Form 8582: Passive Activity Reporting and Impact of 3.8% Medicare

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Form 8582: Passive Activity Reporting and Impact of 3.8% Medicare Tax
Tackling Complex Passive Activity Computations; Navigating Income Tax and AMT Reporting Challenges
WEDNESDAY, NOVEMBER 19, 2014, 1:00-2:50 pm Eastern
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Form 8582: Passive Activity Reporting
and Impact of 3.8% Medicare Tax
November 19, 2014
Albert Dumaual
Capell Barnett Matalon & Schoenfeld
[email protected]
Damien R. Martin
BKD
[email protected]
Douglas N. Rubenstein
Katz Sapper & Miller
[email protected]
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 Albert Dumaual
JD, LLM (TAXATION)
CAPELL BARNETT MATALON & SCHOENFELD, LLP.
ATTORNEYS AT LAW
(516) 931-8100
[email protected]
§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
7
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
8
DISPOSITION CONTINUED
• 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
9
DISPOSITION CONTINUED
• Special Rule
• If dispose of substantially all & can
establish Losses with reasonable
certainty
10
DECEDENT’S UTILIZATION
•
•
•
•
•
Death is treated as complete disposition
Sec 1014 step-up to FMV
Step-up reduces suspended losses
Excess suspended loss available only on D’s final return
Compute property by property – Excess is lost
11
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
12
TRADE/BUSINESS ACTIVITY
• Treas. Reg. §1.469-4(b)
• §162 Trade/Business
• Conducted in anticipation of T/B
• §174 research or experimental
activities
13
MATERIAL PARTICIPATION
• Material Participation – REGULAR,
CONTINUOUS, and SUBSTANTIAL
• 7 Tests – Treas. Reg. §1.469-5T
• More than 500 HOURS is favorite
• Limited partner has only 3 methods
14
USE THE 7 TESTS
1.
2.
3.
The individual participates in it for more than 500 hours during
the year
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
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
15
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
16
THE 7 TESTS continued
5.
6.
7.
The individual materially participated in the activity for any five
tax years (consecutive or not) during the 10 immediately
preceding tax years
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
The individual meets a facts and circumstances test
17
CHARLES E. WADE v. COMM’R,
TCM 2014-169
• 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
18
WADE v. COMM’R
• IRS – H & W Did Not Materially
Participate!
• Court – Met Test #7
• Regular, Continuous, and Substantial
• Over 100 hours (not mgt.)
19
MARRIED
• Can count participation by spouse to meet material
participation only
• Even if do not file joint return!
20
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
21
MATERIAL PARTICIPATION &
CORPORATIONS
• Closely-held C Corp or Personal Service Corp:
• Shareholder(s) holding more than half of its
stock by value materially participates
• Closely-held C Corp also materially
participates if
• At least 1 full-time employee is active
manager
• At least 3 full-time employees but cannot
own more than 5%
• Deductible expenses < 15% of gross income
22
MATERIAL PARTICIPATION &
TRUSTS & ESTATES
• Frank Aragona Trust, 142 T.C. No. 9 (2014)
• Tax Court held: trust materially participated in real property
trade or business
• Trust qualified as a Real Estate Professional
• Trustees’ activities as employee counted
• Duty of Loyalty
• No Clear Guidance
23
INVESTMENT ACTIVITIES
•
•
•
•
Temp. Reg. § 1.469-5T(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
24
NOT CUSTOMARILY DONE
BY OWNERS
• Not counted toward material
participation under any test
• Work of a type not customarily done
by an owner of such activity; and
• Principal purpose for work is to avoid
PAL rules
25
MANAGEMENT ACTIVITIES
• For facts and circumstances test – Not if a paid manager or
another manager performs more services
• Iversen, TCM 2012-19
• Ranch activity insufficient evidence of participation
• Hired manager, therefore taxpayer’s management activities not
counted
26
FORMER PASSIVE
ACTIVITIES
• An activity that is not currently a
passive activity, but was passive in a
prior year
• Losses from when the activity was
passive may still be used to offset
income from that activity
• Any excess losses remain passive
27
SELF-CHARGED INTEREST
• §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
28
RENTAL ACTIVITIES
• Per se passive
• §1.469-1T(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”
29
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)
30
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
31
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 calls
• Motel or B&B and 7 days or less –
Average Rental
32
INCIDENTAL TO NONRENTAL
ACTIVITY
• Not 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
33
INCIDENTAL CONTINUED
• To a Trade or Business (T or B) – only if:
• Taxpayer owns an interest in such T or B.
• Property was “predominantly used” in such
T or 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
34
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
35
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
36
ACTIVE PARTICIPATION
• < Material Participation - regular, continuous, and substantial
involvement not required
• Maquire, TCM 2012-160
• Significant & bona fide participation - making management
decisions – approving new tenants, deciding rental terms,
approving capital expenses; or
• Arranging of others to provide services
37
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
§1411 Exception to NII
38
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
39
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
40
REAL PROPERTY TRADES OR
BUSINESSES
• Development, Redevelopment,
Construction, & Reconstruction
• Acquisition & Conversion
• Rental & Leasing
• Operation & Management
• Brokerage
41
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%
42
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
43
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 over 100 hours
44
MANAGEMENT ACTIVITIES &
REP
•
•
•
•
REP must materially participate in rental
Treas. Reg. § 1.469-9(e)(3)(ii)
Counted toward material participation
Even if conducted through a separate entity
45
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
• Adeyemo, TCM 2014-1: thorough and consistent
• Accurate Account
• Get confirmation of employment hours
• Merino, TCM 2013-167
46
MARRIED
• Can count participation by spouse to meet material
participation only
• Even if do not file joint return!
47
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.
• Cannot group rental activity w/ other real property trades or
businesses
48
EXAMPLE
• 3 Rental Properties, 200 hours each
• 3 Net Lease properties, 90 hours each
• Unless aggregate, fail 750 hour test
• May also fail material participation
49
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
50
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.
2.
Group within corps and then
Group with personal
51
APPROPRIATE ECONOMIC UNIT
•
•
•
•
•
Facts and Circumstances Test
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.
52
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
53
Albert Dumaual
JD, LLM (TAXATION)
CAPELL BARNETT MATALON & SCHOENFELD, LLP.
ATTORNEYS AT LAW
(516) 931-8100
[email protected]
54
Slide Intentionally Left Blank
Form 8582: Passive Activity
Reporting and Impact of
3.8 Percent Medicare Tax
November 19, 2014
Douglas Rubenstein, CPA
© 2014 KSM Business Services, Inc.
Form 8582: Passive Activity Reporting and
Impact of 3.8 Percent Medicare Tax
▪ Objectives
▫ Form 8582 – Passive Activity Loss Limitations
▫ Grouping Disclosure Rules
▫ Grouping Examples
57
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Form 8582
Passive Activity Loss Limitations
58
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Form 8582 – Passive Activity Loss
Limitations
▪ General Rule: Passive Losses are Allowed Up to the
Amount of Passive Income
▪ Purpose of Form: Compute the Passive Activity Loss
Limitation for Each Taxable Year
▪ Excess Passive Losses are Generally Suspended and
Carried Forward to Future Years
59
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Form 8582 – Passive Activity Loss
Limitations
▪ Form 8582 Instructions – Key Issues
▫ Initially Complete Worksheets 1, 2 and 3 of Form 8582
▫ Worksheet 1 – Rental Real Estate Activities
- Active Participation in the Rental Real Estate Activities
- Prior Year Suspended Losses Shown Only for Activities in which
Taxpayer was Previously Active
- If not Previously Active in Rental Real Estate Activity, then Prior
Year Suspended Losses are Disclosed on Worksheet 3
60
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Form 8582 – Passive Activity Loss
Limitations
▪ Form 8582 Instructions – Key Issues
▫ Worksheet 2 – Commercial Revitalization Deductions
(“CRD”) from Rental Real Estate Activities
- Available for Buildings Placed in Service Prior to January 1,
2010
- Deduction Only Available if Activity Previously Elected to
Ratably Claim CRD Deduction over Period of 120 Months
61
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Form 8582 – Passive Activity Loss
Limitations
▪ Form 8582 Instructions – Key Issues
▫ Worksheet 3 – All Other Passive Activities
- Trade or Business Activities
- Passive Rental Real Estate Activities – Not an Active Participant
- Other Rental Activities – Personal Property
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Form 8582 – Passive Activity Loss
Limitations
▪ Form 8582 – Compliance Issues
▫ Proper Coding of Activity
- Non-Passive
- Active Rental Real Estate
- Other Passive
- Material Participating Real Estate Professional
- Subject to Recharacterization Rules – Rental Real Estate
- Subject to Recharacterization Rules - Other
63
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Form 8582 – Passive Activity Loss
Limitations
▪ Form 8582 – Compliance Issues
▫ Total Suspended Losses are Allocated to the Activities on a
Pro-Rata Basis
▫ Confirm that Prior Year Suspended Losses Carried Forward
to Current Year Return
▫ Disposition of Passive Activities
- Prior Year Suspended Losses Shown as Non-Passive Loss on
Schedule E of Form 1040 and Form 1041
- Prior Year Suspended Losses Not Shown on Prior Year Carry
forward Schedule
- Gains from Dispositions of Passive Activities Can Offset Other
Passive Activity Losses
64
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Form 8582 – Passive Activity Loss
Limitations
▪ Form 8582 – Compliance Issues
▫ Publicly Traded Partnerships(“PTPs”)
- Code Section 469(k)(1) provides that Passive Activity Rules are
Applied Separately with Respect to Items Attributable to Each
PTP
- Separate Tracking of Each PTP
- PTPs will Generally be Passive to Most Investors as Material
Participation Rules will not be met
- PTPs are Not Reported on Form 8582
65
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Example
66
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Comprehensive Example
▪ Detailed Example – Douglas and Marla Rubenstein
▫ MFJ with 2 Children – Age 15 and 18
▫ Adjusted Gross income - $1,080,000
▫ Schedule K-1 Investments
- ABC Company – Doug is a 50 Percent Owner
- Non-Passive Income
- $400,000 Ordinary Income
- $5,000 – Share of Self Charged Interest
- RAR Company LLC – Doug is a 50 Percent Owner
- $10,000 Rental Income
- Subject to Rental Recharacterization Rules
- $5,000 of Prior Year Suspended Losses
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Comprehensive Example
▪ Detailed Example – Douglas and Marla Rubenstein
▫ Schedule K-1 Investments
- JRR Company LLC – Doug is a 20 Percent Owner
- Passive Income
- $20,000 Ordinary Income
- MLR Real Estate Services LLC
- Non-Passive Income
- $30,000 Ordinary Loss
- DEF Company LLC – Doug is a 30 Percent Owner
- Non-Passive Income Effective 2013 Tax year
- $100,000 Ordinary Income
- $50,000 Prior Year Suspended Losses
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Comprehensive Example
▪ Detailed Example – Douglas and Marla Rubenstein
▫ Schedule K-1 Investments
- GHI Company LLC
- Passive Investor
- $50,000 Ordinary Loss
- JKL Rental Real Estate Company LLC
- Active Rental Real Estate
- $20,000 Rental Real Estate Loss
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Grouping Disclosure Rules
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Grouping Disclosure Rules
▪ General Rule – Treasury Regulation 1.469-4
▫ Treat Two or More Trade or Business Activities or Rental
Activities as Single Activity if the Activities Constitute
Appropriate Economic Unit (“AEU”)
▫ Facts and Circumstances Determine AEU
- Similarities and Differences of Businesses
- Extent of Common Control
- Extent of Common Ownership
- Geographical Location
- Interdependencies of Businesses
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Grouping Disclosure Rules
▪ General Rule – Treasury Regulation 1.469-4
▫ Facts and Circumstances Determine AEU
- Interdependencies of Businesses – Examples
- Purchasing and Buying Goods Between Related Entities
- Involved in Products and Services Normally Provided
Together
- Same Customers and Employees
- Single Set of Books and Records for Accounting Purposes
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Grouping Disclosure Rules
▪ Who Qualifies for the Grouping Activity Rules
▫ Taxpayers with Multiple Entities for Legal and Economic
Reasons
▫ Examples of Taxpayers
- Physicians
- Trucking Owners
- Restaurant Owners
- Veterinarians
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Grouping Disclosure Rules
▪ Importance of Grouping Activities
▫ Allows for Material Participation Rules to be Applied to Group
of Activities Instead of Individual Activity
▫ Potential Allowance of Prior Year Suspended Passive Losses
▫ Disposition of an Activity in a Grouped Activity Does not
Cause Disposition of Entire Activity
▫ Grouping of Activities Plays Role in Determining 10 Percent
Ownership Rule for Active Participation in Rental Real Estate
Activities
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Grouping Disclosure Rules
▪ Limitations of Grouping Activities
▫ Rental Real Estate Activity May Not be Grouped with Personal
Property Rental Activity
▫ Rental Activity May Not be Grouped with Trade or Business
Activity
▫ Exceptions to the Grouping Limitations Rule
- Rental Activity Inconsequential to Trade or Business Activity
- Trade or Business Activity Inconsequential to Rental Activity
- Owners of Trade or Business Activity has Same Proportionate
Ownership in Rental Activity “and”
- Portion of Rental Activity Involves Rental to Related Trade or Business
Activity
- Personal Property Provided in Connection with Real Property
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Grouping Disclosure Rules
▪ Disclosure and Consistency Requirements
▫ Once the Activities are Grouped Generally Cannot Regroup
Activities in Subsequent Years
▫ Exceptions to Regrouping Limitations
- Inappropriate Grouping
- Material Change in Facts and Circumstances
- Must Regroup Activities
- Comply with Disclosure Requirement prescribed by
Commissioner of Internal Revenue Service
- Affordable Care Act
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Grouping Disclosure Rules
▪ Revenue Procedure 2010-13
▫ Internal Revenue Service Issued Guidance for Grouping
Activities
- Initial Grouping of Activities
- Addition of Activities to Existing Groupings
- Regrouping of Activities
▫ Guidance Does Not Apply to Real Estate Professionals
▫ Effective Taxable Years Beginning On or After January 25,
2010
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Grouping Disclosure Rules
▪ New Grouping Reporting Requirements
▫ Written Statement Attached to Original Filed Income Tax Return
▫ Name Address and EIN of Entities in the Group
▫ Declaration the Grouped Activity Constitutes an Appropriate
Economic Unit for Measure of Gain or Loss for Section 469
▪ Existing Groups – Addition of New Activities
▫ Written Statement Attached to Original Filed Income Tax Return
▫ Name Address and EIN of Entities in the Group
▫ Declaration the Grouped Activity Constitutes an Appropriate
Economic Unit for Measurement of Gain or Loss for Section 469
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Grouping Disclosure Rules
▪ Grouping of Activities
▫ Written Statement Attached to Original Filed Income Tax
Return
▫ Name Address and EIN of Entities Being Regrouped
▫ Declaration the Regrouped Activities Constitutes an
Appropriate Economic Unit for Measurement of Gain or Loss
for Section 469
▫ Explanation of Why the Original Grouping Inappropriate or
Nature of Material Change in Facts and Circumstances that
Causes Original Grouping Inappropriate
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Grouping Disclosure Rules
▪ Failure to Disclose Grouping Election
▫ Failure to Make Grouping Election Will Generally Result in
Each Entity Treated as a Separate Activity
▫ Deemed to Make Timely Disclosure if All Affected Tax
Returns Consistent with Claimed Grouping of Activities and
Make Required Disclosures on Income Tax Return for Year in
Which Failure to Disclose Groupings is First Discovered
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Grouping Disclosure Rules
▪ Failure to Disclose Grouping Election
▫ Amended Income Tax Return
- Not Addressed in the Regulations or Rev. Proc. 2010-13
- Recommendation – If Going to Regroup Activities Through an
Amended Income Tax Return, Engage in Full Disclosure on the
Amended Return and the Succeeding Tax Return
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Grouping Disclosure Rules
▪ Grouping Election Example – Initial Grouping
▫
▫
▫
▫
▫
▫
Taxpayer: John Doe
SSN: XXX-XX-XXXX
Schedule of Groupings
Tax Year: 12/31/2013 Form 1040
Disclosure Pursuant to Regulation 1.469-4
Taxpayer Hereby Elects to Group the Following Entities in
This Original Grouping as an Appropriate Economic Unit
Pursuant to Regulation 1.469-4(d)(1)(c)
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Grouping Disclosure Rules
▪ Grouping Election Example – Initial Grouping
▫ Entity Name Address City State Zip Code EIN Number
▫ ABC Restaurant, LLC 123 Hoosier St. Indpls IN 46260
12-3456789
▫ DEF Restaurant, LLC 123 Billiken Avenue St. Indpls IN
46240 23-4567890
▫ GHI Restaurant, LLC 123 Razorback Drive St. Indpls IN
46204 34-5678901
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Grouping Disclosure Rules
▪ Grouping Election Example – Addition of New Activities
▫
▫
▫
▫
▫
▫
Taxpayer: John Doe
SSN: XXX-XX-XXXX
Schedule of Groupings
Tax Year: 12/31/2013 Form 1040
Disclosure Pursuant to Regulation 1.469-4
Taxpayer Hereby Elects to Add the Highlighted Entities to the
Existing Grouping and Hereby Treats the Grouping as an
Appropriate Economic Unit Pursuant to Regulation 1.4694(d)(1)(c).
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Grouping Disclosure Rules
▪ Grouping Election Example – Addition of New Activities
▫ Entity Name Address City State Zip Code EIN Number
▫ ABC Restaurant, LLC 123 Hoosier St. Indpls IN 46260
12-3456789
▫ DEF Restaurant, LLC 123 Billiken Avenue Indpls IN 46240
23-4567890
▫ GHI Restaurant, LLC 123 Razorback Drive Indpls IN 46204
34-5678901
▫ JKL Restaurant, LLC 123 Bulldog St. Indpls IN 46268
45-6789012
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Grouping Disclosure Rules
▪ How does the Affordable Care Act Affect the Grouping
Disclosure Rules?
▫ Final Regulations Determined Taxpayers Should be Allowed
Opportunity for a Fresh Start with the Groupings
▫ Effective in the First Year Taxpayer Meets the Applicable Income
Thresholds for the Unearned Income Medicare Tax (3.8 Percent)
▫ Have Net Investment Income
▫ Effective as of January 1, 2014, However May Rely on the
Regulations for 2013 Calendar Year if Subject to Unearned
Income Medicare Tax.
▫ Once Grouping is Complete, Would Apply in All Subsequent Years.
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Grouping Disclosure Rules
▪ How Does the Affordable Care Act Affect the Grouping
Disclosure Rules?
▫ Caution: If Taxpayer Does Not Change a Prior Grouping Election
or Does Not Make an Allowable Grouping Election in First Year
Subject to Unearned Income Medicare Tax, then the Grouping
cannot be changed in Future Years Unless it Meets the
Requirement of Either:
- Inappropriate Grouping “or”
- Material Change in Facts and Circumstances
▫ Exception – Taxpayer Allowed to Regroup on Amended Return
- Taxpayer Not Originally Subject to Unearned Income Medicare Tax
- Result of Amended Return Causes Taxpayer Subject to Unearned
Income Medicare Tax
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Grouping Disclosure Rules
▪ How Does the Affordable Care Act Affect the Grouping
Disclosure Rules?
▫ Voided Regrouping Election
- Regrouping will be Voided if Subsequently Determined that Taxpayer is
Not Subject to Unearned Income Medicare Tax
- Regrouping is Void in Regrouping Year and Subsequent Years Until
Valid Regrouping is Done
- Two Exceptions to Voided Regrouping Elections
- Taxpayer Adopts Voided Regrouping in Subsequent Year if Subject
to Unearned Income Medicare Tax
- If Taxpayer Subject to Unearned Income Medicare Tax in
Subsequent Year, May File Amended Return to Regroup in Manner
that Differs from Previous Year’s Voided Regrouping
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Grouping Examples
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Grouping Examples
▪ Husband and Wife Example
▫ Jack and Jill File a Married Filing Joint Return
▫ Jack is the 100 percent owner of a Trucking Company, “S”
Corporation
▫ Jack and Jill own a Building in a Partnership Structure that
Rents to the Trucking Company
▫ Since Jack and Jill file a Joint Return, Treated as One
Taxpayer.
▫ Therefore, Allowed to Treat the Operating Activity and Rental
Real Estate Activity as an AEU and Treated as One Activity
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Grouping Examples
▪ Husband and Wife Example
▫ Jack and Jill File a Married Filing Joint Return
▫ Jack is the 100 percent owner of a Trucking Company, “S”
Corporation
▫ Jack and Jill own a Building in a Partnership Structure that Rents a
Portion of the Building to the Trucking Company
▫ Remainder of Building is Rented to a Third Party
▫ Since Jack and Jill file a Joint Return, Treated as One Taxpayer.
▫ Therefore, Allowed to Treat the Operating Activity and the Portion
of the Rental Real Estate Activity Rented to the Trucking Company
as an AEU and Treated as One Activity
▫ May Need to Keep Separate Books and Records for Two Separate
Rental Activities
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Grouping Examples
▪ Family Planning Trap
▫ Jack and Jill File a Married Filing Joint Return
▫ Jack is the 100 Percent Owner of a Trucking Company, “S”
Corporation
▫ Jack and Jill own 99 Percent of Building in a Partnership
Structure that Rents to the Trucking Company.
▫ The Remaining 1 percent is Owned by their Minor Child
▫ Since Jack and Jill’s Child Maintains a 1 Percent Interest in
the Rental Real Estate Activity, Prevents the Grouping of the
Trucking Activity With the Rental Real Estate Activity.
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Grouping Examples
▪ Trucking Companies
▫
▫
▫
▫
▫
▫
Operating Company
Logistics Company
Warehousing Company
Leasing Company
Rental Real Estate Activity
Since these Activities are Interdependent of Each Other,
Would be Considered an AEU
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Grouping Examples
▪ Health Care Industry
▫
▫
▫
▫
▫
Physician Owned Practices
Ambulatory Surgery Centers
Laboratories
Imaging Centers
Key Issue – How are the Hours of the Physician Determined
at the Applicable Ancillary Centers?
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Grouping Examples
▪ Health Care Industry CAUTION
▫ Physicians Employed by Hospitals May Have Difficult Time
Meeting the Material Participation Rules and Grouping Rules
of Ancillary Medical Activities
▫ Hospitals May Own Majority Interest in the Ancillary Centers
▫ Can Physicians Obtain the Necessary Hours from the
Ancillary Centers to Treat Them as Non-Passive?
▫ How Would Physician Count Hours at Ancillary Center if Paid
by Hospital for Services Performed at Center?
▫ Internal Revenue Service Currently Silent on Position
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Contact Doug
Profile
Doug Rubenstein is a director in Katz, Sapper & Miller's Tax Department and Real
Estate Services Group. He has been with the firm since 1998 and has been in public
accounting since 1994. Doug’s background includes advising clients in a wide
variety of accounting, tax and business matters. He has extensive experience in tax
planning, tax compliance, financial statement analysis, and forecasts and
projections, in addition to managing business issues specific to the real estate
industry.
Doug Rubenstein, CPA
Director
Office
317.580.2271
Fax
317.805.2371
E-mail
[email protected]
Education
Doug received a Bachelor of Science degree in business administration and
accounting from the University of Arkansas and a Master of Business Administration
degree from Saint Louis University.
Associations and Community Involvement
Doug is a member of the American Institute of Certified Public Accountants and the
Indiana CPA Society. He serves as secretary for the Central Indiana Intercollegiate
Soccer Official Association, is a member of the board of directors of Friends of
Holliday Park, and is a member of the board of directors of Congregation Beth-El
Zedeck.
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CPAs & ADVISORS
experience momentum //
NET INVESTMENT INCOME TAX AND THE PASSIVE ACTIVITY RULES
Presented by Damien R. Martin , CPA
OBJECTIVES
Overview of the Net Investment Income Tax
Intersection of §469 and §1411
Self-charged interest exclusion
When is rental income excluded from NII?
Material participation by a trust
Reporting considerations
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NET INVESTMENT INCOME TAX
What is it? 3.8% flat tax on unearned income (“net investment
income”);
Who does it apply to? Individuals with a “modified” adjusted
gross income (AGI with foreign income and deductions added
back) in excess of $200,000 ($250,000 for married taxpayers
filing a joint return, $125,000 for married taxpayers filing a
separate return). Estates and trusts in the top tax bracket
($12,150 for 2014).
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NET INVESTMENT INCOME TAX
What does it apply to? Net investment income –
Gross income from interest, dividends, annuities, royalties,
and rents, other than such income which is derived in the
ordinary course of a trade or business, less allocable
deductions;
Income from a passive activity or a trade or business
trading in financial instruments or commodities;
Realized capital gains attributable to the disposition of
investment properties;
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NET INVESTMENT INCOME TAX
Does NOT apply to:
Wages;
Self-employment income;
Distributions from qualified plans (i.e., IRAs and 401(k)s);
Tax-exempt interest;
Self-charged rent and self-charged interest.
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NET INVESTMENT INCOME TAX
How is it calculated?
Applies to the lesser of:
(i) net investment income; or
(ii) modified adjusted gross income that exceeds the
thresholds.
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NET INVESTMENT INCOME TAX
Individual example:
Single Individual
Married Filing Jointly
Net investment Income
$65,000
$65,000
Wages
185,000
185,000
20,000
20,000
270,000
270,000
(200,000)
(250,000)
MAGI Over Threshold
70,000
20,000
NII Subject to Tax
65,000
20,000
MCT (3.8%)
$2,470
$760
IRA Distribution
MAGI
Threshold
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INTERSECTION OF §469 AND §1411
Material participation under §469 will affect whether a trade
or business activity is
Active and thus excluded from the NIIT
Passive and thus subject to the NIIT
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SELF-CHARGED INTEREST EXCLUSION
Self-charged interest income received from a nonpassive flowthrough entity (not trading in financial instruments or
commodities) is excluded from NII but only to the extent that it
would have been considered passive activity gross income
under the rules of Treas. Reg. §1.469-7 if the payer was a
passive activity of the taxpayer.
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SELF-CHARGED INTEREST EXCLUSION
How do calculate the self-charged interest exclusion:
A = B x (C / Greater of B or C)
A = Owner’s self-charged interest income excluded from NII;
B = Owner’s self-charged interest income;
C = Owner’s pass-through share of interest expense from all owner
loans
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SELF-CHARGED INTEREST EXCLUSION
If loans and interest expense allocations are prorata, 100% of
all self-charged interest income is excluded from NII (assuming
the same interest rate applies to all owner loans);
If a taxpayer loans more than his share, less than 100% of the
taxpayer’s self-charged interest income is excluded from NII;
If taxpayer loans less than his share, 100% of the taxpayer’s
self-charged interest is excluded from NII.
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Qualifying real estate professional
Rental income is self-charged
Rental activity is grouped with a nonpassive trade or business
Significant personal services
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Qualifying real estate professionals (REPs)
Treas. Reg. §1.1411.-4(g)(7) provides a safe harbor – If a REP
participates in rental real estate activity for more than 500 hours
per year, rental income (and any gain) associated with that activity
is presumed to be derived in the ordinary course of a trade or
business;
Must meet the definition of a REP under §469(c)(7)(B) (i.e., the 750hour test). Look to tests for material participation under Treas. Reg.
§1.469-5T;
An election made under Treas. Reg. §1.469-9 to aggregate all
taxpayer’s rental activities is respected for purposes of meeting the
500-hour test
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Rental income is self-charged
Joe Client
(non-passive)
Operating S
Corporation, Inc.
Real Estate, LLC
Rent
$100,000
Excluded from NII if rental income is self-charged
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Rental income is self-charged (cont.)
Reg. §1.469-2(f)(6)
Material participation in trade or business activity; and
Ownership interest in the property that is being rented
Treas. Reg. §1.1411-4(g)(6)
Self-rental income (and any gain associated with the activity)
is deemed to be derived in the ordinary course of a trade or
business and excluded from NII
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Rental activity is grouped with a nonpassive trade or business
A rental activity may only be grouped with a trade or
business activity if the grouped activities constitute an
appropriate economic unit and:
The rental activity is insubstantial in relation to the trade
or business activity; or
Each owner of the trade or business has the same
proportionate ownership interest in the rental activity
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Rental activity is grouped with a nonpassive t/b (cont.)
If a taxpayer would like to regroup their activities in light of
the NIIT, the regrouping must be reported to the IRS
In either 2013 or 2014 if subject to NIIT (Treas. Reg.
§1.469-11(b)(3)(iv);
If not subject to the NIIT in 2013 or 2014, the taxpayer
may regroup in the first year after 2014 in which they
are subject to NIIT
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Rental activity is grouped with a nonpassive t/b (cont.)
If a rental activity is subject to the self-rental
recharacterization rule:
Taxable income will be nonpassive and exempt from the
NIIT regardless of whether a grouping election is made;
Taxable loss will be passive unless a grouping election is
made.
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WHEN IS RENTAL INCOME EXCLUDED FROM NII?
Significant personal services
Treas. Reg. §1.469-1T(e)(3)(ii)
E.g., Hotel
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MATERIAL PARTICIPATION BY A TRUST
There will be some degree of uncertainty for determining
material participation of trusts and estates until clarifying
regulations under §469 are issued by the IRS
Legislative history: “An estate or trust is materially
participating in any activity…if an executor or fiduciary, in
his capacity as such, is so participating." (S. Rep. No. 99313, 99th Cong., 2d Sess. 735 (1986) (emphasis added)
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MATERIAL PARTICIPATION BY A TRUST
Mattie K. Carter Trust v. United States (256 F. Supp. 2d 536): The
Texas District Court expanded the Senate report by concluding
that trust material participation should be determined by
reference to all persons who conduct business on the trust’s
behalf, including employees as well as the trustee;
Frank Aragona Trust v. Commissioner (142 T.C. No. 9): The Tax
Court held that a trust can be considered a real estate
professional under IRC §469(c)(7) because personal services
performed by individual trustees constituted personal services
by the trust. The Court held that services performed by the
individual trustees as employees count towards achieving
material participation by the trust.
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MATERIAL PARTICIPATION BY A TRUST
TAM 200733023: IRS concluded that the sole means for a trust to
establish material participation was by its fiduciaries being
involved in the operations;
PLR 201029014: IRS held that a trust materially participates in a
business only if the trustee is involved in the operations of the
entity’s activities on a regular, continuous, and substantial basis;
TAM 201317010: IRS concluded that the sole means for a trust to
establish material participation in the relevant activities of a
trust-owned business is if the fiduciaries, in their capacities as
fiduciaries, are involved in the operations of the relevant
activities of the trust-owned business on a regular, continuous,
and substantial basis.
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MATERIAL PARTICIPATION BY A TRUST
For purposes of the NIIT, characterization of income at the
trust level is retained when the income is distributed to a
beneficiary. If there is a nonpassive business at the trust level,
a portion of the Distributable Net Income (DNI) attributable to
the business will be excluded from NII at the beneficiary level.
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REPORTING CONSIDERATIONS
NIIT observations:
NIIT touches every code section that affects S corporations,
partnerships, and individuals;
Final regulations are effective beginning after December 31,
2013. Calendar year taxpayers that choose to rely on proposed
regulations in 2013 will need to apply the final regulations in
2014.
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REPORTING CONSIDERATIONS
Required disclosure for exclusion of gain from sale of an equity
interest in a nonpassive pass-through entity:
Name and EIN of pass-through entity of which interest was
transferred;
Amount of transferor’s gain or loss on disposition of interest for
regular tax purposes included in line 5a;
Information provided by the partnership or S corporation to the
transferor relating to the disposition of the activity, if applicable;
Amount of the adjustment to gain or loss due to basis
adjustments attributable to ownership in certain CFCs and QEFs.
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REPORTING CONSIDERATIONS
Form 8960 pulls directly from Form 1040:
Interest: Form 1040, line 8a;
Ordinary dividends: Form 1040, line 9a;
Rental real estate, royalties, partnerships, S corporations,
trusts, etc.: Form 1040, line 17;
Net gain or loss from disposition of property: Form 1040,
lines 13 and 14.
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REPORTING CONSIDERATIONS
Tips for preparing Form 8960:
Don’t rely on the software
Watch for self-charged rental income –Requires and
adjustment on line 4b;
Watch for self-charged interest income –Requires an
adjustment on line 7;
Watch for Domestic Production Activities Deduction –
Requires an adjustment on line 7.
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THANK YOU
FOR MORE INFORMATION // For a complete list of our offices
and subsidiaries, visit bkd.com or contact:
Damien R. Martin, CPA // Senior Manager
[email protected] // 630.282.9577
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