November 27, 2013

By now everyone should have filed their 2012 business and individual income tax returns. Before we settle into the holidays, let’s not forget to do some basic year-end tax planning.

The American Taxpayer Relief Act of 2012 (ATRA) passed in January 2013, as well as the Patient Protection and Affordable Care Act (Obamacare), contained significant tax law changes that take effect in 2013 of which taxpayers may not be aware.

3.8% Tax on Net Investment Income

What’s Included in This Tax?

The Affordable Care Act is funded by the addition of a 3.8% tax on Net Investment Income. Gross receipts from passive rental activities are included in the calculation of Net Investment Income and are subject to this new tax.

In order to avoid the Net Investment Income tax, taxpayers with rental activities that are considered a trade or business, would need to also qualify as a Real Estate Professional under IRC §469 for those rental activities that they are actively involved in. To meet the Real Estate Professional criteria, the taxpayer must meet certain hour requirements performing duties in specific real property activities.

Some taxpayers that are active in multiple rental activities may find it difficult to achieve these hours on a property-by-property basis. However, for these taxpayers, there is an opportunity to meet the Real Estate Professional criteria:

  • For those taxpayers who actively manage and care for their rental properties, the IRS has provided an irrevocable election to pool these activities, whereby the taxpayer collectively could achieve the hour requirement necessary to be a Real Estate Professional.
  • Pooling the rental activities would convert their once passive rental activities into non-passive and potentially avoid the Net Investment Income Tax.

The Sale of LLC interest May Also be Impacted

This new Net Investment Income tax may also apply to the sale of your LLC interest. The Code provides that the amount subject to the Net Investment Income tax is limited to the seller’s share of gain allocable to them in a hypothetical sale of the LLC assets at their fair market value.

Many real estate deals are formed with one member contributing property with a fair market value in excess of their basis (Built-in Gain, or BIG) and other members contributing cash. For those of you who have had an active role in the preparation of your LLC operating agreements, know that the IRS has provided methods to close the BIG gap for the contributing partner by specially allocating specific deductions related to the property to the non-contributing member.

Many times the agreement may be silent as to the method used or may use a default of the “Traditional” method. Non-contributing partners need to work with their tax advisors to make sure that that the method used doesn’t allocate to much of the BIG to them over time, thereby increasing their potential hypothetical gain on the sale of the LLC assets that would be subject to the 3.8% Net Investment Income Tax.

ATRA Tax Benefits Due To Expire December 31, 2013

In addition to the changes to our tax system provided by the Affordable Care Act, the ATRA provided tax benefits that were beneficial to real property owners; however, these benefits are set to expire at the end of 2013.

These expiring opportunities include:

Section 179D Energy efficient commercial buildings deduction

    • Maximum deduction equal to $1.80 x sqft of building
    • Multi-family residential rentals over 3 stories can qualify for this deduction
    • Possible to use a Change in Accounting Method to apply to building placed into service in prior tax years (Rev Proc 2011-14 as modified and clarified by Rev Proc 2012-39)

Section 45L New Energy efficient home credit

    • Maximum credit of $2,000 per dwelling unit
    • Multi-family residential rentals 3 stories or below can qualify

Section 30C Alternative fuel vehicle refueling property credit

    • Electric charging stations in parking garages may qualify
    • Maximum credit of $30,000 per location.

Section 162(k) “Bonus” depreciation on qualified leasehold improvement property

    • May be factor in considering when to place in service your building if considering a cost segregation study.

Section 162(e)(3)(E) 15-Year recovery on qualified leasehold improvement property and qualified restaurant property

Although many members of Congress have expressed desire to have comprehensive tax reform, it seems the current environment in Washington DC doesn’t provide much optimism that this would be completed with bi-partisan support by the end of the year.

Even if these expiring credits and deductions are not applicable to you, it is still a good time to meet with your tax advisors and do some basic tax planning.

© Clark Nuber PS, 2013.  All Rights Reserved

This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.