Final Cutting Edge Part 2

CCH® CPELink 1

You will see controls at the bottom of the screen for adjusting

the volume and advancing slides.

The sidebar shows an outline of each slide and review

questions. You may use the sidebar to jump to a particular

slide at any time.

Materials, including a copy of your final exam questions, are

available to download from the top bar. The final exam is

available to take at the end of the course.

Cutting Edge Tax Strategies for Real Estate: Part 2

[webinar Title] 2©2021, CCH Incorporated. All Rights Reserved.

Cutting Edge Tax Strategies for Real Estate:Part 2

Greg White, CPA

1

2

CCH® CPELink 2

3Cutting Edge Tax Strategies for Real Estate:

Part 2

Speaker Background

Greg White, CPA

▪ Founder and S-H -- WGN, PS. (Seattle, WA)

▪ Adj. Professor, Golden Gate Univ. – Seattle Campus.

▪ Practices in U.S. Tax Court.

▪ Named “Top 50” IRS Practitioner by CPA Magazine.


QBID – Overview

3

4

CCH® CPELink 3


Part 2

QBID

New §199A:

Qualified

Business

Income

Deduction


Part 2

Review Question 1

5

6

CCH® CPELink 4


Do Real Estate Rentals Qualify for QBID?


Threshold Question

• I S T H E R ENTAL A BUSINESS?

7

8

CCH® CPELink 5


Part 2

Business

• Most important word on preceding slide:

• “Business.”

• Regs use business definition in §162. Treas. Reg. 1.199A-1(b)(14).

• Exception: some “self rentals” deemed to be businesses.


Part 2

Exception: Self Rentals

Example (rental → commonly controlled business)

• RE broker rents land (triple net) → 100% owned S corp.

• Rental income deemed to be QBI (self-rental → passthrough).

• Not tested under §162 standard.

9

10

CCH® CPELink 6


Part 2

Rentals and the QBID

• Rental income and the QBID.

▪ Complexity in this areas:

1. IRS has offered seeming contradictory guidance.

2. Different courts have applied different standards.


Part 2

Tax Court, 7th Circuit (and Sometimes IRS)

Different courts have different views of rental as “business”:

• Tax Court and 7th Circuit (sometimes IRS).

1. Merely requires “regular and continuous” activity.

2. But Tax Court appears to impose higher standard for:

a. Prior personal residences held out for lease, but never actually leased.

b. Land leases (if just one piece of land).

11

12

CCH® CPELink 7


Part 2

2nd Circuit (and Sometimes IRS)

Courts have different views of “business”:

• 2nd Circuit (NY, CT, and VT) (sometimes IRS).

• Also require some degree of substantial activity.


Part 2

QBID and Rental Real Estate

1. Real estate rentals qualify if they’re businesses.

a. Business – Use §162 definition.

2. Tax Court “repeatedly held”:

a. Rental of “single piece of real property [is] a ... business.” Curphey v.

Comm’r, 73 TC 766.

─ Curphey involved 162.

b. But also said some rentals not businesses. Appears to be:

i. Former personal residences and

ii. Single pieces of land w/little or no landlord services.

13

14

CCH® CPELink 8


Part 2

Rental Real Estate: Good Cases

Facts Business? Venue/comments

LaGreide v. Cmr. Single-family residence Yes Tax Crt/rental single prop.= business.

Hazard v. Cmr. Single-family, taxpayer lived in different city.

Yes Tax Crt/rental of single property = business.

Jephson v. Cmr. Held for rent, neverrented. Paid maintenance

Yes BTA (predecessor to Tax Court).

Reiner v. U.S. Single-family, mgt. co. Yes CA7/cited LaGreide.


Part 2

Tax Court – Not a Business

Facts Business Venue/comments

Coykendall Former residence, offered for sale or rent, never actually rented.

No. Tax Court.

Horrmann Former residence, attempted to rent, never actually rented.

No Tax Court.

E.R. Fenimore Rental of small portion of residence former residence. Most of property not rented.

No Tax Court.

Not practical concern – if don’t rent out or if just rent small portion.

• Will have a loss anyway (QBID not an issue).

15

16

CCH® CPELink 9


Part 2

Rental Real Estate: Land


Good v. Comm’r. Lease of land. Rented continuously for 20 years.

Owned other rental land.

Yes Tax Court/Followed Hazard case. Seemed to rely upon continuousrental of land.

Durbin v. Birmingham Lease of single piece of land. No. DC, Louisiana.

Emery v. Comm’r. Lease of single piece land No. Tax Court/Failed to provide evidence of landlord activity.

Anderson v. Comm Lease of single piece land. No Tax Court/tenant – all work


Part 2

Rental Real Estate and §199A

Higher Bar

2nd Circuit

Sometimes IRS

17

18

CCH® CPELink 10


Part 2

Rental Real Estate: 2nd Circuit


Grier v. U.S. Single-family, inherited, only one tenant, made repairs.

No CA2/ Circuit has least favorable position.

Balsamo v. Comm’r. Inherited, no repairs, sold 3 mos. after inherit.

No Tax Court used CA2 law, bound by Golsen.

Union Bank of Troy Triple net lease, tenant-maintained bldg.

No. Distr. Ct. NY. (cites Grier, appealable to CA2)


Part 2

Rental Real Estate: Triple Nets

Facts Business? Comments

Fegan v. Comm’r. Rented hotel building to controlled corporation. Tenant maintained interior, landlord exterior (“2 ½ net”).

Yes Tax court/He also rented other part of same building.

Neill v. Comm’r. Inherited property, tenantconstructed building, paid triple net expenses.

No §871 case. Similar to land lease (in that tenant constructed building).

Rev. Rul. 60-206 Rented equipment, no activityat all with respect to property.

Yes §513. Sole activity was to receive rental income. Lessee maintained.

Rev. Rul. 73-522 Supervised negotiation of L-T lease identical to prior lease, lessee paid all exp, incl. landlord’s mortgage.

No §871 case. Appears taxpayer didn’t own underlying land (had to pay ground lease).

19

20

CCH® CPELink 11


Part 2

Important Guidance – Triple Nets

Rev. Rul. 60-206

1. Addresses §513 not-for-profit “unrelated business income.”

• Affects not-for-profit entities.

2. Lessor of personal prop. just collected rent checks.

• Tenant operated and maintained rail cars.

3. IRS concluded this was a business.


Rev. Rul. 60-206 Is it Too Big a Leap?

21

22

CCH® CPELink 12


Part 2

Rev. Rul. 60-206

Rev. Rul. 60-206

1. Same §162 RE rental business definition

• In §199A and §513 cases. Treas. Reg. 1.513-1(b) uses §162 definition.

2. Courts treat RE and personal property rentals same way. Miller,

85 TC 1064.

3. Taxpayers can rely on revenue rulings. Rauenhorst v. Comm’r. , 119 TC 157.

• IRS can’t dispute its own revenue rulings.

• Treated as a concession of issue.


Part 2

Review Question 2

23

24

CCH® CPELink 13


IRS Seems Unsure


Part 2

IRS is Uncertain –Regs

• Twice -- Treasury dodged issue of rental as business:

1. §199A regs.

2. NIIT regs.

“Treasury Department and the IRS do not believe that the rental of a single piece of property rises to the level of a trade or business inevery case as a matter of law.”

The Treasury Department and the IRS decline to provide guidanceon the meaning of trade or business solely within the context of section 1411.” TD 9644.

25

26

CCH® CPELink 14


Part 2

Foggy Areas

• Regs just say it’s “facts and circumstances” test.

1. Decline to say all rentals are businesses. Preamble pg.16.

2. Won’t say land leases are or are not businesses. Preamble pg. 18.


Part 2

Rental Real Estate – Is It a Business?

Regs -- Relevant factors (rental) might include:

1. Type of rental (residential vs. commercial).

2. # properties rented.

3. Owner’s or agents’ day-to-day involvement.

4. Types/significance of ancillary services under the lease.

5. Terms of lease (net lease vs. traditional). Preamble to final regs., pg. 16.

27

28

CCH® CPELink 15


Part 2

199A Regulations

Might?

Include?


Clearing the Fog

29

30

CCH® CPELink 16


Part 2

My View

1. Rental is a business: Substantial authority in almost all cases.• Even for rental of single-family home.

• “Substantial authority” required to take position on tax return.

─ Weight of authority supporting your position is substantial (most think 40%)

─ Unless you disclose it (disclosed positions have “much lower bar”).

2. More difficult in 2nd Circuit (higher bar).

▪ Even if reside in 2nd circuit, still “substantial authority.”

• Substantial authority is required unless you attach Form 8275.

• All circuits weighed equally, irrespective of residence. Treas. Reg. 1.6662-4(d)(3)(iv)(B).

─ This protects preparers against penalties.

▪ But less likely to win if IRS challenges (argue RR 60-206 protects you).


Make Life EasierRaise the Limbo Stick Using Form 8275

31

32

CCH® CPELink 17


Part 2

Alternative Use Form 8275

Form 8275 drops from “substantial authority” to “reasonable basis.”

1. Significantly easier bar.

2. Discuss with client.

• Audit risk? (not historically)

1.Makes sense where want QBID.

• And answer is uncertain.

• Especially if $ are insignificant.

2. Individuals/Entities file 8275’s.


Part 2

We Make These Decisions Every Day

1. Risk of preparer penalties reduced if file Form 8275.

▪ “Reasonable basis” – just need to show “confusion” area. Adams v. Comm’r, TC

Memo 1997-357

• Would you agree there’s “confusion” in this area?

─ Taking into IRS has contradictory rulings?

2. Higher audit risk if file Form 8275?

▪ My belief -- historically, no.

• Based on class participants and other speakers’ experience.

▪ Of course, could change in the future.

33

34

CCH® CPELink 18


Part 2

My View

Substantial authority?

Attach 8275?

Apartment building or duplex. Yes No

Single family rental (house, condo). Yes No

Triple net, landlord involved in maintenance. Yes No

Lease more than one piece of land. Yes No

Triple net, landlord does nothing but collect one check per month.

Unclear Perhaps

Conservative

Single piece of land leased, owner -- little/no activity. Unclear. Yes

Note: My views are neither substantial authority nor reasonable basis. They are just my views.


Part 2

Review Question 3

35

36

CCH® CPELink 19


Part 2

Recap

• Rental Real Estate and the QBID


Part 2

Recap – QBID and Rental Real Estate

Tax Court and 7th Circuit 1. Almost all rental real estate is a business2. Exceptions

a. Former personal residencei. Never actually rented, or only rented small portion

b. Single piece of land, owner inactive

3. Doesn’t seem concerned about payment terms (triple net)

2nd Circuit 1. Higher bar -- Owner needs to engage in more activity

IRS 1. Contradictory position on level of activity to be businessa. Rev. Rul. 60-206 (no activity except collecting check is a

businessb. Rev. Rul. 73-522 – No activity except collecting check not a

business

Form 8275? 1. Consider especially if lease single piece of land, little landlord activity.

37

38

CCH® CPELink 20


Safe HarborRP 2019-38


Part 2

Safe Harbor

• Revenue Procedure is just a safe harbor.

▪ Very likely you won’t meet this standard (very high bar).

• But can still qualify under cases and revenue rulings just covered.

39

40

CCH® CPELink 21


Part 2

Building Blocks

1. Hold “interest” in RP:• Directly (including TIC’s*), or

• Disregarded entity (like SMLLC).

2. “RREE”• Rental real estate enterprise.

• Single property, or

• Group all “similar” use (consistency req’d):

1. Residential.

2. Commercial. §3.02.

* Not explicitly stated but meets definition of direct interest.


Part 2

Separate Books and Records

Requirements

1. Separate books and records for each RREE.

2. Service hours.

3. Contemporaneous time keeping.

4. Attaching statement to tax return.

41

42

CCH® CPELink 22


Part 2

Grouping Rentals

Safe Harbor

Advantage

Easier to meet 250-hour requirement


Part 2

Review Question 4

43

44

CCH® CPELink 23


Part 2

Example (Grouping)

• This grouping has nothing to do with passive activities.

▪ Solely for purpose of safe harbor.

• Chiyun using safe harbor, has two duplexes.

• She can document 150 hours of time on each duplex.

• Neither duplex, by itself, meets 250 hours.

• If grouped, meet 250-hour requirement.

• She will want to group.


RP 2019-38

• What Time Goes Into the Hopper?

• (250 hours)

45

46

CCH® CPELink 24


Part 2

Whose Services Count?

• Services by all the following count:

1. Owners (including owners of entity),

2. Employees,

3. Independent contractors.


Part 2

Qualifying Services

Category Includes

Qualifying Services Rental services 1. Advertising to rent, 2. Negotiating and executing leases; 3. Verifying info in tenant applications; 4. Collection of rent; 5. Daily operation, maintenance, repair,

including purchasing materials/supplies; 6. Management of real estate; and 7. Supervise employees/indep. contractors.

Nonqualifying (don’tcount for 250 hours)

Financial or investment mgt.

activities

1. Arranging financing, procuring property; 2. Studying/reviewing financial stmts. or

reports on operations; 3. Improving prop under § 1.263(a)-3(d); 4. Hours spent traveling to and from RE.

47

48

CCH® CPELink 25


Part 2

Record Keeping

Contemporaneous? Records

Owners Beginning in 2020Form: time reports, logs, similar documents.

Info: all services:1. Hours,2. Description, 3. Dates performed, 4. Who performed.

Employees and contractors

No! Description of rental services performed by each employee and IC,

Amount of time “generally spent” by employee or IC,

Time, wage or payment records.


Part 2

Contemporaneous Record Keeping

Contemporaneous records req’d? 2020 and later

Owner Yes

Employees and indep. contractors No!

49

50

CCH® CPELink 26


Part 2

Documentation

Example

• Chuck has 8 single family rental properties.

• Chuck groups these for safe harbor (statement attached to return).

• Management company does all work. Chuck documents:1. Rental services provided,

2. Amount of time mgt. co. generally spends performing such services.▪ E.g., 60 hours maintenance, 100 hours leasing, 100 hours maintenance

3. Payment information for management co.

• Chuck meets 250 hours record keeping.


Part 2

Safe Harbor Requirements

• Statement:

1. Description of all RRE properties included in RREE.

• Including address and rental category.

• If more than one RREE, submit separately for each.

2. Description of RRE properties acquired/disposed.

• Including address and rental category.

3. Representation that requirements met.

51

52

CCH® CPELink 27


Part 2

Excluded from Safe Harbor

1. Used as a residence under §280A(d).

▪ Generally, if use personally > 14 days.

2. Triple net lease.

3. Rental → commonly controlled entity.

4. Rental treated as SSTB income.


Part 2

IRS Guidance (FAQ # 48)

RP 2019-38 is just a safe harbor.

• Three separate ways rental can produce QBI:

1. Rise to level of a business,

a. Curphey v. Comm’r, Rev. Rul. 60-206, etc.

2. Meet safe harbor, or

3. Lease to commonly controlled S corp or partnership.

53

54

CCH® CPELink 28


Part 2

Ambiguity

It’s a • It’s a “2-Edged” Sword


Part 2

Two-Edged Sword

Taxpayers may use uncertainty in rental area to advantage.

▪ If losses from rentals, may prefer nonbusiness treatment.

55

56

CCH® CPELink 29


Part 2

Two-Edged Sword

• Example

• Taxpayers has QBI from restaurant = $115,000.

• Taxpayer has a rental property.

▪ 2021 – sells rental.

• $115,000 in post-2017 suspended passive losses allowed.

• If rental not “business,” get full QBID from restaurant.

▪ If rental losses not from business, don’t affect QBI.


Part 2

Two-Edged Sword

Rental Is BusinessRental is NOT

Business

Restaurant QBI $115,000 $115,000

Rental loss ($115,000) $0

Net QBI $0 $115,000

57

58

CCH® CPELink 30


Property Factor

UBIA

Unadjusted

Basis

Immediately after

Acquisition


Part 2

Wages/Property Cap

High income taxpayers -- QBID limited to greater of:

1. Wages only – 50% of W-2 wages, or

2. Wages and property (used for rental real estate):

• 25% of wages +

• 2.5% x UBIA.

59

60

CCH® CPELink 31


Part 2

Review Question 5


Part 2

UBIA

UBIA is

▪ Unadjusted

▪ Basis

▪ Immediately

▪ After

▪ Acquisition

• “Fancy way” of saying original cost. Treas. Reg. 1.199A-2(c)(3)

61

62

CCH® CPELink 32


Part 2

Two Issues

Two issues:

1. How much UBIA?

2. For how long do we get count it?

• “Depreciable period.”


Part 2

QBID Property Cap

• 2.5% x unadjusted cost of tangible depreciable property

1. Cost no longer counted after later of:

• 10 years after placed in service, or

• Last day of last full year of recovery period.

2. Don’t count as UBIA -- final partial year of depreciation.

3. Must be owned at end of year.

4. Bonus depreciation & §179 don’t reduce UBIA. Treas. Reg. 1.199A-2(c)(3)(i).

5. Land doesn’t qualify (not depreciable).

63

64

CCH® CPELink 33


Part 2

QBID Property Cap

• Bought apt. building 1/15/97 for $1 million* (“UBIA”).

▪ 27.5-year life ends July 15, 2024.

• Depreciable period ends 2023 (last full-year recovery period).

▪ 2020 cap = $1 million x 2.5% = $25,000.

• But cap only matters high income (MFJ pre-QBID taxable income > $326,600).

*Doesn’t include land.


Part 2

Aggregating Rental Properties

Aggregation

65

66

CCH® CPELink 34


Part 2

Aggregating Businesses

• To aggregate, must meet following:

1. Common control (majority and last day of year).

• Attribution under §267 and 707.

2. Aggregated business need same taxable year.

• Exception for short taxable years.

3. None of the aggregated businesses can be an SSTB.

4. Meet reporting requirements (on tax return).

• Forms 8995 and 8995-A.

5. Must meet at least 2 of 3 factors. Treas. Reg. 1.199A-4(b)(1).


Part 2

Aggregating Businesses

Meet at least 2 of 3 factors. Treas. Reg. 1.199A-4(b)(1)(v).

1. Same products, property or services (restaurant & food truck).

▪ Or items “customarily provided together” (e.g., gas station and car wash).

2. Share facilities or significant centralized business elements (common personnel, accounting, legal, purchasing, HR, etc.), or

▪ Don’t have to share entire facility;

• If catering business and restaurant share kitchen, enough.

3. Businesses operated in coordination with or reliance on other aggregated businesses.

▪ Example – supply chain interdependencies.

▪ My view – should include mgt. companies and companies they manage.

67

68

CCH® CPELink 35


Part 2

Aggregation Allowed

ABC, LLC XYZ, LLC

Bob 40% 40%

John 40% 40%

Carl 10% 20%

Jerry 10% 0%

Total 100% 100%

• Bob manages 2 apartment bldgs. and purchases materials for both.

• Ownership as shown below.

• Not only can Bob and John aggregate, but Carl can also.

• Combined income limited by combined property if elect to aggregate.


Part 2

Aggregation

• Aggregation – multiple businesses treated as single business.

▪ For purposes of the wages/property limits.

▪ The wage/property limits only apply to higher income taxpayers.

• Pre-QBID taxable income > $326,600 (MFJ); $163,300 (single)

─ Example

▪ Bob and Mary have pre-QBID taxable income = $300,000

▪ They can take full QBID on rental property even if no tax basis in property.

• Aggregation works well for higher-income taxpayers with

▪ One rental property lots of income, low tax basis (owned for many years).

▪ One property loss, but lots of tax basis (just acquired).

• Can also work well for self-rentals.

69

70

CCH® CPELink 36


Part 2

Aggregation

• Example

▪ Russ and Maria own 2 rental duplexes and 50% of LLC that owns apt. bldg.

• High income ($500,000/year)

▪ Duplexes have no UBIA.

• Purchase 30 years ago, fully depreciated.

• $100,000 income/year.

▪ Apartment building constructed 3 years ago.

• $6 million in UBIA.

• Break-even for tax purpose ($0 net income).

▪ They should aggregate the duplexes with the 50% interest in apt. building.

• UBIA from apt. building will cover income from duplexes.


Part 2

Aggregation

• Example

▪ Buddy -- high income taxpayer $400,000/year.

• Owns a restaurant ( S corp).

─ Also owns restaurant building in individual name.

─ Leases → S corp.

• Meets requirements to aggregate (common control, etc.)

▪ Restaurant building has very little UBIA.

• But lots of income (no interest exp., very little depreciation).

• Buddy should aggregate:

─ Restaurant building with

─ Restaurant S corp.

• Wages of restaurant can allow QBID for rental income.

71

72

CCH® CPELink 37


Part 2

Aggregation

• Not clear if it’s necessary if individual owns multiple rentals

▪ Likely just a single business.

• But may want to aggregate to play it safe.

▪ Example

• Two spouses own 100% of 7 apartment buildings.

─ High income taxpayers.

• Some apt. buildings have lots income but no UBIA (fully depreciated).

─ Other apartment buildings have lots of UBIA, not much income.

• It’s possible all 3 apartment buildings are a single business (no guidance).

─ Might not need to aggregate.

─ However, consider making aggregation disclosure.

▪ Just to play it safe.


SE Tax and Real Estate

73

74

CCH® CPELink 38


Part 2

Internal Revenue Code

• If real estate rental is business, do you have to pay SE tax?

▪ General rule: SE tax on all businesses.

• Almost all real estate is a business. Curphey v. Commr.

• Exception from SE tax for almost all rental real estate. §1402(a)(1)

▪ Generally, no SE tax, even if it’s a business.


Part 2

Rental Real Estate Exception

• Rental income – self-employment income if:

1. Substantial services provided to tenants.

• “Substantial” if material part of income is from services. Treas. Reg.

1.1402(a)-4(c).

2. Disregard some services.

• If to maintain space in condition for occupancy.

75

76

CCH® CPELink 39


Mobile Home Parks

• Bobo v. Commissioner, 70 TC 706


Part 2

Bobo v. Commissioner., 70 TC 706

Backstory

• The Bobos lived in Novato, CA

▪ North of San Francisco, Marin County

▪ Hit hard by the great depression.

▪ After WWII, homebuilding, rapid development.

• Fabian and Flo Bobo.

▪ Fabian owned construction co. with brother.

▪ 1946 bought land in Novato.

▪ 1952 developed mobile home park.

77

78

CCH® CPELink 40


Part 2

Bobo v. Commissioner., 70 TC 706

• Mobile home park:

1. 46 spaces.

• 38 mobile home pads rented.

─ Bobos owned 8 mobile homes and rented out.

─ Cleaned mobile homes when vacant and available for rent.

• Provided laundry facility for tenants.

2. On-site manager.

• Collected garbage, swept leaves, cleaned laundry facility.


Part 2

Tax Court Holding

Bobos win (no SE tax):

1. Laundry services were “to” tenants.

• But not “substantial” (not material part of rent rec’d).

2. Cleaning, sweeping to maintain for occupancy.

• Disregarded for determining “substantial services.”

79

80

CCH® CPELink 41


Tourist Houses and Maid Service


Part 2

Airbnbs and VRBOs

• Lack of clarity on SE tax for Airbnbs.

1. IRS FAQ #60 (in QBID area)a. Some rental real estate is subject to self-employment tax

• Boarding house, hotel or motel, and bed and breakfast, where substantialservices are rendered for the convenience of the occupants.

• Rental real estate subject to self-employment tax is reported on Schedule C.

b. Notably, doesn’t address Airbnb’s or VRBOs.

2. In practice:a. Some preparers report on Sch. E.

b. Some report on Sch. C.

3. My own view: No SE tax on Airbnb’s unless unusual facts.a. Example of unusual facts: You provide meals or housekeeping each night

i. These would be exceptions and likely result in SE income.

81

82

CCH® CPELink 42


Part 2

Review Question 6


Part 2

Airbnbs and VRBOs

• Issue with Airbnb’s:

1. It’s a little bit like a hotel.

a. Difference – hotel isn’t cleaned every night.

i. Not true maid service, no front desk, etc.

2. Regs indicate that “tourist houses” are subject to SE tax.

a. If services also rendered.

i. Are substantial services rendered in an Airbnb (disregarding maintenance)?

ii. Usually not, don’t clean each night or provide meals.

3. Bobo v. Comm’r. -- Cleaning trailers (between tenants) in Bobo

a. Didn’t cause SE tax.

i. This is analogous → Airbnb’s.

83

84

CCH® CPELink 43


Part 2

Guaranteed Payments

No Self-Employment Tax

Guaranteed Payments

Rental Properties


Part 2

Guaranteed Payments -- Rentals

1. Guaranteed payments (services) from RE rental LLCs▪ Not subject to SE tax. Rev. Rul. 64-220.

• Note: RR 64-220 is a bit convoluted.

2. Guaranteed payments for services not passive income.

▪ Not subject to NIIT. Treas. Reg. 1.469-2(e)(2)(ii) and Prop. Reg. 1.1411-4(g)(10).

• Also don’t qualify for §199A (QBID)

85

86

CCH® CPELink 44


Part 2

Guaranteed Payments – Rental Real Estate

• Example

▪ Kalisha owns 25% of apartment building LLC

• Receives $10,000/mo. management fees.

─ Not subject to self-employment tax.

• Also, not subject to NIIT.


Part 2

Guaranteed Payments – RE Rentals

• If rental real estate has losses.▪ Guaranteed payments can backfire.

▪ Report guaranteed payment income, but rental losses suspended.

87

88

CCH® CPELink 45


Use of Rental for Personal Purposes


Part 2

Vacation Homes – Two Tax Treatments

Two rules:

1. Rent > 14 days (we will cover this).

a. Generally, no net loss if personal use > 14 days.*

i. Carryover unused deductions to future years.

b. Prorate expenses between business and personal.

2. Rent < 15 days (we won’t cover this).

a. Exclude rents from income.

b. Don’t deduct any expenses. §280A(g).

* Or 10% of days rented if greater.

89

90

CCH® CPELink 46


Part 2

Big Difference – 14 Days vs. 15 Days

• There’s a song from 1959 called “What a Difference a Day Makes”

• ≤ 14 days personal use – Loss allowed on vacation rental.

▪ 15 days or more personal use – no loss allowed.

• If very high mortgage interest and RE taxes, possible to create a loss.

• Excess expenses carried forward.

• It’s very common for taxpayers to limit personal use → 14 days.

• Losses allowed under passive loss rules if ≤ 7 days customer use.

▪ And materially participate.


Part 2

What a Difference a Day Makes

14 Days (or less) 15 Days (or more)

Personal use Loss allowed No loss allowed

If rent > 14 days:

91

92

CCH® CPELink 47


Part 2


Example

• Terrell owns a rental home on the beach.

▪ Uses for personal purposes for 15 days.

▪ Rents it for 20 days.

• Generally, no net loss will be allowed.

▪ Possible exception if significant RE taxes and mortgage int and itemizes.


Part 2


Example

• Ted owns rental home on the coast.

▪ Uses for personal purposes for 14 days.

▪ Rents it for 20 days.

• Net loss will be allowed.

93

94

CCH® CPELink 48


Part 2

Definition: Personal Use

What is “personal use” of a dwelling unit?

1. Owner or family members use property (even if pay fair rental).

2. Use by any person who has an “interest” in such unit.

3. Taxpayer’s who swap use of units (even if rent paid).

4. Use by any individual unless fair rental is paid.

a. Allowing friends to use the property without paying a fair rental,

b. Use if you contribute a week’s stay at the beach house as part of a charity raffle.


Personal Use of a Residence

Failure to Charge Fair Rent

95

96

CCH® CPELink 49


Part 2

Personal Use – Hunter v. Comm’r., TC Memo 2014-164

Example

• Harrison Hunter – Crusty, cranky merchant marine.

▪ Mr. Hunter claims to have been audited 10 years in a row.

▪ No rental loss “rented” → “friend” while he was at sea.

• Didn’t show he rented it for fair rental value;

▪ Fair rent is based upon comparable rates in the area.

• He set rent at amount “friend” could pay.

▪ Only collected one month’s rent over the course in 4 years.


Vacation Homes and Repair Days

97

98

CCH® CPELink 50


Part 2

Definition: Personal Use

• “Repair days” not counted as personal use. Covers:

1. Repairs

2. Annual maintenance

• Just one spouse working substantially full time sufficient.

▪ Even if other spouse and kids don’t work. Twohey v. Comm’r.

• “Repair days” used → keep personal use at 14 days or less.


Part 2

Ronald J. Lucero v. Comm’r., TC Memo 2020-136

• Ronald Lucero owned rental home in Sea Ranch, CA (Sonoma).

• House rented approximately > 14 days in 2014.

• Mr. Lucero’s use

• Vacation (personal) – 7 days (holiday season)

• Other use (repairs) – 14 days Mr. Lucero spent landscaping, repairing/oversee repairs, and cleaning.

• Issue: Days spent on “repairs” excluded from “personal use”

• Court: Believed Mr. Lucero worked on repairs enough

• “Repair days” not “personal” use

• This requires taxpayer to “primarily” work on repairs for that day.

• Mr. Lucero not limited by §280A loss restrictions.

• < 15 days personal use because repair days not treated as personal use.

99

100

CCH® CPELink 51


Recap Vacation Homes


Part 2

Recap: Vacation Homes

If 1) Rent home > 14 days and 2) Personal use > 14 days, no net loss

-- Difference between 14 days or personal use and 15 days important

Renting below fair rental treated as personal use by owner-- Even if tenant not related

Owners of vacation homes often try to restrict use → 14 days or less

Repair days not treated as personal use

101

102

CCH® CPELink 52


Passive Activities


Rental Activities

103

104

CCH® CPELink 53


Part 2

The Curse of the Rental Activity

Automatic Passive Treatment


Part 2

Automatically PassiveThe “Per Se” Rule

105

106

CCH® CPELink 54


Part 2

Rental Losses

Usually Trapped in “Passive” Cage


Part 2

Rentals

• Rental income or loss is usually “per se” (automatically) passive.

• Even if taxpayer materially participates.

• Still treated as passive loss (or income).

107

108

CCH® CPELink 55


Part 2

Per Se Passive

Example

• Michelle is a CPA, also owns a duplex.

• Duplex has 2020 loss of ($24,580).

• 2020 -- spends 525 hrs. managing/repairing duplex.

• She materially participates.

• Most businesses, could deduct loss.

• But rentals are usually per se passive.

• Therefore, losses are passive and suspended.


Exceptions

“Per Se” Rule

109

110

CCH® CPELink 56


Part 2

Exceptions (Not “Rental Activities”)

• Common exceptions to per se rule. 1.469-1T(e)(3)(ii):

1. Real estate professionals.

2. Avg. period customer use ≤ 7 days;

3. Group insubstantial rental w/material participation business

4. Rare instances -- Others we won’t cover today.

These are not automatically passive.


Part 2

Review Question 7

111

112

CCH® CPELink 57


Part 2

Exception 1: 7-Day Exclusion

Average use ≤ 7 days exception:

• Not “rental activity” if average period of use ≤ 7 days.

▪ So, not “per se” passive.

• Often applies to beach homes Hawaii, etc.

▪ Also, Airbnb.


Part 2

Short-term Rentals

• Example

▪ Mohammad has an Airbnb.

• Average period of tenant use is ≤ 7 days.

▪ This is not automatically passive (ST rental exception).

• If Mohammad can show material participation.

─ Can deduct losses (and if gain, can avoid NIIT).

113

114

CCH® CPELink 58


Restrictions

Grouping

Rentals with Non-rental Activities


Part 2

General Rule

Generally, can’t group rental activity w/ business activity.

Exceptions

1. Activities grouped are “appropriate economic unit” and

2. Any of the following:

a. Rental activity insubstantial to business.

b. Business activity is insubstantial rental; or

c. Each owner of business activity has same % ownership in rental activity.

115

116

CCH® CPELink 59


Part 2

Grouping Rental with Non-rentals

Example

• Dentists owns part of dental office bldg. LLC.

▪ They lease building to S corp. w/dental practice.

▪ Can group w/dental practice (AEU, insubstantial).

▪ Good: allows losses on rental to be deducted.

▪ No NIIT – material participation activity.


Part 2

Inappropriate Grouping

Example (inappropriate grouping)

• Attorney is a sole practitioner.

▪ Also owns 100% residential rental- rents to college kids.

▪ Law practice is business activity.

▪ RE is rental activity, is insubstantial →law practice.

▪ Law practice and real estate not “appropriate economic unit”.

• Therefore, can’t group law practice and RE. Treas. Reg. 1.469-4(d)1)(ii) example 2.

117

118

CCH® CPELink 60


Real Estate Professionals Freed from “Per Se” Passive Cage


Part 2

Real Estate Professionals

• RE professionals freed from “per se” passive cage. Treas. Reg. 1.469-9(e).

▪ But doesn’t mean rentals losses always deductible.

▪ Just like S-T rentals, must show material participation.

119

120

CCH® CPELink 61


Part 2

Okay

You’re Freed from the PassiveCage

Can Now Deduct All Rental Losses?


Part 2

Can You Now Deduct All Rental Losses?

• Can you now automatically deduct all rental losses?

• Heck No!

121

122

CCH® CPELink 62


Part 2


• RE professional status – possible to deduct rental losses.

▪ But, like all businesses must still materially participate. Perez v. Com’r., TC Memo

2010-232.

• Basically, same requirements as someone who owns a restaurant or dry cleaners.


Part 2


Example

• Karen owns RE development co. (2,000 hrs./yr).

▪ Qualifies as a RE professional.

• She also owns a rental property – big losses.

▪ Hires mgt. co., she spends 50 hours each yr. on rental.

▪ Doesn’t materially participate.

• Even though she’s a RE prof., can’t deduct rental losses.

▪ She doesn’t materially participate.

123

124

CCH® CPELink 63


RE Professional: Clearing 2 Hurdles


Part 2

The Tests

Qualified RE Professionals – Meet both tests:

1. Test 1 (50% personal services)

1. > 50% personal services in “real property businesses” in which taxpayer materially participates, and

2. Test 2 (750 hours) -- > 750 hours during year in “real prop. businesses” in which materially participate.

125

126

CCH® CPELink 64


Part 2

Review Question 8


Part 2

Special Rule

750 Hour and 50% Tests

One Spouse Alone Must Meet

127

128

CCH® CPELink 65


Part 2

One spouse must satisfy 50%/750 hrs.

• Unlike material participation (spouse’s time combined).

▪ Just one spouse (by him or herself) must satisfy both:

• 50% and

• 750 hour tests. Tom Miller v. Com’r., TC Memo 2011-219 and §469(c)(7)(B).


Common Types: RE Professionals

129

130

CCH® CPELink 66


Part 2

Commons Situations – Contractor

• Example

• Lisa is a contractor. Builds custom homes.

▪ ~ 2,000 hrs./yr. and income = $300K/year.

• Also owns rental house.

• Provides substantially all services for rental.

▪ Test 2 material participation.

• Rental house produces loss of ($15,000)/year.

• Lisa can deduct rental losses.

▪ But only because she materially partic. in rental.


Part 2

Common Situations – Spouse Mainly Works on Rentals

• Example

• George is full-time CPA ($300,000/yr. income).

• He and spouse own 8 rentals.

▪ Spouse’s only work -- managing rental properties.

▪ Spouse spends 100 hrs/yr. on each rental (800 hrs total).

• Makes grouping election.

• Rental properties combined loss = ($70K)/year.

• Can offset rental losses against George’s CPA inc.

131

132

CCH® CPELink 67


Part 2

Common Situations – RE Agent/Broker

Example

• Joanne is a RE agent-- independent contractor.

• Works 1,300 hrs/year as RE agent, earns $250K.

• Owns 5 rental houses. $60K/year in losses.

• Materially participates in rentals (“substantially all”).

• Can deduct rental losses. Agarwal v. Com’r.


Definition“Real Property Business”

133

134

CCH® CPELink 68


Part 2

Real Property Trades or Businesses Include

“Real property businesses” include:

1. Development

2. Redevelopment

3. Construction

4. Reconstruction

5. Acquisition

6. Conversion

7. Rental

8. Operation

9. Management

10. Leasing or

11. Brokerage

Note -- regs say some businesses can be combined to measure material participation.


Part 2

Must Materially Participate in Real Estate Business

• Time in RE business only counts if taxpayer materially participates in that business. Treas. Reg. 1.469-9(c)(3).

135

136

CCH® CPELink 69


Part 2

Time Spent as Employee

• Employee time does not count unless employee owns ≥ 5% (under §416(i)(1)(B)). Treas. Reg. 1.469-9(c)(5)


Part 2

Material Participation

Substantially All Test

(Test 2)

FITCH V. COMM’R.TC MEMO 2012 - 3 5 8

137

138

CCH® CPELink 70


Part 2

“Substantially All” Participation Test

Facts

• Don Fitch -- CPA.

▪ Aneurism in 2003, had to sell practice.

• Brenda Fitch – RE agent (> 750 hours).

• Don and Brenda owned 8 rental properties.

• Didn’t elect to aggregate rental activities.

• Brenda performed almost all tasks related to rentals.

▪ Bookkeeping, repairs, screen tenants, insurance, etc.

▪ Occasionally hired a contractor (e.g., an electrician).


Part 2

Substantially All Participation Test

Issue

• Did they materially participate in each rental.

▪ Brenda was “RE professional,”

▪ Hadn’t elected to group

▪ Had to show materially participation in each rental.

139

140

CCH® CPELink 71


Part 2

Substantially All Participation Test

Holding

• Fitches materially participated in each rental.

▪ Met Test 2 –“Substantially all” participation.

▪ Occasional hiring of electrician or engineer not fatal.


RE Professionals – Election to Group Rental Activities

141

142

CCH® CPELink 72


Part 2

Special Rules

• Each rental prop. separate activity, unless make election.

▪ Sometimes called a “RE professional” election.

▪ This is a misnomer.

• Either RE professional or not RE professional (no election required).

▪ Election is to aggregate rentals to check material participation.

• Election may qualify clients as material participants.

▪ But may “freeze” passive losses on disposition of just one property.


Part 2

Qualify as Material ParticipantExample

Client has 14 rental properties.

• Spends 60 hours/yr. on each property (840 hrs).

• Hires mgt. co. (so can’t meet subst. all or 100 hrs.).

▪ Won’t meet any material participation test unless elect to group.

• If she groups rental activities, will meet 1st test (500 hrs).

143

144

CCH® CPELink 73


Part 2

Backfiring!!

Example

• Michelle owns duplex and a triplex.

▪ $30,000 in suspended losses duplex (2014-2017).

• She becomes RE agent in 2018, qualifies as RE prof.

▪ No management company, could qualify under “substantially all” rule.

• She makes “aggregation” election for 2018.

• She deducts rental losses in 2018.

• In 2019, she sells duplex for $10,000 loss.

▪ No loss allowed, duplex loss passive losses stay suspended.

▪ Didn’t dispose of entire activity (since duplex and triplex one activity).


Part 2

Limits on Grouping Election

• Some rentals aren’t included in the grouped activity.

▪ Excluded from “grouping,” won’t count for material partic.

1. Rentals w/avg. period customer use ≤ 7 days. Bailey v. Com’r.

─ Example

▪ Most Airbnb’s, resort houses and condos

2. Self-rentals.

─ Example

▪ Physician owns bldg., leases to medical practice.

145

146

CCH® CPELink 74


Active Participation Exemption

“Per Se” Passive – Rentals

Additional Exception

1. Moderate Income

and

2. “Actively Participate”


Part 2

Basics

• Deduct up to $25,000 loss if “actively participate” in RE rental. §469(i)(1)

▪ Active participation much easer to meet than material participation .

• Not for higher income taxpayers

▪ $25,000 limit reduced by 50% of amount MAGI* > $100,000. §469(i)(3)

• If MAGI ≤ $100,000, rental loss allowed up to $25,000.

• If MAGI > $150,000, no deduction under “active participation” exception.

* Adjusted gross income with some adjustments.

147

148

CCH® CPELink 75


Part 2

Review Question 9


Part 2

Active Participation Requirements

• To be “active participant,” 3 tests must be met:

1. Must own ≥ 10% value of interests in activity.

2. You must “actively participate”

3. Can’t be a limited partner.

149

150

CCH® CPELink 76


Part 2


The committee reports provide:

▪ “... active participation ... can be satisfied without regular, continuous, and substantial involvement in operations, so long as the taxpayer participates, e.g., in the making of management decisions or arranging for others to provide services (such as repairs), in a significant and bona fide sense.


Part 2


• “Management decisions” include:

▪ Approving new tenants,

▪ Deciding on rental terms,

▪ Approving capital or repair expenditures, and

▪ Other similar decisions.

151

152

CCH® CPELink 77


Part 2

Example

• 2020 -- Feliciano has a rental house ($20,000 loss)

▪ House is leased on an annual basis.

▪ Feliciano is not a real estate professional.

• He actively participates in rental (management decisions).

▪ His MAGI = $180,000.

• Feliciano doesn’t qualify for “active participation” exception.

▪ Income too high – he will carry over loss → 2021.

Active Participation Exception


Part 2


Example

• 2020 -- Harold has a rental house ($20,000 loss)

▪ House is leased on an annual basis.

▪ Harold is not real estate professional.


▪ His MAGI = $100,000.

• Harold qualifies for “active participation” exception.

▪ Full $20,000 loss can be used to offset wages, interest income, etc.

153

154

CCH® CPELink 78


Part 2


Example

• 2020 -- DeShawn has a rental house ($20,000 loss)

▪ House is leased on an annual basis, DeShawn not RE professional.


▪ His MAGI = $140,000.

• $40,000 excess x 50% = $20,000 reduction in limit.

─ Limit reduced → $5,000 ($25,000 allowance - $20,000 income phase out).

• DeShawn qualifies for limited “active participation” exception.

▪ $5,000 of total loss can be used to offset wages, interest income, etc.

▪ $15,000 remaining loss carried over → following year.


Life Cycle – Maturity: Sales, Exchanges and Step Up’s

155

156

CCH® CPELink 79


Allocations


Part 2

Legislative History to §1060

• Courts and IRS

▪ Generally, accept parties’ allocation of FMV provided they have “adversetax interests” w/respect to allocation. Senate Explanation, '86 TRA, PL 99-514

157

158

CCH® CPELink 80


Part 2

Treas. Regs

Sales w/personal prop. and other property (e.g., bldg.):

• In general, any arm's-length agreement between buyer and seller will establish the allocation if they have adverse interests. Treas. Reg. 1.1245-1(a)(5).


Part 2

Treas. Reg. 1.1250-1(a)(6)

• Same rule applies to allocations between:

1. Depreciable real property, and

2. Land. Treas. Reg. 1.1250-1(a)(6)*.

* Incorporates respect for adverse interests rule on preceding slide.

159

160

CCH® CPELink 81


Part 2

Big Picture

USE ALLOCATIONS THAT PRODUCE WIN/WINS .


Part 2

Land Improvements

Strategy for land improvements.

• Large allocation to land improvements cuts combined taxes.

▪ Not crazy allocation though.

▪ Seller may have little gain on land improvements.

▪ Buyer can take bonus depreciation.

161

162

CCH® CPELink 82


Are You Bound by the Allocation?


Part 2

Parties Generally Bound by Their Agreement

• Are you bound by written allocations?

▪ Yes.

• Real estate rentals almost always a business.

▪ Danielsen standard applies.

• Must follow written allocation unless: duress, fraud, mutual mistake…

163

164

CCH® CPELink 83


Part 2

No “Agreed” Allocation?

Don’t Sweat the Details


Part 2

Lecturer’s Conviction

If no agreed allocation – need to do some work.

• But don’t lose sleep.

165

166

CCH® CPELink 84


Part 2

Building vs. Land – Assessed Value

Allocating purchase price (if no written agreement):

• Sellers usually prefer assessed value.

▪ Typically provides > allocation to land.

▪ More capital gain, less 25% tax rate.

▪ Support for assessed value: Conroe Office Building, TC Memo 1991-224.

▪ Strategy: Don’t agree to allocation.

• Use assessed value to allocate.


Part 2

Review Question 10

167

168

CCH® CPELink 85


Part 2

Some Case Law Supports Assessed Value

“As the Tax Court noted in footnote 5 in ... Creston Corp.:

[T]he assessed values of properties may be used ‘in determining the relative value’ of properties.” PLR 9110001.


Part 2

Regulations – Formula

• If no agreement between parties, fact & circumst. including:

▪ Original cost, reproduction cost (construction, installation ...),

▪ Remaining economic useful life,

▪ State of obsolescence, and

▪ Anticipated costs to maintain, renovate, or to modernize. Treas. Reg. 1.1245-1(a)(5).

169

170

CCH® CPELink 86


Part 2

Practical Approaches – Personal Property

Example

• Sell apt. building, land improvements and personal property.

▪ Total sales price = $1 million.

• No written agreement on allocation of sales price.

• Carpeting (9 yrs old ) cost $25,000, est’d life = 10 yrs.

▪ Obsolete – newer carpet is much better.

▪ FMV = $1,250 [cost x 10% (remaining life) x 50% (obsolete)].


Aging and Tax Step-ups

171

172

CCH® CPELink 87


Part 2

The Role of Taxpayers’ Ages

Possible step-ups important as get older.

• Older taxpayers – carefully consider:

▪ Holding real property until pass away.

▪ Like kind exchange if must sell.


Like Kind Exchanges

173

174

CCH® CPELink 88


Part 2

“Big 3”

Like Kind Exchange Rules


Part 2

3 Rules of Like-Kind Exchanges

1. Gain = > of :

─ Trade down in equity, or

─ Trade down in FMV

2. Gain to extent

─ Receive cash, other non-like kind property,

─ Net liability relief.

3. Basis roughly equals:

─ FMV of new property less gain not recognized on transaction.

175

176

CCH® CPELink 89


Part 2

3 Rules of Thumb

• Example

• Your client engages in a §1031 exchange.

• Relinquished property FMV = $2 million.

• Replacement property = $1 million.

• Gain will be ~ the lesser of:

• $1 million (decrease in gross FMV), or

• Actual gain if it had been sold for cash.

─ If cash sale would produce only $200,000 in gain, limited → $200,000


Part 2

3 Rules of Thumb

Example

• Your client engages in a §1031 exchange.

• Replacement property FMV = $1 million.

• Gain not recognized = $600,000

• Basis in replacement property = ~ $400,000.

177

178

CCH® CPELink 90


Part 2

Drop-n-Swaps


Part 2

Partnerships Interests

• Partnership interests don’t qualify for §1031.

• Taxpayers use “drop and swaps” to avoid this.

▪ Distribute RE to owners as tenants in common.

▪ Then those partners who want §1031’s can do so.

▪ Others can use taxable sales to “cash out.”

179

180

CCH® CPELink 91


Part 2

Background

Mere co-ownership of property can avoid partnership status for tax purposes. Rev. Rul. 75-374

▪ Including tenancy in common.


Part 2

Review Question 11

181

182

CCH® CPELink 92


Part 2

Drop-n--Swaps

Form 1065

Question


Part 2

Observations

1. Safe harbor for clients to “play it safe.”

a. Rev. Proc. 2002-22 provides PLR’s if meet standards.

b. Client who wants certainty should get PLR.

2. QI’s do the heavy lifting in this area.

a. You discuss w/client possibility of using “drop and swap.”

183

184

CCH® CPELink 93


Real Property vs. Personal Property

Real Property Not Real Property


Part 2

Structural Components

• Personal property no longer qualifies for like-kind exchange

▪ This includes “personal property” associated with real estate.

• So, what is “personal property”?

• Factors

1. Manner, time and expense of installing and removing,

2. Whether component is designed to be moved,

3. The damage that removal would cause to the property or structure,

4. Whether the component is installed during construction of structure.

185

186

CCH® CPELink 94


Part 2

Common Structures/Components

Real Property Personal Property §1031 Eligible?

Land X Yes

Building X Yes

Land improvements X Yes

Cabinets X -1- Yes -1-

Carpeting X -1- Yes -1-

Appliances X No -1-

Furniture X No

-1- These items are not addressed in Prop. Reg. 1.1031(a)-3, but I believe this is a reasonable application of factors identified on the prior slide.


Part 2

Receipt of Personal Property

• Example

▪ Relinquished property:

• Retail strip mall, FMV = $1.1 million, adjusted basis = $400,000

• Gain “realized” = $700,000

▪ Replacement property

• $1 million office building + $100,000 furniture

▪ Gain recognized = $100,000 (lesser of gain realized [$700K] or boot received [$100K]) Treas. Reg. 1.1031(k)-1(g)(8)(vi)

• $100,000 of personal property (furniture) treated same as if received cash

187

188

CCH® CPELink 95


Part 2

Practical Observation

• Although gain will be recognized on most real estate exchanges

▪ Personal property received can be expensed using bonus depreciation. Preamble, pg. 11/28.


Part 2

Practical Observation

• Example

▪ Mohammed trades real estate in like-kind exchange

• Relinquished building (FMV = $1 million), personal property (FMV = $50,000)

• Replacement building (FMV = $1 million), personal property (FMV = $50,000)

▪ If relinquished personal property is fully depreciated,

• $50,000 of ordinary income, but

• $50,000 bonus depreciation on replacement personal property

189

190

CCH® CPELink 96


Part 2

Before §1031 Exchange

What’s Your Significantly Better Replacement Property?


Part 2

§1031 -- Better Value Proposition

• We all get phone calls about §1031 exchanges

▪ Clients thinking about selling property -- should they do §1031 exchange?

▪ Something to ponder:

• Would replacement property provide significantly more upside?

─ Selling expenses usually about 8% of gross sales price (+ cost of QI).

191

192

CCH® CPELink 97


Part 2

Review Question 12


Part 2

Example

• Jim is thinking about selling rental property (roughly $300,000).

▪ Should he do a §1031 exchange?

• Question: Why are you selling?

▪ Great time to sell? Probably a bad time to buy.

▪ Or if want to reinvest, Jim will be worth approx. $26,000 less.

• Selling costs ($24,000) + exchange facilitator fee ($2,000).

• So unless replacement property is incredible deal, why sell original property?

─ Holding on to existing property might make more sense?

§1031 -- Better Value Proposition

193

194

CCH® CPELink 98


IntentReplacement Properties

A view towards retirement.


Part 2

An Eye Towards the Future

• Common to consider future personal use.

▪ Does such future intent wreck §1031?

Example

▪ 58-year-old client has busy life.

▪ Reinvests proceeds of duplex → rental on beach.

▪ Hopes to retire there.

195

196

CCH® CPELink 99


Part 2

Losing Arguments

Tony Goolsby v. Comr., TC Memo 2010-64.No research if covenants

allow rental. Minimal efforts to

rent. Move in 2 mos.Tony loses.

Jessie G. Yates III v. Comr., TC Memo 2013-28.

Move in 3 days after acq (pers. res.)

Not “business or investment” → 1031.

Jessie loses.

What doesn’t work:


Part 2

Winning Argument

PLANNED FUTURE USE AS RESIDENCE.

REESINK V. COMR.

197

198

CCH® CPELink 100


Part 2

Winning Argument

Patrick Reesink v. Comr., TC Memo 2012-118.

• Patrick owns apt. bldg. w/brother – SF.

• Brothers don’t get along.

• Patrick said brother:• Attacked him, strangled him.

• Tried to poison him (cleaning fluid in drinking wtr.).

• Patrick sued brother, collected $60K.

Background


Part 2

Reesink v. Comr.

Already had principal residence in SF.

Wife didn’t want to move.

Kids would have to change schools.

Sells interest in apt. building §1031.

Buys rental house in Sonoma Valley.

199

200

CCH® CPELink 101


Part 2

Replacement Property

After 8 mos. no rental, sells SF residence, moves to Sonoma.

Places rental fliers in town (no ads).

Shows prop. → 2 possible renters.

Can’t rent, won’t lower rent/mo.

Financial pressure builds.


Part 2

Patrick’s Brother

A RAT TESTIFIES FOR IRS.

201

202

CCH® CPELink 102


Part 2

Future Plans

Brother testified for IRS:

• Patrick planned move → Sonoma after kids grown.

• IRS – Patrick therefore lacks investment “intent.”


Part 2

OutcomeTax Court

• Brother’s testimony helps Patrick.

▪ At time of exchange, eldest son was age 14.

▪ Supports intent as investment property.

• Patrick wins!

• Possibly never pay tax? (§1014 step up)

203

204

CCH® CPELink 103


Part 2

IRS Safe Harbor

• Safe harbor: IRS won’t challenge §1031 where both:

1. Relinquished residence, and

2. Replacement residence meet “qualifying use” test:

• For at least 24 months immediately

• Before exchange and

• After exchange (Rev. Proc. 2008-16).


Part 2

Thank You for Attending Today’s Program

205

206

CCH® CPELink 104


Part 2

Final Exam

207

Documents

Final Cutting Edge Part 2