Tax Lawyers Minneapolis

Sales or Exchanges between a Partner and a Controlled Partnership

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In general, when a non-controlling partner makes a transaction with his or her partnership in a non-partner capacity, any resulting gain or loss is likely be recognized, because the transaction is treated as at arm’s length and occurring with a third party. Such transactions may involve sales, loans, rental payments, services provided and other related items to or from the partnership. However, special rules apply when the transaction takes place between a partner who owns more than 50% of the partnership capital or profits (applying both direct and indirect ownership rules) and his or her partnership.

This article will explain the basics of sales or exchanges between partners and controlled partnerships under Internal revenue Code Section 707. It is not intended to constitute tax or legal advice.

Partnership taxation can involve many complex tax and legal issues, so it may be advisable to seek an experienced attorney in these matters. Failure to do proper tax planning can result in significant adverse tax consequences. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs, and help you avoid making costly mistakes.

Disallowed Losses on Sales or Exchanges between a Partner and the Controlled Partnership

If a partner owns (directly or indirectly) more than a 50% of the capital or profits interest of the partnership, under IRS Section 707, losses from a sale or exchange between the partner and the partnership will be disallowed. However, if the partnership eventually sells the property to a third party, any gain realized on the sale may not be recognized to the extent of the disallowed loss. In other words, the disallowed loss may reduce the gain that would otherwise need to have been recognized.

If a sale or exchange takes place between an individual or entity who does not own 50% or more of the capital or profits (directly or indirectly) of a partnership, but is related to a partner, the sale or exchange is likely to be treated as occurring separately between the various partners of a partnership, and the disallowed loss will be determined accordingly. For example, assume partner A in a five-person partnership (with each partner owning 20%) also owns 100% of a corporation. If the corporation has a loss resulting from a transaction with the controlled partnership, the transaction is likely to be treated as if occurring individually between the partners, and 20% of the loss may be disallowed for the corporation (because of partner A’s ownership).

Treatment of Certain Gains Recognized on Sales or Exchanges between a Partner and the Controlled Partnership

Unless an asset is a capital asset to both the seller and purchaser, in a sale or exchange between a partner owning more than a 50% capital or profits interest (directly or indirectly) and a controlled partnership, any gain recognized is likely to be treated as ordinary income. IRS Regulation §1.707-1, transactions between partner and partnership, broadly defines non-capital assets: “[P]roperty other than a capital asset includes (but is not limited to) trade accounts receivable, inventory, stock in trade, and depreciable or real property used in the trade or business.” This can have serious unexpected tax consequences for those taxpayers who do not fully understand the applicable tax laws when making such transactions.

Additionally, if an asset is depreciable property in the hands of a transferee, any gain recognized on a sale of exchange between a partner owning more than a 50% capital or profits interest (directly or indirectly) and a controlled partnership, is also likely to be treated as ordinary income.

Tax Planning is Essential for Controlled Partnership Transactions

It is very easy to misunderstand or misapply the controlled-partnership transactions. The consequences of such actions may be dire and may lead to an unexpected jump in your tax liability (especially, if the re-classification of gain or disallowance of a loss occurs in the context of an IRS audit).

This is why it is essential to conduct comprehensive tax planning with respect to any controlled-partnership transactions. Sherayzen Law Office can help; Mr. Eugene Sherayzen, an experienced tax attorney will thoroughly analyze your partnership transactions, determine potential tax consequences and propose a comprehensive solution aimed to protect you from over-paying taxes to the IRS.

Making a Section 444 Election

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The IRS has established various rules regarding required tax years in order to prevent excess deferral of taxes by partnerships, S corporations, and personal service corporations. In certain circumstances, however, under Internal Revenue Code Section 444, partnerships, S corporations, and personal service corporations may elect to use a tax year other than their required tax year, subject to certain limitations. This article will explain the basics of Section 444 elections. It is not intended to constitute tax or legal advice.

Partnership, S Corporation and personal service corporation taxation can involve many complex tax and legal issues, so it may be advisable to seek an experienced attorney in these matters. Sherayzen Law Office, PLLC can assist you in all of your tax and legal needs.

Requirements

In general, a partnership, S corporation, or personal service corporation can make a section 444 election provided that it meets the following requirements: (1) it is not a member of a “tiered structure” (defined below), (2) it has not previously made a section 444 election, and (3) it elects a tax year that meets IRS deferral period requirements.

A tiered structure is defined in 26 C.F.R. § 1.444-2T: “—(1) In general. A partnership, S corporation, or personal service corporation is considered a member of a tiered structure if— (i) The partnership, S corporation, or personal service corporation directly owns any portion of a deferral entity, or (ii) A deferral entity directly owns any portion of the partnership, S corporation, or personal service corporation.”

Determination of the Deferral Period

The deferral period is determined by whether a partnership, S corporation, or personal service corporation is adopting or changing its tax year by making a section 444 election, or whether it is retaining its tax year.

For partnerships, S corporations, or personal service corporations adopting or changing to a tax year other than its required year, the deferral period is the number of months after the end of the new elected tax year to the end of the required tax year.

If a partnership, S corporation, or personal service corporation makes a Section 444 election to retain its tax year, the deferral period must be three months or less, determined by the number of months from the start of the tax year to be retained and the end of the first required tax year.

Making a Section 444 Election

Form 8716 must be filed in order to make a Section 444 election. In general, the form must be filed by the earlier of the due date (not including extensions) of the elected tax year or the 15th day of the 6th month of the tax year for which the Section 444 election will go into effect. Form 8716 should be attached to Form 1065, Form 1120S, or Form 1120 for the first elected tax year. A Section 444 election will remain in effect until terminated.Required Payments

A partnership or an S corporation making a Section 444 election must also file Form 8752, “Required Payment or Refund Under Section 7519” for every year that the election is in effect. If the required payment is greater than $500, the payment must be made when the form is filed. A personal service corporation must distribute required amounts to its employee-owners by December 31st of each elected Section 444 tax year.

Contact Sherayzen Law Office for Help with Section 444 election.

 

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

Can I Deduct My Rental Real Estate Losses?

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With the uncertain economic environment in the past few years, many individuals who own rental estate property have faced substantial losses. A question that often arises is whether such losses can be deducted, and if so, by how much? This article strives to answer these questions in general and provide a basic understanding of the deductibility of rental real estate losses. It is not intended to provide tax or legal advice. Renting real estate can be a complex area, full of many legal and tax obstacles, so you may wish to seek the advice of a competent, experienced attorney. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

The General Rule of Passive Activity Losses

In general, passive activity losses and deductions are likely to be limited to offsetting income from only passive activities (similarly, credits from passive activities may only be used to offset taxes on passive activity income). Passive activity losses that are greater than passive activity income will be disallowed in a tax year. However, passive activity losses and credits may be carried forward to the next taxable year.

Passive activities are defined to mean trade or business activities in which an individual does not “materially participate”. According to the IRS, material participation means that a taxpayer is involved with the business operations on a “[r]egular, continuous, and substantial basis.” Certain real estate professionals may meet the material participation requirements.

Exceptions

Generally speaking, rental real estate activities will be treated as passive activities, subject to the limitations stated above, unless certain requirements are met. As noted above, one such exception is for material participation in rental real estate activities.

Another limited exception exists for “active participation” in such activities. In general, active participation means that an individual (or married couple) owned at least 10% of the fair market value of the rental property interests, and made management decisions or arranged for others to provide services in a significant and bona fide manner. According to the IRS, “management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions.” Thus, generally, limited partners will not meet the active participation test.

For those who qualify for the “active participation” exception, individuals may offset a maximum of $25,000 per year of passive losses from rental real estate against active and portfolio income. More specifically, $25,000 for single individuals and married couples filing jointly for a tax year, $12,500 for married individuals who lived apart from their spouses for a year filing separately, and $25,000 for a qualifying estate reduced by the special allowance for which a surviving spouse qualified.

Provided the requirements are met, losses may be deducted in full by individuals with a modified adjusted gross income (MAGI) of $100,000 or less ($50,000 or less for married couples filing separately). For incomes greater than MAGI of $100,000, the deduction will be limited to half of the amount greater than $100,000 up to $150,000 of MAGI ($75,000 for married filing separately). For individuals with income greater than MAGI of $150,000, the deduction may not be taken.

Contact Sherayzen Law Office For Advice With Respect to Rental Income and Losses

If you have any questions with respect to rental income or losses, contact the experienced tax law firm of Sherayzen Law Office.

Pursuant to IRS Circular 230, any advice rendered in this communication on U.S. tax issues (i) is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties imposed by the U.S. Internal Revenue Service, and (ii) may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement.

S Corporation At-Risk Rules

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Do you own interest in an S-Corporation (“S-Corp”)? If so, the IRS at-risk rules may apply to you and may limit the loss deductions you will be allowed to take. The IRS at-risk rules may also apply to partnerships, LLCs and closely-held C corporations (subject to certain exceptions), so they may be important to learn if you hold an interest in such entities.

This article will explain the basics of the at-risk rules in the context of S-Corps. It is not intended to provide tax or legal advice. S-Corp taxation can be a very complex area, so you may wish to seek the advice of a competent, experienced attorney. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

A Taxpayer’s At-Risk Amount

In an S-Corp, the deductibility of a distributed loss may be determined by three separate limitations: (1) The shareholder’s adjusted basis of an interest, or the shareholder’s stock plus any loans made by the shareholder to the entity, (2) the at-risk rules, and (3) the passive activity rules. As noted, this article will cover the at-risk rules (the other limitations will be covered in future articles).

Under the Internal Revenue Code Section 465, a taxpayer is considered to be at-risk for an activity with respect to amounts including, “(A) the amount of money and the adjusted basis of other property contributed by the taxpayer to the activity, and (B) amounts borrowed with respect to such activity” to the extent that the taxpayer is, “(A) is personally liable for the repayment of such amounts, or (B) has pledged property, other than property used in such activity, as security for such borrowed amount [to the extent of the net fair market value of the taxpayer’s interest in such property].”

According to the IRS, any of the following activities for a trade or business that produce income will subject a taxpayer to the at-risk rules: “Holding, producing, or distributing motion picture films or video tapes. 2. Farming. 3. Leasing section 1245 property, including personal property and certain other tangible property that is depreciable or amortizable… 4. Exploring for, or exploiting, oil and gas. 5. Exploring for, or exploiting, geothermal deposits [for wells started after September 1978]. 6. Any other activity not included in (1) through (5) that is carried on as a trade or business or for the production of income.” Taxpayers will not be considered at-risk for amounts of nonrecourse financing that protects against losses, guarantees, and other related arrangements.

In general, the at-risk rules do not apply to the holding of real property placed in service before 1987 or to the holding of an interest in a pass-through entity acquired before 1987 that holds real property placed in service prior to 1987. Mineral property holdings, however, are not included in this exception.

Separate Activities or One Activity?

In most S-Corps, the business will be engaged in many different types of transactions and activities. Thus, it will often be necessary to determine whether the loss limitation at-risk rules apply to each activity, determined separately. Every shareholder in an S-Corp should receive a schedule stating their profit or loss share of each separate activity.

However, activities that constitute a trade or business must be aggregated into one activity if a shareholder actively participates in the management of the trade or business, or 65% or more of the losses in a partnership or S-Corp are allocable to individuals who actively participate in the management of the trade or business. Additionally, certain leased items, among others, may be treated as one activity.

Contact Sherayzen Law Office for Help With S-Corporation Tax Issues

If you have any tax questions regarding your S-Corp, contact the experienced tax law firm of Sherayzen Law Office.

Pursuant to IRS Circular 230, any advice rendered in this communication on U.S. tax issues (i) is not intended or written to be used, and it cannot be used, for the purpose of avoiding penalties imposed by the U.S. Internal Revenue Service, and (ii) may not be used or referred to in promoting, marketing or recommending a partnership or other entity, investment plan or arrangement.

Underpayment and Overpayment Interest Rates for the Second Quarter of 2013

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On March 1, 2013, the IRS announced that the underpayment and overpayment interest rates will remain the same for the calendar quarter beginning April 1, 2013. The rates will be:

  • three (3) percent for overpayments [two (2) percent in the case of a corporation];
  • three (3) percent for underpayments;
  • five (5) percent for large corporate underpayments; and
  • one-half (0.5) percent for the portion of a corporate overpayment exceeding $10,000.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points.

Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half (0.5) of a percentage point.

Interest factors for daily compound interest for annual rates of 0.5 percent are published in Appendix A of Revenue Ruling 2011-32. Interest factors for daily compound interest for annual rates of 2 percent, 3 percent and 5 percent are published in Tables 7, 9, 11, and 15 of Rev. Proc. 95-17, 1995-1 C.B. 561, 563, 565, and 569.

Revenue Ruling 2013-6, announcing the rates of interest, is attached and will appear in Internal Revenue Bulletin 2013-13, dated March 25, 2013.