Wednesday, April 03, 2019

Different classes of property

Section 1245 property. This type of property includes tangible personal property, such as furniture and equipment, that is subject to depreciation, or intangible personal property, such as a patent or license, that is subject to amortization.
Section 1250 property - depreciable real property, including leaseholds if they are subject to depreciation. 
The most common examples of §1250 property are buildings and ..... deck, shingles, vapor barrier, skylights, trusses, girders, and gutters. ... of the cost of construction of the building and depreciated over the life of the building.
Section 1252 property, which is farmland held less than 10 years, on which soil, water, or land-clearing expenses were deducted
Section 1254 property, including intangible drilling and development costs, exploration costs, and costs for developing mining operations, 
Section 1255 property, which is cost-sharing payment property described in section 126 of the Internal Revenue Code

Tuesday, March 26, 2019

Attending the IRS Tax Forum in Washington D.C.

Our firm will be attending the National IRS tax forum in Washington D.C. this Summer.  The forum is a 3 day conference that allows practitioners to work closely with the IRS staff on a one to one level.

Saturday, March 23, 2019

IRS extends relief from underpayment penalty

The IRS announced on Friday that it is amending Notice 2019-11 to lower the amount of tax that an individual must have paid in 2018 to avoid the underpayment of estimated income tax penalty to 80% (Notice 2019-25). The change was made after concerns were raised that the earlier relief, which lowered the underpayment penalty threshold from 90% to 85%, did not go far enough given all the uncertainties taxpayers and tax practitioners faced after the many changes wrought by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.
Under Sec. 6654(d)(1)(B), the required annual income tax payment an individual taxpayer is required to make to avoid an underpayment penalty is the lesser of (1) 90% of the tax shown on the return for the tax year or (2) 100% of the tax shown on the taxpayer’s return for the preceding tax year (110% if the individual’s adjusted gross income on the previous year’s return exceeded $150,000). Sec. 6654(a) imposes an addition to tax for failure to make a sufficient and timely payment of estimated income tax. The IRS, however, is entitled to waive the addition to tax in certain unusual circumstances if its imposition would be against equity and good conscience.
With Friday’s notice, the IRS is waiving the Sec. 6654 addition to tax for failure to make estimated income tax payments for the 2018 tax year otherwise required to be made on or before Jan. 15, 2019, for any individual taxpayer whose total withholding and estimated tax payments made on or before Jan. 15, 2019, equal or exceed 80% of the tax shown on that individual’s 2018 return.
To request the waiver, an individual taxpayer must file Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts, with his or her 2018 income tax return. The taxpayer should check the waiver box in Part II, box A, of the form and include the statement “80% waiver” on the return.

Wednesday, March 13, 2019

Sale of Fixed Assets and gains attributable to those assets

When you sell a business asset you can potentially have different types of gains and losses, even within the same transaction.  The gains and losses can be: short term capital gains, short term capital losses, long term capital gains, long term capital losses, section 1245 depreciation recapture, section 1250 depreciation recapture, unrecaptured 1250 gain, and 28% gain (relating to the sale of certain collectibles).  Each of these categories of gains and losses are treated differently and taxed at different rates.
When determining what character of gain you will have when you sell a business asset it is first important to determine what kind of asset you are selling and also what type of entity the asset is being held in.  The three categories of assets that are most commonly sold are (1) Section 1231 property, (2) Section 1245 property, and (3) Section 1250 property.  If the asset that is sold is being held in a C-Corporation the gain is taxed at ordinary tax rates despite what kind of property the asset is.  If the asset that is being sold is held in an entity other than a C-Corporation then you can potentially have different layers of gain, depending on the type of asset that is sold.
Section 1231 property are assets that are used in your trade or business and are held by the Taxpayer for more than one year.  A gain on the sale of Section 1231 business property is treated as long-term capital gain and is taxed at a maximum rate of 15%, at least through December 31, 2012.   A loss on the sale of Section 1231 business property is treated as ordinary loss and can reduce ordinary income on the Taxpayer's return and is not subject to the capital loss limitations ($3,000 limitation for individuals or capital gain limitation for corporations).   However there is a Section 1231 recapture rule that if you sell business property at a gain and you have deducted ordinary losses due to the sale of Section 1231 property in that past five years then the Section 1231 gain that you recognize will be taxed as ordinary income, using the Taxpayer's ordinary income rate, and not the preferential 15% maximum capital gain rate.
Section 1245 property is (1) all depreciable personal property, whether tangible or intangible, and (2) certain depreciable real property (usually, real property that performs specific functions, for example, a storage tank, but not buildings or structural components of building). If you sell Section 1245 property, you must recapture your gain as ordinary income to the extent of your earlier depreciation deductions on the asset that was sold.  Any gain up to the amount of the previously taken depreciation will be taxed at ordinary income rates.  The amount of gain that exceeds the depreciation previously taken is then treated as Section 1231 gain (subject to the Section 1231 rules mentioned above).  The Section 1245 recapture rules do not apply if the asset is sold at a loss.  If a section 1245 asset is sold at a loss, the loss is treated as a Section 1231 loss and is deducted as an ordinary loss which can reduce ordinary income.
Section 1250 property consists of real property that is not Section 1245 property (as defined above), generally buildings and their structural components.  When you sell Section 1250 property you will have to be aware of possible Section 1250 depreciation recapture as well as "unrecaptured Section 1250 gain".  If you sell Section 1250 property that is placed in service after 1986, none of the long-term capital gain attributable to depreciation deductions will be subject to Section 1250 depreciation recapture.  If you depreciated nonresidential real property which was placed in service before 1987 and you depreciated the property placed in service using just straight-line depreciation, there would be no Section 1250 depreciation recapture. However, if at any time an accelerated depreciation method was used, the gain on the sale will be taxed as ordinary income to the extent that the amount of accelerated depreciation taken exceeded depreciation that would have been allowed if you used the straight line depreciation method.  This Section 1250 depreciation recapture is taxed at ordinary income rates.
Any gain in excess of the amount treated as ordinary income because of Section 1250 recapture, but not exceeding the total depreciation claimed, is "unrecaptured Section 1250 gain".   Unrecaptured Section 1250 gain will be taxed at a maximum rate of 25%.  
Any remaining gain in excess of both the Section 1250 depreciation recapture and unrecaptured Section 1250 gains will be treated as Section 1231 gain (long term capital gain), which will be taxed at a maximum rate of 15%, through December 31, 2012.  The sale of Section 1250 property at a loss produces a Section 1231 loss and is deducted as ordinary loss which can reduce ordinary income. The Section 1250 recapture provisions only apply to gains, not losses.
As I'm sure you can see it is not as simple as just selling a business asset.  Every sale of business assets can have many possible tax treatments, producing various tax results.  The tax treatment of the sale of business assets can be quite complex and if you are unsure of the possible tax consequences you should contact your Dermody, Burke, and Brown tax advisor to explain how the sale should be treated.

Tuesday, March 12, 2019

Basis Limitation for k-1 losses

Basis Limitations for K-1 Losses
Definition
The basis limitation is a limitation on the amount of losses and deductions that a partner of a partnership or a shareholder of a S-Corporation can deduct. The basis limits are the first of three limitations that are applied to Schedule K-1 losses and deductions. After the basis limits are applied, the At-risk limits (Form 6198) are applied. If losses are allowed by the basis and at-risk limits, the passive limits (Form 8582) are applied, if applicable.



Per Schedule E (1040), shareholders of S Corporations are required to attach a basis calculation to their tax return each year. There is no form for the basis limitation, but a worksheet, and some instructions have been provided in the partner and shareholder instructions for Schedule K-1.

It is important to note that the capital account shown on the Partner's K-1 is not the same as basis. According to the Partner's Instructions for Schedule K-1, the basis schedule represents outside basis while the capital account represents inside basis. These can differ, even when the partnership maintains its books and records on a tax basis. One way this difference can occur is when a partner buys his partnership interest from another partner, since the purchase price becomes the starting point for his outside basis. (For more information on general K-1 issues, please see K-1 Issues for Individual Taxpayers, General)



Computation
The starting point for the basis limitation is adjusted basis at the beginning of year. The adjusted basis at the beginning of the year is the ending adjusted basis from last year reduced by loss allowed in the previous year. In the initial year, basis is equal to the adjusted basis of property contributed to the partnership, plus any gain recognized on the contribution of property.

The following adjustments are made to arrive at the beginning adjusted basis used in applying the basis limitation:



Increases:
Adjusted basis is increased by current income from the activity, additional amounts invested in the activity, and depletion in excess of the oil and gas property basis.

Additionally, the adjusted basis of a partner's interest in a partnership includes the partner's share of the partnership's liabilities. This is not the case for shareholders in an S-Corporation. Because the S-Corporation is a corporation, it is a distinct legal entity separate from the shareholder, so the shareholder does not increase his or her basis by their share of liabilities. The shareholder only increases their basis by the loans they make directly to the corporation.



Increases to Shareholders' debt basis:
Once losses have reduced a shareholder's stock basis to zero, basis in loans that the shareholder has made to the S-corp is used to allow losses. In future years, any net increases increase debt basis before stock basis. It is important to note "Net Increases" is determined by netting together current year income, losses, prior year losses and distributions. If prior year losses are in excess of current year income, there is no "net increase" and therefore no restoration of debt basis. For more information, please see IRC. 1367(b)(2)(B)).



Decreases:
Distributions, decreases in a partner's share of partnership debt, and repayments on loans the shareholder made to the S corporation are all reductions to a partner's or a shareholder's basis.

If the current year plus prior year disallowed losses exceed basis, some of the loss is disallowed. Any disallowed loss is carried to the following year return and is treated as incurred in the following tax year.

For partners, the allowed loss is allocated pro-rata to each category of loss or deduction (Ordinary, 1231, capital gains/losses, 179 expense, etc). For shareholders, there are ordering rules. Nondeductible expenses and depletion are allowed in full first, unless the shareholder has filed an election to do otherwise. (Regulation 1.1367-1(f))



Distributions in excess of basis
Per Internal Revenue Code Sections 704(a)(2) and 1367(a)(2) basis can never fall below zero. If there has been a distribution in excess of basis, then gain has to be recognized on the distribution. This gain is not reported on schedule K-1. The partner/shareholder reports the gain on their tax return.

Per Internal Revenue Code Section 1368, the treatment of a distribution in excess of stock basis depends upon whether or not the S-Corporation has any earnings or profits from when it was a C-Corporation.

If there were no earnings and profits, then any amount distributed in excess of stock basis is considered gain from the sale or exchange of property. IRC. 1368(b)(2)). The character of the gain is dependent upon the holding period of the S-Corporation stock.

If the S-Corporation had earnings and profits from when it was a C-Corporation, then, per Internal Revenue Code section 1368(c) the following rules apply:

A. The portion of the distribution that does not exceed the accumulated adjustments account is treated as a gain from the sale or exchange of property.

B. The portion of the distribution remaining after step A above is treated as a dividend to the extent it does not exceed accumulated earnings and profits of the S corporation.

C. Any distribution remaining after applying the two steps above is treated as gain from the sale or exchange of property.

For partners, Distributions in excess of basis also results in gain. (IRC. 731(a)(1)) Any gain recognized is considered gain from the sale of exchange of the partnership interest. See Internal revenue code section 731 for how to determine the character of the gain.



Alternative Rule for computing partnership basis
In circumstances where the general rule for computing a partner's basis cannot be practicably followed, an alternative method of computing basis may be available. This alternative method computes the partner's basis by referencing the partner's share of the adjusted basis of partnership property they would receive upon termination of the partnership. (See Regulation 1.705-1(b) for more details about the alternative rule).

Thanks to Intuit for this information

Thursday, February 21, 2019

What to do if you receive form 1099-A


Foreclosures and Capital Gains 

The Internal Revenue Service treats a foreclosure just the same as if you had sold your property. You'll have to calculate your capital gain or loss, but unlike with a normal sale, there's no "selling price" in this scenario. This is where Form 1099-A comes into play.

The Information on Form 1099-A

You'll need the selling date and the selling price of the foreclosed property to report its "sale" to the IRS, and you'll find this information on Form 1099-A. For the sales price, you'll use either the fair market value of the property or the outstanding loan balance at the time of the foreclosure.
The outstanding loan balance is found in box 2 of the !099-A, and the property's fair market value is found in box 4. The date of the foreclosure is indicated in box 1, and this will be used as the "sale date."
Taxpayers must also know if the loan was a recourse loan or a non-recourse loan. The loan was probably a recourse loan if the lender has checked "yes" in box 5, which asks "Was borrower personally liable for repayment of the debt?"

Do You Have a Gain or a Loss?

Capital gains are reported on Schedule D for homes that were personal residences. The IRS does not allow taxpayers to claim losses on personal residences. Any gain—and yes, a foreclosure can actually result in a gain—can usually be offset by the capital gains exclusion for a main home, so it’s unlikely that a foreclosure will result in any capital gains tax coming due.
You must report the 1099-A information anyway, but you probably won't have to take a tax hit. 

Reporting the Foreclosure

Use the date of the foreclosure in box 1 of the 1099-A as your date of sale, then enter the selling price on Schedule D. This will be either the amount in box 2 or the amount in box 4. Which box you'll use will depend on the lending laws of the state in which the property was located, so check with a local tax professional to make sure you select the correct one. 

Calculating Your Gain 

You can calculate your gain by comparing the “sales price” you used to your purchase price, which is your cost basis in the property. This information can typically be found on the HUD-1 closing statement you received when you purchased the property. The difference between the selling price and your cost basis is your gain. Enter this on Schedule D and on line 13 of your Form 1040 tax return.

Investment Properties

Use Form 4797 if the foreclosed property was a rental or investment. You'll probably need the assistance of a tax professional in this case because there are additional factors to take into consideration, such as recapture of depreciation deductions, passive activity loss carryovers, and reporting any final rental income and expenses.

Form 1099-A vs. Form 1099-C

You might receive Form 1099-C instead of Form 1099-A if your lender both foreclosed on the property and canceled any remaining mortgage balance you owed. In this case, the IRS takes the position that you received income from the foreclosure because you received money from the lender to purchase your home and you did not pay all of that money back.
But although forgiven debt reported on Schedule 1099-C is usually taxable income, the Mortgage Forgiveness Debt Relief Act generally excludes mortgages canceled through foreclosure.

An Important Update

This tax provision allowing you to exclude mortgages canceled through foreclosure technically expired on December 31, 2016, but the Bipartisan Budget Act breathed new life into it in February 2018. It was reinstated retroactively to cover tax year 2017. As of January 2019, it is unknown whether Congress will renew it again. 
For now, this provision covers foreclosure agreements entered into in 2017. You should qualify if the total of your debts exceeded the total value of your assets immediately before the time of foreclosure. This means that you're "insolvent" and you must only report canceled debt on your tax return to the extent that it exceeds your insolvency—the difference between your debts and your assets. 
For example, you might have debts totaling $300,000 and all your remaining assets are valued at $200,000. That's a difference of $100,000. If your lender forgave or canceled a $120,000 balance on your mortgage loan, you only have to report $20,000 as income—the amount exceeding your $100,000 insolvency. 
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.
Thanks to William Perez for gathering this information!

Wednesday, January 23, 2019

Qualified Business Income deduction guidance issued

Qualified business income deduction regs. and other guidance issued



On Friday, the IRS released guidance on a large number of Sec. 199A issues, including the eagerly awaited final Sec. 199A regulations (in an as-yet-unnumbered Treasury decision). The IRS also issued new proposed regulations on how to treat previously suspended losses and how to determine the deduction for taxpayers that hold interests in regulated investment companies (RICs), charitable remainder trusts (CRTs), and split-interest trusts. The guidance also includes a notice that provides a safe-harbor rule for rental real estate businesses and a revenue procedure on calculating W-2 wages.
Sec. 199A allows taxpayers to deduction up to 20% of qualified business income (QBI) from a domestic business operated as a sole proprietorship or through a partnership, S corporation, trust, or estate. The Sec. 199A deduction can be taken by individuals and by some estates and trusts. The deduction is not available for wage income or for business income earned through a C corporation.
The deduction is generally available to taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers. The deduction is generally equal to the lesser of 20% of the taxpayer’s QBI plus 20% of the taxpayer’s qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income, or 20% of taxable income minus net capital gains. Deductions for taxpayers above the $157,500/$315,000 thresholds may be limited; the application of those limits is described in the regulations. These amounts are inflation-adjusted. (For more on the deduction, see “Understanding the New Sec. 199A Business Income Deduction,” The Tax Adviser, April 2018).

Final regulations

The IRS noted that the final regulations had been modified somewhat from the proposed regulations issued last August (REG-107892-18) as a result of comments it received and testimony at a public hearing it held. The final regulations apply to tax years ending after their publication in the Federal Register (they have so far only been posted on the IRS website); however, taxpayers may rely on the proposed regulations for tax years ending in 2018.
The final regulations focus on determining the amount of Sec. 199A deduction. They also cover determining when to treat two or more trusts as a single trust for purposes of Subchapter J (governing estates, trusts, beneficiaries, and decedents).
The IRS says it received approximately 335 comments on the proposed regulations. The final regulations contain modifications based on some of those comments, and the IRS says it is continuing to study some comments it received that were beyond the scope of the proposed regulations.
Net capital gain: First, the IRS noted that it had not defined “net capital gain” in the proposed regulations and that a number of commenters had requested a definition. The final regulations, however, reject one comment suggesting that net capital gain exclude qualified dividends. Instead, the regulations define net capital gain for purposes of Sec. 199A as net capital gain under Sec. 1222(11) (the excess of net long-term capital gain for the tax year over the net short-term capital loss for that year) plus qualified dividend income as defined in Sec. 1(h)(11)(B).
Relevant passthrough entities: The proposed regulations define a relevant passthrough entity (RPE) as a partnership (other than a PTP) or an S corporation that is owned, directly or indirectly, by at least one individual, estate, or trust. A trust or estate is treated as an RPE to the extent it passes through QBI, W-2 wages, unadjusted basis immediately before acquisition (UBIA) of qualified property, qualified REIT dividends, or qualified PTP income. The final regulations expand this definition by providing that other passthrough entities, including common trust funds described in Temp. Regs. Sec. 1.6032-T and religious or apostolic organizations described in Sec. 501(d), are also treated as relevant passthrough entities if the entity files a Form 1065, U.S. Return of Partnership Income, and is owned, directly or indirectly, by at least one individual, estate, or trust. It declined to treat RICs as RPEs, however, because they are C corporations.
Trade or business: After considering all relevant comments, the final regulations retain and slightly reword the proposed regulations’ definition of a trade or business. Specifically, for purposes of Sec. 199A, Regs. Sec. 1.199A-1(b)(14) defines a trade or business as a trade or business under Sec. 162 other than the trade or business of performing services as an employee. The IRS again rejected suggestions that the IRS use the Sec. 469 passive activity rules, explaining that whether a trade or business exists is a different determination than that applied to the passive loss rules.
Under the rules, the rental or licensing of tangible or intangible property to a related trade or business is treated as a trade or business if the rental or licensing activity and the other trade or business are commonly controlled under Regs. Sec. 1.199A-4(b)(1)(i). This rule also allows taxpayers to aggregate their trades or businesses with the leasing or licensing of the associated rental or intangible property if all of the requirements of Regs. Sec. 1.199A-4 are met.
One commenter suggested the rule apply to situations in which the rental or licensing is to a commonly controlled C corporation. Another commenter suggested that the rule in the proposed regulations could allow passive leasing and licensing-type activities to benefit from Sec. 199A even if the counterparty is not an individual or an RPE. The commenter recommended that the exception be limited to scenarios in which the related party is an individual or an RPE and that the term related party be defined with reference to existing attribution rules under Sec. 267, 707, or 414. The final regulations clarify these rules by adopting these recommendations and limiting this special rule to situations in which the related party is an individual or an RPE.
Commenters also asked the IRS to provide safe harbors or factors for determining how to delineate separate trades or businesses conducted within one entity and when an entity’s combined activities should constitute a single trade or business, but the IRS declined to provide this guidance.
The IRS warns that taxpayers should report items consistently. For example, the IRS says that taxpayers who treat a rental activity as a trade or business for purposes of Sec. 199A should also comply with the Form 1099 information-reporting requirements under Sec. 6041.
The final regulations also provide computational rules. The final regulations clarify the proposed regulations by providing that for taxpayers with taxable income within the phase-in range, QBI from a specified service trade or business (SSTB) must be reduced by the applicable percentage before the application of the netting and carryover rules described in Regs. Sec. 1.199A1(d)(2)(iii)(A). The final regulations also clarify that the SSTB limitations also apply to qualified income received by an individual from a PTP.
Disregarded entities: The proposed regulations did not address the treatment of disregarded entities. The final regulations provide that an entity with a single owner that is treated as disregarded as an entity separate from its owner under Regs. Sec. 301.7701-3 is disregarded for Sec. 199A purposes. Accordingly, trades or businesses conducted by a disregarded entity are treated as conducted directly by the owner of the entity.
Share of UBIA property: The final regulations modify the proposed regulations with regard to the allocation to partners of the UBIA of qualified property. In the proposed regulations, in the case of a partnership with qualified property that does not produce tax depreciation during the year, each partner’s share of the UBIA of qualified property would be based on how gain would be allocated to the partners pursuant to Secs. 704(b) and 704(c) if the qualified property were sold in a hypothetical transaction for cash equal to the fair market value of the qualified property. The IRS adopted a commenter’s suggestion that for partnerships, only Sec. 704(b), not Sec. 704(c), should apply to determine each partner’s share of the UBIA of qualified property. Thus, the final regulations state that each partner’s share of the UBIA of qualified property is determined in accordance with how depreciation would be allocated for Sec. 704(b) book purposes under Regs. Sec. 1.704-1(b)(2)(iv)(g) on the last day of the tax year.
Under the final regulations, for an S corporation’s qualified property, each shareholder’s share of UBIA of qualified property is a share of the unadjusted basis proportionate to the ratio of shares in the S corporation held by the shareholder on the last day of the tax year over the total issued and outstanding shares of the S corporation.
Basis for contributed property: Another change in response to comments was for a basis rule for property contributed to a partnership in a Sec. 721 transaction or to an S corporation in a Sec. 351 transaction that the property should retain its basis. Therefore, Regs. Sec. 1.199A-2(c)(3)(iv) provides that, solely for Sec. 199A purposes, if qualified property is acquired in a transaction described in Sec. 168(i)(7)(B), the transferee’s UBIA in the qualified property is the same as the transferor’s UBIA in the property, decreased by the amount of money received by the transferee in the transaction or increased by the amount of money paid by the transferee to acquire the property in the transaction.
Similarly, the final rules clarify how to determine the UBIA of replacement property under Sec. 1031 or 1033 in response to comments. They also explain how Sec. 743(b) basis adjustments for partnerships should be treated for UBIA but also request further comments on Sec. 743(b) adjustments.
Aggregating trades or businesses: The IRS declined to adopt most of the comments it received on aggregating trades or businesses, but it did permit an RPE to aggregate trades or businesses it operates directly or through lower-tier RPEs. The resulting aggregation must be reported by the RPE and by all owners of the RPE. An individual or upper-tier RPE may not separate the aggregated trade or business of a lower-tier RPE but instead must maintain the lower-tier RPE’s aggregation. An individual or upper-tier RPE may aggregate additional trades or businesses with the lower-tier RPE’s aggregation if the rules of Regs. Sec. 1.199A-4 are otherwise satisfied.
The IRS also chose to permit taxpayers who have not reported businesses as aggregated on a tax return to choose later to aggregate businesses on a future tax return. However, taxpayers cannot aggregate businesses on an amended return because that would permit taxpayers the benefit of hindsight. Because many taxpayers were not aware of the aggregation rule, though, for 2018, they may report an aggregation on an amended return.
Performing services as an employee: The final regulations, like the proposed regulations, include a presumption that an individual who was previously treated as an employee and is subsequently treated as an independent contractor while performing substantially the same services for the same employer or a related person will be presumed to still be in the trade or business of performing services as an employee for purposes of Sec. 199A. However, in response to comments, the final regulations were modified to include a three-year lookback rule for this presumption. The individual can rebut the presumption by showing records that corroborate the individual’s status as a nonemployee.
Specified service trades or businesses: A large part of the preamble to the final regulations was devoted to comments received on SSTBs. Apart from a few clarifications in the definitions, the final regulations did not adopt these comments.

Proposed regulations

At the same time as it released the final regulations, the IRS also released new proposed regulations (REG-134652-18) treating certain issues not addressed in the proposed regulations issued in August 2018, specifically: (1) the treatment under Sec. 199A of previously suspended losses, (2) “Sec. 199A dividends” paid by a RIC, and (3) the treatment of amounts received from split-interest trusts and CRTs.
Previously suspended losses: The proposed regulations amend Prop. Regs. Sec. 1.199A-3(b)(1)(iv) to provide that previously disallowed, suspended, limited, or carried over losses (including under Secs. 465, 469, 704(b), and 1366(b) and only for disallowance, etc., years ending after Jan. 1, 2018) are taken into account for QBI purposes on a first-in, first-out basis and are treated as from a separate trade or business. To the extent that losses relate to a PTP, they must be treated as losses from a separate PTP. In addition, the attributes of these losses with respect to Sec. 199A are determined according to the year incurred.
Sec. 199A dividends by RICs: In redesignated Prop. Regs. Sec. 1.199A-3(d), the IRS proposed that RICs under Sec. 852(b) may pay Sec. 199A dividends, defined as any dividend that a RIC pays to its shareholders and reports as such in written statements to its shareholders. The rules under which a RIC would compute and report Sec. 199A dividends are based on the rules for capital gain dividends in Sec. 852(b)(3) and exempt interest dividends in Sec. 852(b)(5). The amount of a RIC’s Sec. 199A dividends for a tax year would be limited to the excess of the RIC’s qualified REIT dividends for the tax year over allocable expenses.
Split-interest trusts and CRTs: These proposed regulations redesignate Prop. Regs. Sec. 1.199A-6(d)(3)(iii) to state that a trust with substantially separate and independent shares and multiple beneficiaries is treated as a single trust for determining the application of the threshold amount under Sec. 199A(e)(2). In addition, new Prop. Regs. Sec. 1.199A-6(d)(v) provides that in the case of a CRT, any taxable recipient of a unitrust or annuity amount from a trust must determine and apply the recipient’s own Sec. 199A threshold amount, taking into account any annuity or unitrust amounts received from the trust. These recipients may take into account any included QBI, qualified REIT dividends, or qualified PTP income so distributed for purposes of determining their own QBI deduction.
PTPs: The IRS reserved for further study and comment the treatment of qualified PTP income in qualified Sec. 199A dividends distributed by RICs, noting several technical and administrative problems of their proper characterization with respect to recipients.
These proposed regulations are effective when adopted as final, but the IRS stated that taxpayers may rely on them in the interim.

Calculating W-2 wages

Rev. Proc. 2019-11 provides guidance on how to calculate W-2 wages for purposes of Sec. 199A. Sec. 199A(b)(2) uses W-2 wages to limit the amount of a taxpayer’s Sec. 199A deduction in certain situations. Sec. 199A(b)(4) defines W-2 wages to mean amounts described in Secs. 6051(a)(3) (generally remuneration paid for services paid by an employee to an employer) and 6051(a)(8) (elective deferrals and deferred compensation) paid by a person claiming the deduction with respect to employment of employees by that person during the year. W-2 wages does not include any amount that is not properly allocable to QBI under Sec. 199A(c)(1) or any amount not properly included in a return filed with the Social Security Administration (SSA) on or before the 60th day after the due date for the return.
The revenue procedure provides three methods for calculating W-2 wages: the unmodified box method, the modified box 1 method, and the tracking changes method. The IRS cautions that using one of these methods does not necessarily calculate the W-2 wages that are properly allocable to QBI and eligible for use in computing the Sec. 199A limitations. After using the revenue procedure to calculate W-2 wages, the taxpayer must then determine the extent to which they are properly allocable to QBI. The IRS also cautions that the revenue procedure cannot be used for determining if amounts are wages for employment tax purposes.
The unmodified box method described in the revenue procedure involves taking, without modification, the lesser of (1) the total entries in box 1 (wages, tips, and other compensation) of all Forms W-2, Wage and Tax Statement, filed by the taxpayer with the SSA or (2) the total entries in box 5 (Medicare wages and tips) of all Forms W-2 filed by the taxpayer with the SSA.
The modified box 1 method involves making modifications to the total entries in box 1 of all Forms W-2 filed by the taxpayer with the SSA by subtracting amounts that are not wages for federal income tax withholding purposes (such as supplemental unemployment compensation benefits) and adding the total amounts of various elective deferrals that are reported in box 12.
Under the tracking wages method, the taxpayer tracks total wages subject to federal income tax withholding and elective deferrals reported in box 12.

Rental real estate activities

Many of the comments the IRS received regarding the proposed regulations dealt with the question of when rental activity qualifies as a trade or business. Therefore, in Notice 2019-07, the IRS has issued a proposed revenue procedure that would provide a safe harbor for taxpayers.
Under the proposed safe harbor, a “rental real estate enterprise” would be treated as a trade or business for purposes of Sec. 199A if at least 250 hours of services are performed each tax year with respect to the enterprise. The IRS says this includes services performed by owners, employees, and independent contractors and time spent on maintenance, repairs, rent collection, payment of expenses, provision of services to tenants, and efforts to rent the property. However, hours spent in the owner’s capacity as an investor, such as arranging financing, procuring property, reviewing financial statements or reports on operations, and traveling to and from the real estate will not be considered hours of service with respect to the enterprise.
A rental real estate enterprise is defined, for purposes of the safe harbor, as an interest in real property held for the production of rents. A rental real estate enterprise may consist of multiple properties. The interest must be held directly or through a disregarded entity. Taxpayers either must treat each property held for the production of rents as a separate enterprise or must treat all similar properties held for the production of rents as a single enterprise. Commercial and residential real estate cannot be combined in the same enterprise.
The proposed safe harbor would require that separate books and records and separate bank accounts be maintained for the rental real estate enterprise. Property leased under a triple net lease or used by the taxpayer (including an owner or beneficiary of a relevant passthrough entity) as a residence for any part of the year under Sec. 280A would not be eligible under the proposed safe harbor.
By Sally P. Schreiber, J.D.; Paul Bonner; and Alistair M. Nevius, J.D.
January 22, 2019