Two provisions of the Tax Cuts and Jobs Act (TCJA) are throwing some business owners for a loop as they prepare to file their federal income tax returns for 2018. The new law introduced a limit on the deductions that non-corporate taxpayers could claim for excess business losses while also limiting deductions for net operating loss (NOLs) carryforwards and repealing the use of NOL carrybacks. In addition, taxpayers should note that they must apply the at-risk limits and passive activity loss (PAL) rules under the old Tax Code before calculating the amount of any excess business loss.
An excess business loss is the amount by which the total deductions attributable to all of your trades or businesses exceed your total gross income and gains attributable to those trades or businesses plus $250,000 (or $500,000 in the case of a joint return).
Under the TCJA, taxpayers that are not structured as C Corporations may not deduct excess business losses in the current year. Instead, they can treat the disallowed deduction as a 2018 NOL carryforward that they may now use indefinitely to offset only 80 percent of a business’s future taxable income, according to the new NOL rules, which also prohibit taxpayers from carrying back NOLs that arise in tax years after Dec. 31, 2017. Exceptions apply for certain farming businesses and insurance companies, other than life insurance companies.
Despite Congress’s efforts to simplify the Tax Code, the new law can actually mean more work for taxpayers. For example, businesses will need to adjust carryovers from prior tax years to conform to the excess business loss limitations, and real estate professionals will need to apply the passive activity loss rules before calculating their business losses. In addition, taxpayers will need to carefully consider the scope of their income-generating activities and potentially implement new strategies to minimize the negative impact of these limitations and possible reduce their losses in 2018 and in future years.
The professional advisors and accountants with Berkowitz Pollack Brant have decades of experienced helping individuals and businesses across the globe implement tax-efficient strategies that comply with evolving tax policies.
About the Author: John G. Ebenger, CPA, is a director of Real Estate Tax Services with Berkowitz Pollack Brant, where he works closely with developers, landholders, investment funds and other real estate professionals, as well as high-net-worth entrepreneurs with complex holdings. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at firstname.lastname@example.org.
Businesses that own rental property and are organized as pass-through entities recently received welcome guidance from the IRS concerning their ability to qualify for a potential deduction of 20 percent of qualified business income (QBI) that the new tax law introduced at the end of 2017.
Based on the original language contained in the Tax Cuts and Jobs Act (TCJA), it was unclear if owners of rental real estate could qualify for the QBI deduction. For one, it appeared that the income these taxpayers earn from rental activities could be construed as investment income rather than rising to Section 199A’s requirement that it be trade or business income for purposes of claiming the deduction. Moreover, there was uncertainty as to whether real estate brokerage services would qualify as a specialized service trade or business (SSTB) that is either not entitled to the QBI deduction or subject to additional deduction limitations. Over the past year, the IRS has issued a stream of guidance attempting to clarify these and other issues and most recently providing a safe harbor for rental real estate enterprises structured as relevant pass-through entities (RPEs) to qualify for the deduction.
Section 199A Safe Harbor for Real Estate Rentals
The IRS defines a rental real estate enterprise as an interest in real property held for the production of rents that may consist of an interest in multiple properties. To be treated as a trade or business for purposes of claiming the QBI deduction, a real estate enterprise must first be a relevant pass-through entity (RPE) structured as an S corporation, limited liability corporation (LLC), partnership or sole proprietorship, or it must be a trust or estate. It must treat each property it owns for the production of rents as either a separate enterprise, or it must aggregate qualifying businesses together treat all similar properties held for the production of rents as a single enterprise. In both cases, commercial and residential real estate may not be part of the same enterprise, and taxpayers may not vary treatment from year-to-year unless there has been a significant change in their facts and circumstances.
To make a safe harbor election for treatment as a business or trade, taxpayers must also satisfy the following conditions:
- Maintain separate books and records to reflect income and expenses for each rental real estate enterprise;
- Perform at least 250 hours of rental services per year per rental enterprise for tax years 2018 through 2022. Beginning in 2023, taxpayers can satisfy this 250-hour test during three of the five consecutive tax years that end with the tax year;
- Maintain contemporaneous records, including time reports, logs or similar documents that detail the dates, hours and descriptions of all qualifying services performed and by whom for tax years beginning in 2019; and
- Attach to tax returns claiming Section 199A QBI deductions a statement signed by the taxpayer or the RPE’s authorized representative that the entity has satisfied the safe harbor requirements.
It is important for taxpayers to recognize that under the guidance issued by the IRS rental services that qualify as a trade or business may not include financial or investment management activities, such as arranging financing; procuring property; studying and reviewing financial statements or reports on operations; or planning, managing, or constructing long-term capital improvements. In addition, the guidance specifically excludes from the safe harbor test all real estate that taxpayers use as a residence for any portion of the year (such as a vacation home) as well as triple-net-lease (NNN) property, for which tenants are responsible for paying along with their rents property taxes, insurance, utilities and maintenance costs. This last point may require further clarification from the IRS since it could be argued that NNN still constitutes a valid trade or business under the definition contained in Section 162 of the tax code. In addition, the guidance does not change a rule under the TCJA that excludes all items treated as capital gain or loss from the calculation of QBI.
On a final note, taxpayers should understand the rules they must now follow to make an appropriate election to aggregate two or more separate trades or business together in an effort to maximize the QBI deduction, which include the following:
- The same person or persons must own a majority interest in each the business, either directly or indirectly;
- None of the businesses may be considered an SSTB, as defined by the law
- All of the businesses must have the same tax year
- The aggregated businesses must meet two of the following three requirements:
- They provide products and services that are the same or customarily provided together;
- They share facilities or centralized elements; and/or
- They are operated in coordination with, or in reliance on, other businesses in the aggregated group.
The Section 199A QBI deduction can provide significant tax relief to pass-through entities, including those that own rental real estate. However, taxpayers should be aware that calculating the actual tax savings can be quite complex, based on the definition of QBI and the various limitations that can apply to the deduction. For this reason alone, it is critical that businesses work closely with professional tax advisors and accountants to accurately interpret the law and apply it to their unique facts and circumstances.
About the Author: Dustin Grizzle is an associate director of Tax Services with Berkowitz Pollack Brant, where he provides tax-planning and compliance services to high-net-worth individuals and businesses in the manufacturing, real estate management and property investment industries. He can be reached at the CPA firm’s Boca Raton, Fla., office at (561) 361-2000 or via email at email@example.com.
Information contained in this article is subject to change based on further interpretation of tax laws and subsequent guidance issued by the Internal Revenue Service.
The Tax Cuts and Jobs Act and the new $10,000 cap on the deduction for state and local taxes (SALT) have caused many wealthy families in high-tax states to consider moving to more tax-friendly jurisdictions, such as Florida, where they can avoid the imposition of a state-level personal income tax. However, the rules for establishing tax residency in a new state are complex and rife with many challenges that families must prepare to address in advance of an actual move.
Before uprooting a family and business operations in search of tax savings, taxpayers must understand how their current state of residence determines “domicile” for personal income tax purposes. It is not enough for an individual to have a home or residence in a particular state. In fact, even when taxpayers have multiple homes throughout the world, federal and state governments will recognize only one domicile, or permanent place of residency. Once an individual establishes domicile, that location continues to be his or her tax home until he or she meets several tests for obtaining permanent domicile in a new state and has no intention of returning to the original location in the future.
How states determine domicile depends on a variety of factors, including the number of days a taxpayer spends in the state, where they keep their favorite personal belonging, where their children go to school and their level of involvement and ties to the local community. For example, taxpayers who spend more than 183-days of the year in New York, Connecticut, California or another high tax-state cannot claim domicile in Florida regardless of whether or not they have a home or drivers’ license in the Sunshine State.
Following is a checklist of some of the steps that taxpayers seeking domicile in Florida should take for income tax purposes:
- Establish a permanent Florida address;
- Obtain a Florida driver’s license (for you and your family members) and transfer vehicle registration and insurance to Florida;
- Register to vote in Florida with the applicable County Supervisor of Elections;
- Tie health insurance to your Florida address and secure relationships and visits with local doctors, dentists, etc.;
- Ensure Florida address is included on all estate planning documents, including wills, trusts and powers of attorney;
- Transfer bank accounts, securities, brokerage accounts and similar investments to institutions located in Florida;
- If applicable, move valuables from an out-of-state safety deposit box to one located within Florida and in close proximity to your permanent Florida address;
- Move cherished family possessions, heirlooms and collectibles to the Florida residence you are claiming as your permanent home;
- Change your mailing address for all magazines, catalogs, credit cards, etc. to Florida home;
- Become a member of a Florida-based gym, country club, business association, charity, church or synagogue, etc., and let the organizations you belong to in your previous home state know of your change of address to Florida;
- Maintain a record of your physical presence in Florida, such as a journal or calendar;
- File a Declaration of Domicile with the county in Florida where you are establishing a permanent home.
While there is nothing stopping individuals from moving across state lines for tax reasons, it is critical that they maintain meticulous records, cross every “t” and dot every “i” to prove to state taxing authorities that they are committing to a permanent relocation that could result in significant lifestyle changes.
The advisors and accountants with Berkowitz Pollack Brant’s State and Local Tax (SALT) practice help with individuals and businesses across the globe maintain tax efficiency while complying with often conflicting federal, state and local tax laws.
About the Author: Michael Hirsch, JD, LLM, is a senior manager of Tax Services with Berkowitz Pollack Brant’s state and local tax (SALT) practice, where he helps individual and business to meet their corporate, state and local tax reporting requirements. He can be reached at the CPA firm’s Fort Lauderdale, Fla., office at (954) 712-7000, or via email at firstname.lastname@example.org.
Effective Jan. 1, 2019, Florida’s sales tax rate on the total rent that commercial real estate owners charge and receive from tenants is 5.7 percent, a decrease from 5.8 percent in 2018, and 6.0 percent in 2017. Real property rentals subject to the reduced rate include commercial office space, retail, warehouses and certain self-storage units, excluding storage for motor vehicles, boats and aircraft.
It is important for commercial real estate owners to recognize that the applicable sales tax rate is based on the timing of when the tenant occupies or has a right to occupy the property and not the month or year in which the tenant pays the rent. Therefore, the 5.7 percent tax rate applies only to rental charges a tenant pays for occupancy on or after Jan. 1, 2019. Should a tenant pay rent after Jan. 1, 2019, for a rental period prior to the New Year, the applicable sales tax rate would be 5.8 percent plus any applicable discretionary sales surtax. Similarly, rent a tenant paid in December 2018 for occupancy in 2019 would be subject to the new, reduced rate of 5.7 percent.
Real property leases are taxed on base rent as well as other payments tenants must make as a condition of their occupancy. This includes common-area maintenance fees, property taxes and utilities that a lease agreement specifies are the responsibility of the tenants. In addition, it is the responsibility of the property owner to collect from tenants any County imposed local-option sales surtax on the total rent charged. Depending on the County where the property is located, landlords may be subject to higher surtaxes in 2019 as detailed in the graph below:
Property owners who send invoices to tenants for rental periods after Jan 1, 2019, must account for both the 0.1 percent reduction in state tax rates state tax rate as well as any changes in local option tax rates for 2019.
The advisors and accountants with Berkowitz Pollack Brant’s State and Local Tax (SALT) practice work with individuals and businesses to understand and comply with tax policy and sales tax compliance.
About the Author: Karen A. Lake, CPA, is state and local tax (SALT) specialist and an associate director of Tax Services with Berkowitz Pollack Brant, where she helps individuals and businesses navigate complex federal, state and local tax laws, and credits and incentives. She can be reached at the firm’s Miami office at (305) 379-7000 or via email at email@example.com.