While legislators were settling in to a find a solution to the U.S. ‘Fiscal Cliff’’, Sperry Van Ness|Bluestone & Hockley, B&H University and Portland accounting firm Perkins & Co. brought together investors and professionals to discuss the possible outcomes. “Don’t Fall off the Fiscal Cliff in 2013: Things to Consider Before Year-End” was the title of the class lead by Tim Kalberg & Trent Baeckl of Perkins & Co. Now that The American Taxpayers Relief Act has been passed, what has changed and how will that change influences business?
For real estate professionals the act cleared up major questions regarding capital gains, bonus depreciation, and section 179 of the IRC. Some clarity on the bill and how it relates to real estate will help pros make wise decisions for your clients and yourself now and in the future.
Capital Gains & Qualified Dividends
Capital Gains often include Real Estate transactions when being evaluated for tax purposes. In the wake of the most recent fiscal legislation the top rate for long-term capital gains and qualified dividends will see a permanent 5% increase, from 15% to 20%. For investors who exceed the $400,000 taxable income threshold for single filers and $450,000 of taxable income for married couples filing jointly, they will abide by the new 20% tax. For investors below these thresholds the 15% rate will still apply. This will be in addition to an individual’s state’s sales tax, which can greatly affect a transaction in the top-tax rate. With the 3.8% Medicare surtax on capital gains, federal capital gains taxes can be as much as 23.8% when all is said and done.
15-year Treatment on Leasehold Properties
In the new bill certain leasehold properties were given special consideration. For certain leasehold properties that have been placed in service before January 1, 2014 the ATR act will extend owners or lessee’s ability to depreciate certain properties over a recovery period of 15 years. Properties that apply are qualified leasehold improvement property, qualified retail improvement property, and qualified restaurant property. Provisions for each of these properties can be found at the IRS page for Depreciation of Rental Property.
Bonus Depreciation
The Act extends the 50% first year bonus-depreciation to certain properties placed in service before 2014. The taxpayer is allowed to write off 50% of their property’s cost basis in the year it is placed in service and depreciate the remaining amount over the property’s suitable recovery period. Applicable properties must be original use, or new, and must include those with a 20 year or less recovery period, which is determined by the Modified Accelerated Cost Recovery System. Qualified leasehold property is eligible, however retail improvement property and restaurant property are not eligible.
IRC Section 179 & The Business
According to the ATR Act, taxpayers other than an estate, trust or a few non-corporate lessors may deduct up to $500,000 of certain property. To qualify this property must be deducted in the year it is placed in service year and be purchase for business/trade purposes. It is generally limited to tangible, depreciable, personal property. If a taxpayer places more than $2,000,000 worth of property into service during a single taxable year, the § 179 deduction is reduced, dollar for dollar, by the amount exceeding the $2,000,000 threshold.
Medicare Tax
The 3.8% surtax included in the Patient Protection and Affordable care act Affordable care act comes in addition to the recent 5% increase on capital gains and net investment income; however materially participating real estate professionals (MPREPs) have been given a bit of leeway. Materially participating real estate professionals will have the option of qualifying for exemption from the Medicare tax because rental collection is seen as a non-passive form of income. MPREPs also are able to exclude the capital gains resulting from the sale of qualifying real property from this 3.8%. To qualify for this exemption the individual taxpayer must:
- Spend more than half of their personal services during the year must be in real property activities
- They must log over 750 hours a year in real property activities.
- They must log over 500 hours a year in rental real estate activities. Most individuals choose to combine all rental real estate into a single activity. This decision is binding but many do this in order to qualify as materially participating in rental real estate.
*real property activities include property development, redevelopment, construction, acquisition, rental, operation, management, or leasing activities.
Despite the fact that Capitol Hill managed to come to an agreement the tax code is bound to come under attack soon. Keep in mind these new regulations, but keep your one ear pointed towards Washington and the 113th Congressional meeting.
