B — December 20, 2013 - January 16, 2014 — Owners, Developers & Managers — Mid Atlantic Real Estate Journal
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B uilding S ervices & S uppliers
By Brian T. Lovett, CPA, JD, Senior Tax Manager, WithumSmith & Brown Real estate professionals and the medicare surtax
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formed by the taxpayer in the tax year must be performed in real estate trades or businesses in which the taxpayer materi- ally participates. Second, the taxpayer must perform at least 750 hours in real estate trades or businesses in which that tax- payer materially participates. A solution for a taxpayer try- ing to qualify as a real estate professional lies in a special election available to taxpay- ers under Regulation Section 1.469-9(g). This regulation al- lows a taxpayer to aggregate all real estate activities into one activity. After aggrega-
tion, a taxpayer must perform 750 hours across the grouped activities. In light of Section 1411 and the new net investment in- come tax, qualification as a real estate professional has an even greater impact on a taxpayer’s tax position. Under the provisions of the net invest- ment income tax, taxpayers will be subject to a surtax of 3.8% on the lesser of (1) their net investment income or (2) the excess of their modified AGI (adjusted gross income) over the threshold amount. For single individuals, the
threshold amount is $200,000; for married individuals filing a joint return, the threshold is $250,000 ($125,000 if married and filing a separate return). Net rental income is gener- ally included in the calculation of net investment income and is therefore subject to the 3.8% surtax. There is, however, an exception if the following three conditions are met: (1) the taxpayer is a real estate profes- sional under Sec. 469(c)(7); (2) the rental activity rises to the level of a trade or business; and (3) the taxpayer materially par- ticipates in the trade or busi-
ness. If these three conditions are met, the income from the rental real estate activity can be excluded from the calcula- tion of net investment income. The recently issued final regulations greatly expand the available safe harbor men- tioned above, particularly the test of having the rental activ- ity rise to the level of a trade or business. Under the final regulations, if the taxpayer participates in the an activity for more than 500 hours in a given year, or for more than 500 hours in five of the last ten years, then the rental income associated with that activity will be presumed to be derived in the ordinary course of a trade or business. Traditionally, a taxpayer with losses from rental real estate activities desired real estate professional status since those losses would be considered ordi- nary losses and would be avail- able to offset other ordinary income. Now, taxpayers with profitable rental real estate should consider qualification as a real estate professional as it is the only way to convert passive income that would otherwise be subject to the net investment income tax to income derived in the ordinary course of a trade or business. Conversely, tax- payers with rental real estate losses may decide to retain the passive nature of those losses in order to allow them to offset other passive income, lowering their exposure to the net invest- ment income tax. The final wrinkle in the deci- sion to elect real estate profes- sional status deals with the gain upon the ultimate sale of the rental real estate property. If the real estate activity is con- sidered a passive activity, any gain on the sale of the property would generate gain that would be subject to the net investment income tax. If, however, the tax- payer qualifies as a real estate professional and the activity is considered an active trade or business, any gain on the sale of the property may be exempt from the net investment income tax. The characterization of the property for purposes of taxation of the gain on dispo- sition is determined based on the treatment of the property during operation. As a result, taxpayer’s need to carefully consider these implications when determining whether to attempt to qualify as a real estate professional. n
or individuals with in- vestments in real es- tate, qualification as
a real estate professional can result in many favor- able tax con- sequences. In order to qualify as a real estate professional,
Brian Lovett
a taxpayer must pass both tests of Internal Revenue Code Sec- tion 469(c)(7)(B). First, more than one half of the overall personal service hours per-
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Rebecca Machinga, CPA, Partner Practice Leader, Real Estate Services % ( $! ''~a\PRWX]VP/fXcWd\ R^\
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