscated by the Nazi gov t for 5 years). 116

59 Seventh Circuit in Reiner, Quoting the Ta Court in LaGriede: It is clear from the facts that the real estate was devoted to rental purposes, and we [the Ta Court] have repeatedly held that such use constitutes use of the property in trade or business, regardless of whether or not it is the only property so used th Circuit in Reiner We add that the use of the property in trade or business was, upon the facts, an operation of the trade or business in which it was so used. It is clear, also, that the business was regularly carried on, there having been no deviation, at any time, from the obviously planned use. Factually indistinguishable from Grier. 118

60 The Ta Court only follows Grier in the Second Circuit (Golsen Rule) 119 Balsamo, TC Memo (1987) Ta Court emphasized that it disagreed with the 2 nd Circuit but eplained that it was bound by the Golsen rule to follow Second Circuit law: [The Ta Court s] position is not controlling for purposes of our decision today. We must decide this issue pursuant to the law as articulated by the Second Circuit [per Golsen]. The case of Grier provides the basis for our conclusion. (Citations omitted). Observation: The IRS has a major hazard of litigation outside of the 2 nd Circuit -- the Hazard line of cases 120

61 Keefe, TC Memo (3/15/19) Footnote 10: This case is appealable to the U.S. Court of Appeals for the Second Circuit, absent a stipulation to the contrary. Sale of land following meager (didn t advertise) attempts to rent: While we have no doubt that petitioners devoted a great deal of time, effort, and epense to the renovation of Wrentham House Mansion, the record overwhelmingly confirms that Wrentham House Mansion was never held out for rent or rented after the restoration was complete. Quite simply, the rental activity with respect to Wrentham House Mansion never commenced in any meaningful or substantive way. 121 Tapayer sought a section 1231 ordinary loss. Ta Court agreed with IRS: not a T- B. 122

62 Keefe Ta Court: The Court of Appeals for the Second Circuit requires that tapayers be engaged in continuous, regular, and substantial activity to support a conclusion that the property was used in a trade or business and was not a capital asset.. ( Grier is settled law in the Second Circuit). 123 Ta Court: Conspicuously absent from the Ta Court s citations and legal standard: Campbell and Jephson Even if the tapayer had rigorously attempted to rent the property (but failed), it would likely not be substantial enough to rise to the level of a T-B in the Second Circuit. Compare, Redisch v. Comm r, TC Memo , the Ta Court ruled that a loss on a second home was a nondeductible personal loss. Minimal attempted rentals were insufficient to convert the personal use to investment use. Even if etensive attempted rental efforts, the tapayer would only achieve investment status with a converted vacation home (Redisch suggests). 124

63 Other Eample of Ta Court in the 2 nd Circuit: Murtaugh TC Memo (1997) Facts: A sale (foreclosure) of two timeshare rentals at a loss -- managed via a property manager. Investment (capital loss) or T-B ( 1231 ord. loss)? IRS stressed Golsen rule and 2 nd Circuit thus Grier. Tapayer focused on distinguishing Grier. Ta Court Holding: A T-B. Overcame Grier, because multiple transient rentals. 125 Murtaugh Follows the Sup. Ct Groetzinger case. To be engaged in a trade or business, there must be continuity and regularity to the activity. Commissioner v. Groetzinger Although it does not appear that the *** [tapayer] did anything herself in connection with the management of these *** buildings, an appreciable amount of time and work was necessarily required on the part of the managing agent. And if such management was a trade or business, the *** [tapayer] was so engaged although she acted only through an agent. [Gilford (2d Cir. 1953).] 126

64 Does the Ta Court (outside of the 2 nd Circuit) ever treat a rental as an investment? Yes! 127 Triple Net Lease Property A net lease in which the tenant is responsible for insurance, taes and repairs, is a mere investment. See McCoach v. Minehill & Schuylkill Haven Railroad Co., 228 U.S. 295 (1913) See also: Neill v. Comm r 46 BTA 197 (1942) mere ownership of property from which income is drawn does not constitute the carrying on of business Herbert v. Comm r, 30 T.C. 26 (1958) (but both Neill and Herbert interpreted 864/871 or prior law equivalent) 128

65 JCT Bluebook Pg. 24 An activity that is treated as a trade or business for all relevant Federal income ta purposes (and that keeps a complete and separable set of books and records) may be treated as a qualified trade or business. For eample, assume that an individual owns a rental building in which the ground floor space is rented to three unrelated commercial establishments (a coffee shop, a drycleaner, and a newsstand) and the upper floors hold apartments rented to residential tenants. For Federal ta purposes, the individual accounts for the rental activities with respect to the entire building using a single set of books and records. 129 JCT Bluebook Pg. 24 continued Assume further that the individual materially participates in the rental activity, cost recovery deductions under section 168 are allowable with respect to the building, and deductions for epenses with respect to operating and maintaining the building are allowable under section 162. Because a complete and separable set of books and records is kept with respect to the entire building (including both the commercial and residential rentals), and because deductions under section 162 are allowable, the real estate rental trade or business is a qualified trade or business for purposes of section 199A. 130

66 Final Reg. Discussion of Multiple T-Bs Whether a single entity has multiple trades or businesses is a factual determination. However, court decisions that help define the meaning of trade or business provide tapayers guidance in determining whether more than one trades or businesses eist. (Final Reg. Preamble) 131 Multiple T-Bs continued The Treasury Department and the IRS also believe that multiple trades or businesses will generally not eist within an entity unless different methods of accounting could be used for each trade or business under (d). Section (d) eplains that no trade or business is considered separate and distinct unless a complete and separable set of books and records is kept for that trade or business. Further, trades or businesses will not be considered separate and distinct if, by reason of maintaining different methods of accounting, there is a creation or shifting of profits and losses between the businesses of the tapayer so that income of the tapayer is not clearly 132 reflected.

67 Deemed T-B Treatment for Self-Rentals [R]ental or licensing of tangible or intangible property (rental activity) that does not rise to the level of a section 162 trade or business is nevertheless treated as a trade or business for purposes of section 199A, if the property is rented or licensed to a trade or business conducted by the individual or an RPE which is commonly controlled under 1.199A-4(b)(1)(i) (regardless of whether the rental activity and the trade or business are otherwise eligible to be aggregated under 1.199A-4(b)(1)). Reg A-4(b)(14). Observation: also applies to a self-rental to an SSTB. 133 Back to 199A T-Bs and 134

68 Sch C income, 1065/1120S K-1 ordinary business income. Ordinary net 1231 loss reduces. Secs and 1250 recapture is. o Bonus depreciation recapture o 179 recapture 481 Adjustments. Eamples of Freed-up losses previously disallowed (including under s 465, 469, 704(d), and 1366(d)) reduce unless pre Income, gain, deduction, and loss to the etent such items are: Allowed in determining T.I. (Sch C, E (K-1s), F) must be effectively connected with the conduct of a trade or business within the United States within the meaning of 864(c). ( 199A(c)(3)(A)). Qualified Items 136

69 Foreign Source Eample (not in tet): U.S. citizen performs services in China and is paid $100,000. Service income is sourced where the services are performed. Foreign source so not U.S. ECI and not. 137 Per the TCJA, sales of inventory are sourced solely based upon where produced (outbound and inbound). 863(b) -- TYBA 2017 E.: Inventory produced in the U.S. and sold in Meico is U.S. source effectively connected income (ECI). 138

70 General Rule and Eception For Inventory Sale General Rule. is ECI. Only U.S. source business income Eception. For inventory, foreign source sales are U.S. ECI if (1) a U.S. office is "a material factor in the production of such income", and (2) the U.S. office "regularly carries on activities of the type from which such income, gain, or loss is derived." 139 Foreign Source Eample: Richard, a U.S. citizen sells inventory in the U.S. that was manufactured (by Richard s sole proprietorship) in Meico. No U.S. office is a material factor in the sale. Foreign source business income thus not ECI so not. Observation: If Richard were a foreign person, he would not be subject to U.S. ta on the sale. 140

71 Rental Real Estate under 864(c) The preamble to the final regulations eplain that: In addition to meeting the safe harbor for a rental real estate enterprise per Notice , and the deemed T-B treatment for commonly controlled self-rentals, the items must be effectively connected to a trade or business within the United States as described in section 864(c). 141 When is Rental Real Estate U.S. ECI? Again, a net lease is not ECI, but section 871(d) allows nonresidents to elect to treat U.S. rental real estate as ECI U.S. T-B Eliminates 30% withholding on gross rents. Can this election be used by a U.S. tapayer to make triple net lease real estate a T-B under section 199A? No. Because section 162 must also be satisfied. 142

72 Preamble Quote (in italics) 871(d) allows a nonresident alien individual to elect to treat income from real property in the United States as effectively connected. However, for purposes of 199A, if items are not attributable to a trade or business under 162, such items do not constitute. How to Elect: Reg (d)(1)(ii). File a statement with the return before the S of L for refunds epires. 143 A Higher Bar Than 162 for Rentals With respect to 864(c)(2), a U.S. business activity must be considerable, continuous, and regular. A higher bar than section 162 (more like Grier). See Lewenhaupt 20 T.C. 151 (1953), aff'd per curiam, 221 F. 2d 227 (9th Cir. 1955); Herbert 30 T.C. 26 (1958), acq C.B. 6; Rev. Rul Solution: With Grier facts, U.S. citizens should make the 871(d) election to overcome 864(c)(2). 144

73 Qualified REIT Dividend (QRD) 145 Qualified REIT dividend. A dividend from a REIT that is: Not a capital gain dividend Not qualified dividend income. Anti-abuse rule in Final Regs.: The REIT stock must be held for the period described in section 246(c)(1)(A) (45 days ) 146

74 2018 Form 1040 Instructions Page Form 1099-DIV 5 Section 199A Dividends 148

75 Mutual Funds (RICs) The 1/18/2019 proposed regulations under section 199A (REG , RIN 1545-BP12): provide rules under which a RIC that receives qualified REIT dividends may pay section 199A dividends. Non-corporate shareholders receiving section 199A dividends would treat them as qualified REIT dividends under section 199A(e)(3), provided the shareholder meets the holding period requirements for its shares in the RIC. (Preamble to Prop. Regs.) The proposed regs. do not allow RICs to pass through qualified PTP income. 149 Qualified Publicly Traded Partnership Income (QPTPI) 150

76 Qualified Publicly Traded Partnership Income. With respect to any qualified T or B, the sum of: Allocable share of income, gain, deduction and loss from a PTP that is not taed as a corporation. Any gain upon disposition if ordinary income under 751(a) or (b) (per Prop. Regs.) 151 Determination Of W-2 Wages And UBIA Reg A-2 152

77 W-2 Wages 153 Definition Total wages (defined in 3401(a)), plus Elective deferrals, and Deferred compensation Designated Roth Contributions. 154

78 W-2 Wages must be properly allocable to the ( 199A(b)(4)(B) No related party prohibition. The definition of W-2 wages includes amounts paid to officers of an S corporation and common-law employees of an individual or RPE. 155 Treasury declined to include a commentator s request that tapayers should be able to include wages paid during the 12 months prior to the sale, disposition, or other transactions involving a business segment that generates LIFO and depreciation recapture. Lesson: All such transactions early in the year can be short on W-2 wages paid. 156

79 Third Party Payors OK W-2 wages, an individual or RPE may take into account any W-2 wages paid by another person and reported by the other person on Forms W-2 with the other person as the employer listed in Bo c of the Forms W-2, provided that the W-2 wages were paid to common law employees or officers of the individual or RPE for employment by the individual or RPE. Reg A-2(b)(2)(ii). Observation: This is a green light for professional employer organizations (PEOs) companies that provide payroll and other services to small and midsize businesses (AKA: employee leasing ( coemployers )). 157 Notice (Trumps Notice ) Applies to TYs Ending After 12/31/2017 W-2 wages to a statutory employee ( 3121(d)(3)) do not count. Is limited to employees as defined in 3121(d)(1) and (2): officers of a corporation and employees of the person under the common law rules. Three Methods to determine W-2 wages (the higher the better) 158

80 159 1) Unmodified Bo Method The lesser of W-2 Bo 1 or Bo 5. (Bo 1 does not include elective deferrals) 2) Modified Bo 1 Method W-2 Bo 1 minus Bo 1 amounts not wages subject to withholding (such as supplemental unemployment comp. benefits). Plus amounts in Bo 12 Codes D,E,F,G,S (Elective Deferrals and salary reductions 160 under SIMPLE plans)

81 3) Tracking Wages Method W-2 Wages subject to fed. income ta withholding, plus Amounts in Bo 12, coded D,E,F,G and S. 161 Social Security Admin. (SSA) Filing Deadline To be counted, the W-2 wages must be filed with the SSA on or before the 60 th day after the due date (including etensions). W-2 and W-3 (transmittal form) are generally due to SSA by January 31. Corrected W-2 and W-3 (W2c and W3-c) are due to SSA by January

82 Allocable Share of W-2 Wages Once W-2 wages for each T-B have been determined, each individual or RPE must identify the amount of W-2 wages properly allocable to for each T-B. W-2 wages are properly allocable to if the associated wage epense is taken into account in computing under 1.199A-3. Reg A-2(b)(2)(iv)(C)(4) 16 3 UBIA (Unadjusted Basis Immediately After Acquisition) 164

83 Qualified property" is Qualified Property any tangible property, subject to depreciation ( 199A(b)(6(A)). Held at year end and available for use. Used at any point during the year in the business. If the depreciable period has not ended. 165 Depreciable period begins when the property is first placed in service and Ends on the LATER OF 1)10 years, or 2)The last day of the last full year in the applicable recovery period (not ADS). 166

84 Meaning of Unadjusted Basis Use the basis on the placed in service date, but ignore all depreciation including bonus depreciation, and ignore any section 179 epense. 167 Anti-Abuse Rule Property is not qualified property if the property is acquired within 60 days of the end of the taable year and disposed of within 120 days of acquisition without having been used in a trade or business for at least 45 days prior to disposition, unless the tapayer demonstrates that the principal purpose of the acquisition and disposition was a purpose other than increasing the section 199A deduction. Reg A-2(c)(1)(iv) 168

85 Eample A Sch C. Business purchases a machine for $500,000 (5 year MACRS life) in 2013 and claims regular MACRS depreciation. $500,000 unadjusted basis through 2022 (10 years) 5 years beyond its MACRS life (unless disposed of earlier) Won t work with de minimis safe harbor. No unadjusted basis. 169 Eample B In 2013, tapayer purchases a commercial building for $5 mil. that is depreciable over 39 years (on leased land). $5 mil. unadjusted basis through 2051 unless disposed of earlier. 2.5% $5 mil. = $125,

86 UBIA of Qualified Property Partners. Each partner s share of the UBIA of qualified property is determined in accordance with how depreciation would be allocated for section 704(b) book purposes under Reg (b)(2)(iv)(g) [adjustments to reflect book value] on the last day of the taable year. o The Treasury Department and the IRS request comments on whether a new regime is necessary in the case of a partnership with qualified property that does not produce ta depreciation during the taable year. (Final reg. preamble). Reg (a)(3)) 171 S corporations. Each shareholder s share of UBIA of qualified property is a share of the unadjusted basis proportionate to the ratio of shares in the S corporation held by the shareholder on the last day of the taable year over the total issued and outstanding shares of the S corporation. (Final reg. preamble) Penalty if Not Reported. The UBIA of qualified property is presumed to be zero if not determined and reported for each trade or business. 172

87 Property Contributed to Partnerships and S Corporations. Qualified property contributed to a partnership or S corp. in a nonrecognition transaction retains its UBIA on the date it was first placed in service by the contributing partner or shareholder decreased by money received or increased by money paid in the transaction (contrary to proposed regs). (Reg A-2(c)(3)(iv)) The depreciable period begins on the date the contributing PTR or S shareholder placed the property in service. See E. (8) in Reg A Election Adjustments Ecess section 743(b) basis adjustments (defined in reg A- 2(a)(3)(iv)(B)) are treated as qualified property (contrary to prop. regs). Otherwise, basis adjustments under sections 734(b) and 743(b) are not treated as qualified property. 174

88 Ecess 743(b) Basis Adjustment. The partner increases UBIA by the ecess of-- (1)The partner s 743(b) adjustment with respect to an item of qualified property, over (2)The partner s 743(b) basis adjustment calculated as if the adjusted basis of all of the partnership s property was equal to the UBIA of such property. See Reg A-2(a)(3)(iv) and see E. (1) (positive adjustment) and E. (2) (negative adjustment) 175 An ecess section 743(b) basis adjustment is treated as being placed in service when the transfer of the partnership interest occurs. The recovery period for such property is determined under reg (j)(4)(i)(B) with respect to positive basis adjustments and reg (j)(4)(ii)(B) with respect to negative basis adjustments. Observation: UBIA from a section 743(b) adjustment could have arisen well before It will require reconstruction for prior years and won t be on the prior year K-1s. 176

89 Eample (1) (Similar to Reg A-2(a)(3)(iv) E. 1) A, B, and C are equal partners in partnership, PRS. PRS has a single trade or business that generates. PRS has no debt and and only one asset, a single item of qualified property with an inside adjusted basis of $600,000, and a UBIA (cost) equal to $900,000. Each partner s share of inside adjusted basis and inside UBIA is $200,000 and $300,000 respectively. A sells its one-third interest in PRS to T for $350,000 when a section 754 election is in effect. 177 T s 743(b) adjustment is 150,000 ($350,000 (T s O.B.) minus 200,000 (T s (inside A.B.)). T s 743(b) adjustment using inside UBIA is $50,000 (350,000 (T s O.B.) minus 300,000 (T s inside UBIA). Ecess 743(b) adjustment: 100,000 ($150,000 50,000) Therefore, T s UBIA is equal to 400,000 (300,000, T s one-third share of the qualified property s UBIA, plus 100,000, T s ecess 743(b) basis adjustment ). Observation: T s depreciable period begins on the purchase date for the 100,000 ecess. 178

90 Reduced 743(b) Basis Adjustment. The partner reduces UBIA by the ecess of (1) The partner s 743(b) basis adjustment calculated as if the adjusted basis of all of the partnership s property was equal to the UBIA of such property, over (2) The partner s 743(b) adjustment with respect to an item of qualified property. See Reg A-2(a)(3)(iv) Eample (2) 179 Eample (2) (Similar to Reg A-2(a)(3)(iv) E. 2) Same facts as Eample (1) ecept A sells its one-third interest in PRS to T for $200,000 when a section 754 election is in effect. T s 743(b) adjustment using inside UBIA is <100,000> ($200,000 (T s O.B.) minus $300,000 (T s inside UBIA). T s 743(b) adjustment is zero ($200,000 T s O.B. minus $200,000 (T s inside A.B.)). Reduced 743(b) adjustment: <100,000> (<100,000> - 0) Therefore, T s UBIA is equal to $200,000 ($300,000 (1/3 of inside UBIA) 100,000 (Reduced adjustment) 180

91 Eample (3) (same as reg. eample (2)) Same facts as Eample (2) ecept T s inside basis is $250,000 (PSP inside basis is $750,000) T s 743(b) adjustment using inside UBIA is <100,000> ($200,000 (T s O.B.) minus $300,000 (T s inside UBIA). T s 743(b) adjustment is <$50,000> ($200,000 T s O.B. minus $250,000 (T s inside basis)). Reduced 743(b) adjustment: <50,000> (<100,000> - <50,000>) Therefore, T s UBIA is equal to $250,000 ($300,000 (1/3 of inside UBIA) 50,000 (Reduced adjustment)) 181 Preamble Comments on 734 Adjustments The Treasury Department and the IRS do not believe that a section 734(b) adjustment is an acquisition of qualified property for purposes of determining UBIA. The Treasury Department and the IRS do not believe that the adjustment to basis is an acquisition for purposes of section 199A. The Treasury Department and the IRS continue to study this issue. 182

92 Qualified Property Acquired In Transactions Described In Section 168(i)(7)(B). [I]f qualified property is acquired in a transaction described in section 168(i)(7)(B) (pertaining to treatment of transferees in certain nonrecognition transactions), the transferee s UBIA in the qualified property shall be the same as the transferor s UBIA in the property, decreased by the amount of money received by the transferee in the transaction or increased by the amount of money paid by the transferee to acquire the property in the transaction. For eample, the partnership s UBIA in qualified property carries over to a partner that receives a distribution of the qualified property. 183 Reg. Eample (9) 1/5/2012, LLC (PSP) purchases depreciable T-B Machinery Z for $30K and uses it in its T-B. 12/31/2018, A s adjusted basis in Machinery Z is $7,500 a 10 year recovery period (LLC uses straight-line). On 1/1/2019, LLC distributes Machinery Z to PTR A in full liquidation of A s PSP interest. A s O.B. is $35K. A s UBIA from 2011 through 2018 is its $30,000 cost basis. Under section 732(b), PTR A s basis in Machinery Z is $35K (O.B.) Partner A s UBIA of Machinery Z is $30,

93 Inherited Property In the case of qualified property acquired from a decedent and immediately placed in service, the UBIA of the property will generally be the fair market value at the date of the decedent s death under section A new depreciable period for the property begins as of the date of the decedent s death. 185 Like-Kind Echanges Replacement Property Unadjusted Basis The UBIA of qualified like-kind property that a tapayer receives in a section 1031 like-kind echange is the UBIA of the relinquished property (contrary to proposed regs.) 186

94 Like-Kind Echange Depreciable Period Subject to one eception, for purposes of determining the depreciable period: The date the echanged basis in the replacement qualified property is first placed in service by the trade or business is the date on which the relinquished property was first placed in service by the individual or RPE and The date the ecess basis in the replacement qualified property is first placed in service by the individual or RPE is the date on which the replacement qualified property was first placed in service by the individual or RPE. Similar rules for involuntary conversions. 187 Reg. Eample (1) 1/5/2012, A purchases depreciable real property X (RPX) for $1 mil and uses it as a T- B. 12/31/2018, A s adjusted basis in RPX is $821,550. A s UBIA is $1 mil. regardless of any later depreciations deductions and resulting basis adjustments under section 1016(a)(2). 188

95 Reg. Eample (2) -- E. (1) Continued 1/15/2019, A enters into a 1031 echange and echanges RPX for RPY. Both properties are worth $1 mil. so no cash or other property is involved. A s adjusted basis in RPX on the echange date is $820,482. A s UBIA in RPY (the replacement property) is $1 mil placed in service by A on 1/5/2012 (for 199A purposes only). 189 Adjustment for Ecess Boot The tapayer s UBIA in the replacement property is adjusted downward by the ecess of any money or the fair market value of other property received by the tapayer in the echange over the tapayer s appreciation in the relinquished property (ecess boot). o Appreciation for this purpose is the ecess of the relinquished property s fair market value on the date of the echange over the fair market value of the relinquished property on the date of acquisition by the tapayer. o This reduction reflects a partial liquidation of the tapayer s investment in qualified property. 190

96 Reg. Eample (3) Same as Eample (2) ecept both RPX and RPY are worth $1.3 million on the echange date (1/15/2019). A s adjusted basis in RPX on the echange date is $820,482. Same answer as Eample (2). A s UBIA in RPY (the replacement property) is $1 mil placed in service by A on 1/5/2012 (for 199A purposes only). 191 Reg. Eample (5) E. (1) Continued 1/15/2019, A enters into a 1031 echange and echanges RPX for RPY. RPX has appreciated to $1.3 mil. but RPY has an FMV of $1 mil so A receives $300,000 cash. A s adjusted basis in RPX on the echange date is $820,482. A s UBIA in RPY (the replacement property) is $1 mil.: o $1 mil minus ecess boot of zero ($300K cash received minus $300,000 appreciation in RPX) placed in service by A on 1/5/2012 (for 199A purposes) 192

97 Reg. Eample (6) E. (1) Continued 1/15/2019, A enters into a 1031 echange and echanges RPX for RPY. RPX has appreciated to $1.3 mil. but RPY has an FMV of $900,000 so A receives $400,000 cash. A s adjusted basis in RPX on the echange date is $820,482. A s UBIA in RPY (the replacement property) is $900K: o $1 mil minus ecess boot of 100K ($400K cash received minus $100,000 appreciation in RPX) placed in service by A on 1/5/2012 (for 199A purposes) 193 Reg. Eample (7) E. (1) Continued 1/15/2019, A enters into a 1031 echange and echanges RPX for RPY. RPX has declined in value from $1,000,000 (cost) to $900,000 and RPY also has an FMV of $900,000. A s adjusted basis in RPX on the echange date is $820,482. A s UBIA in RPY (the replacement property) is $1 mil because no cash or other property was involved in the echange placed in service by A on 1/5/2012 (for 199A purposes) 194

98 Receipt of Non-Like-Kind Property If the tapayer receives other property in the echange that is qualified property, the tapayer s UBIA in the qualified other property will equal the fair market value of the other property. o Thus qualified other property is treated, for UBIA purposes, as if the tapayer receives cash in the echange and uses that cash to purchase the qualified property. 195 Adjustment for Boot Paid If the tapayer adds money or other property to acquire replacement property, the tapayer s UBIA in the replacement property is adjusted upward by the amount of money paid or the fair market value of the other property transferred to reflect additional tapayer investment. 196

99 Reg. Eample (4) E. (1) Continued 1/15/2019, A enters into a 1031 echange and echanges RPX for RPY. RPX has appreciated to $1.3 mil. but RPY has an FMV of $1.5 mil so A pays $200,000 cash. A s adjusted basis in RPX on the echange date is $820,482. A s UBIA in RPY (the replacement property) is $1.2 mil.: $1 mil placed in service by A on 1/5/2012, plus $200,000 placed in service by A on 1/15/ Involuntary Conversions The rules are similar to like-kind echanges ecept: o appreciation for this purpose is the difference between the fair market value of the converted property on the date of the conversion over the fair market value of the converted property on the date of acquisition by the tapayer. o In addition, other property is property not similar or related in service or use to the converted property. 198

100 Computation if T.I. is Above The Threshold Amount -- Reg A-1(d) 199 Final Reg. Ordering Rule 1) Determine, W-2 wages and UBIA for each SSTB. 2) Aggregate, if eligible and chosen. 3) Netting of Loss. If from one T-B (including aggregated T-Bs) is negative, offset against positive in proportion to net positive in the T-Bs. 4) Calculate the component. Special Loss Rule: If from all T-Bs is less than zero, then the component is zero and is carried forward as a separate T-B; W2+UBIA disappears. Reg A-1(d)(2) (i) (iv) s200

101 Threshold Amount For TYBB 2019: $315,000 (MFJ) $157,500 (Other) (Inflation adjusted after 2018) 201 When T.I. is Above the Threshold: 1) 199 deduction phases-out for SSTBs 2) The W-2+UBIA limit applies. o Aggregation of T-Bs may be available to minimize the W-2+UBIA limit (not an option for SSTBs). 3) The overall T.I. limit still applies. 202

102 Formula 1) The Component, plus 2) (QRD and QPTPI Component) = The tentative 199A deduction General rule: The 199A deduction is the lesser of: a)the tentative 199A deduction or b) of taable income minus net capital gain. 203 Definition of component The sum of the following for each T-B: The lesser of: 1) (as modified for SSTBs) 2) The greater of: i. 50% W-2 wages, or ii. 25% W-2 wages + 2.5% UBIA 204

103 Prop. Reg. Language Component QRD + QPTPI Component 199A Ded. Sub. (a) T-B #1 T-B #2 T-B #3 <> QRD T-B #4 QPTPI * The 199A(a) deduction is the lesser of: (a) the combined components or (b) taable income (TI) minus net capital gain. 205 First Step Determine the phase out of, W-2 wages, and UBIA for any SSTB: 206

104 Phase-Out For SSTBs Applies to SSTBs with TI above the threshold amount and within the phase-out range. Only the applicable percentage of, W-2 wages, and unadjusted basis are taken into account for purposes of 199A 207 The Applicable Percentage 100% minus the percentage equal to the following ratio: TI Threshold Amount ($315K (MFJ) or 157.5K (other) Phase-out range (100K (MFJ) or 50K (other)) 208

105 SSTB Eample S1 is the sole-proprietor of a law practice that earns a net profit () of $200,000. o W-2 wages paid of $100,000 o UBIA of $100,000 The couple files a joint return. The couple s TI (pre- 199A) is $340,000 (due to S2 s W- 2 wages earned). 33 The applicable percentage is 75% calculated as follows: 100% - 25% ($25,000 ($340,000 - $315,000) $100,000). 209 $150,000 of for the law practice (75% $200,000). $75,000 of W-2 wages (75% 100,000) are treated as paid. $75,000 of UBIA (75% 100,000). 210

106 Pub 535: Schedule A SSTBs Keep for Your Records W-2 Wages UBIA T.I. Threshold Line 5 minus Line 6 Phase-In Range LAW Practice , , , , ,000 25, ,000 Line % Applicable Percentage = 100% minus Line 9 75% Line 2 75% (Applicable Percentage) 150,000 Line 3 75% (Applicable Percentage) 75,000 Line 4 75% (Applicable Percentage) 75, If Beyond the Phase-Out Range for SSTB No. No W-2 Wages. No UBIA. No 199A deduction for the SSTB. 212

107 W2+UBIA Limit and Phase-in 213 If a Fully Phased in W2+UBIA Limit, then the component is: The sum of the following for each T-B: The lesser of: 1) (as reduced for SSTBs) 2) The greater of: i. 50% W-2 wages, or ii. 25% W-2 wages + 2.5% UBIA 214

108 Eample (1) Fully Phased-in W2+UBIA Limit A married couple owns rental real estate (T-B#1) that constitutes a qualified T-B and earns a net profit () of $200,000. The couple files a joint return. Due to one spouse s W-2 wages of $244,000, the couple s TI (pre- 199A) is $420,000 (they claim the standard deduction). The maimum 199A(a) deduction is $40,000 ( 200,000). The couple s unadjusted basis in the depreciable rental property (building and related personalty) is $2,000,000. They do not pay any W-2 wages Taable Income (Pre-199A) S2 s W-2 Wage Income 244,000 Sch. E Rental T-B 200,000 AGI 444,000 -Standard Deduction - 24,000 = Taable Income = 420,

109 T-B#1 200,000 40, The Greater of 50% of 25% of W-2 Wages W-2 Wages + 2.5% U.B. T-B#1 200,000 40, ,

110 The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component T-B#1 200,000 40, ,000 40, The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component T-B#1 200,000 40, ,000 40,

111 The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component Tentat. 199A Ded. (Combined Amount) T-B#1 200,000 40, ,000 40, ,000 The 199A deduction is $40,000 (the lesser of $40,000 (the tentative 199A deduction) or $84,000 ( $420,000 (TI) 0 (NCG)) 221 Observation Same answer if T.I. were say $340,000 due to lower W-2 wages of the spouse. The partially phased-in W-2 limit is never more than the fully phased-in limit. 222

112 Eample (2) Fully Phased-in W2+UBIA Limit Same facts as Eample 1 above (T.I. is $420,000), in which the couple s is from rental real estate is $200,000 but with one change, the unadjusted basis of the building is $640,000 (instead of $2,000,000). 2.5% $640,000 is $16,000 so the fully phased-in W2+UB limit is $16,000. Recall, No W-2 wages are paid. Taable Income (Pre-199A) S2 s W-2 Wage Income 244,000 Sch. E Rental T-B 200,000 AGI 444,000 -Standard Deduction - 24,000 = Taable Income = 420, The Greater of 50% of 25% of W-2 Wages W-2 Wages + 2.5% U.B. T-B#1 200,000 40, ,

113 The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component Tentat. 199A Ded. (Combined Amount) T-B#1 200,000 40, ,000 16, ,000 The 199A deduction is $16,000 (the lesser of $16,000 (the tentative 199A deduction) or $84,000 ( $420,000 (TI) 0 (NCG)) 225 Phase-In of W2+UBIA Limit The W2+UB limit phases in by reducing the maimum deduction by the product of an ecess amount multiplied by a fraction. 226

114 The ecess amount is the ecess (if any) of the maimum 199A deduction ( ) over the fully phased-in W-2+UB limit. The ecess amount is multiplied by a fraction: Ecess Amount TI Threshold Amount ($315K (MFJ) or 157.5K (other) Phase-out range (100K (MFJ) or 50K (other)) The product reduces the maimum deduction. 227 Eample (3A) Phased-in W2+UBIA Limit Same facts as Eample 2 ecept the spouse s W-2 wages are $164,000 (instead of $244,000). Recall, the couple s unadjusted basis in the depreciable rental property (building and related personalty) is $640,000. They do not pay any W-2 wages. If fully phased-in the W2+UBIA Limit is $16,000 (2.5% 640K) Taable Income (Pre-199A) S2 s W-2 Wage Income 164,000 Sch. E Rental T-B 200,000 AGI 364,000 -Standard Deduction - 24,000 = Taable Income = 340,

115 The ecess amount is $24,000 ($40,000 (maimum 199A deduction) - $16,000 (fully phased-in W2+UB limit)). The phased-in reduction of the maimum 199A deduction is $6,000 calculated as follows: $24,000 $340,000 - $315,000 $100K = $6,000 The tentative deduction is $34,000 ($40,000 minus $6,000), which is the 199A deduction because the TI-NCG limit is $68,000 ( 340,000). 229 Pub 535: Worksheet Part 1: Line 1 Keep for Your Records T-B #

116 Part II: Lines 2 thru 16 Line 2: 200,000 Line 3: 40,000 Line 4: W-2 Wages 0 Line 5: Line 4 50% 0 Line 6: Line 4 25% 0 Line 7: UBIA 640,000 Line 8: Line 7 2.5% 16,000 Line 9: Add Lines 6 and 8 Line 10: Greater of 5 or 9 16,000 16,000 Line 11: W-2+UBIA Limit -- Lesser of 3 or 10 16,000 Line 12: Phase-in Reduction from Part III Line 26, if any 231 Part III: Phased-In Reduction of W2+UBIA Limit Line 17: Enter Amt. from Line 3 Line 18: Enter Amt. from Line 10 Line 19: Line 17 minus Line 18 Line 20: T.I. before 199A deduction Line 21: T.I. Threshold for MFJ Line 22: Line 20 minus Line 21 Line 23: Phase-in Range for MFJ 340, ,000 25, ,000 40,000 (Ma. Ded.) 16,000 (Ma. W-2+UBIA Limit) 24,000 Line 24: Phase-in Percentage 25% Line 25: Line 24 Line 19 6,000 Line 26: after Reduction: Line 4 75% (Applicable Percentage) Line 17 minus Line 25 34,000 (40,000 75,000 6,000) 232

117 Finish Part II: Lines 2 thru 16 Line 2: 200,000 Line 3: 40,000 Line 4: W-2 Wages 0 Line 5: Line 4 50% 0 Line 6: Line 4 25% 0 Line 7: UBIA 640,000 Line 8: Line 7 2.5% 16,000 Line 9: Add Lines 6 and 8 16,000 Line 10: Greater of 5 or 9 16,000 Line 11: W-2+UBIA Limit -- Lesser of 3 or 10 16,000 Line 12: Phase-in Reduction from Part III Line 26, if any Line 13: Greater of 11 or 12 Line 14: Patron Reduction, if any Line 15: Component for each T-B: Line Line 16: Total Component: Add 15s 34,000 34,000 N/A 34,000 34, Part IV Determine Your Deduction Line 27: Total Component from all T-Bs 34,000 Line 28: Qualified REIT Div and Qualified PTPI or <L> 0 Line 29: Qualified REIT Div and QPTPI Loss PY Carryover <0> Line 30: Total Qualifed REIT Div and QPTPI: Add Lines 28 and 29 0 Line 31: REIT and PTP Component: Line 30 0 Line 32: Deduction Before Income Limitation Line 33: T.I. Before Deduction 340,000 Line 34: Net Capital Gain 0 Line 35: Subtract Line 34 from Line ,000 Line 36: Line 35 (340,000 ) Line 37: Deduction: Smaller of Line 32 or 36 Line 38: Qualified REIT and QPTP loss carryforward Line 39: DPAD from Ag. Cooperative. Don t enter more than line 33 minus line 37. Enter on Line 1040 Line 10 (T.I.). 34,000 68,000 34,000 0 N/A 234

118 Eample (3B) Same as 3B but zero UBIA (and still zero W-2 wage) Taable Income (Pre-199A) S2 s W-2 Wage Income 164,000 Sch. E Rental T-B 200,000 AGI 364,000 -Standard Deduction - 24,000 = Taable Income = 340, Part II: Lines 2 thru 16 Line 2: 200,000 Line 3: 40,000 Line 4: W-2 Wages 0 Line 5: Line 4 50% 0 Line 6: Line 4 25% 0 Line 7: UBIA 0 Line 8: Line 7 2.5% 0 Line 9: Add Lines 6 and 8 Line 10: Greater of 5 or Line 11: W-2+UBIA Limit -- Lesser of 3 or 10 0 Line 12: Phase-in Reduction from Part III Line 26, if any 236

119 Part III: Phased-In Reduction of W2+UBIA Limit Line 17: Enter Amt. from Line 3 Line 18: Enter Amt. from Line 10 Line 19: Line 17 minus Line 18 Line 20: T.I. before 199A deduction Line 21: T.I. Threshold for MFJ Line 22: Line 20 minus Line 21 Line 23: Phase-in Range for MFJ 340, ,000 25, ,000 40,000 (Ma. Ded.) 40,000 Line 24: Phase-in Percentage 25% Line 25: Line 24 Line 19 10,000 Line 26: after Reduction: 0 (Ma. W-2+UBIA Limit) Line 4 75% (Applicable Percentage) Line 17 minus Line 25 30,000 75,000 (40,000 10,000) 237 Finish Part II: Lines 2 thru 16 Line 2: 200,000 Line 3: 40,000 Line 4: W-2 Wages 0 Line 5: Line 4 50% 0 Line 6: Line 4 25% 0 Line 7: UBIA 0 Line 8: Line 7 2.5% 0 Line 9: Add Lines 6 and 8 0 Line 10: Greater of 5 or 9 0 Line 11: W-2+UBIA Limit -- Lesser of 3 or 10 0 Line 12: Phase-in Reduction from Part III Line 26, if any Line 13: Greater of 11 or 12 Line 14: Patron Reduction, if any Line 15: Component for each T-B: Line Line 16: Total Component: Add 15s 30,000 30,000 N/A 30,000 30,

120 Part IV Determine Your Deduction Line 27: Total Component from all T-Bs 30,000 Line 28: Qualified REIT Div and Qualified PTPI or <L> 0 Line 29: Qualified REIT Div and QPTPI Loss PY Carryover <0> Line 30: Total Qualifed REIT Div and QPTPI: Add Lines 28 and 29 0 Line 31: REIT and PTP Component: Line 30 0 Line 32: Deduction Before T.I. Limit: Line 27 + Line 31 Line 33: T.I. Before Deduction 340,000 Line 34: Net Capital Gain 0 Line 35: Subtract Line 34 from Line ,000 Line 36: Line 35 (340,000 ) Line 37: Deduction: Smaller of Line 32 or 36 Line 38: Qualified REIT and QPTP loss carryforward Line 39: DPAD from Ag. Cooperative. Don t enter more than line 33 minus line 37. Enter on Line 1040 Line 10 (T.I.). 30,000 68,000 30,000 0 N/A 239 Eample (7) Multiple Businesses No Aggregation F, an unmarried individual, owns as a sole proprietor 100 percent of three trades or businesses, Business X, Business Y, and Business Z. None of the businesses are SSTBs and all income is effectively connected with a U.S. trade or business. No capital gains or losses are reported. None of the businesses hold qualified property. F does not aggregate the trades or businesses under 1.199A-4. For taable year 2018: Business X generates $1 million of and pays $500,000 of W-2 wages with respect to the business. Business Y also generates $1 million of but pays no wages. Business Z generates $2,000 of and pays $500,000 of W-2 wages with respect to the business. 240

121 W-2 Wages Pd. UBIA T-B: X 1,000, ,000 0 T-B: Y 1,000, T-B: Z 2, ,000 0 F also has $750,000 of wage income from employment with an unrelated company. After allowable deductions unrelated to the businesses, F's taable income is $2,722, The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component Tentat. 199A Ded. (Combined Amount) X T-B 1,000, , , , ,

122 The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component Tentat. 199A Ded. (Combined Amount) X T-B 1,000, , , , ,000 Y T-B 1,000, , The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component Tentat. 199A Ded. (Combined Amount) X T-B 1,000, , , , ,000 Y T-B 1,000, , Z T-B 2, , ,

123 The Lesser of The Greater of 50% of W-2 Wages 25% of W-2 Wages + 2.5% U.B. Component QRD + QPTPI Component Tentat. 199A Ded. (Combined Amount) X T-B 1,000, , , , ,000 Y T-B 1,000, , Z T-B 2, , , Total 2,002, , ,400 The 199A deduction is $200,400 (the lesser of $200,400 (tentative deduction) or $544,400 ( $2,722,000 (TI) 0 (NCG)) 245 Pub 535: Worksheet Part 1: Line 1 Keep for Your Records X T-B Y T-B Z T-B

124 Part II: Lines 2 thru 16 Line 2: 1,000,000 1,000,000 2,000 Line 3: 200, , Line 4: W-2 Wages 500, ,000 Line 5: Line 4 50% 250, ,000 Line 6: Line 4 25% 125, ,000 Line 7: UBIA Line 8: Line 7 2.5% Line 9: Add Lines 6 and 8 125, ,000 Line 10: Greater of 5 or 9 250, ,000 Line 11: W-2+UBIA Limit -- Lesser of 3 or , Line 12: Phase-in Reduction from Part III Line 26, if any N/A N/A N/A Line 13: Greater of 11 or , Line 14: Patron Reduction, if any Line 15: Component for each T-B: Line 16: Total Component: Add 15s N/A N/A N/A 200, , Part IV Determine Your Deduction Line 27: Total Component from all T-Bs 200,400 Line 28: Qualified REIT Div and Qualified PTPI or <L> 0 Line 29: Qualified REIT Div and QPTPI Loss PY Carryover <0> Line 30: Total Qualifed REIT Div and QPTPI: Add Lines 28 and 29 0 Line 31: REIT and PTP Component: Line 30 0 Line 32: Deduction Before T.I. Limit: Line 27 + Line 31 Line 33: T.I. Before Deduction 2.722,000 Line 34: Net Capital Gain 0 Line 35: Subtract Line 34 from Line 33 2,722,000 Line 36: Line 35 (2,722,000 ) Line 37: Deduction: Smaller of Line 32 or 36 Line 38: Qualified REIT and QPTP loss carryforward Line 39: DPAD from Ag. Cooperative. Don t enter more than line 33 minus line 37. Enter on Line 1040 Line 10 (T.I.) 200, , ,400 0 N/A 248