2011 federal tax update
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2011 Federal Tax Update. Real Estate & Investment. New Tax Legislation. Real Estate Tax News. Landlord’s 1099 reporting repealed Repeal retroactive to 1/1/11 TIGTA tells IRS to audit more rentals 53% of landlords misreport income $12b of unreported income

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2011 Federal Tax Update

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2011 federal tax update

2011 Federal Tax Update

Real Estate & Investment


New tax legislation

3-1

New Tax Legislation


Real estate tax news

Real Estate Tax News

3-2

  • Landlord’s 1099 reporting repealed

    • Repeal retroactive to 1/1/11

  • TIGTA tells IRS to audit more rentals

    • 53% of landlords misreport income

    • $12b of unreported income

    • IRS agrees to audit more rental activities

  • Passive loss Form 8582 instructions to be revised

New!


Residences

3-3

Residences


First time homebuyer credit update

First Time Homebuyer Credit Update

3-4

  • 2008 Credit payback began in 2010

  • IRS sending reminder letters

  • Reminder: Allowed for purchases through April, 2011 for

    • Extended duty military

    • Foreign service

    • Intelligence community workers


Gain on sale of residence

3-5

Gain on Sale of Residence

The $250,000/$500,000 MFJ

Exclusion Rule


The exclusion rule

The Exclusion Rule!

3-5

  • $250,000 (or $500,000 if married filing joint) of gain is excluded on sale (or exchange) of principal residence if:

  • Owned for two of last five years,

  • Occupied for two of last five years, and

  • No sale in last two years


How to exclude 500 000

How to Exclude $500,000!

3-6

  • Either spouse owns 2 out of 5 years

  • Both spouses use 2 out of 5 years

  • Neither spouse excluded gain in last 2 yrs

  • Must file “Married Filing Joint”

Is this Jessie?


Surviving spouse may qualify for 500 000 exclusion

Surviving Spouse May Qualify for $500,000 Exclusion

3-6

  • $500,000 exclusions applies if

    • After 12/31/07

    • Sale within 2 years of death of spouse

    • Immediately prior to death

      • Either spouse owned 2 out of 5 years

      • Both spouses used 2 out of 5 years

      • Neither spouse excluded gain in last 2 yrs

Is this Jessie?


Recent court cases

Recent Court Cases

3-7

  • 50% owner gets 100% of exclusion (Hsu)

  • Divided court says must live in house to qualify for exclusion (Gates)

Is this Jessie?


No exclusion for prior non qualified use

No Exclusion for Prior Non-Qualified Use

3-8

  • Substantial limitation on vacation homes

  • Gain must be prorated, S/L for qualified & non-qualified time

  • Non-qualified: time not principal residence

  • Non-qualified time doesn’t include:

    • After use as principal residence before sale

    • Temporary absence (up to two years)


Example rent 2 yrs use 3 yrs

Example: Rent 2 yrs; Use 3 yrs

3-8


Example rent after personal use

Example:Rent after Personal Use

3-8


Example gain before 2009

Example: Gain Before 2009

3-9


Qualification for the reduced exclusion rule

Qualification for The “Reduced Exclusion” Rule

3-9

  • Homeowner Violates:

    • 2 Year Ownership Rule, or

    • 2 Year Use Rule, or

    • Only Once in Last 2-year rule

  • Because of:

    • Change in Place of Employment

    • Health, or

    • IRS’s “Unforeseen Circumstances”


Converting residence to rental

Converting Residence to Rental

3-10

  • Can you convert a personal residence to a rental property? Yes!

  • But watch out –

    • Basis is the lower of cost or FMV at date of conversion

    • Losses resulting prior to rental are not deductible


2011 federal tax update

3-10


Foreclosures on the rise

Foreclosures on the Rise

3-

  • Nevada, Arizona, California &Florida still leading the way

    • (RealtyTrac.com)

  • More than 1,000,000 foreclosures in 2010


Cod exceptions

COD Exceptions

3-11

  • Excluded by law, e.g., gifts & bequests

  • Qualified student loan COD

  • Cancelled debt would have been deductible

  • Qualified purchase price reduction


Cod exclusions

COD Exclusions

3-11

  • Qualified principal residence debt

  • Bankruptcy COD

  • Insolvency COD

  • Qualified Farm COD

  • Qualified real property business COD


Foreclosure results in cod

Foreclosure Results in COD

3-12

  • Reduction in debt taxable as ordinary income

    • Form 1099-A (foreclosure sale), but not needed if foreclosure and COD in same year

    • Form 1099-C (loan reduced)


Mortgage modification

Mortgage Modification

3-12

  • Foreclosures

  • Deed in lieu

  • Mortgage workout


Foreclosure results in cod1

Foreclosure Results in COD

3-12

  • Foreclosure

    • Even a forced sale is a taxable sale


Nonrecourse vs recourse debt

Nonrecourse vs. Recourse Debt

3-12

  • Nonrecourse debt (not personally liable)

  • Recourse debt (personally liable)


Foreclosure of nonrecourse debt

Foreclosure of Nonrecourse Debt

3-13

  • Sales price = nonrecourse debt

    • Result: No COD

  • Home acquisition debt in 14 states often non-recourse (CA, MT)

    • But, be careful! A refinance changes status of debt


Foreclosure of nonrecourse debt1

Foreclosure of Nonrecourse Debt

3-13


Foreclosure of recourse debt

Foreclosure of Recourse Debt

3-13

  • Recourse debt must be bifurcated

    • Amount of cancellation of debt &

    • Gain/loss on sale

  • COD income results

  • Refi’s are often recourse debts


Foreclosure of recourse debt1

Foreclosure of Recourse Debt

3-14


Worksheet

Worksheet

3-15

  • Calculates COD income for

    • Foreclosures

    • Repossessions


Property type matters

Property Type Matters

3-15

  • Business, investment or personal

    • Business = ordinary loss on sale

    • Investment = capital loss on sale

    • Personal = non deductible loss on sale

    • What did you do with the money?


Foreclosure of business property

Foreclosure of Business Property

3-15

  • Calculate COD

    • Loan less COD

  • Calculate gain or loss on “sale”

    • FMV at foreclosure is sales price

  • Character of gain or loss same as if property sold


Sharon loses las vegas rental

Sharon Loses Las Vegas Rental

3-16


Bill loses phoenix rental

Bill Loses Phoenix Rental

3-16


Short sale

Short Sale

3-17

  • House sold, not enough to pay off bank

  • If “short pay” forgiven by bank, COD results (Stevens)

  • Bank files Form 1099C


108 exceptions to cod income

§108 Exceptions to COD Income

3-18

  • Bankruptcy

  • Insolvency

  • Farm debt for solvent farmer

  • Seller financing

  • If payment of liability creates a deduction

  • Discharge of real property business debt

  • Bona fide dispute

  • Qualified home acquisition debt


Bankruptcy

Bankruptcy

3-18

  • Exclusion does not apply to a debtor in a bankruptcy case

    • The bankruptcy exclusion rules apply

    • Taxpayer may choose insolvency exclusion


Insolvency

Insolvency

3-18

  • Taxpayer insolvent to extent liabilities exceed assets

    • Includes house, pension, IRA, autos, furniture, tools, etc.

  • How to calculate insolvency worksheet

  • Pub. 4681


Reduction of tax attributes

Reduction of Tax Attributes

3-19

When COD non-taxable, reduce tax attributes in the following order

  • NOLs

  • General business credits

  • AMT Credits

  • Capital losses

  • Basis reduction

  • Passive activity losses

  • Foreign tax credits


Qualified residence debt exception under 108

Qualified Residence Debt Exception Under §108

3-20

  • Must meet two requirements

    • Qualified principal residence

    • Qualified home acquisition debt


Principal residence

Principal Residence

3-20

Requirement #1: Qualified Principal Residence

  • Same definition as §121

  • Not available for vacation homes, rentals or investment properties


Qualified acquisition debt

Qualified Acquisition Debt

3-20

Requirement#2: Original or refinanced debt used for

  • Acquisition, construction or improvement of principal residence

  • Secured by the principal residence

  • Limited to recourse debt under $2 million

  • Mortgage workout debt relief qualifies


Only portion is acquisition debt

Only Portion is Acquisition Debt

3-20

  • Ordering rules are required if acquisition debt less than total debt relief

  • Any forgiven home equity debt not used for improvements cannot be excluded


Mortgage debt forgiveness facts checklist

Mortgage Debt Forgiveness Facts/Checklist

3-21

  • Must be principal residence

  • Must be acquisition indebtedness

  • Homeowner not bankrupt

  • Homeowner not insolvent

  • Cancellation is not for personal services

  • See Interactive COD calculator on IRS website


Reduce basis of residence

Reduce Basis of Residence

3-21

  • Basis of home is reduced by the amount of excluded income

    • Turns ordinary income back into capital gains


Passive activities

3-22

Passive Activities


469 passive loss overview

§469 Passive Loss Overview

3-22

  • Passive losses only deductible to the extent of passive income

  • Excess losses carried forward

  • Current year passive income may be offset by prior year passive losses

  • Losses are allowed if

    • Complete disposition

    • To unrelated party

    • In taxable transaction


What activities are passive

What Activities Are Passive?

3-23

  • Rentals, regardless of level of participation

  • Trade or business, if no material participation


Irs issues 7 rental activity tips

IRS Issues 7 Rental Activity Tips

3-23

  • Income reported when received

  • Advance rent reported when received

  • Security deposits not taxable unless kept

  • Property or services in lieu of rent taxable

  • Expenses paid by tenants are income

  • Expenses pertaining to rental deductible

  • All personal use must be pro rated


Rental activities that aren t

Rental Activities That Aren’t!

3-24

  • Avg. stay < 7 days

  • Avg. stay < 30 and significant services

  • Extraordinary personal services provided

  • Rental is incidental to non-rental activity

    • Rent to employee at employer convenience

    • Rents < 2% of lesser of basis or FMV

  • Non exclusive use by customers

  • Rental to entity owned by landlord


Why identify activities

Why Identify Activities?

3-25

  • Determine if a rental activity

  • Determine if taxpayer materially participates (Sidney Shaw)

  • Determine whether or not complete disposition has occurred

  • Apply pre enactment transitional rules


Considerations when grouping activities

Considerations When Grouping Activities

3-26

  • Similarities & differences of businesses

  • Common control of businesses

  • Common ownership between businesses

  • Geographical locations of each business

  • Interdependencies between businesses

  • Also, any other “reasonable method” to determine “appropriate economic unit”

    • Consistency from year to year is required


Statement required to group

Statement Required to Group

3-26

  • Grouping election must be annually attached

    • Original grouping rule: 1st year 2nd activity purchased

    • Existing grouping rule: Each year another activity added to or deleted from group

    • Regrouping rules: Original grouping was inappropriate or material change in facts and circumstances


Other provisions of new grouping rules

Other Provisions of New Grouping Rules

3-28

  • Activities treated as separate if no grouping election

  • Late election may be available if

    • Timely disclosure made by taxpayer

    • All relevant tax returns filed consistent with desired activity groupings

    • Disclosure is made on tax return in year omission is discovered

      Reasonable cause required if IRS discovers


Passive loss cases

Passive Loss Cases

3-29

  • Limited partner may MP

    • 500 hour or

    • 5-of-the-last-10-years or any 3 year personal service activity

  • LLC members not LPs per se (Newell, Garnett, Gregg, Thompson,)

    • IRS says “we quit” - AOD issued


Real estate professional

Real Estate Professional

3-30

  • Rental real estate is owned

  • The 50% test

  • The 750 hour test

  • The real estate businesses

    • Development, redevelopment , conversion, construction , reconstruction, acquisition

    • Rental & leasing

    • Operation & Management

    • Brokerage

  • Materially participate


Time test is different

Time Test is Different

3-32

  • 50%/750 hour test

    • Either spouse may be RE professional

    • But spouses time may not be combined (Goolsby)

    • Must be >5% owner to count time (Bahas)

    • On-call time doesn’t count (Moss)

  • Material participation test


Material participation for re pro

Material Participation for RE Pro

3-32

  • Managing rentals >500 hours

  • Substantially all the work (70%?)

  • Managing 100 hours and no one does more (including property manager)

  • Spouse’s time “tacks”

  • Time that doesn’t count

    • Work not customarily done by owner

    • Counting only the money


What is brokerage

What is Brokerage?

3-33

  • IRS argues only brokers can do brokerage, not agents

  • Tax Court disagrees (Agarwal )

    • Brokerage is bringing buyer/seller together

    • Brokerage is not a licensed qualification

  • RE agents/salespersons can qualify for real estate professional relief provision


Aggregation of business and rental by r e professional

Aggregation of Business and Rental by R.E. Professional

3-35

  • Each rental a separate activity

  • Unless election made to combine rentals

    • (§469(c)(7)(A))

  • File election in year rental purchased

  • Can be done late, with IRS permission


Real estate professional cases

Real Estate Professional Cases

3-36

  • Bed and Breakfast not a real estate activity (Todd and Pamela Bailey)

  • Vacation rental not a real estate activity (Bruce and Judy Bailey)

  • Real estate professional Donald Trask forgot to make §469(c)(7)(A) election

  • Full time engineer misunderstands, and then fails 50% test (Yusufu Anyika)

  • Denelda Goolsby made §469(c)(7)(A) election but time records not credible


Recharacterization required

Recharacterization Required

3-46

  • Certain property developed by TP and sold for a gain

  • Renting property to own business

    • Unless written binding contract before 2/19/88 (Farris)

  • Significant participation passive activity net income

  • Qualified working interest in gas and oil

  • Rental from “raw land” (less than 30% depreciable)

  • Passive equity-financed lending activity

  • Intangible property leased by pass-through entity

  • Sale within 12 months of conversion to passive

  • Sale of “substantially appreciated” property

  • Income from a “dealers” investment property


No recharacterization

No Recharacterization

3-46


No recharacterization1

No Recharacterization

3-46


No recharacterization2

No Recharacterization

3-46


Recharacterization required1

Recharacterization Required

3-46

  • Renting property to taxpayer’s own business

    • Dental office rented to S Corp. Michael Willock v. Comm.

    • C Corporations - see Gary Beecher v. Comm.

    • S Corporations - see Tony R. Carlos v. Comm.


Passive loss trigger requirements

PassiveLossTriggerRequirements

3-47

  • Dispose of entire interest

  • Fully taxable transaction

  • To unrelated party


Weird passive loss dispositions

Weird Passive Loss Dispositions

3-48

  • Death: basis increase eliminates losses

    • Only basis decrease triggers loss

  • Installment sale: PAL as gain reported

  • Gift/divorce: Add loss to basis

  • Bankruptcy: COD relief reduces PAL

  • Single activity election: last one sold


2011 federal tax update

3-49


1031 overview

§1031 Overview

3-49

  • Productive use in trade or business or investment

  • Gain recognized to extent boot received

  • Net mortgage relief is boot

  • Boot is decreased by exchange expenses

  • No actual or constructive receipt (Crandall and Dulin)


Qualified use requirements

Qualified Use Requirements

3-51

  • Productive use in trade or business or investment

  • Problem: Personal residence

  • Problem: Vacation homes

  • Problem: Property acquired for exchange


Delayed exchange overview

Delayed Exchange Overview

3-53

  • 45 days to identify

  • 180 days to complete exchange

  • Filing on time may reduce the 45/180 time limits


Problems with delayed exchange

ProblemswithDelayed Exchange

3-53

  • Miss 45/180 deadline? Gain recognized

    • Even if cash already spent on new property

  • Risks include

    • Death of any party to exchange

    • Divorce of buyer or seller

    • EPA or financing problems

    • Qualified Intermediary steals money (It’s an installment sale! Rev. Proc. 2010-14)


Related party exchanges

Related Party Exchanges

3-57

  • Original exchange not qualified for §1031 if either property disposed of within 2 years

    • Using accommodator didn’t help (Ocmulgee)

  • Exceptions

    • Death, involuntary conversion or other non-tax-avoidance purpose

    • Diminish risk of loss


Related party exchange case

Related Party Exchange Case

3-58

  • OFI transfers shopping center (w/$6 million gain) to accommodator

  • OFI indentifies commercial property owned by Treaty Fields (a related party)

  • Accommodator sells shopping center

  • Court says OFI-Treaty exchange occurs first followed by Treaty selling w/2 years

  • Treaty’s sale triggers OFI’s $6M gain!


Thank you

Thank you!


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