2019 Chapter Highlights - PowerPoint Presentation

2019 Chapter Highlights §199A and rental activities New law limits §1031 exchangesIRS keeps intense audit pressure on passive activities, especially on real estate professionalsIRS challenges who is a real estate professional 2 3-1

2019 Chapter Highlights Converting vacation home to rental activity Tax issues for online rentalsDetermining if property is dealer or investor propertySale of residences 3 3-1

§199A and Rental Activities4 3-1

The 20% QBI DeductionUp to 20% of qualified business incomeAny trade or business income except specified service trade or businessIs my rental activity a trade or business? 5 3-1

Reg. §1.199A-1(b)(14)Trade or business means a §162 trade or businessFacts and circumstancesNo bright-line test 6 3-1

Case Law on §162Higgins (1941)Is there a profit motive?Groetzinger (1987)Considerable, regular and continuousIRS (2019) Type of property, number of properties, day-to-day involvement, services provided, terms of lease 73-1

Safe HarborRev. Proc. 2019-38Solely for §199A:Separate books and records250 or more hours of rental servicesContemporaneous records of time (beginning in 2020) 8 3-2

“Rental Services”AdvertisingNegotiating & executing leasesVetting tenant applicationsRent collection 9 3-2 Operation, maintenance & repairs management Materials purchase Supervising workers Work by owner, agent, employees, and contractors may be combined

Who Keeps the Log?Property owner?Property manager?Someone else?See sample letter for property manager on page 3-42 10 3-3

Excluded RE ActivitiesReal estate used by the taxpayer for any part of the yearTriple net leasesBut “facts and circumstances” may help 11 3-3

Safe Harbor Statement“Under penalties of perjury, I (we) declare that I (we) have examined 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.” 12 3-3

1031 Exchanges 13 3-4

TCJA Changes Exchange RulesTax deferred exchanges are limited to real property onlyPersonal property cannot be exchangedEffective for exchanges after Dec. 31, 2017 Transition rule applies for exchanges in process before Dec. 31, 2017 14 3-4

Exchange ExamplesSharon trades old truck for new truck and receives $10,000 trade in allowanceVern trades his shopping center for an office building. Cost seg. study of shopping center identified many items of 5 and 7 year property 15 3-4

ExchangesA client with a cost seg study when he bought a property may need another at saleClient must establish sales price of personal property included with the real property 16 3-4

§1031 OverviewProductive use in trade or business or investmentGain recognized to extent boot received Net mortgage relief is boot Boot is decreased by exchange expenses17 3-4

Basis Carry ForwardCharles & Yvonne BrelandBasis calculation remains open for exam even if exchange is oldRetain records of original property basis that was transferred to new propertyDepreciation schedule not enough! 18 3-5

Delayed ExchangesQualified intermediary is not taxpayer, related, or agent within 2 years andActs to facilitate exchangeAcquires relinquished propertyTransfers relinquished property Acquires replacement propertyTransfers replacement property 193-6

Reverse ExchangesTwo methodsReplacement property owned by accommodatorRelinquished property owned by accommodator 20 3-7 EXCHANGE REVERSE

Related Party ExchangesFamily members, business entities, trusts2-year rule:Disposition within 2 years triggers gainExceptions exist to 2-year rule Must file Form 8824 for next 2 years 213-10

Related Party ExchangesMulti-member LLC requests PLR to dispose of 2 properties acquired in a related-party exchangeFirst property further exchanged into another property – no cash or non-like-kind property receivedSecond property contributed to another LLC value for value (PLR201834010) 22 3-11

Online Rentals233-12

Online RentalsIs Airbnb rental income taxable?14 days or fewer rule says “no”Is it your personal residence?“yes” and §280A applies“no” and §469 appliesWhat if I don’t own the home? Careful of sub-lease restrictions 243-12

Online RentalsWhat about occupancy taxes?San Diego says it can collect $12M by taxing Airbnb-type rentalsSome municipalities have ordinances prohibiting online rentals 25 3-13

Online Rentals26 3-13 Chart for reporting on 3-13

Vacation Homes273-14

Vacation Home DisallowanceIs personal residence rented? Yes, if used personally more than the greater of:14 days or10% of days rented 28 3-14

Definition of Personal UsePersonal use if used by:Owner(s)Owner’s family, unless main home and FMV rent Anyone who doesn’t pay FMV rent or anyone who lets owner use other property 293-14

Limiting Deductions §280A Determine number of fair market rental daysDetermine total number of days used for any purpose Rental deduction = 303-15 # days fair market rent # days total use Actual expenses x

Deduction Ordering §280ADeductions otherwise allowed under the CodeDeductions allowed for rental useDepreciation and amortization 31 3-15

Court Takes Favorable ViewBolton wanted to put all category 1 expenses on Schedule ACourt said “no” but offered another formula:# days fair market rent# days in entire year Must be applied to all expenses in the category 323-16

Passive Loss Rules333-18

§469 Passive Loss Overview Passive losses only deductible to the extent of passive incomeReal estate exceptionsRental real estate losses of up to $25,000 for middle-income taxpayers (Stewart Oatman )Real estate professionals 343-18

§469 Passive Loss OverviewExcess losses carried forwardCurrent year passive income may be offset by prior year passive lossesLosses are allowed if: Complete disposition To unrelated partyIn taxable transaction 353-19

What Activities Are Passive?Rentals, regardless of level of participationTrade or business, if no material participation 36 3-19 PASSIVE ACTIVE

Material Participation Time TestsWork 500 hours Telephone and travel records substantiate narrative Do substantially all the work 100 hours and no one does moreWork 500 hours in SPAs 37 3-19

Material Participation Time Tests500 hours in 5 of last 10 years Personal service with 3 years of material participation Facts and circumstances38 3-20

Rental Activity DefinitionRentals are per se passive activitiesA rental is any transfer of property for compensation 39 3-20

Rental Activities That Aren’t!Avg. rental period < 7 days Avg. stay < 30 days and significant servicesExtraordinary personal services provided 40 3-20

Rental Activities That Aren’t!Rental is incidental to nonrental activityRent to employee at employer convenience Rents < 2% of lesser of basis or FMV Nonexclusive use by customersRental to entity owned by landlord 41 3-21

Short-Term Rental is BusinessMay still be passive depending on amount of participationSelf-employment tax?No, probably notWhy do I care?Not RE business for RE professional Not allowed for $25,000 loss 423-22

Why Identify Activities?Determine if a rental activityDetermine if taxpayer materially participates Determine whether or not complete disposition has occurred Apply pre-enactment transitional rules43 3-22

Grouping of Passive ActivitiesIs each business separate?Are two similar businesses one activity?What difference does it make to the taxpayer?Grouping is all about material participation and avoiding the passive rules 44 3-22

Five Factors to Establish Groups Business similarities and differences (Scott Williams) Common controlGeographical location Common ownershipInterdependencies Any other “reasonable method” allowed – consistency required 45 3-22

Statement Required to GroupAnnually attach grouping electionOriginal grouping rule: 1st year that 2nd activity purchased Existing grouping rule : Each year new activity added to or deleted fromRegrouping rules: Original grouping was inappropriate or material change in facts and circumstances 46 3-23

Other Grouping ProvisionsActivities treated as separate if no grouping electionLate election may be available Reasonable cause required if IRS discovers 47 3-24

Disposition of Passive Activity Suspended losses fully deductible if:Complete dispositionFully taxable To unrelated party 48 3-24

Nonqualifying DispositionsLike-kind exchangesConversion to personal useTransfers in a divorce and giftingInstallment sales (PALs prorated) Transfer due to death (to the extent of stepped up basis) Disposition to a related party 493-24

Complete Disposition PointersA gift is not a “disposition”Transfer incident to a divorce is not a dispositionGrouping may delay complete dispositionDisposition must be to unrelated party 50 3-25

Real Estate ProfessionalRental real estate is ownedThe 50% testThe 750-hour testEach spouse tested separately Materially participate 51 3-25 Tax Law Loves My Real Estate Agent

Real Estate BusinessesThe real estate businessesDevelopment, conversion, construction, acquisition Rental and leasingOperation and management Brokerage (real estate agent)But not mortgage broker (Kurt Hickam) 52 3-26

Time Tests Cause ProblemsEither spouse may be RE proMust be >5% owner to include time as an employee Can’t count spouse’s time for RE pro (Tony Goolsby) Concise records and credible testimony needed 533-27

Time Test LoserRonnie Hairston managed 2 rentals, both single family residencesRonnie did not keep a log but provided calendars claiming 781 hoursJudge noted handwriting seemed identical, entries made all at once and deemed to be inflated 54 3-27

Time Test WinnerJose Franco spent 649 hours in his small architecture business Jose also managed 2 rentals in Burlingame. He kept an activity log, backed up with receipts and emails, that showed he spent 1,137 managing his rentalsThe judge believed Jose’s logbook 55 3-28

Time Test WinnerSoccer mom qualifies as real estate professional (Roberta Birdsong)Two rentals, nine units total in OaklandRoberta produced spreadsheet detailing activities including: cleaning, repairs, collecting rents, communicating with tenants, researching and supervising contractors, advertising, interviewing. 56 3-28

“Guesstimate” Always a LoserPhilip & Leanna Rose failed to keep adequate recordsLogbook created for trial from calendars also created after the factCourt didn’t believe 18 hours on Thanksgiving and 16 on New Year’s Day! 57 3-29

Short Term StaysSteven and Stacey Ellison rented property with short-term stays, so not a rental activity for §469 hours Hours spent managing do not count for RE professionalThird property rented to relative below market rent, so no losses allowed under §280A 58 3-29

RE Pro Tests for Material ParticipationManaging rentals >500 hoursSubstantially all the work Managing 100 hours and no one does more (including property manager or employees)Spouse’s time “tacks” for this test 59 3-30

Aggregation of Rentals by Real Estate ProfessionalEach rental a separate activity Election to combine may be made(§469(c)(7)(A))File election in year second rental purchasedGrouping doesn’t always result in material participation 60 3-31

Late Aggregation Elections Reason not made—election not filedAggregated consistently on all returnsTimely filed all affected returnsFile on amended return Late election may be filed at appeals (Rev. Proc. 2011-34) 61 3-32

Recharacterizing Self-RentalsRenting property to taxpayer’s own businessRental income not passive (no: PIGs)Rental losses remain passive (yes: PALs) Doesn’t matter if businesses are completely separate entities; rent is non passive income 623-32

Dealer vs. Investor633-33

Real Estate Dealer vs. InvestorSubstantiality of gain on sale Sales or development activities Substantiality of sales to other incomeLiquidate unexpectedly obtained property Purpose of acquisition and disposition Length property held Number and frequency of sales Continuity of sales or sales activities Reluctance to sell property 64 3-33

Capital vs. Ordinary LossBarry Conner’s wholly owned LLC sold all if its land in a single saleBarry made no effort to sell the property, had no sales office or sales people. He incurred no development expenses and had a conservation easement on the land$1.9M loss was capital 65 3-34

No Capital Gain if not §1231 GainHisham Ashkouri developed, built and sold condo project of two unitsSole purpose was to acquire, develop and sell the condos Therefore, not assets used in trade or business or for investment (capital), but property held for sale to customers (ordinary) 663-35

Cancellation of Debt673-35

Cancellation of Debt IncomeReduction in debt is taxable as ordinary incomeForm 1099-A (foreclosure sale)Form 1099-C (loan reduced) 68 3-35

Exception to COD Income §108Bankrupt - reduce tax attributesInsolvent -reduce tax attributesSolvent farmer, etc.Payment of liability creates deduction Real property business debt - reduce basis Qualified debt principal residence 3-3569

Reduction of Tax AttributesWhen COD non-taxable, reduce tax attributes in the following orderNOLs General business credits AMT CreditsCapital lossesBasis reduction Passive activity losses Foreign tax credits 70 3-35

Can Use More Than One §108 ExclusionMary Bui performed short sale of primary residence in 2011Of the $355,488 COD, only $12,000 was acquisition debtCourt allowed additional exemption of $42,852 for insolvency 71 3-37

Gain on Sale of Personal Residence72 3-37

Tax ReformProposals were made to change the §121 gain exclusion rulesNo changes were included in the final legislation 73 3-37

Gain on Sale of Personal Residence$250,000 of gain is excluded on sale (or exchange) of principal residence if:Owned for 2 of last 5 years,Occupied for 2 of last 5 years, andNo sale in last 2 years $500,000 for married filing joint 743-37

Sale is Not a Casualty LossExtraordinary tax liability in 2005 caused Louis & Sandra Shuman to sell home at a loss to pay taxesDiscovered in 2010 that their preparer incorrectly reported incomeRefunds barred under statute Taxpayers try to recoup in this novel way! 753-39

Other Real Estate Developments763-39

InterestDirect and indirect costs associated with producing property, including investment property, must be capitalized under §263ADavid Keefe had to capitalize interest during renovation of property 77 3-39

Cash TransactionsFinCEN expands and extends Geographic Targeting Orders (GTOs)Title companies must identify persons behind shell companies purchasing for all cash in:5 boroughs of NYC, 3 FL counties, 5 CA counties, & 1 each in TX & HI 78 3-40

79Thank you!