§1411, Passive Activities
and Planning
Opportunities
AGC Financial Issues Forum
January 2014
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The material appearing in this presentation is for informational purposes
only and should not be construed as advice of any kind, including, without
limitation, legal, accounting, or investment advice. This information is not
intended to create, and receipt does not constitute, a legal relationship,
including, but not limited to, an accountant-client relationship. Although
this information may have been prepared by professionals, it should not be
used as a substitute for professional services. If legal, accounting,
investment, or other professional advice is required, the services of a
professional should be sought.
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AGENDA
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Definition of §1411
Trade or Business Determination
Grouping Rules
Real Estate Professional
Self-Rental Rules
Self-Interest Rules
Former Passive Activities
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SECTION 1411 – MEDICARE CONTRIBUTION
TAX OR NET INVESTMENT INCOME TAX
• For each tax year, the tax is equal
to 3.8% of the lessor of:
1. net investment income for
the tax year, or
2.
the excess (if any) of the
modified adjusted gross
income for the tax year over
the threshold amount which is
$250,000 MFJ or $200,000
Single.
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PERSONAL INCOME TAX:
NET INVESTMENT INCOME TAX
What is included in net investment income?
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Interest
Dividends
Capital gains
Rents
Royalty income
Nontrade or business income
Any other passive income
(where taxpayer does not
materially participate in the
business)
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PERSONAL INCOME TAX:
NET INVESTMENT INCOME TAX
What is excluded from net investment income?
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Wages
Self-employment income
Active trade or business income
Retirement plan distributions
Alimony
Social Security benefits
Interest from tax-free bonds
Unemployment compensation
Gains excluded from gross income for regular income tax
purposes
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TRADE OR BUSINESS DETERMINATION
Ordinary Course of Trade or Business Exception
• Certain income earned in the ordinary course of a
trade or business is exempted from § 1411
• Ordinary course of a trade or business is a two part
test
• Income must be derived in a “trade or business” that
is not passive or trading financial instruments
• Income and expenses must be derived in the
“ordinary course” of such trade or business
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TRADE OR BUSINESS DETERMINATION
• Neither §1411 nor the §1411 Regulations define a
“trade or business,” but describe it as conducting a
trade or business within the meaning of §162
• Passive determination for disregarded entities and
interests held in pass through entities is made at the
taxpayer level (individual, estate, or trust) in
accordance with the principals of § 469
• Income earned from interests held in tiered pass
through entities preserves is character as active,
passive or trading in financial instruments as it
flows up through the various tiers of ownership
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RENTAL TRADE OR BUSINESS
• Determination based on case law – much of it
old case law – facts and circumstances intensive
• Focus is on regular and continuous activities
related to the rental property
• Significant incidental services provided to
tenants is indicative of trade or business
• Activities may be performed by a manager
• Number of buildings owned may be
determinative
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GROUPING ACTIVITIES
• Reg. 1.469-4(c)(2) identifies the following factors to
consider in determining whether activities
constitute an appropriate economic unit:
1.
Similarities and differences in types of trades or business
2.
Extent of common control and ownership
3.
Geographic location
4.
Interdependencies between the activities
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GROUPING RENTAL ACTIVITIES WITH A
TRADE OR BUSINESS
A rental activity may not be grouped with a
trade or business activity unless the grouping
constitutes an appropriate economic unit and;
1. the rental activity is insubstantial in relation to
the business activity (or vice versa) or
2. each owner of the trade or business activity has
the same proportionate ownership interest in
the rental activity
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MATERIALLY PARTICIPATING REAL ESTATE
PROFESSIONALS – SAFE HARBOR (NEW)
• The final regulations provide a safe harbor offering
relief from the 3.8 percent NII tax for rental income
of real estate professionals derived in the ordinary
course of a trade or business.
• The safe harbor provides that if a real estate
professional participates in rental real estate
activities for more than 500 hours per year, the
rental income associated with that activity will be
deemed to be derived in the ordinary course of a
trade or business, and thus not subject to section
1411.
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MATERIALLY PARTICIPATING REAL ESTATE
PROFESSIONALS – SAFE HARBOR (NEW)
• CAUTION: The preamble to the final regulations
states that “not all of the material participation
tests provide conclusive evidence that a taxpayer
is regularly, continuously, and substantially
involved in a rental trade or business within the
meaning of section 162.” Therefore, the only
test that is applicable for this safe harbor is
the 500-hour test.
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§ 469 ACTIVITY REGROUPING FOR §1411
– A FRESH START
• Regrouping election available for first year §1411
applies
• Rev. Proc. 2010-13 disclosure requirements apply
• May regroup on amended return but only if the
taxpayer was not subject to 1411 on original return
• Final regulations do NOT allow regrouping by
partnerships and S corporations
• §469 grouping rules apply
o Does not convert rents to T or B income
o Standard grouping restrictions apply
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SELF-RENTAL RULES
• Self rental exists where taxpayer rents property to a
non-passive activity in which taxpayer owns an
interest
• Amount of ownership generally disregarded
• Re characterizes rental income as non-passive
• Re characterizes asset sale as non-passive
• Rental loss remains passive
• Final regulations state that self-rental income is not
subject to 1411
• Final regulations provide that any gain or loss from
the assets associated with that rental activity will be
treated as non-passive
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SELF CHARGED INTEREST
Self Charged Interest
• In the case of self-charged interest from a
nonpassive entity, the amount of interest income
excluded from NII is the taxpayer’s allocated
share of the nonpassive deduction.
• This rule does not apply where the interest
deduction is taken into account in determining
self-employment income.
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FORMER PASSIVE ACTIVITIES (FPAS)
• Passive loss rules applied on a year by year basis
• Passive activities may become non passive from
material participation or becoming a real estate
professional
• Special rules apply to former passive activities
o Suspended passive losses from the FPA are carried
forward and applied first against current year income
from that activity
o Any remaining suspended passive losses continue to
be treated as passive losses
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QUESTIONS??
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