Tax Court Rules Trusts Can Be Real Estate Professionals

The United States Tax Court has recently released a decision in Frank Aragona Trust v. Commissioner that will affect tax planning for many trusts that own businesses or hold real estate. In that case, a trust operated rental real estate properties and developed other real estate properties. It incurred losses from these activities, which it deducted as non-passive losses.

Under prior law, rental real estate losses were automatically passive losses unless incurred by a “real estate professional.” The IRS’s position in Frank Aragona Trust was that a trust could never qualify as a real estate professional. However, the Tax Court found for the taxpayer. It stated that a trust could qualify as a real estate professional if the rental real estate activities of its trustees were regular, continuous, and substantial. It did not, however, address whether trusts could count the activities of employees who were not trustees. The decision will also have a significant impact on planning for the Net Investment Income Tax.

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What is the Net Investment Income Tax (NII)?

The NII refers to a new tax called the Tax on Net Investment Income. This is a 3.8% tax that applies starting in 2013 to income that generally is considered passive. The tax is going to apply to dividends, to interest, to capital gains unless they are from an active business and any business in that category. If you are in the tax bracket, it’s $200,000 if you are single and $250,000 if you are married filing joint, you are going to be subject to this tax. If you are close to that line, you are going to want to look carefully at managing any of that type of income that you can.

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How Does the NII Relate to Real Estate?

The Net Investment Income Tax applies to real estate in a variety of ways. One of those ways is if your income from real estate is passive, then it’s going to be subject to the NII if you’re in a bracket that is subject to the tax. In addition, to the extent that your income is passive from capital gains, those capital gains are going to be subject to this tax. To the extent that you are involved in real estate, this tax will have an impact and should be considered in your tax planning.

© 2014 Parsonage Vandenack Williams LLC

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2013 Tax Review

There have been a number of important tax developments in 2013 that could impact you and your business in this and future tax years. Among the more notable changes include:

• Additional Medicare Tax. Beginning with 2013 tax returns, there will be an additional Medicare tax of 0.9% on certain high income earners. This tax generally applies to earned income in excess of $200,000 for single and head of household filers, $250,000 for married filing jointly filers and $125,000 for married filing separately filers. When applicable, employers are required to withhold the additional 0.9%.
• Tax on Net Investment Income. Beginning with 2013 tax returns, single and head of household taxpayers with modified adjusted gross income (MAGI) in excess of $200,000, married taxpayers filing jointly with MAGI over $250,000 and married taxpayers filing separately with MAGI over $125,000, are subject to an additional 3.8% Medicare tax on certain net investment, such as interest, dividends, rents, royalties and net gains from the sale of property. The tax is generally calculated by multiplying 3.8% by the lesser of net investment income for the year or the amount by which MAGI exceeds the $200,000/$250,000/$125,000 income threshold. The threshold amounts are not indexed for inflation.
• Phase-Out of Itemized Deductions. Beginning in 2013, the total amount of itemized deductions allowed is reduced by three percent (3%) of adjusted gross income in excess of $250,000 for single taxpayers, $275,000 for head of household taxpayers, $300,000 for married taxpayers filing jointly and $150,000 for married taxpayers filing separately. A taxpayer may not lose more than 80% of itemized deductions due to the phase-out.
• Phase-Out of Personal Exemptions. For 2013, a taxpayer’s personal exemption are phased-out by 2% for each $2,500 or fraction thereof by which the taxpayer’s adjusted gross income exceeds $250,000 for single filers, $275,000 for head of household filers, $300,000 for married filing jointly filers and $150,000 for married filing separately filers. In 2013, a married taxpayer filing jointly will have all personal exemptions phased out at income of $422,501.
• Increase in Top Tax Brackets. For the 2013 tax year, there is a new top tax bracket of 39.6%. This rate applies to income in excess of $400,000 for single filers, $425,000 for head of household filers, $450,000 for married filing jointly filers and $225,000 for married filing separate filers. The previous top tax bracket was 35%.
• Same Sex Couples Must File as Married Filing Jointly or Married Filing Separately. Effective September 16, 2013, same-sex couples who were legally married in jurisdictions that recognize same-sex marriages will be treated as married for federal tax purposes. This rule applies regardless of where the same-sex couple currently resides.
• Small Employer Tax Credit. Effective January 1, 2014, employers with no more than 25 full-time employees who offer health insurance coverage to their employees may be eligible to receive a tax credit. The employees must have annual equivalent wages that average no more than $50,000. The maximum credit available is 50% of the premium payments made on behalf of employees.
• Employer Shared Responsibility Payment Delayed until 2015. Effective January 1, 2015, employers with more than 50 full-time equivalent employees may be subject to penalties if they do not offer insurance that meets certain minimum affordability standards to their employees. This penalty was originally set to be enforced beginning January 1, 2014.

 © 2014 Parsonage Vandenack Williams LLC

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