By Raymond Jacobi, CPA
Rental Real Estate
For real estate professionals, losses from rental real estate activities are not subject to the passive loss rules if during a tax year:
- More than 50 percent of the taxpayer’s personal services are performed in real property businesses, and
- More than 750 hours of service are performed in real property businesses.
For both of these tests, the taxpayer must materially participate in the real property businesses. If a joint return is filed, these two tests are met only if they are separately satisfied by either spouse. (However, in determining material participation, a spouse’s participation is taken into account.) Services performed as an employee are ignored unless the employee owns more than 5 percent of the employer.
In determining whether a taxpayer materially participates in any real estate activities for purposes of applying this test, each interest of the taxpayer in rental real estate must generally be treated as if it were a separate activity. However, the taxpayer may alternatively elect to treat all of his or her interests in rental real estate as a single activity. The election is irrevocable but is often necessary to qualify. A closely held C corporation will satisfy the tests if more than 50 percent its gross receipts are derived from real property businesses in which the corporation materially participates.
Real property businesses are those engaged in real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage.
Sale
of Principal Residence
When selling a principal residence, up to $500,000 of gain on a joint return (up to $250,000 on a single or separate return) can be excluded. To be eligible for the exclusion, the residence must have been owned and occupied as a principal residence at least two of the five years preceding the sale. The exclusion is available each time a principal residence is sold, but only once every two years. Special rules apply in the case of sales of a principal residence after a divorce and sales due to certain unforeseen circumstances. If a taxpayer satisfied only a portion of the two-year ownership and use requirement, the exclusion amount is reduced on a pro-rata basis if due to an unforeseen circumstance.
Example: Husband and wife file a joint return. They own and use a principal residence for 15 months and then move because of a job transfer. They can exclude up to $312,500 of gain on the sale of the residence (5/8 of the $500,000 exclusion).
Planning Suggestions: If you wish to sell your principal residence but are unable to do so because of unfavorable market conditions, you can rent for up to three years after the date you move out and still qualify for the full exclusion. However, any depreciation claimed during the rental period will be recaptured upon sale and taxed at a 25 percent rate.
If you own appreciated rental property that you wish to sell in the future, consider moving to the property to convert it to your principal residence. You must live in the property for two of the five years preceding the sale of the property. Provided you have not sold another principal residence for the two years prior to the sale, all gain up to the $500,000 or ($250,000) is excluded. Any prior depreciation claimed will be recaptured upon sale and taxed at a 25 percent rate.
The sale of a principal residence does not qualify for the exclusion if during the five-year period prior to the sale the property was acquired in a tax-free like-kind exchange.
Gifts
The end of the year is the traditional time for making gifts. For 2007, you may give up to $12,000 in cash or property, to a person without incurring any federal gift tax liability. Thus, you can make $12,000 gifts to any number of people as you like. If you are married, you and your spouse can give $24,000 to each person, so long as both consent to the gift or if you give community property. To qualify for the annual exclusion, the property must be given outright to the donee or put into a trust that meets certain conditions.
In addition to the annual exclusion, the lifetime unified gift tax credit allows each person to transfer a cumulative total of $1 million without incurring any gift tax liability. Using the credit now keeps future appreciation of the gifted property out of the donor’s estate. Other than the annual exclusion and the lifetime credit, direct payments of tuition made on another person’s behalf to a university or other qualified educational organization are also excluded from gift tax, as are direct payments of medical expenses to a medical care provider.
Consider using appreciation property in making gifts since any gain on sale is likely to be taxed at lower rates. It is generally unwise to give property that has declined in value. Rather, the property should be sold to realize the tax benefits of the loss.
Raymond J. Jacobi, CPA is a partner with Mengel, Metzger, Barr & Co. LLP and may be reached at Rjacobi@mmb-co.com
Reprinted with permission of The Daily Record 2007
