2011 Federal Tax Update
Real Estate &
Investment
1
3-1
© 2011 Vern Hoven Tax Seminars
2
Real Estate Tax News
3-2
• Landlord’s 1099 reporting repealed
▫ Repeal retroactive to 1/1/11
• TIGTA tells IRS to audit more rentals
▫ 53% of landlords misreport income
▫ $12b of unreported income
▫ IRS agrees to audit more rental activities
• Passive loss Form 8582 instructions to be
revised
© 2011 Vern Hoven Tax Seminars
3
3-3
© 2011 Vern Hoven Tax Seminars
4
First Time Homebuyer Credit Update
3-4
• 2008 Credit payback began in 2010
• IRS sending reminder letters
• Reminder: Allowed for purchases
through April, 2011 for
▫ Extended duty military
▫ Foreign service
▫ Intelligence community workers
© 2011 Vern Hoven Tax Seminars
5
3-5
The $250,000/$500,000 MFJ
Exclusion Rule
© 2011 Vern Hoven Tax Seminars
6
The Exclusion Rule!
3-5
• $250,000 (or $500,000 if married filing
joint) of gain is excluded on sale (or
exchange) of principal residence if:
1. Owned for two of last five years,
2. Occupied for two of last five years,
and
3. No sale in last two years
© 2011 Vern Hoven Tax Seminars
7
How to Exclude $500,000!
3-6
• Either spouse owns 2 out of 5 years
• Both spouses use 2 out of 5 years
• Neither spouse excluded gain in last 2 yrs
• Must file “Married Filing Joint”Is this Jessie?
© 2011 Vern Hoven Tax Seminars
8
Surviving Spouse May Qualify
for $500,000 Exclusion
3-6
• $500,000 exclusions applies if
▫ After 12/31/07
▫ Sale within 2 years of death of spouse
▫ Immediately prior to death
Is this Jessie?
 Either spouse owned 2 out of 5 years
 Both spouses used 2 out of 5 years
 Neither spouse excluded gain in last 2 yrs
© 2011 Vern Hoven Tax Seminars
9
3-7
Recent Court Cases
• 50% owner gets 100% of exclusion (Hsu)
• Divided court says must live in house to
qualify for exclusion (Gates)
Is this Jessie?
© 2011 Vern Hoven Tax Seminars
10
No Exclusion for Prior
Non-Qualified Use
3-8
• Substantial limitation on vacation homes
• Gain must be prorated, S/L for qualified
& non-qualified time
• Non-qualified: time not principal
residence
• Non-qualified time doesn’t include:
▫ After use as principal residence before sale
▫ Temporary absence (up to two years)
© 2011 Vern Hoven Tax Seminars
11
Example: Rent 2 yrs; Use 3 yrs
Sales Price
$700,000
Purchase Price
400,000
Accumulated Dep.
-20,000 $380,000
Gain
Dep. Recapture
3-8
$320,000
$20,000
Non-Qualified Use; 2/5
$120,000
Qualified Use: 3/5
$180,000
© 2011 Vern Hoven Tax Seminars
12
Example: Rent after Personal Use
Sales Price
$600,000
Purchase Price
400,000
Accumulated Dep.
-20,000 $380,000
Gain
Dep. Recapture
3-8
$220,000
$20,000
Non-Qual. Use: 2/12
N/A
Qualified Use: 10/12
$200,000
© 2011 Vern Hoven Tax Seminars
13
Example: Gain Before 2009
Sales Price
Purchase Price (7/1/05) 100,000
Accumulated Dep.
-20,000
Gain
3-9
$300,000
$80,000
$220,000
Dep. Recapture
$20,000
Pre-2009 Alloc. 3.5/8.5
$82,353
Qualified Use; 3/8.5
$70,588
Non-Qual. Use: 2/8.5
$47,059
© 2011 Vern Hoven Tax Seminars
14
Qualification for The
“Reduced Exclusion” Rule
3-9
• Homeowner Violates:
▫ 2 Year Ownership Rule, or
▫ 2 Year Use Rule, or
▫ Only Once in Last 2-year rule
• Because of:
▫ Change in Place of Employment
▫ Health, or
▫ IRS’s “Unforeseen Circumstances”
© 2011 Vern Hoven Tax Seminars
15
Converting Residence to Rental
3-10
• Can you convert a personal residence to a
rental property? Yes!
• But watch out –
• Basis is the lower of cost or FMV at date of
conversion
• Losses resulting prior to rental are not
deductible
© 2011 Vern Hoven Tax Seminars
16
3-10
© 2011 Vern Hoven Tax Seminars
17
Foreclosures on the Rise
3-
• Nevada, Arizona, California &Florida
still leading the way
▫ (RealtyTrac.com)
• More than 1,000,000 foreclosures in 2010
© 2011 Vern Hoven Tax Seminars
18
COD Exceptions
3-11
1. Excluded by law, e.g., gifts & bequests
2. Qualified student loan COD
3. Cancelled debt would have been
deductible
4. Qualified purchase price reduction
© 2011 Vern Hoven Tax Seminars
19
COD Exclusions
1.
2.
3.
4.
5.
3-11
Qualified principal residence debt
Bankruptcy COD
Insolvency COD
Qualified Farm COD
Qualified real property business COD
© 2011 Vern Hoven Tax Seminars
20
Foreclosure Results in COD
3-12
• Reduction in debt taxable as ordinary
income
▫ Form 1099-A (foreclosure sale), but not
needed if foreclosure and COD in same year
▫ Form 1099-C (loan reduced)
© 2011 Vern Hoven Tax Seminars
21
Mortgage Modification
3-12
1. Foreclosures
2. Deed in lieu
3. Mortgage workout
© 2011 Vern Hoven Tax Seminars
22
Foreclosure Results in COD
3-12
• Foreclosure
▫ Even a forced
sale is a taxable
sale
© 2011 Vern Hoven Tax Seminars
23
Nonrecourse vs. Recourse Debt
3-12
• Nonrecourse debt (not personally liable)
• Recourse debt (personally liable)
© 2011 Vern Hoven Tax Seminars
24
Foreclosure of Nonrecourse Debt
3-13
• Sales price = nonrecourse debt
▫ Result: No COD
• Home acquisition debt in 14 states often
non-recourse (CA, MT)
▫ But, be careful! A refinance changes status of
debt
© 2011 Vern Hoven Tax Seminars
25
Foreclosure of Nonrecourse Debt
3-13
$600,000
Adjusted Basis
($50,000) Loss
Foreclosure Gain (Loss)
$550,000
Sales Proceeds (Debt)
© 2011 Vern Hoven Tax Seminars
26
Foreclosure of Recourse Debt
•
3-13
Recourse debt must be bifurcated
1. Amount of cancellation of debt &
2. Gain/loss on sale
•
•
COD income results
Refi’s are often recourse debts
© 2011 Vern Hoven Tax Seminars
27
Foreclosure of Recourse Debt
3-14
$600,000
Adjusted Basis
($100,000) Loss
Foreclosure Gain (Loss)
$500,000
Sales Proceeds (FMV)
$50,000
COD Income
$550,000
Recourse Debt
© 2011 Vern Hoven Tax Seminars
28
Worksheet
3-15
• Calculates COD income for
▫ Foreclosures
▫ Repossessions
© 2011 Vern Hoven Tax Seminars
29
Property Type Matters
3-15
• Business, investment or personal
▫ Business = ordinary loss on sale
▫ Investment = capital loss on sale
▫ Personal = non deductible loss on sale
▫ What did you do with the money?
© 2011 Vern Hoven Tax Seminars
30
Foreclosure of Business Property
3-15
1. Calculate COD
▫ Loan less COD
2. Calculate gain or loss on “sale”
▫ FMV at foreclosure is sales price
3. Character of gain or loss same as if
property sold
© 2011 Vern Hoven Tax Seminars
31
Sharon Loses Las Vegas Rental
Purchase Price
Acc. Dep.
1st recourse mtg
FMV
$450,000
($20,000)
$400,000
$250,000
COD Income
Sales Price
Adjusted Basis
Loss: Form 4797
$150,000
$250,000
$430,000
$180,000
© 2011 Vern Hoven Tax Seminars
3-16
32
Bill Loses Phoenix Rental
Purchase Apartment Bldg
Down payment
Mortgage
Deferred gain
$1,300,000
$250,000
$1,050,000
$200,000
Depreciation taken
FMV at Foreclosure
COD at Foreclosure
Gain at “sale”
$125,000
$1,000,000
$50,000
$25,000
© 2011 Vern Hoven Tax Seminars
3-16
33
Short Sale
3-17
• House sold, not
enough to pay off bank
• If “short pay” forgiven
by bank, COD
results (Stevens)
• Bank files Form
1099C
© 2011 Vern Hoven Tax Seminars
34
§108 Exceptions to COD Income
3-18
• Bankruptcy
• Insolvency
• Farm debt for solvent farmer
• Seller financing
• If payment of liability creates a deduction
• Discharge of real property business debt
• Bona fide dispute
• Qualified home acquisition debt
© 2011 Vern Hoven Tax Seminars
35
Bankruptcy
3-18
• Exclusion does not apply to a debtor in a
bankruptcy case
▫ The bankruptcy exclusion rules apply
▫ Taxpayer may choose insolvency exclusion
© 2011 Vern Hoven Tax Seminars
36
Insolvency
3-18
• Taxpayer insolvent to extent liabilities
exceed assets
▫ Includes house, pension, IRA, autos,
furniture, tools, etc.
• How to calculate insolvency worksheet
• Pub. 4681
© 2011 Vern Hoven Tax Seminars
37
Reduction of Tax Attributes
3-19
When COD non-taxable, reduce tax
attributes in the following order
1. NOLs
2. General business credits
3. AMT Credits
4. Capital losses
5. Basis reduction
6. Passive activity losses
7. Foreign tax credits
© 2011 Vern Hoven Tax Seminars
38
Qualified Residence Debt
Exception Under §108
3-20
• Must meet two requirements
1. Qualified principal residence
2. Qualified home acquisition debt
© 2011 Vern Hoven Tax Seminars
39
Principal Residence
3-20
Requirement #1: Qualified Principal
Residence
▫ Same definition as §121
▫ Not available for vacation homes, rentals or
investment properties
© 2011 Vern Hoven Tax Seminars
40
Qualified Acquisition Debt
3-20
Requirement#2: Original or refinanced debt
used for
1. Acquisition, construction or improvement
of principal residence
2. Secured by the principal residence
3. Limited to recourse debt under $2 million
4. Mortgage workout debt relief qualifies
© 2011 Vern Hoven Tax Seminars
41
Only Portion is Acquisition Debt
3-20
• Ordering rules are required if acquisition
debt less than total debt relief
• Any forgiven home equity debt not used
for improvements cannot be excluded
© 2011 Vern Hoven Tax Seminars
42
Mortgage Debt Forgiveness
Facts/Checklist
3-21
• Must be principal residence
• Must be acquisition indebtedness
• Homeowner not bankrupt
• Homeowner not insolvent
• Cancellation is not for personal services
• See Interactive COD calculator on IRS
website
© 2011 Vern Hoven Tax Seminars
43
Reduce Basis of Residence
3-21
• Basis of home is reduced by the amount
of excluded income
▫ Turns ordinary income back into capital
gains
© 2011 Vern Hoven Tax Seminars
44
3-22
© 2011 Vern Hoven Tax Seminars
45
§469 Passive Loss Overview
3-22
• Passive losses only deductible to the
extent of passive income
• Excess losses carried forward
• Current year passive income may be
offset by prior year passive losses
• Losses are allowed if
▫ Complete disposition
▫ To unrelated party
▫ In taxable transaction
© 2011 Vern Hoven Tax Seminars
46
What Activities Are Passive?
3-23
• Rentals, regardless of
level of participation
• Trade or business, if
no material
participation
© 2011 Vern Hoven Tax Seminars
47
IRS Issues 7 Rental Activity Tips
3-23
1.
2.
3.
4.
Income reported when received
Advance rent reported when received
Security deposits not taxable unless kept
Property or services in lieu of rent
taxable
5. Expenses paid by tenants are income
6. Expenses pertaining to rental deductible
7. All personal use must be pro rated
© 2011 Vern Hoven Tax Seminars
48
Rental Activities That Aren’t!
1.
2.
3.
4.
3-24
Avg. stay < 7 days
Avg. stay < 30 and significant services
Extraordinary personal services provided
Rental is incidental to non-rental activity
▫ Rent to employee at employer convenience
▫ Rents < 2% of lesser of basis or FMV
5. Non exclusive use by customers
6. Rental to entity owned by landlord
© 2011 Vern Hoven Tax Seminars
49
Why Identify Activities?
3-25
1. Determine if a rental activity
2. Determine if taxpayer materially
participates (Sidney Shaw)
3. Determine whether or not complete
disposition has occurred
4. Apply pre enactment transitional rules
© 2011 Vern Hoven Tax Seminars
50
Considerations When Grouping
Activities
1.
2.
3.
4.
5.
6.
3-26
Similarities & differences of businesses
Common control of businesses
Common ownership between businesses
Geographical locations of each business
Interdependencies between businesses
Also, any other “reasonable method” to
determine “appropriate economic unit”
▫ Consistency from year to year is required
© 2011 Vern Hoven Tax Seminars
51
Statement Required to Group
3-26
• Grouping election must be annually
attached
1. Original grouping rule: 1st year 2nd
activity purchased
2. Existing grouping rule: Each year another
activity added to or deleted from group
3. Regrouping rules: Original grouping was
inappropriate or material change in facts
and circumstances
© 2011 Vern Hoven Tax Seminars
52
Other Provisions of New Grouping
Rules
3-28
• Activities treated as separate if no
grouping election
• Late election may be available if
▫ Timely disclosure made by taxpayer
▫ All relevant tax returns filed consistent with
desired activity groupings
▫ Disclosure is made on tax return in year
omission is discovered
Reasonable cause required if IRS discovers
© 2011 Vern Hoven Tax Seminars
53
Passive Loss Cases
3-29
• Limited partner may MP
▫ 500 hour or
▫ 5-of-the-last-10-years or any 3 year personal
service activity
• LLC members not LPs per se (Newell,
Garnett, Gregg, Thompson,)
▫ IRS says “we quit” - AOD issued
© 2011 Vern Hoven Tax Seminars
54
Real Estate Professional
3-30
1. Rental real estate is owned
2. The 50% test
3. The 750 hour test
• The real estate businesses
▫ Development, redevelopment , conversion,
construction , reconstruction, acquisition
▫ Rental & leasing
▫ Operation & Management
▫ Brokerage
• Materially participate
© 2011 Vern Hoven Tax Seminars
55
Time Test is Different
3-32
• 50%/750 hour test
▫ Either spouse may be RE professional
▫ But spouses time may not be combined
(Goolsby)
▫ Must be >5% owner to count time (Bahas)
▫ On-call time doesn’t count (Moss)
• Material participation test
© 2011 Vern Hoven Tax Seminars
56
Material Participation for RE Pro
3-32
1. Managing rentals >500 hours
2. Substantially all the work (70%?)
3. Managing 100 hours and no one does
more (including property manager)
• Spouse’s time “tacks”
• Time that doesn’t count
▫
▫
Work not customarily done by owner
Counting only the money
© 2011 Vern Hoven Tax Seminars
57
What is Brokerage?
3-33
• IRS argues only brokers can do
brokerage, not agents
• Tax Court disagrees (Agarwal )
▫ Brokerage is bringing buyer/seller together
▫ Brokerage is not a licensed qualification
• RE agents/salespersons can qualify for
real estate professional relief provision
© 2011 Vern Hoven Tax Seminars
58
Aggregation of Business and
Rental by R.E. Professional
3-35
• Each rental a separate activity
• Unless election made to combine rentals
▫ (§469(c)(7)(A))
• File election in year rental purchased
• Can be done late, with IRS permission
© 2011 Vern Hoven Tax Seminars
59
Real Estate Professional Cases
3-36
• Bed and Breakfast not a real estate
activity (Todd and Pamela Bailey)
• Vacation rental not a real estate activity
(Bruce and Judy Bailey)
• Real estate professional Donald Trask
forgot to make §469(c)(7)(A) election
• Full time engineer misunderstands, and
then fails 50% test (Yusufu Anyika)
• Denelda Goolsby made §469(c)(7)(A)
election but time records not credible
© 2011 Vern Hoven Tax Seminars
60
Recharacterization Required
3-46
• Certain property developed by TP and sold for a gain
• Renting property to own business
•
•
•
•
•
•
•
•
▫ Unless written binding contract before 2/19/88 (Farris)
Significant participation passive activity net income
Qualified working interest in gas and oil
Rental from “raw land” (less than 30% depreciable)
Passive equity-financed lending activity
Intangible property leased by pass-through entity
Sale within 12 months of conversion to passive
Sale of “substantially appreciated” property
Income from a “dealers” investment property
© 2011 Vern Hoven Tax Seminars
61
3-46
No Recharacterization
Active
Passive Income
Less: Passive Deductions
Net Passive LOSS
© 2011 Vern Hoven Tax Seminars
Passive
$160,000
-$200,000
-$40,000
62
3-46
No Recharacterization
Active
Passive Income
Less: Passive Deductions
Net Passive LOSS
© 2011 Vern Hoven Tax Seminars
Passive
$200,000
-$160,000
+$40,000
63
3-46
No Recharacterization
Active
Passive Income
Less: Passive Deductions
Net Passive LOSS
© 2011 Vern Hoven Tax Seminars
$40,000
Passive
$160,000
-$160,000
-0-
64
Recharacterization Required
3-46
• Renting property to taxpayer’s own
business
▫ Dental office rented to S Corp. Michael
Willock v. Comm.
▫ C Corporations - see Gary Beecher v. Comm.
▫ S Corporations - see Tony R. Carlos v.
Comm.
© 2011 Vern Hoven Tax Seminars
65
PassiveLossTriggerRequirements
3-47
1. Dispose of entire interest
2. Fully taxable transaction
3. To unrelated party
© 2011 Vern Hoven Tax Seminars
66
Weird Passive Loss Dispositions
•
Death: basis increase eliminates losses
▫
•
•
•
•
3-48
Only basis decrease triggers loss
Installment sale: PAL as gain reported
Gift/divorce: Add loss to basis
Bankruptcy: COD relief reduces PAL
Single activity election: last one sold
© 2011 Vern Hoven Tax Seminars
67
3-49
© 2011 Vern Hoven Tax Seminars
68
§1031 Overview
3-49
• Productive use in trade or business or
investment
• Gain recognized to extent boot received
• Net mortgage relief is boot
• Boot is decreased by exchange expenses
• No actual or constructive receipt
(Crandall and Dulin)
© 2011 Vern Hoven Tax Seminars
69
Qualified Use Requirements
3-51
• Productive use in trade or business or
investment
• Problem: Personal residence
• Problem: Vacation homes
• Problem: Property acquired for exchange
© 2011 Vern Hoven Tax Seminars
70
Delayed Exchange Overview
3-53
• 45 days to identify
• 180 days to complete exchange
• Filing on time may reduce the 45/180
time limits
© 2011 Vern Hoven Tax Seminars
71
Problems with Delayed Exchange
3-53
• Miss 45/180 deadline? Gain recognized
▫ Even if cash already spent on new property
• Risks include
▫ Death of any party to exchange
▫ Divorce of buyer or seller
▫ EPA or financing problems
▫ Qualified Intermediary steals money (It’s an
installment sale! Rev. Proc. 2010-14)
© 2011 Vern Hoven Tax Seminars
72
Related Party Exchanges
3-57
• Original exchange not qualified for
§1031 if either property disposed of
within 2 years
▫ Using accommodator didn’t help (Ocmulgee)
• Exceptions
▫ Death, involuntary conversion or other nontax-avoidance purpose
▫ Diminish risk of loss
© 2011 Vern Hoven Tax Seminars
73
Related Party Exchange Case
3-58
• OFI transfers shopping center (w/$6
million gain) to accommodator
• OFI indentifies commercial property
owned by Treaty Fields (a related party)
• Accommodator sells shopping center
• Court says OFI-Treaty exchange occurs
first followed by Treaty selling w/2 years
• Treaty’s sale triggers OFI’s $6M gain!
© 2011 Vern Hoven Tax Seminars
74
Thank you!
75