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A Better Partnership


Oct 2013
October 29, 2013

Rental Property Faces New Income Tax

A new 3.8% tax on net investment income goes into effect for the 2013 tax year as part of the Affordable Care Act, and there are options you should consider for year-end tax planning that may reduce your tax liability.

Who is affected and how?
  • The new 3.8% tax on net investment income will be applicable to net investment income when an individual’s modified adjusted gross income exceeds $200,000 ($250,000 for married couples).
  • Rental income from a passive activity, or that is not derived in the ordinary course of a trade or business, is generally included in net investment income subject to the new tax.
  • Many of our clients own entities that lease real estate to a separate operating entity. For example, a limited liability company owns real estate that is leased to a commonly-owned S Corporation. When the rental property and operating company are commonly-owned, it may be possible to elect “grouping” of the rental and operating activities, in which case the combined income will not be passive income subject to the new tax.

What options should be considered?
  • You may be able to remove the tax liability for net rental income on properties you own and lease to your separate operating entity by making a special election on your personal income tax return. The election would essentially group your rental entity with your operating entity.
  • You may also need to amend the lease arrangement between the rental entity and the operating entity. The current interpretation by the IRS in their proposed regulations requires that the rental activity separately qualify as a trade or business. Real estate rental activity may qualify as a trade or business if the landlord provides services, e.g. a gross lease agreement as distinguished from a triple-net lease agreement. Note that the final regulations may eliminate the need to amend your lease arrangement but at this point the proposed regulations are the sole source of authority.

In order to take advantage of this planning strategy, you should consider making the grouping election on your 2013 tax return and revise leases before the end of this year (assuming the IRS position does not change in the final regulations). We would be happy to work with you and your accountants to quantify the potential tax savings available with the grouping election. We can assist with the qualification and reporting requirements of this election as well as the revision of your lease. For more information, please contact any of our Trusts & Estates or Tax Law attorneys.

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