Only 250 Hours? Sec. 199A and Rental Real Estate.

While most of the posts on this blog pertain to estate planning topics, there are a few income tax related items that are making the tax headlines.

Tax professionals are in the midst of sorting through the nuances of the Tax Cuts and Jobs Act of 2017 (the “Act”) as they begin to prepare 2018 income tax returns.  A notable addition to the Internal Revenue Code (the “Code”) as a result of the Act is Sec. 199A, which allows a deduction up to 20 percent of a non-corporate taxpayer’s qualified business income.  This new deduction only applies to a qualified trade or business other than a specified service trade (as further defined).  The definition of a trade or business remains consistent with Sec. 162’s standard.

The Department of Treasury has proposed regulations for this new section.  Additionally, the Internal Revenue Service has issued guidance on several items related to the new deduction, one of which is a separate safe harbor for owners of rental real estate who wish to avail themselves of the deduction.

IRS Notice 2019-07 (the “Notice”) provides that a rental real estate enterprise will be treated as a trade or business for purposes of Sec. 199A if the following requirements are satisfied during the taxable year:

(1)  separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;

(2)  for tax years prior to January 1, 2023, 250 or more hours of rental services are performed per year with respect to the rental enterprise; for tax years after December 31, 2022, 250 or more hours of rental services are performed in any three of the five consecutive taxable years; and

(3)  the taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following:  (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services.

According to the Notice, a rental real estate enterprise is an interest in real property held for the production of rents and may consist of an interest in multiple properties.

Keep in mind that these requirements are solely for purposes of determining the eligibility of the taxpayer’s QBI deduction under Sec. 199A.

Rental real estate owners should recognize most of these requirements since they are very similar to the real estate professional rules under the Sec. 469 Regulations.  However, the reduction of the hour requirement may provide an additional tax incentive to those taxpayers who devote 250 hours of activity to rental real estate activities.

It is strongly advised that taxpayers consult with their tax counsel to ensure compliance with this new safe harbor.

An $11 Million Exemption?! Estate Planning Considerations and the Tax Cuts and Jobs Act of 2017

January 1, 2018 ushered in more than a new year for taxpaying Americans. Tax professionals of all areas of concentration continue to study the changes to the Internal Revenue Code enacted by the Tax Cuts and Jobs Act of 2017.  Most media reports have focused on the changes affecting income tax, such as doubling the standard deduction, eliminating personal exemptions, cutting back on certain deductions and adding a new treatment of “passthrough” income.  Few reports have addressed the one change in the federal estate tax:  doubling the exemption amount.  While this change is not nearly as exciting as the changes to the income tax, it does warrant consideration as taxpayers of varying degrees of net worth attempt to implement tax efficient estate plans.

Under the new law, individuals now have approximately $11 million of exemption before they are subject to federal estate tax. The “portability” of a spouse’s unused exemption has not been changed, which means that a married couple has a collective exemption amount of approximately $22 million.  Note, however, that the new law sunsets on January 1, 2026, with a reversion to the pre-2018 exemption amount thereafter.  So, what does one do?

Taxpayers whose net worth is above the new exemption amount should consider using the increased exemption amount as a further opportunity to continue moving value out of their estates. The use of irrevocable gift trusts, grantor retained annuity trusts (GRATs), qualified personal residence trusts (QPRTs), transfers to intentionally defective grantor trusts (IDGTs) and  family limited partnerships (FLPs) are still viable methods to move value (particularly rapidly appreciating assets) from one generation to the next by minimizing the sting of the estate tax.

Also, taxpayers subject to a state estate tax should determine whether the change in the federal law also increases the exemption at the state level. For example, Illinois has a fixed exemption amount of $4 million that is not indexed to the federal exemption amount.  Other states, such as Connecticut, Massachusetts, Minnesota, New Jersey, Oregon, Rhode Island, Vermont and Washington, also have exemptions significantly less than the federal exemption.  Delaware, Washington D.C., Hawaii, and Maine currently have exemption amounts that are indexed to the federal exemption amount.  Maryland and New York are set to have exemption amounts indexed to the federal exemption as of January 1, 2019.

Furthermore, taxpayers who are no longer affected by the estate tax due to the increase in exemption, but have previously implemented value-based estate planning techniques to remove value from their estates, should consider options to utilize the step-up in basis wherever possible. Assets that are considered part of a decedent’s estate at death receive a “step-up” in basis to the fair market value of such assets as of the decedent’s date of death.  Effectively utilizing this rule will be more important so as to minimize post-death capital gains tax.

Taxpayers with a net worth significantly less than both the federal and, if applicable, state estate tax exemptions should still be concerned with post-death income tax planning considerations, such as an effective use of the step-up rule to minimize post-death capital gains (as discussed above) and the transfer of income to taxpayers who are taxed at a lower income tax rate.

Finally, annual per donee exclusion gifting is still an option for making gifts to individuals. An individual may gift up to $15,000 per year to an individual without any gift tax implications.

Opportunity exists for planning at all levels and the implications of the increased federal estate tax exemption should be considered in the context of a taxpayer’s specific circumstances.

It’s Year End Tax Planning Time!

U.S. News and World Report recently published an article highlighting 11 income tax saving strategies to consider before the end of the year.  If you’re looking for ways potentially to reduce your 2015 income tax liability, you may want to consider some of the ideas contained in this article:  11 Tax Moves Every Taxpayer Should Make Before The End Of The Year.

Income Tax 101 For Homeowners!

Most individual taxpayers are aware of the annual income tax benefits of owning a home, such as the ability to deduct from gross income any mortgage interest and real estate taxes paid during the taxable year.  There are, however, other income tax rules of which homeowners should be aware, especially those who are disposing of a primary residence — either by sale or gift — or changing the home’s use from a primary residence to investment/rental property.  The article, 7 Tax Tricks For Homeowners , offers a good overview of the income tax implications that most taxpayers overlook in these circumstances.  As always, there’s no substitute for professional advice in these situations.

Avoid Paying Penalties To The IRS!

Today marks the extension deadline for 2014 partnership and calendar-year corporate returns.  Before it’s too late, now is a good time to remember October 15, which is the extension deadline for personal returns.  If you timely filed an extension for your 2014 personal tax filing, make sure you file your return on or before October 15.

Around the April 15 deadline, the following press release was issued regarding the extent to which penalties may be assessed for federal income tax that’s not paid by April 15:  Tax Attorney Advice on Avoiding Interest and Penalties for Outstanding Tax Liabilities.  It may be worthwhile to review your particular tax situation so that you can avoid paying unnecessary penalties and interest in the future!

Win Big In Vegas? Uncle Sam Does Too!!!

If you’ve ever been to Las Vegas, you know first-hand the allure of the gambling scene. Rows of card game tables, flashing lights on the slot machines and the shouts of joy as fellow gamblers strike it big—these are the sights and sounds that entice casino patrons to place the wager on the line. If you’re fortunate to come out ahead of the game, you may not be the only one winning. Gambling winnings are subject to income tax.

The Internal Revenue Code (“Code”) defines gross income as “. . . all income from whatever source derived . . .”[1] While this Code section lists various types of income that fit into this definition, the Regulations provide that gross income “. . . is not limited to the items so enumerated.”[2]

Internal Revenue Service Publication 525 provides that gambling winnings are to be included in line 21 of the taxpayer’s Form 1040.[3]

Furthermore, the IRS requires the payer of gambling winnings to report any winnings that meet the following criteria: (1) the winnings are $1,200 or more from bingo or slot machines, (2) the winnings are $1,500 (reduced by the wager) or more from a keno game, (3) the winnings are more than $5,000 (reduced by the wager or buy-in) from a poker tournament, (4) the winnings, reduced by the wager, are $600 or more and 300 times the amount of the wager, or (5) the winnings are subject to federal income tax withholding.[4] So, if your winnings meet any of these criteria, you will receive a Form W2-G listing your winnings and any income tax withheld.

For most infrequent gambling patrons, this question is more pertinent: are gambling losses deductible? The answer: it depends. The Code provides that wagering losses are deductible to the extent of gains derived from such transactions.[5] Additionally, the Code categorizes wagering losses as miscellaneous itemized deductions subject to the two percent limitation.[6] As a result, in order to be able to deduct any portion of incurred gambling losses, the taxpayer must (a) itemize his or her deductions for the applicable tax year and (b) incur expenses categorized as miscellaneous itemized deductions in excess of two percent of the taxpayer’s adjusted gross income.[7] Any portion of miscellaneous itemized deductions that exceeds the two percent limitation may be deducted on Schedule A.

Separate rules apply to “professional gamblers,” which are beyond the scope of this brief explanation.

[1] IRC § 61(a).

[2] Treas. Reg. § 1.61(a)

[3] IRS Pub. 525.

[4] IRS Instructions for Forms W2-G and 5754.

[5] IRC § 165(d).

[6] Id. at § 67(b)(3).

[7] For further discussion on itemizing expenses, see “Can I Write That Off?

Will You Owe Income Tax When You Sell Your Home?

As a result of my practice areas covering tax related matters and real estate transactions, clients often ask me whether they will be in for a surprise when they file their tax return the year after they sell their home.  As with most legal questions, the answer is “it depends.”  I have found that most people automatically assume they will pay no income tax from the gain that may result from the sale of their home.  However, that is not necessarily true.  Here’s why.

The Internal Revenue Code (“Code”) provides the following with respect to excluding the gain from the sale of your principal residence:

Gross income shall not include gain from the sale or exchange of property if, during the 5-year period ending on the date of the sale or exchange, such property has been owned and used by the taxpayer as the taxpayer’s principal residence for periods aggregating 2 years or more.[1]

Here are the key components to this part of the Code section:  (a) an understanding of what principal residence means; (b) the five-year period ending on the sale of the home; and (c) the amount of time you lived in the home during the five-year period.

The determination of “principal residence” is based on a facts and circumstances analysis that considers, for example, where you spend most of your time, your primary mailing address and the proximity of the home to your work location.[2]

If you considered the home you’re selling your principal residence for a total of two out of the last five years prior to the date of sale, then you meet what I call the “time” test.

Now, here’s the second part, which is what I call the “dollar amount” component.  For single tax filers, the amount of gain that you’re allowed to exclude is $250,000.[3]  For married filing jointly filers, the amount of gain doubles to $500,000.[4]  In the event that you meet the “time” test, any gain above your applicable exclusion threshold needs to be reported as income on your tax return.

There are exceptions to this rule, such as for work-related moves, unforeseeable circumstances and health-related moves.[5]  Some of these exceptions may allow for a total or partial exclusion of gain from the sale of your primary residence depending on other facts and circumstances.

In any event, above-mentioned factors should be evaluated when preparing your tax return the year following the sale of your primary residence.

[1] I.R.C. § 121(a).

[2] See IRS Pub. 523, Sale of Your Home, located at http://www.irs.gov/publications/p523/ar02.html#en_US_2014_publink10009003

[3] Id. at (b)(1).

[4] Id. at (b)(2).

[5] See IRS Pub. 523, Sale of Your Home, located at http://www.irs.gov/publications/p523/ar02.html#en_US_2014_publink10009003