Nonpassive Business Loss Limit (Sec. 461(l))

Transcription

1 Nonpassive Business Loss Limit (Sec. 461(l)) Excess Nonpassive Business Loss Not Deductible in Current Year Excess business loss is where aggregate deductions exceed gross income or gain which is attributable to such trade or business, plus: $250,000, or $500,000 (if MFJ) (inflation indexed) The excess loss is an NOL carryforward (thus can only offset 80% of T.I.) 2

2 Applies to all taxpayers other than C corporations. Applies after the sec. 469 PAL rules. Could be big surprise in the year that nonpassive losses are freed-up from a complete disposition of the activity. Applied at partner or S shareholder level. Applies to Trusts and Estates. 3 Consider impact of excess losses when claiming bonus depreciation. Applies before new sec. 199A Effective Date: TYBA 12/31/2017 4

3 Example Taxpayer is Single or H of H and the Business Loss is <$600,000> 5 Income/ Loss Div. Inc. 900K Bus Loss <600K> Allowed Loss? AGI NOL Carryover 6

4 Div. Inc. Bus Loss <600K> Income/ Loss 900K NOL Carryover Allowed Loss <250K> <350> AGI 650K The excess loss limits the ability of taxpayers to use large losses against nonbusiness income: W-2 wages, pensions, interest, dividends, capital gains, etc. 7 20% x QBI Deduction (Sec. 199A) Revenue Impact: <415 Bil.> Over 10 Years

5 Title 1 Tax Cuts and Jobs Act Subtitle A Individual Tax Reform Part I Tax Rate Reform Part II?? Sec : Deduction for Qualified Business Income [new IRC 199A] Sec : Limitations on Losses of Taxpayers Other than Corporations [new IRC 461(l)] Title 1 Tax Cuts and Jobs Act Subtitle A Individual Tax Reform Part I Tax Rate Reform Part II Deduction for Qualified Business Income of Pass-Thru Entities Sec : Deduction for Qualified Business Income [new IRC 199A] Sec : Limitations on Losses of Taxpayers Other than Corporations [new IRC 461(l)]

6 Overview Of Sec 199A 11 QBI Deduction - Sec. 199A Individuals, trusts, and estates can deduct 20% of qualified business income (QBI) Applies to each profitable Trade or Business of the taxpayer. QBI deduction will never generate an NOL and must be removed from an NOL (new sec. 172(d)(8)). 12

7 QBI can be a passive or nonpassive T or B income. Sec. 469 definition of activity may differ from QBI business. Presumably applies after sec. 469 PAL loss limits. Apples after the sec. 461(l) limit on nonpassive excess business losses. 13 QBI is business income from PSPs, S Corps, Sch C, E, and F. Applies to net rental income if the rental is a trade or business Most rentals are a T or B based upon caselaw detail below. 14

8 FOUR STEPS (Detail below) 1)Potential QBI Deduction: 20% x QBI 2)W2+UB Limit Phases-in based upon TI: (% W-2 Wages + Unadjusted Basis) 3)SSB Exception Phases-out based on TI: (specified service business = SSB) 4)TI-NCG Limit: Taxable income minus Net Capital Gain. 15 Unlike current sec. 199 (repealed), sec. 199A does not allow a taxpayer to use W-2 wages from a separate T or B. The QBI deduction must be computed for "each" qualified trade or business. (Section 199A(b)(1)(A)) No analog to repealed sec. 199 QPAI (qualified production activity income) 16

9 The deduction is neither for AGI (i.e., does not reduce AGI), nor an itemized deduction. (Conference Rpt. Pg. 39) Is allowed for AMT purposes (analogous to repealed sec. 199). (Sec. 199A(f)(1)(B)) The deduction does not apply for SE purposes. (Sec. 199A(f)(1)(B)) 17 Impact on the NIIT The QBI deduction does not reduce the NII. (Sec. 199A(f)(1)(B)) Because the QBI deduction is not a for AGI deduction, it does not reduce modified AGI. A profitable rental will generally be subject to the NIIT and eligible for the QBI deduction. The NIIT is 3.8% of the LESSER OF: 1) NII for the tax year, OR 2) The excess of modified AGI over the threshold amount (250K MFJ or 200K Other) 18

10 Effective Date: tax years beginning after Dec. 31, 2017, and before Jan. 1, Single H of H MFJ Indiv. Bracket Rate on QBI <$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% 20

11 Detail 21 Qualified Business Income (QBI) 22

12 [The net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer. 23 Qualified Items Income, gain, deduction, and loss to the extent such items are: U.S. Effectively Connected Income Allowed in determining T.I. (Sec. 199A(c)(3)(A). 24

13 Investment Items Not Qualified Items STCG, STCL, LTCG, LTCL (Does this include sec Gain?) Dividends, dividend equivalents, and payments in lieu of dividends. Interest income unless allocable to a T or B. Annuity income (See Sec. 199A(c)(3)(B) 25 Qualified Trade or Business (T or B) Any T or B except: (A) a specified service T or B, or (B) a T or B of performing services as an employee. 26

14 Treatment of reasonable compensation and guaranteed payments. (Sec 199A(c)(4) 27 (A) Qualified business income shall not include: reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business, (B) (C) any guaranteed payment described in section 707(c) paid to a partner for services rendered with respect to the trade or business, and to the extent provided in regulations, any payment described in section 707(a) to a partner for services rendered with respect to the trade or business. 28

15 STEP ONE Potential QBI Deduction 29 20% of QBI for each trade or business. (Sec. 199A(b)(2)) Note: NOT each activity. 30

16 STEP TWO W-2+UB Limit phases-in begins when T.I. reaches: $157,500 or $315,00 MFJ (fully phased-in when T.I. reaches 207,500 or $415,000 (MFJ)) 31 Taxable Income T.I. Warning: whenever sec. 199A mentions taxable income (TI), it means TI without regard to the sec. 199A deduction (sec. 199A(e)(1)). 32

17 W-2+UB Limit The deduction for each business is limited to the GREATER OF: 50% of "W-2 wages" paid by the business, OR 25% of "W-2 pages" paid by the business PLUS 2.5% of the "unadjusted basis" immediately after acquisition of all "qualified property. (Sec. 199A(b)(2)) 33 Assume for now that the W-2+UB Limit is fully phased-in so TI (presec. 199) is above either: $207,500 or $415,000 for MFJ 34

18 W-2 Wages must be properly allocable to the QBI (Sec. 199A(b)(4)(B) No related party prohibition. Ex: 100% S shareholder counts as W-2 wages paid. Partners and S Shareholders shares will be on the K-1 (detail below) % of Unadjusted Basis Qualified property" is any tangible property, subject to depreciation (Sec. 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. 36

19 Depreciable period begins when the property is first placed in service and Ends on the LATER OF 1)10 years, or 2)Last year of the recovery period (not ADS) 37 Example A Bad News Sch C. Busines purchases a machine for $500,000 on Oct. 1, 2016 and claims sec. 179 expense for entire $500,000. $0 unadjusted basis. Apparently the same if 100% bonus depreciation. 38

20 Definition of Unadjusted Basis? Per Pub. 946, pg. 40: Original basis, but without reducing it by MACRS depreciation; however, you do reduce your original basis by: Amortization taken on the property Any section 179 deduction claimed. Any special depreciation allowance taken. 39 Example B Sch C. Business purchases a machine for $500,000 (5 year MACRS life) in 2013 and claims MACRS depreciation (no 179 or bonus). $500,000 unadjusted basis through 2022 (10 years) 5 years beyond its MACRS life (unless disposed of earlier) 40

21 Example C In 2013, taxpayer 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% x $5mil. = $125, Partners and S Shareholders QBI deduction is determined at the partner or S shareholder level. Allocable share of W-2 wages or a partner must match the allocation of W-2 wage expense. Allocable share of unadjusted basis of a partner must match the allocation of depreciation. Note: Every K-1 must show W-2 wages and unadjusted basis for each T or B. 42

22 Trusts and Estates W-2 wages and unadjusted basis will be apportioned between the beneficiaries and the fiduciary (and among the beneficiaries) under the treasury regulations (per sec. 199A(f)(1)(B) incorporating sec. 199(d)(1)(B)(i)) See Reg (e) 43 Phase-in of W-2+UB Limit The W2+UB limit phases in when T.I. is above the Threshold amount. Threshold amount: $157,500, or $315,000 (MFJ) Phase-in based upon ratio of T.I. over phase-in range divided by the range: $50,000, or $100,000 for MFJ 44

23 Example (1) (MFJ) Not a Service Business Income/ QBI/Loss W-2 Wages Sch. C TorB 300K 0 0 Dividends 24K AGI 324K Std. Ded. -24K 300K T.I. (pre-199a) Unadj. Basis 45 Income/ QBI/Loss W-2 Wages Sch. C TorB 300K 0 0 Dividends 24K Unadj. Basis AGI 324K Std. Ded. -24K T.I. (pre-199a) 300K QBI Ded. - 60K 20% x 300K T.I. =240K A.M.T.I. =264K 240K (T.I.) + 24K (s.d.)_ Pre-sec. 199A T.I. does not exceed $315K so W-2+UB Limit is inapplicable 46

24 Example (2) Same as Ex. (1) except $340K of QBI (v. 300K) 47 Example (2) (MFJ) Income/ QBI/Loss W-2 Wages Sch. C TorB 340K 0 0 Dividends 24K AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded. T.I. Unadj. Basis Now, the W-2+UB limit is phased in because TI exceeds 315K. 48

25 Excess Amount (sec.199(b)(3)(b)(iii)) QBI deduction without the W2+UB limit in excess of the deduction if the limit applied in full: $68 (20% x 340K) - $0 ($0 W-2 wages and unadjusted basis) = $ Phase-in of W-2+UB Limit Multiply the excess amount by ratio of: (T.I. Threshold Amount) phase-in range) 68,000 x 25% (340K 315K) 100K = $17 QBI Deduction = $51 ($68 (full amount - $17 (phased-in limit) 50

26 Income/ QBI/Loss W-2 Wages Sch. C TorB 340K 0 0 Dividends 24K Unadj. Basis AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded. - 51K 68K 17K* = 51 T.I. =289K *Phase-in of W-2+UB limit: $17 ($68K x 25% (25 (340K 315K) 100K) 51 Example (3) Same as Ex. (2) except the business pays $40K of W-2 wages 52

27 Income/ QBI/Loss W-2 Wages Sch. C TorB 340K 40K 0 Dividends 24K AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded. T.I. Unadj. Basis The W-2+UB limit is phased-in because T.I. exceeds $315, Excess Amount QBI deduction without the W2+UB limit in excess of the deduction if the limit applied in full: $68 (20% x 340K) - $20 (W-2 wages of $40,000) = $48. 54

28 Income/ QBI/Loss W-2 Wages Sch. C TorB 340K 0 0 Dividends 24K Unadj. Basis AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded. - 56K 68K 12K* = 56 T.I. =284K *Phase-in of W2+UB Limit: $12 ($48K x 25% (25 (340K 315K) 100) 55 Example (4) Same as Ex. (3) except Sch C business of $420,000 56

29 Income/ QBI/Loss W-2 Wages Sch. C TorB 420K 40K 0 Dividends 24K AGI 444K Std. Ded. -24K 420K T.I. (pre-199a) Unadj. Basis W2+UB limit is fully phased-in; T.I. exceeds $415, Income/ QBI/Loss W-2 Wages Sch. C TorB 420K 40K 0 Dividends 24K Unadj. Basis AGI 444K Std. Ded. -24K T.I. (pre-199a) 420K QBI Ded. 20K 50% x $40K T.I. 400K 58

30 Partners and S Shareholders Rules applied at Partner or S Shareholder level. Allocable share of W-2 wages and unadjusted basis. For PSPs, the W-2 wages cannot exceed the K-1 expense allocation for W-2 wages. (Section 199A(f)(1)) 59 STEP THREE The SSB Exception (The exception begins to phase out if T.I. reaches $157,500 or $315,000 MFJ) 60

31 Qualified Trade or Business: Any T or B except: (A) a specified service business, or (B) a T or B of performing services as an employee. 61 Specified Service Businesses: 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 any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its [owners]. OR 62

32 63 Exception for specified service businesses [SSB] based on taxpayer's income. (Sec. 199A(d)(3)) 64

33 SSB Exception Phase-out No phase-out if T.I. does not exceed: $157,500 or $315,000 if MFJ. Phases-out if T.I. exceeds the above Threshold Amounts. The phase-out range is $50,000 or $100,000 if MFJ 65 For SSBs, only the applicable percentage of qualified income, W-2 wages, and unadjusted basis is taken into account in calculating the QBI deduction. (sec. 199A(d)(3)(A)(ii)) The applicable percentage reflects how much of SSB exception remains after a portion is phased-out based on the TI in excess of the threshold amount. 66

34 Example (1) (MFJ) -- An SSB Income/ QBI/Loss W-2 Wages Sch. C TorB 300K 0 0 Dividends 24K AGI 324K Std. Ded. -24K 300K T.I. (pre-199a) Unadj. Basis 67 Income/ QBI/Loss W-2 Wages Sch. C TorB 300K 0 0 Dividends 24K Unadj. Basis AGI 324K Std. Ded. -24K T.I. (pre-199a) 300K QBI Ded. - 60K 20% x 300K T.I. =240K A.M.T.I. =264K 240K (T.I.) + 24K (s.d.)_ The applicable percentage is 100%. None of the SSB exception is phased-out because TI is below the threshold amount of $315K. 68

35 Example (2) Same as Ex. (1) except $340K of QBI (v. 300K) and W-2 wages of $150K are paid (still $0 unadjusted basis) 69 The taxpayer s T.I. is 25% of the way through the phase-out range; therefore, the applicable percentage is 75% (100% - 25%) 70

36 Income/ QBI/Loss W-2 Wages x 75% QBI x 75% Sch. C TorB 340K 112.5K $255K Dividends 24K AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded. $51K 20% x $255 T.I. $289K The SSB exception is 25% phased-out. I believe that W2+UB Limit would be phased-in (also 25%) AFTER first applying the SSB exception phase-out (guidance needed). 71 Phase-in of W-2+UB Limit Excess amount: QBI deduction without the W2+UB limit (after the SSB exception) in excess of the deduction if the limit applied in full (after SSB exception): $51 (20% x 255K) - $51 ($112.5 W- 2 wages) = $0. 72

37 Phased-in W2+UB limit: $0 because W-2 wages are sufficient. $0 x 25% = $0 QBI Deduction = $51 ($51 (full amount - $0 (phased-in limit) 73 Income/ QBI/Loss W-2 Wages x 75% QBI x 75% Sch. C TorB 340K 112.5K $255K Dividends 24K AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded. $51K 20% x $255 T.I. $289K Result after considering the phase-out of the SSB exception and next applying the phase-in of the W2+UB limit. 74

38 Example (3) Same as Ex. (2) except $0 W-2 wages (instead of $150K) Guidance needed here but sec. 199A(d)(3)(A)(ii) applies to this section [199A] NOT merely this subsection. 75 Income/ QBI/Loss W-2 Wages x 75% QBI x 75% Sch. C TorB 340K 0 $255K Dividends 24K AGI 364K Std. Ded. -24K 340K T.I. (pre-199a) Applying the phase-out of the SSB exception before the phase-in of the W2+U.B. limit, the QBI deduction is potentially $51K (20% x $255K). 76

39 Excess Amount of $51K QBI deduction without the W2+UB limit (after SSB exception phase-in) in excess of the deduction if the limit applied in full (after SSB exception phase-in): $51K ((20% x 255K) - $0 ($0 W-2 wages and UB) = $51K) 77 Phasing-in of W2+UB Limit: Multiply the excess amount by 25% and the product is the W2+UB phased-in limit: 51K (excess amt.) x 25% = $12.75K (phased-in limit) QBI Deduction = $38.25 ($51K (full amount - $12.75K (phased-in limit) 78

40 Income/ QBI/Loss W-2 Wages x 75% QBI x 75% Sch. C TorB 340K 0 $255K Dividends 24K AGI 364K Std. Ded. -24K T.I. (pre-199a) 340K QBI Ded K $51 - $12.75 T.I Applying the SSB exception phase-out first, the QBI deduction is potentially $51K (20% x $255K). Next, the phase-in of the W2+UB limit reduces the deduction by 25% to $12.75K. 79 STEP FOUR The TI-NCG Limit (The sum total of the taxpayers QBI deductions cannot exceed T.I. minus Net Capital Gain) (Sec. 199A(a)(1)) 80

41 Add up the deductible amounts for each business. The sum is the combined qualified business income amount (CQBIA) 81 For now, ignore qualified REIT dividends, publicly traded partnership income, and qualified cooperative dividends. These are not QBI. 82

42 TI-NCG Limit The total QBI deduction cannot exceed THE LESSER OF: 1) CQBIA (sum of combined deductions), OR 2) 20% x (T.I. minus net capital gain (NCG)) 83 Zero or negative QBI for a T or B means no QBI deduction for that particular T or B. The loss does not reduce the QBI of other T or Bs included in the CQBIA (not netted). Instead, the loss is pushed to the following year and reduces the QBI of that T or B. 84

43 T or B Example (1) (MFJ) Not an SSB and Businesses are Nonpassive Income/ Loss 500K W-2 Wages Unadjusted Basis QBI Loss Carryover Div. Inc. Bus. #1 $300K $150K $0 Bus. #2 <300K> N/A N/A <300> AGI 500K Std. Ded. <24K> T.I. (pre-199a) 476K QBI Ded. -60K $300K x 20% T.I. =416K QBI from Business #1 qualifies despite loss from Business #2. TI-NCG limit does not apply because T.I. is high due to dividend income (or spouse s W-2 wages, etc). 85 Example (2) Same as Ex. (1) except the taxpayer is Single or H of H and the loss from Bus. #2 is <$600,000> 86

44 Before Net Bus. Loss limit or QBI Ded. T or B Income/ Loss 500K W-2 Wages UB Div. Inc. Bus 1 300K $150K $0 Bus 2 <600K> N/A N/A Net Bus. Loss <300K> AGI? 200K Std. Ded. T.I. (pre-199a) QBI Ded. T.I. Note: Potential QBI Deduction of $60K but the TI-NCG limit is a problem 87 Excess business loss is where aggregate deductions exceed gross income or gain which is attributable to such trade or business, plus: $250,000, or $500,000 (if MFJ) 88

45 *After considering sec. 461(l) only <250K> of the net <loss is allowed in current year T or B Income/ Loss W-2 Wages UB QBI Loss Carryover NOL Carryover Div. Inc. 500K Bus 1 300K $150K $0 Bus 2 <600K> N/A N/A <600> Net Bus. Loss <250K>* <50> AGI? 250K Std. Ded. 12K T.I. (pre-199a) 238K QBI Ded % x 238K (TI-NCG Limit) T.I The taxpayer needs more T.I. to get the full QBI deduction. 89 Example (3) Same as Ex. (1) except both Business #1 and Business #2 are passive activities. 90

46 How do PAL rules interact with QBI Deduction? Income/ Loss W-2 Wages UB Div. Inc. 500K Bus. #1 $300K $150K $0 Bus. #2 <300K> N/A N/A <300> AGI 500K Std. Ded. <24K> T.I. (pre-199a) 476K QBI Loss Carryforward Same answer as (1), probably. Presumably the full QBI deduction of <$60K> is allowed independent of the sec. 469 PAL rules because the QBI deduction is neither an above or below the line deduction and it is a separate code section with an artificial deduction. If it somehow reduces the passive income of Bus. #1, then the current year allowed passive loss for Bus. #2 is <$240K>. More sensible (?) if the PAL rules are applied first and are fully independent of sec. 199A. 91 Example (4) Same as Ex. (1) except LTCG of $500K (instead of dividends) 92

47 T or B Income/ Loss 500K W-2 Wages Unadjusted Basis QBI Loss Carryover LTCG Bus. #1 300K 150K $0 Bus. #2 <300K> N/A N/A <300> AGI 500K Std. Ded. <24K> T.I. (pre-199a) 476K QBI Ded. - 0K 476 (TI) 500 LTCG = $0 QBI Ded. T.I. =476K Zero QBI deduction because T.I. LTCG is zero. 93 Example (5) For non-sbbs, no upper limit on the QBI deduction if the W2+UB and TI-NCG limits are met. 94

48 In Millions (ignore itemized deduction or std. ded.) Not an SSB T or B Income W-2 Wages Bus. #1 $300 Mil. $120 mil. $0 T.I. (pre-199a) 300 Mil. QBI Ded Mil. $300 mil. x 20% T.I. =440 Mil. Unadjusted Basis 95 When is rental real estate a Section 162 trade or business? Caselaw 96

49 Campbell v. Comm r, 5 TC 272 (1945) Taxpayer inherited residential property in 1934 and tried to rent or sell it. Never used it as his residence, and 97 attempted to rent it (unsuccessfully), until it was sold in 1941 at a loss. Campbell sought ordinary loss treatment under the predecessor to section 1221(a)(2), which required the property to be a trade or business asset. 98

50 The Tax Court Found a Trade or Business 99 Cited Jephson v. Comm r, 37 BTA 1117 (1938), with similar facts. BTA said the taxpayer was carrying on a business, albeit without actual profit during the years in question. 100

51 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 taxpayer and thus produced an ordinary loss on sale under the predecessor to sections 1221(a)(2) and Second Circuit applied a tougher test in Grier v. U.S., 218 F.2d 603 (2nd Cir. 1955) (Rejected Hazzard) 102

52 Grier required a broader activity than a single residential rental, long-term (14 years), to one tenant, with minimal repair activity. Ruled that the rental was an investment activity. 103 Grier referred to: Pinchot (eleven commercial buildings in New York), Gilford (eight buildings in New York), Fackler (a six-story commercial building), and Rogers (sixty-one properties). 104

53 The Tax Court only follows Grier in the Second Circuit (Golsen Rule) 105 Balsamo v. Comm r, TC Memo (1987) [The Tax Court s] position [implicitly contrary] 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). 106

54 Reiner v. U.S., 222 F.2d 770 (7th Cir. 1955) The issue was whether the taxpayer, 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). 107 Reiner, Quoting the Tax Court in LaGriede: It is clear from the facts that the real estate was devoted to rental purposes, and we [the Tax 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. 108

55 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. 109 Stratton v. Comm r, TC Memo (1962), Full-time attorney who sold at a net loss, a singlefamily residence that had been rented to the same tenant for three years. Taxpayer sought capital loss treatment. 110

56 Tax Court agreed with IRS: This [Tax] Court has repeatedly held that the renting of improved real estate constitutes the carrying on of a trade or business, regardless of whether or not the taxpayer engaged in any other trade or business, [citing Hazard, Jephson and another case] 111 Does the Tax Court ever treat a rental as an investment? Yes! 112

57 Triple Net Lease Property A triple-net lease in which the tenant is responsible for taxes, insurance, and repairs, is normally a mere investment. Herbert v. Comm r, 30 T.C. 26 (1958) 113 But the IRS has never revoked its acquiescence to Hazard. 114

58 GCM (7/27/81) Chief Counsel rejected the National Office audit division request for a reversal of the acquiescence to Hazard. 115 Other Sec. 199A Issues 116

59 REITS and PTPs [C]ombined qualified business income amount means, an amount equal to (A) the sum of the [QBI] deductions for each qualified trade or business carried, plus (B) 20 percent of the aggregate amount of the qualified REIT dividends and qualified publicly traded partnership income... (so the TI-NCG limit applies) 117 Because qualified REIT dividends, qualified publicly traded partnership income, and qualified cooperative dividends are not QBI, the W-2+UB limit does not apply but the TI-NCG limit does apply. 118

60 Qualified REIT dividend. A dividend from a REIT that is: Not a capital gain dividend Not qualified dividend income. 119 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 taxed as a corporation. Any gain upon disposition if ordinary income under sec. 751(a) 120

61 Sec. 199A Deduction for Specified Agricultural or Horticultural Cooperatives (SAHCs) (Sec. 199A(g)) The sec. 199A deduction for SAHCs is 20% of the excess of gross income of the SAHC over qualified cooperative dividends. Limits: 1) a W2+U.B. limit (see sec. 199A(g)(1)) and 2) A TI limit (see sec. 199A(g)(2)). 121 Qualified Cooperative Dividends (QCDs) (Sec. 199A(a)(2)) QCD is defined in sec. 199A(e)(4). QCD s are not qualified business income (sec. 199A(c)(1)) so no W-2+UB limit. Potential deduction is 20% x QCD (sec. 199A(2)(A)) The TI-NCG limit is really the TI-(NCG +QCD) limit and it applies to QCDs. 122

62 Owner SEP/401(k)/Qualified Plan Contribution Is the qualified plan contribution (Form 1040 front page) deductible in calculating the QBI? Will influence QBI deduction planning. Best guess is no (doesn t reduce it) based upon analogous repealed sec Not discussed in committee reports or statute. 123 Penalty Mod. For Any Taxpayer Who Claims the QBI Deduciton There is a substantial understatement if the amount of the understatement for the taxable year exceeds the greater of- (i) 10 5 percent of the tax required to be shown on the return for the taxable year, or (ii) $5,000. (Sec. 6662) 124

63 Bonus Depreciation 100% Bonus Depreciation for property acquired and placed in service after 9/27/2017 and before

64 Expanded to used property purchases (provided not acquired from a related party or in a carryover basis transaction). 127 Expanded to include certain qualified film and television productions, as well as certain qualified theatrical productions. 128

65 Excludes from qualified property, property which is primarily used for: (1) Electrical energy, water, or sewage disposal services; (2) Gas or Steam through a local distribution system, or (3) Transportation of gas or steam by a pipeline if rates are established by government. 129 Excludes from qualified property, property used in a trade or business that has a floor plan indebtedness* unless: (1)Not a tax shelter prohibited from using cash method; and, (2)Exempt from interest limit due to small business gross receipts test. *Defined in paragraph (9) of Section 163(j) 130

66 Repeals the election to accelerate AMT credits in lieu of bonus depreciation. 131 Effective Date Property acquired and placed in service after September 27, 2017, as well as specified plants planted or grafted after that date. Not treated as acquired after the date on which a written binding contract is entered into for its acquisition. Transition Rule. Can elect to utilize 50% bonus depreciation, instead of 100%, for qualified property placed in service during the first tax year ending after September 27,

67 Property Acquired Before 9/28/2017 and Placed in Service After 133 Property Acquired On or After 9/28/

68 Observation: Consider the new limit on excess losses (sec. 461(l)) and sec. 199A when estimating the benefit of bonus depreciation and sec Luxury Car Limits

69 New Sec. 280F Limits New 2017 Law Year 1 $10,000 $3,160 Year 2 $16,000 $5,100 Year 3 $9,600 $3,050 Year 4 and later $5,760 $1,875 Effective Date: Property placed in service after Dec. 31, Computer or peripheral equipment is no longer listed property subject to heightened substantiation requirements. Also not required to switch to straight-line depreciation if business use drops below 50%. 138

70 Farm Property Depreciation MACRS life is shortened to 5 (from 7) for any new (original use) machinery or equipment used in farming. Not for grain bin, cotton ginning asset, fence or other land improvement. 140

71 Eliminates the requirement that property used in farming with a recovery period of 10 years or less must use 150% declining balance--can now use 200% DDB unless 15-year or 20-year property or 150% by election). Effective Date: Property placed in service after Dec. 31, 2017 in tax years ending after such date. 141 If farming T or B elects out of interest deduction limit, then must use ADS depreciation for farm property with a recovery period of 10 years or more (such as single purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements.) Effective for TYBA Dec. 31, 2017 (applies to property already in service). 142

72 Certain Citrus Replanting Costs For citrus plants lost or damaged due to casualty, the provision makes replanting costs deductible by a person other than the taxpayer if the taxpayer has an equity interest of at least 50% in the replanted citrus plants; OR The other person must acquire all the taxpayer s equity interest in the land on which the plants were located when damaged and replant on such land. 144

73 Real Property Depreciation ADS recovery period for residential rental property is reduced to 30 years (from 40 years). Replaces qualified leasehold improvement, qualified restaurant, and qualified retail improvement property with qualified improvement property (QIP). QIP gets a general 15-year SL recovery (20 for ADS) says conf. rpt. (but not in statute technical correction needed). 146

74 QIP: Nonresidential real prop. building improvement. Interior portion (not currently required for restaturant property) Place in service after the building is first placed in service. Not a building enlargement. Not an elevator or escalator. Not an internal structural framework. 147 A restaurant building placed in service after 2017 that is not QIP is depreciated over 25 years as nonresidential real property, straight-line and mid-month convention. A conforming change to section 179 so that only QIP meets section 179 ( qualified real property ). Bad news: A restaurant building placed in service after 2017 cannot get sec

75 A restaurant building placed in service after 2017 that is not QIP is depreciated over 25 years as nonresidential real property, straight-line and mid-month convention. A conforming change to section 179 so that only QIP meets section 179. Bad news: A restaurant building placed in service after 2017 cannot get sec Effective: Property Placed in service after A real property trade or business (defined by sec. 469(c)(7)(C) electing out of the interest expense limit must use ADS to depreciate any: Nonresidential property Residential rental property QIP Effective for tax years beginning after 2017 (applies to property already in service). 150

76 Section 179 Maximum deduction $1 mil. (up from $500,000) Phase-out begins at $2.5 mil. (up from 2 mil.) The $25K sec. 179 limit on heavy SUVs is inflation indexed. But bonus depreciation for such vehicles, new or used, acquired and placed in service after 9/27/2017 and before 2023, is 100%. 152

77 Gross Vehicle Weight 6,100 to 7,050 SUV if truck bed interior length is under 6 ft Jeep Grand Cherokee Gross Vehicle Weight 6,100 to 7,050

78 Section 179 property is expanded to include certain tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging (Conf. Rpt.): beds and other furniture, refrigerators, ranges, and other equipment used in the living quarters of a lodging facility such as an apartment house, dormitory, or any other facility (or part of a facility) where sleeping accommodations are provided and let. See Treas. Reg. sec (h). Conf. Rpt. Footnote Same restriction for buyers who are noncorporate lessors: Term of lease less than 50% of class life; and For first 12 months, sec. 162 deductions exceeds 15% of the rental income produced by such property. 156

79 Qualified Real Property (QRP) is now qualified improvement property (QIP). Recall, QIP is also eligible for bonus depreciation. QRP also now includes the following improvements to nonresidential real prop. placed in service after the property was first placed in service: (A) Roofs; (B) HVAC property; (C) Fire protection and alarm systems; (D) Security systems. Recall: Sec. 179 is not subject to sec. 263A. 157 Effective Date: Property placed in service in tax years beginning after Dec. 31,

80 What is Nonresidential Real Property? 159 Nonresidential: The term nonresidential real property means section 1250 property which is not residential rental property,. (Section 168(e)(2)(B)) 160

81 Residential Rental: The term residential rental property means any building or structure if 80 percent or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units. (Section 168(e)(2)(A)(i)) 161 Dwelling Unit: The term dwelling unit means a house or apartment used to provide living accommodations in a building or structure, but does not include a unit in a hotel, motel used on a transient basis. (Section 168(e)(2)(A)(ii)(I)) 162

82 163 Like Kind Exchanges

83 Like-kind exchanges are limited to real property. Effective for exchanges completed after December 31, A transition rule where taxpayer has either disposed of the relinquished property or acquired replacement property on or before December 31, This provision does not sunset. 165 Rev. Proc (04/20/2017) 1-2 IRS Guidance on Path Act Changes to Sections 179 and

84 Section 179 Background 167 For 2017 $510,000 $2,030,

85 Rev. Proc Taxpayers can make, revoke, or modify the section 179 election on an amended return. The PATH Act (12/18/2015) made this permanent. 169 New For 2016 The flush language in section 179(d)(1) that excludes air conditioning and heating units from the definition of qualifying property is removed. 170

86 For example, portable air conditioners, such as window air conditioning units, and portable heaters, such as portable plug-in unit heaters, that are placed in service by the taxpayer in a taxable year beginning after 2015 may qualify [for the section 179 expense] 171 If a component of a central air conditioning or heating system of a building meets the definition of qualified real property, as defined in 179(f)(2), placed in service after 2015, the component may qualify as 179 property 172

87 Section 179 Qualified Real Property (QRP) 173 Qualified Real Property for Property Placed in Service Before 1/1/2018 1) Qualified Leasehold Improvement Property 2) Qualified Retail Improvement Property 3) Qualified Restaurant Property 174

88 Qualified Real Property for Property Placed in Service Before 1/1/2018 1) Qualified Leasehold Improvement Property 2) Qualified Retail Improvement Property 3) Qualified Restaurant Property Replaced with QIP for property placed in service after For tax years beginning on or after 2016, the $250,000 cap attributable to qualified real property is removed. Therefore: $510K cap in 2017 and $1 mil. cap in 2018 for QIP, etc. 176

89 Depreciation of Qualified Real Property in yrs. Straight-line Instead of 39 yrs. (Recall: For 2018, QIP is also 15 years S/L) (Section 168(e)(3)(E)(iv), (v), and (ix)) 177 Rev Proc Example (1) In 2010, A places in service a new office building. In February 2016, A sells this office building to B at fair market value. B uses the office building in its trade or business. 178

90 In March 2016, B begins to construct improvements to the interior portion of the office building and places the improvements in service in December Because the office building was first placed in service in 2010 and the improvements made by B are [QIP]. 180

91 Rev Proc Example (2) In 2015, C, a corporation and manufacturer, enters into a written contract with X for X to construct a new building for use by C in its trade or business. The building will house a manufacturing operation and office space. 181 The initial construction plans did not include a private restroom for the owner of C. During the construction of the building, C enters into a written contract with Y to construct a private restroom in the new building for the owner of C. On May 27, 2016, C places in service the building, except for the private restroom. 182

92 On May 28, 2016, the private restroom in the building for the owner of C is placed in service. Because the building is first placed in service on May 27, 2016, and the private restroom is placed in service on May 28, 2016, the assets in the private restroom [may qualify as QIP]. 183 Rev Proc Example (3) Same facts as Example (2) except the private restroom is constructed by the original contractor X pursuant to an amendment to the existing written contract. Same answer as Example (2). 184

93 Rev Proc Example (4) D is engaged in the commercial building rental business. In March 2015, D enters into a written contract with Z to construct a multi-story building. Pursuant to this contract, Z constructs a completely finished exterior of the building and a minimally finished interior of the building with only elevators, 185 heating, ventilation, and air conditioning systems, plumbing, restrooms, and concrete floors. In December 2015, D and E entered into a lease agreement providing that E will lease one floor of the new building and E will install on that floor drop ceilings, lighting, interior walls, electrical outlets, carpeting, and trade fixtures necessary for the operation of E's trade or 186

94 business (collectively referred to as a build-out). On February 8, 2016, D places in service the new building. On June 4, 2016, E places in service the build-out. Because the building is first placed in service on February 8, 2016, and the build-out is placed in service after that date, the assets of the build-out that are 1250 property are [QIP]. 187 Rev Proc Example (5) In 2016, F constructs and places in service an improvement to a restaurant building [interior] and that improvement meets the definitions of both qualified restaurant property under 168(e)(7) and qualified improvement property under 168(k)(3). 188

95 Accordingly, the improvement is [QIP] 189 Rev Proc Example (6) In 2016, G constructs and places in service a new restaurant building and that building meets the definition of qualified restaurant property under 168(e)(7). However, that building is not qualified improvement property under 168(k)(3). Accordingly, the building is not eligible for [Bonus depreciation]. 190

96 But, in 2017, is eligible for: 15 year straightline deprec. Section