R EAL E STATE T AXATION , FIRPTA & QBI DAVID PROTHERO, CPA, CFP DAVID J. PROTHERO, CPA, P.C. 617-871-6602 | D A V I D . P R O T H E R O @CPADP.COM
R EAL E STATE T AXES ❖ Ordinary Income Taxes: 0% to 37% o See list on page 13 for common tax deductions for rental real estate o Depreciation expense = large “non - cash” expense = building cost / 27.5 years • e.g. $275,000 cost / 27.5 years = $10,000 expense to offset rental income down to zero or below-This is a big reason why rental real estate is such a tax efficient investment ❖ Capital Gains Tax o 1 5% of the gain (sales price - adjusted basis) o 20% if in highest tax bracket ($612,000 for married couple) o State taxes vary – long term capital gains tax in MA is 5.1% ❖ Net Investment Income Tax (NIIT) o 3.8% (for gross income over $250,000 for married couple) o Non-resident aliens not subject to NIIT ❖ Estimated Tax Payments o Calculate tax due on sale, make federal and/or state estimated tax payments as necessary o This may help reduce/eliminate underpayment of estimated tax penalties
R EAL E STATE T AXES ( CONT ’ D ) ❖ Estate Tax o Maximum Rate of 40% o Lifetime exclusion for U.S. Persons = $11,400,000 o Lifetime exclusion for foreign persons = $60,000 ❖ Consideration for foreign investors o Foreign Individual >>> Foreign Corp >>> US Corp >>> US real estate o Life Insurance to pay estate tax o Seek legal advice for estate tax reduction planning ❖ Sales Tax (aka deed/tax stamps) o Varies by town/city • Generally .456% in MA or $4,560 on $1,000,000 sale
FIRPTA (F OREIGN I NVESTMENT I N R EAL P ROPERTY T AX A CT ) ❖ Non- Resident Aliens (NRA’s) o Individual taxpayer who is NOT a US citizen or resident alien o Default 15% FIRPTA withholding on the sale of US real property o Consider Filing Election under IRC section 871(d) to treat rental income as effectively connected with US trade or business • Graduated tax rates • Avoids mandatory 30% withholding on gross rents o Property Mgmt companies must withhold and remit 30% tax to IRS w/o election • Allows tax deductions against rental income (e.g. real estate tax, insurance, fees) ❖ Apply for tax ID # (ITIN) for rental property with filing of first tax return (if no SSN) o Lengthy process requiring a certified copy of passport of other government issued ID o File annual tax returns to report rental income = 1040-NR and state
FIRPTA ❖ Buyer must withhold 15% of sales price upon disposition of US real property by a non-resident alien or foreign entity o This would be $150,000 on a $1,000,000 sale!!! o May far exceed any tax due on the sale and can cause a cash flow problem for the seller o Many sellers don’t want to wait until following April to file taxes to receive some/all $ back ❖ Reduced 10% Buyer Withholding o Building is acquired for use as a residence o Amount realized between $300,000 - $1,000,000 o Per Code Sec 1445(c)(4) – provide code section to those accustomed to 15% rule ❖ Withholding reduced – foreign / non-foreign transferors o Based on capital contribution o e.g. Husband and wife
FIRPTA: C OMMON E XCEPTIONS ❖ Transferor furnishes a non-foreign affidavit ❖ Transferor provides a withholding certificate from the IRS ❖ Real property is acquired for use as a residence, and amount realized < =$300,000
N ON -F OREIGN A FFIDAVIT ❖ Sworn statement under penalties of perjury o States transferor (seller) is not a non-resident alien o Includes: • Address of property • Transferor’s SSN • Transferor’s address
W ITHHOLDING C ERTIFICATE ❖ Transferor uses Form 8288-B to apply for withholding certificate o If possible, apply months before closing ❖ Applicant must provide calculation showing transferor’s tax liability is less than the 10% / 15% tax withholding ❖ The claim could state transferor is entitled to non-recognition treatment under 1031 exchange o No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business, or for investment, if such property is exchanged solely for property of like-kind, which is to be held either for productive use in a trade or business, or for investment. DOES NOT APPLY TO PRIMARY RESIDENCE.
W ITHHOLDING C ERTIFICATE ( CONT ’ D ) ❖ Must have non- foreign affidavit from transferor’s original purchase of property, to prove original seller did not require withholding ❖ IRS withholding certificate states no / reduced tax is due (if approved by IRS) o Eliminates / reduces tax withheld at closing o Increases cash flow to the seller If an application for a withholding certificate is submitted to the IRS by the transferor on or before the closing date, transferor must provide notice to transferee before the transfer is made The amount withheld (10% or 15%), or a lesser amount if so determined by IRS, does not need to be reported (transferee files Forms 8288 and 8288-A) and paid over until the 20 th day following IRS’s final determination as to the application for a withholding certificate IRS must process request within 90 days
$300,000 O R L ESS E XCEPTION Property must be residence of transferee or a family member of the transferee. ❖ Qualifications ✓ Transferee is an individual ✓ Definite plans to reside at property > 50% # of days ✓ Property used in each of the first two 12-month periods after sale ❖ Recommend asking the buyer to sign affidavit to reduce exposure for all parties
T RANSFEREE D UTIES ❖ Transferee (Buyer) has a duty to withhold o Must file Forms 8288 and 8288-A and submit taxes withheld within 20 days after closing o Seller will receive a stamped Form 8288-A copy B from the IRS to file with their income tax return ❖ Attorneys will often negotiate to have seller’s CPA prepare forms for buyer o Saves buyer fees
R ENTAL R EAL E STATE O WNERS Expenses may include: • Accounting • Mortgage interest paid • Advertising • Office expense – rent, • Auto – repairs, insurance, tolls, parking, phone tires, gas, cabs, carwash, oil changes, business miles • Professional membership • Bad debt fees / dues • Bank fees • Real estate taxes • Business insurance • Rent of vehicles / • Commissions paid equipment • Computer eqpt / software • Repairs and maintenance • Condo fees • Subscriptions • Conferences / Seminars • Supplies • Homeowners insurance • Taxes • Legal • Travel expenses • Licenses • Utilities (not first • Management fees telephone line) • Meals & entertainment • Wages paid • Mortgage insurance • Other
Q UALIFIED B USINESS I NCOME D EDUCTION (QBI) – S ECTION 199A ❖ An individual taxpayer, estate, or trust generally may deduct 20% of qualified business income, and 20% of qualified REIT dividends and qualified PTP income. ❖ The deduction is limited above a threshold amount of taxable income ($157,500, or $315,000 for joint returns, indexed) by the following: ➢ Wages paid and capital investment with respect to the trade or business (except in the case of qualified REIT dividends and qualified PTP income) and ➢ The type of trade or business: specified service trades or businesses limited ❖ Taxable income means without regard to the section 199A deduction, for this purpose ❖ The deduction may not exceed 20% of taxable income minus net capital gain ❖ Taxable income means without regard to the section 199A deduction, for this purpose ❖ Real estate agent income may qualify for this deduction ❖ Effective for taxable years 2018 - 2025
W HAT IS A Q UALIFIED T RADE OR B USINESS ? ❖ A qualified trade or business means any trade or business other than the trade or business of performing services as an employee ❖ The final QBI regulations define a trade or business as a Sec. 162 trade or business other than performing services as an employee. Case law provides that a Sec. 162 trade or business entails a profit motive and requires considerable, regular, and continuous activity. A sporadic activity or hobby does not qualify for this purpose. The final QBI regulations offer several factors for analyzing whether a rental real estate activity is a Sec. 162 trade or business: o The type of property rented (commercial versus residential); o The number of properties rented; o The owner's (or the owner's agents') day-to-day involvement; o The types and significance of any ancillary services provided under the lease; and o The terms of the lease (e.g., a net versus a traditional lease and a short-term versus a long-term lease).
W HAT IS A Q UALIFIED T RADE OR B USINESS ( CONT ’ D ) ❖ Trade or business can also include certain rental real estate activities ➢ See Notice 2019-07 for safe harbor requirements for a rental property to qualify as a trade or business. ➢ 250 or more hours of rental services are performed (as described in this revenue procedure) per year with respect to the rental enterprise ➢ Beginning in 2019, The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services ❖ A taxpayer may have multiple trades or businesses
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