Nonpassive Business Loss Limit (Sec. 461(l))mntaxclass.com/files/ACh01_New_Law2.pdf · Nonpassive Business Loss Limit (Sec. 461(l)) • “Excess business loss” is where “aggregate

NonpassiveBusiness Loss

Limit(Sec. 461(l))

• “Excess business loss” is where “aggregate deductions” exceed “gross income or gain which is attributable to such trade or business,” plus:

• $250,000, or• $500,000 (if MFJ) (inflation indexed)

• The excess loss is an NOL carryforward (thus can only offset 80% of T.I.)

Excess Nonpassive Business LossNot Deductible in Current Year

2

• Applies to all taxpayers other than C corporations.

• Applies after the sec. 469 PAL rules.

• Could be big surprise in the year that nonpassivelosses are “freed-up” from a complete disposition of the activity.

• Applied at partner or S shareholder level.

• Applies to Trusts and Estates.3

• Consider impact of excess losses when claiming bonus depreciation.

• Applies before new sec. 199A

• Effective Date: TYBA 12/31/2017

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Example

5

Taxpayer is Single or H of H and the Business Loss is

<$600,000>

6

Income/Loss

NOLCarryover

Div. Inc. 900KBus Loss <600K>

Allowed Loss ?AGI

7

Income/Loss

NOLCarryover

Div. Inc. 900KBus Loss <600K>

Allowed Loss <250K> <350>AGI 650K

The excess loss limits the ability of taxpayers to use large losses against nonbusiness income: W-2 wages, pensions, interest, dividends, capital gains, etc.

20% x QBIDeduction

(Sec. 199A)Revenue Impact:

<415 Bil.> Over 10 Years

Tax Cuts and Jobs ActTitle 1Subtitle A – Individual Tax ReformPart I – Tax Rate Reform

Part II – _____________________??

· Sec. 11011: Deduction for Qualified BusinessIncome [new IRC §199A]

· Sec. 11012: Limitations on Losses of TaxpayersOther than Corporations [new IRC §461(l)]

Tax Cuts and Jobs ActTitle 1Subtitle A – Individual Tax ReformPart I – Tax Rate Reform

Part II – Deduction for Qualified BusinessIncome of Pass-Thru Entities

· Sec. 11011: Deduction for Qualified BusinessIncome [new IRC §199A]

· Sec. 11012: Limitations on Losses of TaxpayersOther than Corporations [new IRC §461(l)]

OverviewOf Sec 199A

11

• Individuals, trusts, and estates can deduct 20% of qualified business income (QBI)

• Applies to each profitable Trade or Business of the taxpayer.

• QBI deduction will never generate an NOL and must be removed from an NOL (new sec. 172(d)(8)).

QBI Deduction - Sec. 199A

12

• QBI can be a passive or nonpassive T or B income.

• Sec. 469 definition of “activity” may differ from QBI business.

• Presumably applies after sec. 469 PAL loss limits.

• Apples after the sec. 461(l) limit on nonpassive excess business losses.

13

• QBI is business income from PSPs, S Corps, Sch C, E, and F.

• Applies to net rental income if the rental is a “trade or business”

• Most rentals are a T or B based upon caselaw—detail below.

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FOUR STEPS (Detail below)1)Potential QBI Deduction: 20% x QBI

2)W2+UB Limit Phases-in based upon TI: (% W-2 Wages + Unadjusted Basis)

3)SSB Exception Phases-out based on TI:(specified service business = SSB)

4)TI-NCG Limit: Taxable income minus Net Capital Gain. 15

• Unlike current sec. 199 (repealed), sec. 199A does not allow a taxpayer to use W-2 wages from a separate T or B.

• The QBI deduction must be computed for "each" qualified trade or business. (Section 199A(b)(1)(A))

• No analog to repealed sec. 199 QPAI (qualified production activityincome)

16

• The deduction is neither for AGI (i.e., does not reduce AGI), nor an itemized deduction. (Conference Rpt. Pg. 39)

• Is allowed for AMT purposes (analogous to repealed sec. 199). (Sec. 199A(f)(1)(B))

• The deduction does not apply for SE purposes. (Sec. 199A(f)(1)(B))

17

• The QBI deduction does not reduce the NII.(Sec. 199A(f)(1)(B))

• Because the QBI deduction is not a for AGI deduction, it does not reduce modified AGI.

• A profitable rental will generally be subject to the NIIT and eligible for the QBI deduction.

Impact on the NIIT

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The NIIT is 3.8% of the LESSER OF:1) NII for the tax year, OR2) The excess of modified AGI over the threshold

amount (250K MFJ or 200K Other)

Effective Date: tax years beginning after

Dec. 31, 2017, and before Jan. 1, 2026.

19

20

Single H of H MFJ Indiv.Bracket

Rate on QBI

<$9,525 <$13,600 <$19,050 10% 8%<$38,700 <$51,800 <$77,400 12% 9.6%<$82,500 <$82,500 <$165,000 22% 17.6%<$157,500 <$157,500 <$315,000 24% 19.2%<$200,000 <$200,000 <$400,000 32% 25.6%<$500,000 <$500,000 <$600,000 35% 28%>$500,000 >$500,000 >$600,000 37% 29.6%

Detail

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Qualified Business Income(QBI)

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“[The net amount of qualified items of income, gain, deduction, and loss with respect to any qualified trade or business of the taxpayer.”

23

Income, gain, deduction, and loss to the extent such items are:

• U.S. Effectively Connected Income

• Allowed in determining T.I. (Sec. 199A(c)(3)(A).

24

Qualified Items

• STCG, STCL, LTCG, LTCL(Does this include sec. 1231 Gain?)• Dividends, dividend equivalents, and

payments in lieu of dividends.

• Interest income unless allocable to a T or B.

• Annuity income(See Sec. 199A(c)(3)(B)

25

Investment Items Not Qualified Items

Any T or B except:

(A) a specified service T or B, or

(B) a T or B of performing services as an employee.

26

Qualified Trade or Business (T or B)

“Treatment of reasonable

compensation and guaranteed payments.”

(Sec 199A(c)(4)27

“Qualified business income shall not include:

28

(A) reasonable compensation paid to the taxpayer by any qualified trade or business of the taxpayer for services rendered with respect to the trade or business,

(B) any guaranteed payment described in section 707(c) paid to a partner for services rendered with respect to the trade or business, and

(C) to the extent provided in regulations, any payment described in section 707(a) to a partner for services rendered with respect to the trade or business.

STEP ONE

Potential QBI Deduction

29

20% of QBI “for each trade or business.” (Sec. 199A(b)(2))

Note: NOT each “activity”.

30

STEP TWOW-2+UB Limit—phases-in begins when T.I. reaches:

$157,500 or$315,00 MFJ

(fully phased-in when T.I. reaches 207,500 or $415,000 (MFJ))

31

Warning: whenever sec. 199A mentions “taxable income” (TI), it means TI without regard to the sec. 199A deduction (sec. 199A(e)(1)).

“Taxable Income” T.I.

32

The deduction for each business is limited to the GREATER OF:• 50% of "W-2 wages" paid by the

business, OR

• 25% of "W-2 pages" paid by the business PLUS2.5% of the "unadjusted basis" immediately after acquisition of all "qualified property.“ (Sec. 199A(b)(2))

W-2+UB Limit

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• Assume for now that the W-2+UB Limit is fully phased-in so TI (pre-sec. 199) is above either:

$207,500 or

$415,000 for MFJ

34

• W-2 Wages must be “properly allocable” to the QBI(Sec. 199A(b)(4)(B)

• No related party prohibition. Ex: 100% S shareholder counts as W-2 wages paid.

• Partners and S Shareholders shares will be on the K-1 (detail below).

35

• “Qualified property" is

• any tangible property, subject to depreciation (Sec. 199A(b)(6(A)).

• Held at year end and available for use.

• Used “at any point” during the year in the business.

• If the “depreciable period” has not ended.

2.5% of Unadjusted Basis…

36

• Depreciable period begins when the property is first placed in service and

• Ends on the LATER OF

1)10 years, or

2)Last year of the recovery period (not ADS)

37

38

• Sch C. Busines purchases a machine for $500,000 on Oct. 1, 2016 and claims sec. 179 expense for entire $500,000.

• $0 unadjusted basis.

• Apparently the same if 100% bonus depreciation.

Example A – Bad News

39

Per Pub. 946, pg. 40:Original basis, but without reducing it by MACRS depreciation; however, you do reduce your original basis by:

• Amortization taken on the property• Any section 179 deduction claimed.• Any special depreciation allowance

taken.

Definition of Unadjusted Basis?

40

• Sch C. Business purchases a machine for $500,000 (5 year MACRS life) in2013 and claims MACRS depreciation(no 179 or bonus).

• $500,000 unadjusted basis through 2022 (10 years) – 5 years beyond its MACRS life (unless disposed of earlier)

Example B

41

• In 2013, taxpayer purchases a commercial building for $5 mil. that is depreciable over 39 years (on leased land).

• $5 mil. unadjusted basis through 2051 unless disposed of earlier.

• 2.5% x $5mil. = $125,000

Example C

• QBI deduction is determined at the partner or S shareholder level.

• Allocable share of W-2 wages or a partner must match the allocation of W-2 wage expense.

• Allocable share of unadjusted basis of a partner must match the allocation of depreciation.

Note: Every K-1 must show W-2 wages and unadjusted basis for each T or B.

Partners and S Shareholders

42

W-2 wages and unadjusted basis will be apportioned between the beneficiaries and the fiduciary (and among the beneficiaries) under the treasury regulations–(per sec. 199A(f)(1)(B) incorporating sec. 199(d)(1)(B)(i))

See Reg. 1.199-5(e)

Trusts and Estates

43

• The W2+UB limit phases in when T.I. is abovethe “Threshold amount”.

• Threshold amount:• $157,500, or• $315,000 (MFJ)

• Phase-in based upon ratio of T.I. over phase-in range divided by the range: • $50,000, or• $100,000 for MFJ

Phase-in of W-2+UB Limit

44

Example (1) (MFJ)Not a Service Business

45

Income/QBI/Loss

W-2 Wages

Unadj.Basis

Sch. C TorB 300K 0 0Dividends 24KAGI 324K

Std. Ded. -24KT.I. (pre-199A) 300K

46

Income/QBI/Loss

W-2 Wages

Unadj.Basis


Std. Ded. -24KT.I. (pre-199A) 300KQBI Ded. - 60K 20% x 300KT.I. =240KA.M.T.I. =264K 240K (T.I.) + 24K (s.d.)_

Pre-sec. 199A T.I. does not exceed $315K so W-2+UB Limit is inapplicable

Example (2)

47

Same as Ex. (1) except $340K of QBI

(v. 300K)

Example (2) (MFJ)

48

Income/QBI/Loss

W-2 Wages

Unadj.Basis


Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded.T.I.

Now, the W-2+UB limit is phased in because TI exceeds 315K.

Excess Amount (sec.199(b)(3)(B)(iii))

49

QBI deduction without the W2+UB limit in excess of the deduction ifthe limit applied in full:

$68 (20% x 340K) - $0 ($0 W-2 wages and unadjusted basis) = $68.


50

Multiply the excess amount by ratio of: (T.I. – Threshold Amount) ÷phase-in range)

68,000 x 25% (340K – 315K) ÷ 100K = $17

QBI Deduction = $51 ($68 (full amount - $17 (phased-in limit)

51

Income/QBI/Loss

W-2 Wages

Unadj.Basis


Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded. - 51K 68K – 17K* = 51T.I. =289K

*Phase-in of W-2+UB limit: $17 ($68K x 25% (25 (340K – 315K) ÷ 100K)

Example (3)

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Same as Ex. (2) except the business pays $40K of W-2 wages

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Income/QBI/Loss

W-2 Wages

Unadj.Basis

Sch. C TorB 340K 40K 0Dividends 24KAGI 364K

Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded.T.I.

The W-2+UB limit is phased-in because T.I. exceeds $315,000

Excess Amount

54

QBI deduction without the W2+UB limit in excess of the deduction ifthe limit applied in full:

$68 (20% x 340K) - $20 (W-2 wages of $40,000) = $48.

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Income/QBI/Loss

W-2 Wages

Unadj.Basis


Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded. - 56K 68K – 12K* = 56T.I. =284K

*Phase-in of W2+UB Limit: $12 ($48K x 25% (25 (340K – 315K) ÷ 100)

Example (4)

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Same as Ex. (3) except Sch C business of $420,000

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Income/QBI/Loss

W-2 Wages

Unadj.Basis



W2+UB limit is fully phased-in; T.I. exceeds $415,000

58

Income/QBI/Loss

W-2 Wages

Unadj.Basis


Std. Ded. -24KT.I. (pre-199A) 420KQBI Ded. 20K 50% x $40KT.I. 400K

• Rules applied at Partner or S Shareholder level.

• Allocable share of W-2 wages and unadjusted basis.

• For PSPs, the W-2 wages cannot exceed the K-1 expense allocation for W-2 wages. (Section 199A(f)(1))

Partners and S Shareholders

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STEP THREEThe SSB Exception

(The exception begins to phase out if T.I. reaches

$157,500 or $315,000 MFJ)

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Any T or B except:

(A) a specified service business, or

(B) a T or B of performing services as an employee.

61

Qualified Trade or Business:

Specified Service Businesses:

“any trade or business involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business where the principal asset of such trade or business is the reputation or skill of 1 or more of its [owners].” OR

62

63

“Exception for specified service businesses [SSB]

based on taxpayer's income.”

(Sec. 199A(d)(3))

64

• No phase-out if T.I. does not exceed:

• $157,500 or• $315,000 if MFJ.

• Phases-out if T.I. exceeds the above Threshold Amounts. The phase-out range is• $50,000 or• $100,000 if MFJ

SSB Exception Phase-out

65

66

• For SSBs, only the “applicable percentage” of qualified income, W-2 wages, and unadjusted basis is taken into account in calculating the QBI deduction. (sec. 199A(d)(3)(A)(ii))

• The “applicable percentage” reflects how much of SSB exception remains after a portion is phased-out based on the TI in excess of the threshold amount.

Example (1) (MFJ) -- An SSB

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Income/QBI/Loss

W-2 Wages

Unadj.Basis



68

Income/QBI/Loss

W-2 Wages

Unadj.Basis


Std. Ded. -24KT.I. (pre-199A) 300KQBI Ded. - 60K 20% x 300KT.I. =240KA.M.T.I. =264K 240K (T.I.) + 24K (s.d.)_

The “applicable percentage” is 100%. None of the SSB exception is phased-out because TI is below the threshold amount of $315K.

Example (2)

69

Same as Ex. (1) except $340K of QBI

(v. 300K) and W-2 wages of $150K are paid (still $0 unadjusted basis)

70

• The taxpayer’s T.I. is 25% of the way through the phase-out range; therefore, the “applicable percentage” is 75% (100% - 25%)

71

Income/QBI/Loss

W-2 Wages x 75%

QBI x 75%

Sch. C TorB 340K 112.5K $255KDividends 24KAGI 364K

Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded. $51K 20% x $255T.I. $289K

• The SSB exception is 25% phased-out.• I believe that W2+UB Limit would be phased-in

(also 25%) AFTER first applying the SSB exception phase-out (guidance needed).

72

Excess amount: QBI deduction without the W2+UB limit (after the SSB exception) in excess of the deduction if the limit applied in full (after SSB exception):

$51 (20% x 255K) - $51 ($112.5 W-2 wages) = $0.


73

Phased-in W2+UB limit: $0 because W-2 wages are sufficient.

$0 x 25% = $0

QBI Deduction = $51 ($51 (full amount - $0 (phased-in limit)

74

Income/QBI/Loss

W-2 Wages x 75%

QBI x 75%

Sch. C TorB 340K 112.5K $255KDividends 24KAGI 364K

Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded. $51K 20% x $255T.I. $289K

Result after considering the phase-out of the SSB exception and next applying the phase-in of the W2+UB limit.

Example (3)

75

Same as Ex. (2) except $0 W-2 wages (instead of $150K)

Guidance needed here but sec. 199A(d)(3)(A)(ii) applies to “this section [199A] ” NOT merely this

subsection.

76

Income/QBI/Loss

W-2 Wages x 75%

QBI x 75%

Sch. C TorB 340K 0 $255KDividends 24KAGI 364K


• Applying the phase-out of the SSB exception before the phase-in of the W2+U.B. limit, the QBI deduction is potentially $51K (20% x $255K).

Excess Amount of $51K

77

QBI deduction without the W2+UB limit (after SSB exception phase-in) in excess of the deduction if the limit applied in full (after SSB exception phase-in):

$51K ((20% x 255K) - $0 ($0 W-2 wages and UB) = $51K)

Phasing-in of W2+UB Limit:

78

Multiply the excess amount by 25% and the product is the W2+UB phased-in limit:

51K (excess amt.) x 25% = $12.75K (phased-in limit)

QBI Deduction = $38.25 ($51K (full amount - $12.75K (phased-in limit)

79

Income/QBI/Loss

W-2 Wages x 75%

QBI x 75%

Sch. C TorB 340K 0 $255KDividends 24KAGI 364K

Std. Ded. -24KT.I. (pre-199A) 340KQBI Ded. 38.25K $51 - $12.75T.I. 301.75

• Applying the SSB exception phase-out first, the QBI deduction is potentially $51K (20% x $255K).

• Next, the phase-in of the W2+UB limit reduces the deduction by 25% to $12.75K.

STEP FOURThe TI-NCG Limit

(The sum total of the taxpayers QBI deductions cannot exceed T.I. minus

Net Capital Gain)(Sec. 199A(a)(1))

80

• Add up the deductible amounts for each business.

• The sum is the “combined qualified business income amount” (CQBIA)

81

• For now, ignore qualified REIT dividends, publicly traded partnership income, and qualified cooperative dividends.

These are not QBI.82

TI-NCG Limit

83

The total QBI deduction cannot exceed THE LESSER OF:

1) CQBIA (sum of combined deductions),

OR

2) 20% x (T.I. minus “net capital gain” (NCG))

Zero or negative QBI for a T or B means no QBI deduction for that particular T or B.

• The loss does not reduce the QBI of other T or Bs included in the CQBIA (not netted).

• Instead, the loss is pushed to the following year and reduces the QBI of that T or B.

84

Example (1) (MFJ) – Not an SSB and Businesses are Nonpassive

85

T or B Income/Loss

W-2 Wages

UnadjustedBasis

QBI Loss Carryover

Div. Inc. 500KBus. #1 $300K $150K $0Bus. #2 <300K> N/A N/A <300>

AGI 500KStd. Ded. <24K>T.I. (pre-199A) 476KQBI Ded. -60K $300K x 20%T.I. =416K

QBI from Business #1 qualifies despite loss from Business #2. TI-NCG limit does not apply because T.I. is high due to dividend income (or spouse’s W-2 wages, etc).

Example (2)

86

Same as Ex. (1) except the taxpayer is Single or H of H and the loss from Bus. #2 is

<$600,000>

Before Net Bus. Loss limit or QBI Ded.

87

T or B Income/Loss

W-2 Wages

UB

Div. Inc. 500KBus 1 300K $150K $0Bus 2 <600K> N/A N/A

Net Bus. Loss <300K>AGI? 200KStd. Ded.T.I. (pre-199A)

QBI Ded.T.I.

Note: Potential QBI Deduction of $60K but the TI-NCG limit is a problem

• “Excess business loss” is where “aggregate deductions” exceed “gross income or gain which is attributable to such trade or business,” plus:

• $250,000, or• $500,000 (if MFJ)

88

*After considering sec. 461(l) only <250K> of the net <loss is allowed in current year

89

T or B Income/Loss

W-2 Wages

UB QBI Loss Carryover

NOLCarryover

Div. Inc. 500KBus 1 300K $150K $0Bus 2 <600K> N/A N/A <600>

Net Bus. Loss <250K>* <50>AGI? 250KStd. Ded. 12KT.I. (pre-199A) 238KQBI Ded. 47.6 20% x 238K (TI-NCG Limit)T.I. 190.4

The taxpayer needs more T.I. to get the full QBI deduction.

Example (3)

90

Same as Ex. (1) except both Business #1 and Business #2

are passive activities.

91

Income/Loss

W-2 Wages UB

QBILoss Carryforward

Div. Inc. 500KBus. #1 $300K $150K $0Bus. #2 <300K> N/A N/A <300>

AGI 500KStd. Ded. <24K>T.I. (pre-199A) 476K

How do PAL rules interact with QBI Deduction?

Same answer as (1), probably. Presumably the full QBI deduction of <$60K>is allowed independent of the sec. 469 PAL rules because the QBI deduction is neither an above or below the line deduction and it is a separate code section with an artificial deduction. If it somehow reduces the passive income of Bus. #1, then the current year allowed passive loss for Bus. #2 is <$240K>. More sensible (?) if the PAL rules are applied first and are fully independent of sec. 199A.

Example (4)

92

Same as Ex. (1) except LTCG of $500K

(instead of dividends)

93

T or B Income/Loss

W-2 Wages

UnadjustedBasis

QBI Loss Carryover

LTCG 500KBus. #1 300K 150K $0Bus. #2 <300K> N/A N/A <300>

AGI 500KStd. Ded. <24K>T.I. (pre-199A) 476KQBI Ded. - 0K 476 (TI) – 500 LTCG = $0 QBI Ded.T.I. =476K

Zero QBI deduction because T.I. – LTCG is zero.

Example (5)

94

For non-SBBs, no upper limit on the QBI deduction if the

W2+UB and TI-NCG limits are met.

In Millions (ignore itemized deduction or std. ded.)

Not an SSB

95

T or B Income W-2 Wages

UnadjustedBasis

Bus. #1 $300 Mil. $120 mil. $0T.I. (pre-199A) 300 Mil.QBI Ded. - 60 Mil. $300 mil. x 20%T.I. =440 Mil.

When is rental real estate a Section

162 trade or business?

Caselaw96

97

• Taxpayer inherited residential property in 1934 and tried to rent or sell it.

• Never used it as his residence, and

Campbell v. Comm’r, 5 TC 272 (1945)

98

• attempted to rent it (unsuccessfully), until it was sold in 1941 at a loss.

• Campbell sought ordinary loss treatment under the predecessor to section 1221(a)(2), which required the property to be a trade or business asset.

99

The Tax Court Found a Trade or Business

100

• Cited Jephson v. Comm’r, 37 BTA 1117 (1938), with similar facts.

• BTA said the taxpayer was “carrying on a business, albeit without actual profit during the years in question.”

101

In Hazard v. Comm.’r, 7 T.C. 372 (1946), acq. 1946-2 CB 3

A single family residential rental in Kansas City was viewed as a

trade or business of the taxpayer and thus produced an ordinary loss on sale under the

predecessor to sections 1221(a)(2) and 1231.

102

Second Circuit applied a tougher test

in Grier v. U.S., 218 F.2d 603

(2nd Cir. 1955)(Rejected Hazzard)

103

• Grier required a “broader activity” than a single residential rental, long-term (14 years), to one tenant, with minimal repair activity.

• Ruled that the rental was an investment activity.

104

Grier referred to:• Pinchot (eleven commercial

buildings in New York),

• Gilford (eight buildings in New York),

• Fackler (a six-story commercial building),

• and Rogers (sixty-one properties).

105

The Tax Court only follows Grier in the

Second Circuit(Golsen Rule)

106

Balsamo v. Comm’r, TC Memo 1987-477 (1987)

“[The Tax Court’s] position [implicitly contrary] is not controlling for purposes of our decision today. We must decide this issue pursuant to the law as articulated by the Second Circuit [per Golsen]. The case of Grier …provides the basis for our conclusion.” (Citations omitted).

107

The issue was whether the taxpayer, living in the U.S. could carry back and forward her NOL resulting from the 1944 bombing raid on her rental property (former primary residence) in Austria during WW2 (confiscated by the Nazi gov’t for 5 years).

Reiner v. U.S., 222 F.2d 770 (7th Cir. 1955)

108

Reiner, Quoting the Tax Court in LaGriede:

“It is clear from the facts that the real estate was devoted to rental purposes, and we [the Tax Court] have repeatedly held that such use constitutes use of the property in trade or business, regardless of whether or not it is the only property so used.

109

We add that the use of the property in trade or business was, upon the facts, an operation of the trade or business in which it was so used. It is clear, also, that the business was ‘regularly’ carried on, there having been no deviation, at any time, from the obviously planned use.”

Factually indistinguishable from Grier.

110

• Full-time attorney who sold at a net loss, a single-family residence that had been rented to the same tenant for three years.

• Taxpayer sought capital loss treatment.

Stratton v. Comm’r, TC Memo 1962-218 (1962),

111

Tax Court agreed with IRS:“This [Tax] Court has repeatedly held that the renting of improved real estate constitutes the carrying on of a trade or business, regardless of whether or not the taxpayer engaged in any other trade or business, … [citing Hazard, Jephson and another case]”

112

Does the Tax Court ever treat a rental as

an investment?

Yes!

113

Triple Net Lease Property

• A triple-net lease in which the tenant is responsible for taxes, insurance, and repairs, is normally a mere investment.

Herbert v. Comm’r, 30 T.C. 26 (1958)

114

But the IRS has never revoked its acquiescence to

Hazard.

115

Chief Counsel rejected the National Office audit

division request for a reversal of the

acquiescence to Hazard.

GCM 38779 (7/27/81)

OtherSec. 199A

Issues116

117

“[C]ombined qualified business income amount” means, …an amount equal to—

(A) the sum of the [QBI] deductions for each qualified trade or business carried…, plus

(B) 20 percent of the aggregate amount of the qualified REIT dividends and qualified publicly traded partnership income...”

(so the TI-NCG limit applies)

REITS and PTPs

118

Because qualified REIT dividends, qualified publicly traded partnership income, and qualified cooperative dividends are not QBI, the W-2+UB limit does not apply but the TI-NCG limit does apply.

119

A dividend from a REIT that is:

• Not a capital gain dividend

• Not qualified dividend income.

Qualified REIT dividend.

120

With respect to any qualified T or B, the sum of:

• Allocable share of income, gain, deduction and loss from a PTP that is not taxed as a corporation.

• Any gain upon disposition if ordinary income under sec. 751(a)

Qualified Publicly Traded Partnership Income.

121

• The sec. 199A deduction for SAHCs is 20% of the excess of gross income of the SAHC over “qualified cooperative dividends”.

• Limits:1) a W2+U.B. limit (see sec. 199A(g)(1))

and2) A TI limit (see sec. 199A(g)(2)).

Sec. 199A Deduction for Specified Agricultural or Horticultural

Cooperatives (SAHCs) (Sec. 199A(g))

122

• QCD is defined in sec. 199A(e)(4).

• QCD’s are not “qualified business income” (sec. 199A(c)(1)) so no W-2+UB limit.

• Potential deduction is 20% x QCD (sec. 199A(2)(A))

• The TI-NCG limit is really the TI-(NCG +QCD) limit and it applies to QCDs.

Qualified Cooperative Dividends (QCDs) (Sec. 199A(a)(2))

123

Owner SEP/401(k)/Qualified Plan Contribution

• Is the qualified plan contribution (Form 1040 front page) deductible in calculating the QBI?

• Will influence QBI deduction planning.

• Best guess is no (doesn’t reduce it) based upon analogous repealed sec. 199.

• Not discussed in committee reports or statute.

“There is a substantial understatement … if the amount of the understatement for the taxable year exceeds the greater of-

(i) 10 5 percent of the tax required to be shown on the return for the taxable year, or

(ii) $5,000.” (Sec. 6662)124

Penalty Mod. For “Any Taxpayer Who Claims” the

QBI Deduciton

Bonus Depreciation

100%Bonus Depreciation

for property acquired and placed in service after 9/27/2017 and

before 2023 126

Expanded to used property purchases

(provided not acquired from a related party or in a carryover

basis transaction). 127

Expanded to include certain qualified film and television productions,

as well as certain qualified theatrical

productions. 128

Excludes from qualified property, property which is primarily used for:(1) Electrical energy, water, or sewage

disposal services;

(2) Gas or Steam through a local distribution system, or

(3) Transportation of gas or steam by a pipeline if rates are established by government.

129

Excludes from qualified property, property used in a trade or business that has a floor plan indebtedness* unless:

(1)Not a tax shelter prohibited from using cash method; and,

(2)Exempt from interest limit due to small business gross receipts test.

130*Defined in paragraph (9) of Section 163(j)

Repeals the election to accelerate AMT credits

in lieu of bonus depreciation.

131

132

Effective Date• Property acquired and placed in service after

September 27, 2017, as well as specified plants planted or grafted after that date.

• Not treated as acquired after the date on which a written binding contract is entered into for its acquisition.

• Transition Rule. Can elect to utilize 50% bonus depreciation, instead of 100%, for qualified property placed in service during the first tax year ending after September 27, 2017.

133

Property Acquired Before 9/28/2017 and Placed in Service After

134

Property Acquired On or After 9/28/2017

Observation: Considerthe new limit on “excess losses” (sec. 461(l)) and

sec. 199A when estimating the benefit of bonus depreciation and

sec. 179 135

Luxury Car Limits

New Sec. 280F Limits

137

New Law

2017

Year 1 $10,000 $3,160Year 2 $16,000 $5,100Year 3 $9,600 $3,050Year 4 and later

$5,760 $1,875

Effective Date: Property placed in service after Dec. 31, 2017

• Computer or peripheral equipment is no longer listed property subject to heightened substantiation requirements.

• Also not required to switch to straight-line depreciation if business use drops below 50%.

138

Farm Property Depreciation

MACRS life is shortened to 5 (from 7) for any new (original use) machinery or equipment used in farming.

• Not for grain bin, cotton ginning asset, fence or other land improvement.

140

• Eliminates the requirement that property used in farming with a recovery period of 10 years or less must use 150% declining balance--can now use 200% DDB unless 15-year or 20-year property or 150% by election).

• Effective Date: Property placed in service after Dec. 31, 2017 in tax years ending after such date.

141

• If farming T or B elects out of interest deduction limit, then must use ADS depreciation for farm property with a recovery period of 10 years or more (such as single purpose agricultural or horticultural structures, trees or vines bearing fruit or nuts, farm buildings, and certain land improvements.)

• Effective for TYBA Dec. 31, 2017 (applies to property already in service).

142

Certain Citrus Replanting

Costs

• For citrus plants lost or damaged due to casualty, the provision makes replanting costs deductible by a person other than the taxpayer if the taxpayer has an equity interest of at least 50% in the replanted citrus plants; OR

• The other person must acquire all the taxpayer’s equity interest in the land on which the plants were located when damaged and replant on such land.

144

Real Property Depreciation

• ADS recovery period for residential rental property is reduced to 30 years (from 40 years).

• Replaces qualified leasehold improvement, qualified restaurant, and qualified retail improvement property with qualified improvement property (QIP).

• QIP gets a general 15-year SL recovery (20 for ADS) says conf. rpt. (but not in statute—technical correction needed). 146

• Nonresidential real prop. building improvement.

• Interior portion (not currently required for restaturantproperty)

• Place in service after the building is first placed in service.

QIP:

147

• Not a building enlargement.

• Not an elevator or escalator.

• Not an internal structural framework.

148

• A restaurant building placed in service after 2017 that is not QIP is depreciated over 25 years as nonresidential real property, straight-line and mid-month convention.

• A conforming change to section 179 so that only QIP meets section 179 (“qualified real property”).

• Bad news: A restaurant building placed in service after 2017 cannot get sec. 179.

149

• A restaurant building placed in service after 2017 that is not QIP is depreciated over 25 years as nonresidential real property, straight-line and mid-month convention.

• A conforming change to section 179 so that only QIP meets section 179.

Bad news: A restaurant building placed in service after 2017 cannot get sec. 179.

• Effective: Property Placed in service after2017

150

• A “real property trade or business” (defined by sec. 469(c)(7)(C) electing out of the interest expense limit must use ADS to depreciate any:

• Nonresidential property• Residential rental property• QIP

• Effective for tax years beginning after 2017 (applies to property already in service).

Section 179

• Maximum deduction $1 mil. (up from $500,000)

• Phase-out begins at $2.5 mil. (up from 2 mil.)

• The $25K sec. 179 limit on heavy SUVs is inflation indexed.

• But bonus depreciation for such vehicles, new or used, acquired and placed in service after 9/27/2017 and before 2023, is 100%. 152

Gross Vehicle Weight 6,100 to 7,050SUV if truck bed interior length is under 6 ft.

Gross Vehicle Weight 6,100 to 7,050

2014 Jeep Grand Cherokee

Section 179 property is expanded “to include certain tangible personal property used predominantly to furnish lodging or in connection with furnishing lodging (Conf. Rpt.):”

“beds and other furniture, refrigerators, ranges, and other equipment usedin the living quarters of a lodging facility such as an apartment house, dormitory, or any other facility (or part of a facility) where sleeping accommodations are provided and let.” See Treas. Reg. sec. 1.48-1(h). Conf. Rpt. Footnote 620

155

• Same restriction for buyers who are noncorporate lessors:

• Term of lease less than 50% of class life; and

• For first 12 months, sec. 162 deductions “exceeds 15% of the rental income produced by such property.”

156

• “Qualified Real Property” (QRP) is now “qualified improvement property” (QIP).

• Recall, QIP is also eligible for bonus depreciation.

• QRP also now includes the following improvements to nonresidential real prop. placed in service after the property was first placed in service: (A) Roofs; (B) HVAC property; (C) Fire protection and alarm systems; (D) Security systems.

Recall: Sec. 179 is not subject to sec. 263A.157

Effective Date: Property placed in

service in tax years beginning after Dec. 31, 2017.

158

What is NonresidentialReal Property?

159

Nonresidential:

“The term ‘nonresidential real property’ means section 1250 property which is not residential rental property, ….

(Section 168(e)(2)(B))160

Residential Rental:

“The term ‘residential rental property’ means any building or structure if 80 percent or more of the gross rental income from such building or structure for the taxable year is rental income from dwelling units.”(Section 168(e)(2)(A)(i))

161

Dwelling Unit:

“The term ‘dwelling unit’ means a house or apartment used to provide living accommodations in a building or structure, but does not include a unit in a hotel, motel …used on a transient basis….”(Section 168(e)(2)(A)(ii)(I))

162

163

Like Kind Exchanges

• Like-kind exchanges are limited to real property.

• Effective for exchanges completed after December 31, 2017.

A transition rule where taxpayer has either disposed of the relinquished property or acquired replacement property on or before December 31, 2017.

• This provision does not sunset. 165

166

Rev. Proc. 2017-33 (04/20/2017)

IRS Guidance on Path Act Changes to Sections 179

and 168

1-2

Section 179Background

167

• $510,000

• $2,030,000

For 2017

168

Taxpayers can “make, revoke, or modify” the

section 179 election on an amended return.

The PATH Act (12/18/2015) made this

permanent.169

Rev. Proc. 2017-33

The flush language in section 179(d)(1) that

excludes air conditioning and heating units from

the definition of qualifying property is

removed.

New For 2016

170

“For example, portable air conditioners, such as

window air conditioning units, and portable heaters,

such as portable plug-in unit heaters, that are

placed in service by the taxpayer in a taxable year beginning after 2015 may

qualify [for the section 179 expense]”

171

“If a component of a central air conditioning or heating system of a building meets the definition of qualified

real property, as defined in § 179(f)(2), … placed in service…after 2015, the

component may qualify as § 179 property”

172

Section 179 Qualified Real Property (QRP)

173

1) Qualified Leasehold Improvement Property

2) Qualified Retail Improvement Property

3) Qualified Restaurant Property

“Qualified Real Property” for Property Placed in Service

Before 1/1/2018

174

1) Qualified Leasehold Improvement Property

2) Qualified Retail Improvement Property

3) Qualified Restaurant Property

“Qualified Real Property” for Property Placed in Service

Before 1/1/2018

175

Replaced with QIP for property placed in service after 2017

• For tax years beginning on or after 2016, the $250,000 cap attributable to “qualified real property” is removed.

• Therefore: • $510K cap in 2017 and• $1 mil. cap in 2018 for QIP, etc.

176

15 yrs. Straight-line Instead of 39 yrs.

(Recall: For 2018, QIP is also 15 years S/L)

(Section 168(e)(3)(E)(iv), (v), and (ix))

Depreciation of Qualified Real Property in 2017

177

178

Rev Proc 2017-33 Example (1)

• In 2010, A places in service a new office building.

• In February 2016, A sells this office building to B at fair market value.

• B uses the office building in its trade or business.

179

• In March 2016, B begins to construct improvements to the interior portion of the office building and places the improvements in service in December 2016.

180

• Because the office building was first placed in service in 2010 and the improvements made by B are [QIP].

181


• In 2015, C, a corporation and manufacturer, enters into a written contract with X for X to construct a new building for use by C in its trade or business.

• The building will house a manufacturing operation and office space.

182

• The initial construction plans did not include a private restroom for the owner of C.

• During the construction of the building, C enters into a written contract with Y to construct a private restroom in the new building for the owner of C.

• On May 27, 2016, C places in service the building, except for the private restroom.

183

• On May 28, 2016, the private restroom in the building for the owner of C is placed in service.

• Because the building is first placed in service on May 27, 2016, and the private restroom is placed in service on May 28, 2016, the assets in the private restroom … [may qualify as QIP].

184


• Same facts as Example (2) except the private restroom is constructed by the original contractor X pursuant to “an amendment to the existing written contract.”

• Same answer as Example (2).

185


• D is engaged in the commercial building rental business.

• In March 2015, D enters into a written contract with Z to construct a multi-story building. Pursuant to this contract, Z constructs a completely finished exterior of the building and a minimally finished interior of the building with only elevators,

186

heating, ventilation, and air conditioning systems, plumbing, restrooms, and concrete floors.

• In December 2015, D and E entered into a lease agreement providing that E will lease one floor of the new building and E will install on that floor drop ceilings, lighting, interior walls, electrical outlets, carpeting, and trade fixtures necessary for the operation of E's trade or

187

business (collectively referred to as a build-out).

• On February 8, 2016, D places in service the new building.

• On June 4, 2016, E places in service the build-out.

• Because the building is first placed in service on February 8, 2016, and the build-out is placed in service after that date, the assets of the build-out that are § 1250 property are [QIP]….

188


• In 2016, F constructs and places in service an improvement to a restaurant building [interior] and that improvement meets the definitions of both qualified restaurant property under §168(e)(7) and qualified improvement property under §168(k)(3).

189

• Accordingly, the improvement is [QIP]

190


• In 2016, G constructs and places in service a new restaurant building and that building meets the definition of qualified restaurant property under §168(e)(7).

• However, that building is not qualified improvement property under §168(k)(3).

• Accordingly, the building is not eligible for [Bonus depreciation].

191

• But, in 2017, is eligible for:

• 15 year straight-line deprec.

• Section 179.

Documents

Nonpassive Business Loss Limit (Sec. 461(l))mntaxclass.com/files/ACh01_New_Law2.pdf · Nonpassive Business Loss Limit (Sec. 461(l)) • “Excess business loss” is where “aggregate