Form 8582: Passive Activity Reporting and Impact of New 3.8% Medicare Tax
Tackling Complex Passive Activity Computations and Navigating Income Tax and AMT Reporting Challenges
TUESDAY, NOVEMBER 5, 2013,1:00-2:50 pm Eastern
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Form 8582: Passive Activity Reporting
and Impact of New 3.8% Medicare Tax
November 5, 2013
David Holets, Crowe Horwath
david.holets@crowehorwath.com
Robert S. Barnett, Capell Barnett Matalon & Schoenfeld
rbarnett@cbmslaw.com
Today’s Program
Passive Activity Groups and Rental Real Estate
[Robert Barnett]
Slide 7 – Slide 72
Passive Activity Loss Rules and Net Investment Income Tax
Slide 73 – Slide 84
Forms 8582 and 8960
[Dave Holets]
The New Medicare Tax
[Dave Holets]
Slide 85 – Slide 97
PASSIVE ACTIVITY GROUPS
AND RENTAL REAL ESTATE
By Robert S. Barnett
CPA, JD, MS (TAXATION)
CAPELL BARNETT MATALON & SCHOENFELD, LLP.
ATTORNEYS AT LAW
(516) 931-8100
rbarnett@cbmslaw.com
PASSIVE ACTIVITY
• 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
7
YANO, TCM 2012-101
• 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
8
THOMPSON
• §469 limits utilization of PAL’s to PA income
• LP is presumed passive unless meets 1 of 3 tests
(#1, #5 or #6)
• GP is NOT treated as a LP – 7 Tests available
• 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
9
PROPOSED REG.
§1.469-5(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
10
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
11
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
isn’t less than that of any other individual
(including non-owners) for that year
12
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
13
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
14
HOW DO YOU PROVE
PARTICIPATION?
• Regs – Any reasonable means
• Calendars, appointment books, logs
• Contemporaneous daily logs are not required IF
other reasonable means exist to establish material
participation
• Participation of spouse may be counted – even if
file separately
• Participation as investor requires day to day
management activity
15
MANAGEMENT ACTIVITIES
• For facts and circumstances test – Not if a paid
manager or another manager performs more
services
• Iverson, TCM 2012-19
• Ranch activity insufficient evidence of
participation
• Hired manager, therefore taxpayer’s
management activities not counted
16
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
17
ACTIVITY
• If dispose of less than entire interest in
the activity - losses remain suspended
and passive
–If dispose less than all, losses remain
suspended
–What constitutes an entire activity?
• C & S Corps separately group
activities
18
DISPOSITION CONTINUED
• Special Rule
• If dispose of substantially all & can
establish Losses with reasonable certainty
19
ACTIVITY
• Treas. Reg. 1.469-4 – sets forth rules for
grouping activities
• Trade or Business –activities that meet §162
other than Rental criteria, INCLUDING:
– Activities conducted in “anticipation of the
commencement of a trade or business”
– Certain research or experimental expenditures
20
RENTAL ACTIVITIES
• Cannot generally group rental activities
with active businesses or personal property
rental activities
• EXCEPT if the rental is “incidental to a
nonrental activity of the taxpayer”
21
REAL ESTATE RENTAL
ACTIVITIES
• RENTAL ACTIVITIES are generally
deemed passive
• Regardless of participation
• § 469(i) provides a $25,000 exception
within limited income limits if active
participation
22
RENTAL ACTIVITIES
• Treas. Reg. §1.469-1T(e)(3) – 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”
23
BAILEY v. COMM’R
• TC Summary Opinion 2011-22
• 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)
24
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
25
EXAMPLE 1 –
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
calls
• Motel or B&B and 7 days or less – Average
Rental
26
EXAMPLE 2 –
A RENTAL ACTIVITY
• Hotel guests stay over 7 but less than 30 days
• Maid services and cleaning common areas
• Such services are similar to those provided for
long term rentals of high grade property
• Value of maid services less than 10% of rental
• Not significant personal services
27
REV. PROC. 2010-13
• Treas. Reg. § 1.469-4(c) provides rules for
grouping of activities – the procedure discusses
requirements
• A trade or business activity may be grouped with
rental activity
• If constitutes an “APPROPRIATE ECONOMIC
UNIT” & rental is insubstantial in relation to T
or B activity
28
Slide Intentionally Left Blank
GROUPINGS
•
•
•
•
Similarities (or Differences)
Common Control & Ownership
Geographical Location
Interdependence between or among the
activities
– Ex. Purchase and sale of goods, similar
customers, employees, books, etc.
30
GROUPINGS
• Subjective but must be reasonable
• Consistency required
• Difficult to change grouping-needs change of
circumstance or clearly inappropriate
• IRS may initiate re-grouping
31
EXAMPLE – REGULATIONS
• Bakery and Movie Theater in shopping mall in
Baltimore and same in Philadelphia
• May be several reasonable groupings
– A Movie Theater activity & a Bakery activity
– Baltimore activity & Philadelphia activity
– Four separate activities
32
RENTAL & BUSINESS
• Generally cannot group rental and trade or
business activities
• May group if:
– Constitute an appropriate economic unit AND
– The rental is insubstantial in relation to T or B
– OR if same proportionate ownership
33
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 corps and then
2. Group with personal
34
EXAMPLE CONTINUED
• Real estate professional
• Grouping election available
• Group land – but not camp activity
with land
35
PEREZ
• Real estate broker could not group her real
estate rentals and her brokerage business
• Real estate was not used in brokerage
• Reporting on Schedule E was not sufficient to
aggregate
• Taxpayer did not properly present evidence of
material participation
• PENALITES! No reasonable GF
36
S CORPORATION,
C CORPORATION AND
PARTNERSHIPS
• Must independently group it’s activities
• Must report groupings on FORM K-1
• Shareholder/Partner may then group with
his/her other activities – must disclose
grouping
• Generally no need to keep reporting
37
MUST REPORT
• Written Statement
• Original grouping – must state appropriate
economic unit
• Additions
• Changes/deletions, but do not have to report
dispositions
• Regroupings if Material Change – in facts or
clearly inappropriate
• Must explain regrouping
38
MAY REGROUP IF:
• If original grouping is “CLEARLY
INAPPROPRIATE” or if nature of activities
changes
• Material change in facts and circumstances
• Provide sufficient identification – names,
addresses, ID, etc.
• State that regrouping constitutes an appropriate
economic unit
39
REV. PROC. 2010-13 RESCUE
• If failed to properly report group – each activity is
treated as separate activity
• 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. 2011-34
40
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
41
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
42
REAL PROPERTY TRADES OR
BUSINESSES
•
•
•
•
•
Development & Construction
Acquisition & Conversion
Rental & Leasing
Management
Brokerage
43
EXAMPLE
•
•
•
•
Employee of Construction Co. (not an owner)
Works 1,000 hours
Works in his rental property 600 hours
What about if works 751 hours in rental
property?
• FAILS TEST!
• Must own at least 5%
44
• DO NOT COUNT HOURS FOR 750 HOUR
TEST UNLESS MATERIALLY
PARTICIPATE
– Each real estate activity is treated separately
– Must materially participate in EACH
ACTIVITY
– IRC does NOT require 750 hours for each
activity
45
MILLER v. COMMISSIONER
• 2 property losses not passive 2005 &
2006
• 4 property losses were passive
• No penalty imposed
• H worked as a tugboat pilot
46
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
47
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
48
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
49
MILLER
•
•
•
•
Contemporaneous work logs BUT
Failed to aggregate
7 tests reviewed by Court
Reasonable cause & good faith – no penalties
50
MATERIAL PARTICIPATION
•
•
•
•
Regular, continuous & substantial
7 Tests – Treas. Reg. § 1.469-5T
More than 500 HOURS is favorite
Limited partner has only 3 methods
(Test # 1, #5 or #6)
51
OTHER TESTS TO CONSIDER
• More than 100 hours (+ more than anyone
else)
• Significant participation activity
• Prior year material participation
• Facts and Circumstances
• Substantially ALL participation is by taxpayer
52
MARRIED
• Can count participation by spouse to meet
material participation only
• Even if do not file joint return!
53
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.
54
ANJUM SHIEKH, TCM 2010-126
• 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
55
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
56
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
57
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
58
ELECTION TO AGGREGATE ALL
RENTAL REAL ESTATE INTERESTS
• Treas. Reg. § 1.469-9(g)(3)
• Statement with Return
• Taxpayer X SS# 123-45-6789 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
59
LATE ELECTION
• Rev. Proc. 2011-34, 2011-24 IRB 875
• PLR 201126026 & 200728016 allowed taxpayers
to make a late aggregation election
– Treas. Reg. § 301.9100-3
•
•
•
•
Acted reasonably and promptly
Good faith – no prejudice to government
Reasonable cause for failure
Such as reliance on professional
60
Rev. Proc. 2011-34, 2011-24 IRB 875
•
•
•
•
•
Allow late election
Attach Statement
Filed consistently and timely
Amend last filed return
Identify year desired for election
61
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.
62
EXAMPLE
• 3 Rental Properties, 200 hours each
• 3 Net Lease properties, 100 hours each
• Unless aggregate fail, 750 hour test
63
3.8% SURTAX
• NII includes rental income
• Excluded if:
1. Not passive and
2. §162 Trade/Business
• Real Estate Professionals
64
REAL ESTATE
PROFESSIONALS
• Not per se passive
• Meets 1st test
• §162 Trade/Business
65
§162 TRADE/BUSINESS
•
•
•
•
Groetzinger
Regular continuous activities
Profit motive
Lagreide 23 TC 508
66
SELF-CHARGED ITEMS
• §1.469-7 – 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
67
SELF-RENTAL RULE
• Treas. Reg. §1.469-2(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
68
EXAMPLE
•
•
•
•
•
A is a shareholder in CPA firm
A materially participates
A rents a building to the company
Rental income is NOT PASSIVE
Kucera, TC Summary 2001-18
69
L. A. SAMARASINGHE
TCM 2012-23 (1/19/2012)
•
•
•
•
•
Lease to Dr.’s medical corporation
Dr. treated rental income as passive
Self-Rental Rule applied
Dr. was active in the practice
NO PENALTY – reasonable reliance on CPA
70
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The Unique Alternative to the Big Four®
Passive Activity Loss Rules and Net
Investment Income Tax
Forms 8582 and 8960
The Unique Alternative to the Big Four®
DISCLOSURE REQUIRED BY U.S. TREASURY DEPARTMENT CIRCULAR 230:
Crowe Horwath LLP must inform you that any advice in this communication
to you was not intended or written to be used, and cannot be used, to avoid
any government penalties that may be imposed on a taxpayer.
Audit | Tax | Advisory | Risk | Performance
© 2013 Crowe Horwath LLP
73
The Unique Alternative to the Big Four®
Form 8582 - The Gauntlet
 Losses from a flow through entity are subject to the following limitations:
1.
Basis Rules
1.
2.
2.
At Risk Rules
1.
3.
No specific form to report.
Track along with Schedule K-1
Form 6198
Passive Activity Rules
1.
Form 8582 and Form 8582-CR
 A taxpayer can never deduct more losses than the amount that flows through
from the prior limit.
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© 2013 Crowe Horwath LLP
74
The Unique Alternative to the Big Four®
Form 8582 - The Gauntlet
 Basis Limitations under Section 704(d) for
partnerships and 1366(d) for S
corporations – Losses are limited to a
partner’s outside basis. Does not limit the
allocation of losses.
 At Risk Limitations under Section 465 –
Limits losses from an activity to amount atrisk. Entity may have more than one
activity.
 Passive Activity Loss Limitation under
Section 469 – Limits losses from passive
activities to passive income from all
sources.
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75
The Unique Alternative to the Big Four®
Form 8582 - The Gauntlet-Example
Partner's Outside Basis
Partner's At-Risk Limitation
Partner's share of loss (passive)
Partner's passive income-other sources
Loss
Suspended
$50,000
$35,000
($60,000)
$25,000
Allowable
Basis
$60,000
$10,000
$50,000
At-Risk
$50,000
$15,000
$35,000
Passive
$35,000
$10,000
$25,000
Audit | Tax | Advisory | Risk | Performance
Allowed
$25,000
© 2013 Crowe Horwath LLP
76
The Unique Alternative to the Big Four®
Form 8582 – Who files?
 Individuals
 Estates
 Trusts
 Closely-held C corporations and personal
service corporations subject to the passive
loss rules use Form 8810.
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77
The Unique Alternative to the Big Four®
Form 8582 – What is Reported?
 Section 469 divides income into three categories:
1.
Active – Income from activities in which the taxpayer materially
participates, including activities in which wages and salaries are earned.
1.
2.
2.
Portfolio – Investment income such as annuities, royalties, interest,
dividend, capital gains/losses, guaranteed payments for interest on capital
1.
3.
Not reported on Form 8582
Exception – Rental real estate activities with active participation – reported on
Line 1
Reported on appropriate form – Schedule B, D, etc.
Passive – Income from activities in which the taxpayer does not materially
participate.
1.
Reported on Line 3
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78
The Unique Alternative to the Big Four®
Grouping Activities Disclosures-Rev. Proc. 2010-13
DISCLOSURES:
 Section 469 entities: Annual activity grouping disclosures required in accordance
with the instructions to Forms 1065 and 1120S.
 Forms require separate activity reporting: 17 items required for each activity.
 If disclosures not made, does reporting net income/loss on Schedule K, Line 1
constitute grouping?
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The Unique Alternative to the Big Four®
Grouping Activities Disclosures-Rev. Proc. 2010-13
 Grandfather rule for individual taxpayer groupings prior to the effective date of
Rev. Proc. 2010-13.
 No need to disclose unless:
1.
New passive activity is added to the group.
2.
Original grouping is inappropriate.
3.
Material change in facts.
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80
The Unique Alternative to the Big Four®
Grouping Activities Disclosures-Rev. Proc. 2010-13
 If a taxpayer fails to disclose a grouping that is required to be disclosed, then
each trade or business activity will be treated as a separate activity (unless the
IRS regroups under anti-avoidance rule of Regulation Section 1.469-4(f).
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81
The Unique Alternative to the Big Four®
Changing from Passive to Active (and Back Again)
 Losses suspended as passive investor remain passive if the investor becomes
active.
 Losses may be claimed:
 Against income from the same activity which is now nonpassive;
 Against other passive income;
 In full if the activity is disposed of.
 Planning note:
 Changing from active to passive may not be simple due to the rule establishing material
participation for taxpayers who materially participated in 5 of the last 10 years
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The Unique Alternative to the Big Four®
THE NEW 3.8% MEDICARE TAX
The Unique Alternative to the Big Four®
Effect on Medicare Contribution Tax
 Beginning in 2013, a tax of 3.8% will apply to “net investment income” of
individuals, estates and trusts.
 Draft Form 8960
 Net Investment Income includes:
1.
Portfolio type income,
2.
Income from passive activities as defined in Section 469 and
3.
Income from the trade or business of trading in financial instruments or
commodities.
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85
The Unique Alternative to the Big Four®
Effect on Medicare Contribution Tax
 Grouping under Section 469 will affect whether trade or business activities are:
1.
Active and thus excluded from the Medicare tax, or
2. Passive and thus subject to the Medicare tax.
 Net passive losses will not reduce non-passive net income for purposes of the
Medicare tax.
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The Unique Alternative to the Big Four®
Medicare Contribution Tax
 As discussed above, taxpayers generally cannot regroup after initial tax return
filing.
 A one-time regrouping election is available if the following conditions are met:
1. The taxpayer is an individual or an estate
2. The taxpayer is subject to the 3.8% tax in 2013
3. The taxpayer’s first taxable year is after December 31, 2013 and
4. The taxpayer’s modified adjusted gross income exceeds the
threshold amount
 Once made, the regrouping election is binding on all future years.
 Partnerships and S corporations CAN NOT REGROUP under this one time
election.
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87
The Unique Alternative to the Big Four®
Minimizing the 3.8% Medicare tax with Grouping Elections
 The key to minimizing the new 3.8% tax is to avoid the characterization of an
activity as passive.
 The net investment income rules provide a fresh start to passive activity grouping
if the new 3.8% tax applies.
 Taxpayers may regroup their activities in the first taxable year beginning after
December 31, 2013 in which the taxpayer’s modified adjusted gross income
exceeds the applicable threshold ($200,000/$250,000) and the taxpayer has net
investment income.
 A taxpayer may only regroup activities once under this rule. That regrouping will
apply to the taxable year and all subsequent taxable years,
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The Unique Alternative to the Big Four®
The Intersection of 469 and 1411
 The preamble to the 1411 regulations
states that the definition of a passive
activity for 1411 is narrower than
under 469.
 The 1411 regulations provide that
despite any grouping under 1411 for
self-rentals, each rental activity must
on its own rise to the level of a IRC
162 trade or business in order to
escape the 3.8% tax.
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The 3.8% Medicare Tax-The Intersection of Sections 1411 and
1402
 S Corporations- Material participation will avoid the 3.8% tax.
 Only actual wages paid will be subject to employment taxes.
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Effect on Medicare Contribution Tax - Planning
Self- Charged Interest Rules:
 If a taxpayer lends money to a partnership or S-Corporation in which the
taxpayer owns an interest, or vice versa, the taxpayer will have interest income
and expense related to the loan.
 If the loan proceeds are used in a passive activity, there could be a mismatch
between the passive deductions generated and the portfolio interest income from
the loan.
 The self-charged interest rules are intended to allow an offset.
 The regulations also apply to guaranteed payments for the use of capital under
Section 707(c).
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Effect on Medicare Contribution Tax - Planning
 The regulations re characterize the
“applicable percentage” of the interest
income and/or interest expense as
arising from a passive activity. See
Regulation Section 1.469-7.
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Effect on Medicare Contribution Tax - Planning
Self Charged Interest Rule Example:
 Paul lends money to the Blackacre partnership. The Blackacre partnership is
50% owned by Paul and 50% owned by John. The Blackacre partnership pays
Paul $5000 of interest on his loan.
 The interest is deductible by the Blackacre partnership and is allocated $2500 to
Paul and $2500 to John. Paul is passive in the partnership.
 Paul’s applicable percentage is 50%. Thus, $2500 of Paul’s interest income is recharacterized as income from a passive activity.
 The balance of the interest income is portfolio income.
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Planning for Self-Charged Rents
 Self-charged rents and Net Investment Income tax:
 Owners of a closely held business form a pass through entity to own the real property
used in the operating business. The operating business leases the property from the
real estate entity at an arms length rate. These leases are typically structured as triple
net leases.

Rental income is recharacterized as nonpassive.

However, the preamble to the 1411 regulations points out that two tests must be satisfied for
income from pass through entities to be exempt from the tax:

The income must be from a trade or business under Section 162; and

The income is not passive income under 469.

Triple net leases will not qualify as a trade or business, and conversion of triple net leases to
traditional leases will not necessarily result in a trade or business.

Grouping of a rental activity that does not constitute a trade or business with a trade or business
activity under Section 469 will not result in the rental activity being treated as a trade or business.
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For more information, contact:
David Holets
Direct 317.706.2683
david.holets@crowehorwath.com
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of Crowe Horwath International. © 2013 Crowe Horwath LLP
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