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					       Module 29
Tax Motivated Investments
  and Loss Limitations
                  Menu
Tax shelter activities
The passive activity limitations
Loss limitations associated with vacation
  homes
Anatomy of a tax shelter: residential real
  estate
Anatomy of a tax shelter: low-income housing
  investment
     Tax Shelter Activities: An
           Introduction

       Key Learning Objectives (1)

 Definition of a tax shelter
 The goals of a good tax shelter
 §6111 registration requirements
 §6707 & §6708 penalties related to
  registration
            Definition of a
             Tax Shelter
 Minimize the tax effects of the income tax
 Generates significant tax losses as a result
  of the allowable deductions associated with
  the investment
§6111 Registration Requirements

 A tax savings to investment cost ratio of
  more than two to one, and
 The offering is (a) treated as a security
  regulated by law, or (b) exempted from
  regulations but has five or more investors or
  will initially attract investments exceeding
  $250,000
    §6707 and §6708 Registration
             Penalties
 §6707
  (a) organizer's failure to
       register a shelter
 §6707
  (b)--failure to furnish
       a registration number
 §6708--organizer's failure to retain
      list of investors
            The Goals of a
           Good Tax Shelter
 Deferral of taxation
 Conversion of
  ordinary income
     into capital gain
§6700 and §6701 False Statement
           Penalties
 §6700--organizer furnishes false statements
 §6700--organizer furnishes gross
  overvaluation statement
 §6701--aiding and abetting understatement
  of tax liability
     Tax Shelter Activities: An
           Introduction

       Key Learning Objectives (2)

 The sham transaction doctrine as a weapon
  against tax shelters
 §6700 & §6701 penalties related to false
  statements
 §7408 injunctive relief
 The Sham Transaction Doctrine
 The transaction was entered into primarily
  for tax avoidance and
 No economic substance, (no possibility of
  profit)
        §7408 Injunctive Relief
   Empowers IRS to seek civil action in
    District Court that would enjoin any person
    from further engaging in conduct subject to
    §6700 or §6701

   Promoters can be shut down much quicker
    under this procedure
The Passive Activity Limitations:
         A Closer Look

           Key Learning Objectives (1)

   The passive activity limitations (PALS)
   Identifying an activity
   The active basket and material participation
   The portfolio basket
   Legislative curbs on tax shelters: an overview
         Passive Activity Rules
 Loss limit rule applies to individuals,
  estates, trusts, closely held C corporations,
  and personal service corporations
 All items of income or loss classified as
     Active
     Portfolio,   or
     Passive
              General Rule

 Passive losses offset only passive income
 Suspended losses carried forward
             Active Basket
 Wages and salaries
 Profit/loss from trade or business in which
  taxpayer materially participates
 Gain/loss from sale of active business assets
       Material Participation
          (Dirty Hands)

 Regular
 Continuous
 Substantial
 Extremely complex rules
           Portfolio Basket

 Interest
 Dividends
 Annuities
 Royalties
 Gain/loss from sale of portfolio assets
The Passive Activity Limitations:
         A Closer Look
        Key Learning Objectives (2)
The passive basket
 Applying the passive activity limitations
 Real estate exceptions to the passive loss
  limitations
 Passive activity credits
 Disposition of passive activities
                Passive Basket
   Profit/loss from trade or business IF
       Taxpayer does not materially participate
   Any rental activity, regardless of material
    participation
    Passive Activity Limitations
            PAL Rules
 Record income/loss for each activity
 Net all activities
 If overall net income--report in full
 If overall loss--report zero net income
 Disallowed (suspended) losses
       Carryover in full to next year
       Record by activity
        Compliance Query:
          PAL Rules (1)
What is AGI if the taxpayer has
 $500,000 of salary income and
 Two passive businesses
                      Activity    Activity
                        -A-         -B-
          Income      50,000      20,000
          Expense     25,000      30,000
   Solution: Compliance Query:
          PAL Rules (1)
         AGI is $515,000
Passive activities net as follows:
           Activity Activity Netted
              -A-          -B-
Income      50,000       20,000    70,000
Expense 25,000           30,000    55,000
Net Inc     25,000 -10,000         15,000*
*When passive net >0,include in AGI
        Compliance Query:
          PAL Rules (2)
What is AGI if the taxpayer has
  $500,000 of salary income and
  Two passive businesses

                      Activity     Activity
                        -A-          -B-
          Income      50,000       20,000
          Expense     75,000        5,000
  Solution--Compliance Query:
        AGI is $500,000
Passive activities net as follows:
           Activity Activity Netted
              -A-         -B-
Income      50,000       20,000    70,000
Expense 75,000            5,000    70,000*
Net Inc   -25,000     15,000         -0-
*Can’t deduct >passive income
                  Passive
                  Credits

 Apply against tax                    from
  passive income only
 Suspended credits carried forward
 Use or lose in year of disposition
Disposition of Passive Activities
 In the year of disposition
 In a fully taxable transaction
 Suspended losses may be deducted against
  any source of income
      Transfers to Related Parties
   Not a disposition of a passive activity
        Exception for Qualified
        Real Estate Professional
   >50% of personal services related
     To   real estate trade or business and
   >750 real estate related hours
             Exception for
        Active Rental Real Estate

   Up to $25,000 excess loss allowed
     Reduces   active/portfolio income

   Phase-out of $25,000 if
       AGI > 100,000
       Lose 50¢ for each excess $

   Active participation required
        The Active Participation
             Requirement
   Own at least a 10% interest
     By   value
 Not be a limited partner and
 Demonstrate regular, continuous, and
  substantial involvement
       Compliance Query:
     Active Rental Exception
What is AGI if the taxpayer has
  $100,000 of salary income and
  Two passive businesses (A is active rental)

                       Activity     Activity
                         -A-          -B-
          Income       50,000       20,000
          Expense      75,000        5,000
   Solution--Compliance Query:
          AGI is $90,000
Passive activities net as follows:
           Activity Activity Netted
              -A-          -B-
Income     50,000        20,000       70,000
Expense    75,000         5,000       70,000*
Net Inc   -25,000        15,000           -0-
Excess    -10,000         -0-
ARE*      -10,000
      *ARE = active real estate exception
         In Class Exercise:
    More Active Rental Exception

 How does the answer to last Query change?
 Case 1:
     Activity   B is the active real estate rental
   Case 2:
     Salary income is $140,000?
     Activity A is the active real estate rental
  Solution--In Class Exercise:
 More Active Rental Exception
           Case 1: AGI = 100,000
 The excess loss is not from active rental
 It must be suspended
  Solution--In Class Exercise:
 More Active Rental Exception
           Case 2: AGI = 135,000
 AGI is over 100,000
     Exception   must be phased out
 Lose (140,000-100,000) x .5 of $25,000
 Only 5,000 of 25,000 exception remains
    Decedent’s Suspended Losses
 Suspended losses are generally allowed on a
  decedent's final tax return
 Deduction is reduced by any step-up in
  basis to FMV
         Gifts of Activities With
           Suspended Losses
   Transfer by gift not a qualifying disposition
   Losses are not allowable to either the donor
    or donee
   Donee’s basis is increased by the suspended
    loss
 Tax Shelters in Residential Real
              Estate
 Limited tax benefits are still available for
  the small investor
 Use of leveraging, depreciation, capital
  gains, benefits of tax losses, positive cash
  flows
 $25,000 exception for PAL’s
    Loss Limitations Associated
      With Vacation Homes
       Key Learning Objectives (1)

 The basic rules of §280A
 Rule 1: De minimis rentals
 Rule 2: Insignificant personal usage
 Rule 3: Significant personal usage
             “Vacation Home”
   To determine if rental is a vacation rental
    COMPARE days of personal use to days
    ACTUALLY rented at FMV


   Note: OA stands for “otherwise allowable”
    deductions found on Schedule A
           Vacation Home?
 THERE ARE 3 POSSIBLE OUTCOMES
 Exclude all income and non “otherwise
  allowable” expenses
 Rental is a passive activity--see PAL rules
 Deduct
   Expenses FOR AGI to zero out rental income
   Excess otherwise allowable deductions FROM
    AGI
        De Minimis Rentals
            Exclude
 If rented < 15 days
 Exclude all income and non-otherwise
  allowable expenses
     Insignificant Personal Usage
          Follow PAL Rules
   If personal use
       < 15 days OR
       < 10% of days rented at FMV
 All income and expenses related to the
  rental are passive
 Passive actively rules apply
 Rental exception may be available
        Significant Personal Usage
              Zero Out AGI
   If personal use
     > 14 days AND
     > 10% of days rented at FMV

 All income is reported for AGI
 Expenses related to the rental (including
  OA's) are deductible FOR AGI but limited
  to amount of income generated by the rental
 Excess OA’s are deductible FROM AGI
          In Class Exercise:
       Rental or Vacation Home?
   Discuss these cases in your groups

 CASE             -A-   -B-   -C-   -D- -E-
 Rented           300   200   250    10 75
 Used              22    21    22    32 14
 CASE             -F-   -G-   -H-   -I- -J-
 Rented           100   200   200   300 300
 Used              13    14    22     29 36
      Solution: In Class Exercise:
       Rental or Vacation Home?
   De minimis rental
     Case:    D
   Insignificant personal usage (PAL)
     Cases:   A, C, E, F, G, I
   Significant personal usage
     Cases    B, H, J
    Loss Limitations Associated
      With Vacation Homes
       Key Learning Objectives (2)
 Special considerations applicable to
  vacation homes
 Expense allocation methods: the IRS vs. the
  courts
 Carryovers of unused deductions
                 Special Issues
   Ordering rule for deductions
       "Otherwise allowable"
       Other allowable cash expenditures
       Depreciation
   Personal use includes
       Rental < FMV to related party
       Donated use to charitable organization
    Expense Allocation Methods
         Why The Issue?

 Total deduction FOR AGI limited to income
  from rent
 Excess OA's can be deducted FROM AGI
 Taxpayer would like to increase percentage
  of deduction FOR AGI coming from items
  not OA
     Expense Allocation Methods
      What’s The Denominator?
   365 days for interest and tax deductions
     Per   the Courts

   Total number of days actually used for
    rental or personal usage
     Perthe Code
     Excludes any days the unit was vacant
        In Class Exercise:
    Expense Allocation Methods
      What’s The Difference?
   Use the following facts to determine the
    deduction for/from AGI
 Rental income                           5,000
 Interest and taxes                     15,000
 Repairs                                 6,000
 Days rented at FMV                        100
 Days of personal use                       50
   Solution--In Class Exercise:
   Expense Allocation Methods
     What’s The Difference?
     Per the Courts              Per the IRS
% = 100 ÷ 365 = .274      % = 100 ÷ 150 = .333
        For AGI                   For AGI
Income            5,000   Income             5,000
Less Interest     4,110   Less Interest      5,000
     Repairs        990        Repairs          0
Net Income           0    Net Income            0

From AGI 15,000 - 4,110   From AGI 15,000 - 5,000
        Carryovers of Unused
             Deductions
 OA s used in full, either for or from AGI,
  so no carryover issue
 Depreciation, repairs, etc. carryover
 Cannot be used to create a loss
     Anatomy of a Tax Shelter:
      Residential Real Estate
       Key Learning Objectives (1)
 Tax shelters in residential real estate
 Analysis of a typical residential real estate
  investment
 The benefits of leveraging
     Anatomy of a Tax Shelter:
      Residential Real Estate
        Key Learning Objectives (2)
 Comparing taxable income (loss) with net
  cash flows
 Impact of the passive activity limitations
 Incorporating the effects of liquidating the
  investment
 Summary: the tax advantages of residential
  real estate
Anatomy of a Tax Shelter: Low-
 Income Housing Investment
       Key Learning Objectives (1)
 Investments in low-income housing tax
  credit projects
 Project description: qualified units and
  financing terms
 Project description: project rents and equity
  requirements
Anatomy of a Tax Shelter: Low-
 Income Housing Investment
       Key Learning Objectives (2)
 Projected cash flows
 Disposition of the project in year 16
 Assessing the impact of the passive activity
  limitations

				
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posted:2/10/2013
language:English
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