taxation law services

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.

Deductible Expenses for a Newly-Formed Partnership

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Are you planning on starting a partnership for business purposes? Usually, partnerships will incur various costs while forming a partnership. Some of these costs may be deductible or amortizable, others will not. This article will examine the deductibility of the most common costs in the formation of a partnership.

Partnerships often involve complex legal and tax issues, so it may be advisable to obtain legal counsel when forming a partnership. Sherayzen Law Office, Ltd. can assist you in all of your tax and legal needs.

Syndication Costs

Often, the formation of a partnership will involve various costs associated with marketing and selling partnership interests to prospective partners. These fees are termed “syndication” costs. Unfortunately for taxpayers, such costs are neither deductible nor amortizable under Internal Revenue Code Section 709. This will be the case regardless of whether the costs were incurred or actually paid.

Organizational Expenses

Unlike syndication costs, however, certain organization costs connected with forming a partnership may be deductible or amortizable. Under IRC Section 709, organizational costs include expenses that are: “(1) are incident to the creation of the partnership; (2) are chargeable to a capital account; and (3) would be amortized over the life of the partnership if they were incurred for a partnership having a fixed life.” Organizational costs may include certain legal and accounting fees associated with the formation of a partnership.

In general, a partnership may be allowed a $5,000 initial deduction for the organizational costs it incurs in its first year of business. However, if organization costs amount to more than $50,000, the $5,000 deduction will be reduced by any amount that exceeds the $50,000 threshold. Organization costs that are not deductible because of the threshold may be amortizable over a period of not less than 180 months, beginning with the month that the partnership begins operating its business. Note, special rules that are not covered in this article apply to partnerships formed before October 22, 2004.

It is important to also note that not all initial costs a partnership may incur or pay will be treated as organizational costs. Besides syndication costs (covered above), costs associated with acquiring and transferring assets to the new partnership, admitting or removing partners after the initial formation of a partnership, and various other costs may not be treated as organizational costs under these rules.

Startup Costs

Startup Costs are amounts that are paid or incurred after a business is formed, but before business operations actually start. In general, startup costs include pre-operation costs associated with employee training, advertising, promotion and market surveys, and related expenses. Costs associated with investigating the purchase of a partnership interest of a partnership may also be treated as startup costs by partners, provided certain rules are met.

A partnership may deduct $5,000 of startup costs in its initial year of operations. Startup costs that exceed $50,000 will reduce this amount, similar to operating expenses (explained above). A partnership may elect to amortize startup costs that have been reduced by the $50,000 limit over a period of 180 months, beginning with the month the partnership commences its operations. If a business is acquired, the period of amortization will begin the month after the business is purchased.

Contact Sherayzen Law Office for Partnership Organization and Tax Planning

If you are thinking about starting a partnership or your existing partnership is need of a sound tax plan, contact Sherayzen Law Office. Our experienced business and tax law firm will thoroughly analyze your current situation and create a customized plan to move your business toward achieving your business and tax goals.

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.