Section 469 Passive Activity Loss Limitation Rules for Individual Taxpayers: Completing Form 8582

Transcription

1 FOR LIVE PROGRAM ONLY Section 469 Passive Activity Loss Limitation Rules for Individual Taxpayers: Completing Form 8582 WEDNESDAY, AUGUST 10, 2016, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. You will have to write down only the final verification code on the attestation form, which will be ed to registered attendees. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

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3 Section 469 Passive Activity Loss Limitation Rules for Individual Taxpayers Aug. 10, 2016 Jason Watson, EA, MBA, Managing Partner Watson CPA Group, Colorado Springs, Colo. Robert S. Barnett, Partner Capell Barnett Matalon & Schoenfeld, Jericho, N.Y.

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

5 PASSIVE ACTIVITIES By Robert S. Barnett CPA, JD, MS (TAXATION) CAPELL BARNETT MATALON & SCHOENFELD, LLP. ATTORNEYS AT LAW (516) By Jason Watson WATSON CPA GROUP PLLC (719)

6 AGENDA I. Passive activity rules of IRC Section 469 and regulations - Rob II. Material participation rules - Rob III. Active participation for real estate - Jason IV. Real estate professional standards - Rob V. Form 8582 Jason VI. Disposition of passive activity investments - Rob 6

7 RECENT IRS ACTIVITY Kutney, TC Sum. Op Fitch, TCM Harnett, 110 AFTR 2d Chambers, TC Sum. Op Jafarpour, TCM Iovine, TC Sum. Op Manalo, TC Sum. Op Yano, TCM Iversen, TCM Hoskins, TCM

8 RECENT IRS ACTIVITY CONT. Hudzik, TC Sum. Op Hassanipour, TCM Merino, TCM Almquist, TCM Oderio, TCM Adeyemo, TCM Gragg v. U.S., 113 AFTR2d (ND Cal 2014) Wade, TCM Williams, TCM Schumann, TCM

9 RECENT IRS ACTIVITY CONT. Lewis, TC Summ Op Lopez, TC Summ Op Lamas, TCM Williams, TCM Kline, TCM Leland, TCM

10 469 PASSIVE ACTIVITY LOSS RULES Passive Activity Losses offset passive income May not offset active or portfolio income Excess PAL is suspended Any activity involving a trade or business In which the taxpayer does NOT MATERIALLY PARTICIPATE Material Participation REGULAR, CONTINUOUS and SUBSTANTIAL Most rental activities 10

11 DISPOSITION Suspended losses may be utilized to offset non passive income Requires disposition of ENTIRE ACTIVITY IN A FULLY TAXABLE TRANSACTION (not 351, 721, 1041, or 1031) Loss is then treated as not from a passive activity Complete worthlessness may qualify 11

12 DISPOSITION CONTINUED If dispose of less than entire interest in the activity - losses remain suspended and passive What constitutes an entire activity? C & S Corps separately group activities 12

13 DISPOSITION CONTINUED Special Rule If dispose of substantially all & can establish Losses with reasonable certainty 13

14 3.8% MEDICARE SURTAX IRC % surtax on lesser of: Net investment income OR Excess, if any, of Modified AGI over Threshold amount 14

15 NET INVESTMENT INCOME Gross income from interest, dividends, annuities, royalties, and rents Other than from ordinary T or B Passive activity income Net gain from disposition of property, other than property held in T or B Includes gain from passive activity T or B trading in financial instruments/commodities Less allocable deductions 15

16 PASSIVE ACTIVITIES 469(c) Activity involving a Trade or Business in which the Taxpayer does not materially participate Generally Any Rental Activity Working Interest in Oil and Gas Property 16

17 TRADE/BUSINESS ACTIVITY Treas. Reg (b) 162 Trade/Business Conducted in anticipation of T/B 174 research or experimental activities 17

18 MATERIAL PARTICIPATION Material Participation REGULAR, CONTINUOUS, and SUBSTANTIAL 7 Tests Treas. Reg T More than 500 HOURS is favorite Limited partner has only 3 methods 18

19 USE THE 7 TESTS 1. The individual participates in it for more than 500 hours during the year 2. The individual's participation in the activity for the tax year is substantially all of the participation in it by all individuals (including non-owner individuals) for the year 3. The individual participates in the activity for more than 100 hours during the tax year and that is not less than that of any other individual (including non-owners) for that year 19

20 THE 7 TESTS continued 4. The activity is a significant participation activity for the tax year, and the individual s aggregative participation in all significant participation activities that year exceeds 500 hours. Significant participation activity is a trade or business in which the individual significantly participates (for more than 100 hours), but in which he doesn t otherwise materially participate 20

21 THE 7 TESTS continued 5. The individual materially participated in the activity for any five tax years (consecutive or not) during the 10 immediately preceding tax years 6. The activity is a personal service activity, and the individual materially participated in the activity for any three tax years (consecutive or not) before the tax year 7. The individual meets a facts and circumstances test 21

22 CHARLES E. WADE v. COMM R, TCM Facts & Circumstances T & Spouse owned Shs. S Corp Converting Chem. Waste T built Co. Son took over Son day-to-day mgt. Large Losses carryback claim 22

23 WADE v. COMM R IRS H & W Did Not Materially Participate! Court Met Test #7 Regular, Continuous, and Substantial Over 100 hours (not mgt.) 23

24 YANO, TCM Taxpayers claimed losses from solar systems Activity was managed by others No records of participation, appointment books, or logs Discussed 7 test of material participation Mercury Solar manufactured and installed the systems, collected payments from homeowners, and paid expenses and state excise taxes 24

25 MANAGEMENT ACTIVITIES Facts and Circumstances Test Not if a paid manager or another manager performs more services Iverson, TCM Ranch activity insufficient evidence of participation Hired manager, therefore taxpayer s management activities not counted Special Rules - Real Estate Professionals 25

26 INVESTMENT ACTIVITIES Temp. Reg T(f)(2)(ii) Work as an investor not counted Unless: directly involved - daily Work as an investor includes: Studying & Reviewing Financial Data Preparing/Compiling summaries or analysis for the individual s own use Monitoring finances/operations in nonmanager capacity 26

27 LAMAS, T.C. MEMO % owner of S Corp and LLC Real estate development Companies generated large losses Carry back claim IRS: Losses Passive TC: Losses Not Passive 27

28 LAMAS cont. No contemporaneous records Instead Telephone records Testimony from 10 witnesses Reg T(f): reasonable means Witness testimony was credible 28

29 LAMAS cont. Investor Participation Daily Management Essential for company business Investors Needed Market Crash 29

30 MATERIAL PARTICIPATION & LIMITED PARTNERS 469(h)(2) Interest in Limited Partnerships Limited Partner presumed not materially participating Exceptions: Tests 1, 5, and 6 Participation > 500 hours during the year Material Participation in 5 of last 10 years Personal Service Activity & Material Participation in any of last 3 years 30

31 THOMPSON WHAT ABOUT LLC MEMBERS? Treas. Regs. only define LP LLC member limited liability, but allowed to participate in management IRS acquiesced in result use 7 tests! of material participation for LLC member 31

32 PROPOSED REG (e)(3)(i) New definition of LP Interest for PAL Purposes Interest in an entity may be treated as LP Interest 1. Entity is classified for tax purposes as a partnership and 2. Holder does NOT have management rights under State law or under governing agreements 32

33 PROPOSED REG. CONTINUED IRS is looking at ability to participate in management and control Better adapted to modern partnership law RULPA allows participation of LP s Member Managed LLC s retain liability protection Issue of limited liability less important 33

34 CAN AN ESTATE OR TRUST MATERIALLY PARTICIPATE? Stay Tuned. 34

35 SELF-CHARGED INTEREST : Applies only to Interest Income/Expenses that are recognized in the same taxable year Treat such Income/Expense as passive Apply to Partnership and S Corporation taxpayer loans Will re-characterize Portfolio Interest Income as Passive Income of owner to avoid mismatch 35

36 RENTAL ACTIVITIES Per se passive T(e)(3) Definition Amounts received for use of Tangible Property EXCEPT if average period of customer use is seven days or less Increased to 30 days or less if SIGNIFICANT PERSONAL SERVICES are provided by or on behalf of the owner (special rule for extraordinary personal services) EXCEPT if the rental is incidental to a nonrental activity of the taxpayer 36

37 BAILEY v. COMM R TC Summary Opinion B&B Inn having several buildings One property was rented for short term average period of customer use under 8 days Not counted for 750 hour test of Real Estate Professional (discussed later) 37

38 SIGNIFICANT PERSONAL SERVICES Will allow up to 30 days of rental average customer use Facts & circumstances type and value of services Only services performed by individuals Not construction or capital repairs Not services customarily performed in high grade real estate rentals 38

39 EXAMPLE NOT A RENTAL ACTIVITY 1. Rental of copy machine < 8 days and no services provided 2. Rental of copy machines for less than 30 days & Company performs significant personal services, such as maintenance and service Motel or B&B and 7 days or less Average Rental 39

40 INCIDENTAL TO NONRENTAL ACTIVITY Not Considered A Rental Activity Principal Purpose: Realize gain from appreciation of property Gross Rental Income < 2% of the lesser of unadjusted basis and fair market value 40

41 INCIDENTAL CONTINUED To a Trade or Business (T/B) only if: Taxpayer owns an interest in such T/B. Property was predominantly used in such T/B during year or during at least 2 out of 5 immediately preceding years AND the gross rental income is less than 2% of the lesser of (i) the unadjusted basis AND (II) the FMV of the property 41

42 GROUPING If failed to properly report group each activity is treated as separate activity Treas. Reg (c) provides rules for grouping of activities Activities must constitute an appropriate economic unit Rev. Proc : discusses requirements 42

43 APPROPRIATE ECONOMIC UNIT Facts and Circumstances Test Similarities (or Differences) Common Control & Ownership Geographical Location Interdependence Ex. Purchase and sale of goods, similar customers, employees, books, etc. 43

44 REV. PROC RESCUE Allow LATE ELECTION make disclosure in year of DISCOVERY (if filed consistently with grouping) Before IRS discovers omission or reasonable cause for failure to disclose must then be shown (reliance on CPA) Does not apply to Real Estate professionals See, Rev. Proc

45 GROUPING Rev. Proc Subjective but must be reasonable Consistency required Difficult to change - need change of circumstance or clearly inappropriate IRS may initiate re-grouping 45

46 RENTAL & BUSINESS Generally cannot group rental and trade or business activities May group if: Constitute an appropriate economic unit AND Rental is insubstantial in relation to T/B OR if same proportionate ownership 1411 Considerations 46

47 EXAMPLE GROUPING PERMITTED Husband owns grocery Wife owns real estate rented to grocery File joint return and treated as commonly controlled EXAMPLE: Summer Camp & Land Consider Real Estate grouping, or business grouping, or combined S Corp. considerations 1. Group within corp. and then 2. Group with personal 47

48 GLICK, 96 F Supp 2d 850 (DC Ind. 2000) Aggregation of S CORP real estate management company with many real estate partnerships Court looked at expired regulations 80/20 Rule one operation had to contribute at least 80% of revenue to other Management Co. totally dependent on realty partnerships for revenue IRS stipulated Appropriate Economic Unit 48

49 RENTAL REAL ESTATE ACTIVITIES Generally deemed passive regardless of participation Exceptions Appropriately Grouped w/ Active T/B $25,000 Exception Self-Rental Real Estate Professional 49

50 ACTIVE PARTICIPATION (REAL ESTATE) $25,000 deduction if: Taxpayer (natural person) actively participates Estate 2 years after D s death, if D actively participated Reduced by amount surviving spouse used Income phase-out (50%) when AGI > $100,000 After 2 years, rental real estate becomes passive 50

51 ACTIVE PARTICIPATION < Material Participation - regular, continuous, and substantial involvement not required Maquire, TCM Significant & bona fide participation - making management decisions approving new tenants, deciding rental terms, approving capital expenses; or Arranging of others to provide services 51

52 SELF-RENTAL RULE Treas. Reg (f)(6) Prevents abuse PIG Rental of property to T or B in which TP materially participates Heads they win tails you lose Income is not passive; losses are passive 1411 Exception to NII 52

53 WILLIAMS, T.C. MEMO Self-Rental Rule (5th Cir. upheld) 100% owner of S & C Corp C paid wages to Taxpayer (f/t employee) S leased property to C TP: S rental income offset PALs TC: S rental income is nonpassive 53

54 REAL ESTATE PROFESSIONALS May treat rental real estate losses as NONPASSIVE 469(c)(7)(B) May use passive losses to offset active income SUBJECT TO material participation requirements Employee must be more than 5% OWNER 54

55 RECENT IRS ACTIVITY Harnett, 110 AFTR 2d Jafarpour, TCM Hoskins, TCM Hudzik, TC Summ Op Hassanipour, TCM Merino, TCM Almquist, TCM Oderio, TCM Adeyemo, TCM Gragg v. U.S., 113 A.F.T.R.2d (N.D. Cal. 2014) Wade, TCM Williams, TCM Schumann, TCM Lewis, TC Summ Op Lopez, TC Summ Op Simmons-Brown, TC Summ Op Moon, TC Summ Op

56 TWO TESTS 1) More than one-half of the personal services performed in trades or businesses by the taxpayer during such taxable year are performed in real property trades or businesses in which the taxpayer materially participates, and 2) Such taxpayer performs more than 750 hours of services during the taxable year in real property trades or business in which the taxpayer materially participates. The taxpayer must still materially participate in the activity or it is considered passive 56

57 REAL PROPERTY TRADES OR BUSINESSES Development, Redevelopment, Construction, & Reconstruction Acquisition & Conversion Rental & Leasing Operation & Management Brokerage 57

58 750 HOUR TEST DO NOT COUNT HOURS FOR 750 HOUR TEST UNLESS MATERIALLY PARTICIPATE Each real estate activity is treated separately Consider aggregation election Must materially participate in EACH ACTIVITY 750 hours for each activity NOT REQUIRED USE THE 7 TESTS 58

59 EXAMPLE Employee of Construction Co. (not owner) Works 1,000 hours Works in his rental property 600 hours? If works 751 hours in rental property? FAILS TEST! Must own at least 5% 59

60 TESTS TO CONSIDER More than 500 hours More than 100 hours (+ more than anyone else) Significant participation activity Prior year material participation Facts and Circumstances regular, continuous, and substantial and >100 hours 60

61 MANAGEMENT ACTIVITIES REP must materially participate in rental Treas. Reg (e)(3)(ii) Counted toward material participation Even if conducted through a separate entity Compare T(b)(2)(ii) 61

62 CAN AN ESTATE OR TRUST QUALIFY AS A REP? Stay Tuned. 62

63 PRACTICAL CONSIDERATIONS 63

64 MATERIAL PARTICIPATION Regular, continuous & substantial 7 Tests Treas. Reg T More than 500 HOURS is favorite Participation is substantially all of the participation in it by all individuals Participates for more than 100 hours and not less than that of any other individual 64

65 HOW DO YOU PROVE PARTICIPATION? Regs Any reasonable means Calendars, appointment books, logs Contemporaneous daily logs are not required IF other reasonable means exist Adeyemo, TCM : thorough and consistent Accurate Account Get confirmation of employment hours Merino, TCM Llamas Telephone & Witnesses 65

66 MARRIED Can count participation by spouse to meet material participation only Even if do not file joint return! 66

67 MILLER v. COMMISSIONER 2 property losses not passive 2005 & property losses were passive No penalty imposed H worked as a tugboat pilot 67

68 MILLER H had contractor s license Kitchen remodeling, siding, decks, fences, etc. Wife leases, advertising, research, bidding H contemporaneous time sheets for contracting work but not administrative work such as planning, ordering H rental maintenance and repair 68

69 MILLER Burden of Proof for a deduction Deficiency Notice presumed correct Burden may shift to Commissioner if certain conditions satisfied Petitioner did not claim that burden shifted 69

70 MILLER Prove Participation by any reasonable means Not ballpark estimate Look at performance of both spouses for material participation H performed over 750 hours as contractor and on rental properties H performed more time on real estate than as tugboat pilot 70

71 MILLER Contemporaneous work logs BUT Failed to aggregate 7 tests reviewed by Court Reasonable cause & good faith no penalties 71

72 LEWIS, T.C. Summ. Op Real Estate Professional TP disabled veteran & mostly unemployed Managed triplex apartment next to home Performed routine maintenance & repairs Normal duties of property management IRS: TP overstated hours 72

73 LEWIS cont. No contemporaneous log or calendar TC: Real Estate Professional 50% Test Met: TP was unemployed 750 Hours Test Met: TP was disabled Reasonable for TP to spend more time 73

74 LOPEZ, T.C. Summ. Op Taxpayer was not a Real Estate Professional Reconstructed log from daily planners Discrepancies between logs & other documents Substantiation was not credible 74

75 SEPARATE ACTIVITY Each interest in rental real estate is treated as a separate activity subject to the material participation requirements. UNLESS AGGREGATION ELECTION Treat ALL rental realty as single activity Election makes it easier to meet the material participation requirement. 75

76 ANJUM SHIEKH, TCM Taxpayer had several rental properties Claimed he was Real Estate Professional Had to meet Material Participation for EACH activity Court also required taxpayer to capitalize investigatory expenses he did not abandon search for new rental 76

77 SCHEDULE E Is not sufficient to constitute aggregation Need formal election & notice IRS said he failed the Material Participation test for one property Failed to present evidence of hours worked (use contemporaneous log) Net leases more troublesome 77

78 COMPLETE DISPOSITION Mr. Shiekh did dispose of one property Because he did not aggregate this was considered a COMPLETE DISPOSITION Capital gain from sale considered passive income and suspended losses were able to be utilized 78

79 TO ELECT OR NOT TO ELECT Do not make if have passive income from real estate and passive losses from other activities because you want to keep the income passive Do not include property to be sold 79

80 ELECTION TO AGGREGATE ALL RENTAL REAL ESTATE INTERESTS Treas. Reg (g)(3) Statement with Return Taxpayer X SS# is a qualifying taxpayer and hereby elects pursuant to IRC 469(c)(7)(A) to treat ALL interests in rental real estate as one activity 80

81 LATE ELECTION Rev. Proc , IRB 875 PLR & allowed taxpayers to make a late aggregation election Treas. Reg Acted reasonably and promptly Good faith no prejudice to government Reasonable cause for failure Such as reliance on professional 81

82 Rev. Proc , IRB 875 Allow late election Attach Statement Filed consistently and timely Amend last filed return Identify year desired for election 82

83 ELECTION IS IRREVOCABLE Applies to all future years Unless a material change in circumstances Make the Election if it results in utilization of losses that would otherwise be suspended. 83

84 EXAMPLE 3 Rental Properties, 200 hours each 3 Net Lease properties, 100 hours each Unless aggregate fail, 750 hour test NII Considerations grouping respected 84

85 REGROUPING Generally not permitted One-Time Regrouping for taxpayers subject to 1411 Final Regs respect grouping rules Rev. Proc & apply 85

86 ELIGIBILITY FOR REGROUPING May occur only during first taxable year after 12/31/2013 in which taxpayer Meets income threshold under 1411; and Has Net Investment Income Taxpayer may apply to tax years beginning after 12/31/

87 The Band-Aid Consider utilizing Rev. Proc Consider all group possibilities Run the projections Don t lose credibility; maintain records Watch Schedule E closely 87

88 CAN AN ESTATE OR TRUST MATERIALLY PARTICIPATE? 88

89 LEGISLATIVE HISTORY An estate or trust is treated as materially participating in an activity if an executor or fiduciary, in his capacity as such, is so participating. S. Rep. No , at describes trust as a taxpayer subject to Passive Activity Loss Rules 89

90 MATTIE K. CARTER TRUST Ranch and Oil & Gas Interests Can consider trust employees activities IRS said look only to trustee s activities Court stated: Such a contention is arbitrary, subverts common sense, and attempts to create ambiguity where there is none. Mattie K. Carter Trust v. U.S., 256 F. Supp. 536 (N.D. Tex. 2003). 90

91 TAM Trust held LLC interest Trust provided for appointment of Special Trustee Contract stated Special Trustee could not bind Trust 91

92 TAM cont d. Trust s Material Participation measured by Trustee s activities 469(h)(1): regular, continuous & substantial Absence of explicit guidance Special Trustees did not have discretionary power Only the Trustee held power 92

93 PLR Trustee acts on behalf of beneficiaries Look to activities of the Trustee In a business context look at activities of the owner Trustee must be involved in operations on a regular, continuous and substantial basis 93

94 TAM Trust A & B own an interest in S Corp A appointed as Special Trustee Power Sale, Retain & Vote Shares IRS concedes A s powers sufficient But only in A s capacity as Special Trustee A was President of QSSS & could not differentiate time 94

95 CONSIDER Vesting Special Trustee with Power Draft Trust to describe activities and vote Appoint a Trustee who will qualify 95

96 Frank Aragona Trust, 142 T.C. No. 9 (2014) Trust owned rental properties net losses Rental and Development Activities 6 Trustees (5 children) fees included in rental losses 3 children very involved 96

97 FRANK ARAGONA TRUST continued Paul V. Aragona acted as Executive Trustee Trustees acted as Management Board Delegated powers to Paul for daily operations Board made all major decisions Met every few months 97

98 FRANK ARAGONA TRUST continued Three children worked full-time for SM LLC Owned by the Trust SM LLC managed Trust properties SM LLC employed several additional people Trust aggregated all rental activities 2 children held minority interests in some properties 98

99 FRANK ARAGONA TRUST continued IRS Passive loss disallowed Fiduciary Fee Deduction Rental Per Se Passive unless 469(c)(7) IRS Trust cannot perform personal services Tax Court rejected IRS position Trust acts by Trustees 99

100 FRANK ARAGONA TRUST continued IRS conceded Trust s real estate operations Qualify as Real Property Trade or Business Court held Trust Materially Participated Trustees activities as employees of SM LLC counted Trustee Duties of Loyalty 100

101 FRANK ARAGONA TRUST continued Tax Court recognized Trustee-Employee activities Did not need to consider activities of other employees Trust met 469(c)(7) exception Trust materially participated in rental activity 101

102 FRANK ARAGONA TRUST & TRUSTEE OWNERSHIP IN ACTIVITY Trustees also owned interests personally IRS said could not allocate participation to Trust Not in this case because: Personally owned small, minority interest; Combined ownership never exceeded Trust; Compatible goals; and Trustee involved in day-to-day management 102

103 WHAT FRANK ARAGONA TRUST DID NOT SAY Whether non-trustee employees count Hours of personal services rendered Whether one trustee s activity alone sufficient What test used to find material participation Whether 5% ownership rule applicable Court did not apply > 50% test What if trustee owned > % 103

104 CAN AN ESTATE OR TRUST QUALIFY AS A REP? 104

105 FRANK ARAGONA TRUST Trust Qualified 469(c)(7)(B) REP Trust materially participated in Real Property T/B Trustees activities as employees of SM LLC counted Explicit guidance not presented Trust made aggregation election 105

106 3.8% MEDICARE SURTAX IRC % surtax on lesser of: Net investment income OR Excess, if any, of Modified AGI over Threshold amount 106

107 NET INVESTMENT INCOME Gross income from interest, dividends, annuities, royalties, and rents Other than from ordinary T or B Passive activity income Net gain from disposition of property, other than property held in T or B Includes gain from passive activity T or B trading in financial instruments/commodities Less allocable deductions 107

108 SELF-CHARGED INTEREST Interest income from nonpassive entity Excluded from NII Limited to allocable share of entity s interest deduction 108

109 S CORP/P SHIP ASSET SALE Excluded from NII if asset: Used in ordinary T/B; Not passive activity as to owner Not T/B of trading in financial instruments. Ordinary T/B determination at entity level Passive activity determination at owner level 109

110 SALE OF S CORP/P SHIP INTEREST 1411(c)(4) Look-through Exception Reduce gain if material participation NII to extent of allocable share of gain from deemed sale of passive assets 110

111 2012 v Proposed Regs: 4-step method of calculation 2013 Proposed Regs: Deemed Sale Method Complex Reporting Requirements 111

112 RENTAL REAL ESTATE AND

113 RENTAL REAL ESTATE Per se passive activity Rental income generally included in NII Rental excluded if not passive activity Proper grouping with T/B Self-Charged Rent REP Safe Harbor 113

114 NII SAFE HARBOR Rental income & gain or loss from sale Derived in ordinary course of T/B IF: Qualified REP 469(c)(7)(B) & participation > 500 hours; OR Qualified REP & participation > 500 hours in any 5 of the last 10 years. 114

115 SAFE HARBOR & T/B Rental must be a T/B Not defined in Code or Regs Fact specific Final Regs Preamble: reference to 162 incorporates case law and administrative guidance applicable to

116 Groetzinger, 480 US 23 (1987) Sup. Ct. established standards for T/B Full-time gambling activity was T/B Must be: Involved with continuity and regularity Primary purpose for income or profit NOT sporadic activity, hobby, amusement Fact-specific: Not every income-producing and profit-making endeavor is T/B TP may be subject to SE tax 116

117 RENTAL REAL ESTATE AS T/B Regular & continuous involvement Intent to earn profit NOT purchased for investment or personal use Held out for rent to customers Active management Size of property Scope of ownership & management activities 117

118 Higgins, 61 S.Ct. 475 (1941) TP s rentals constituted T/B 26 NY rental real estate properties TP controlled all decisions TP actively managed properties All leases approved and signed by TP Facts and Circumstances 118

119 SINGLE REAL ESTATE ACTIVITY Can rise to the T/B level Final Regs Preamble: in certain circumstances, the rental of a single property may require regular and continuous involvement such that the rental activity is a trade or business within the meaning of section 162. However: not in every case 119

120 PREAMBLE NON-EXHAUSTIVE LIST OF FACTORS Type of property (commercial vs residential); Number of properties rented Day-to-day involvement of owner or agent Type of rental (net lease vs traditional, shortterm vs long-term) Preamble cites 3 cases: Fackler v. Comm r, Hazard v. Comm r, and Lagreide v. Comm r 120

121 ELECTION Group all rental activities As a single activity to meet safe harbor If REP generally need election 121

122 SELF-RENTAL RULE Treas. Reg (f)(6) Prevents abuse PIG Rental of property to T or B in which TP materially participates Heads they win tails you lose Income is not passive; losses are passive NII Exclusion Final Regulations 122

123 If a T/B, TP escapes 3.8% surtax! BUT Is TP now subject to SE tax? 123

124 SELF-EMPLOYMENT TAX 1402: SE Tax on income from T/B 1402(a)(1): Rent excluded from SE tax Unless TP is real estate dealer William Barry Blythe, et ux. v. Commissioner, T.C. Memo Revenue Ruling

125 REAL ESTATE DEALER Reg (a)-4: In business of selling RE to customers NOT real estate dealer if holding RE for investment or speculation 125

126 Blythe, TC Memo TP not liable for SE tax TP not real estate dealer Properties held to produce rental income Not acquired for sale Not advertised for sale 126

127 EXAMPLE TP rents commercial realty TP in rental real estate T/B; AND TP is real estate professional and > 500 hours Rental income excluded from NII Rental income excluded from SE tax Not held for purpose of sale Never advertised for sale Not a real estate dealer 127

128 TP ESCAPES 3.8 SURTAX AND SE TAX!! 128