CPA & Business Advisory Blog

Tax Laws for 2013: IRS Issues Favorable Guidance on Self-Rental

In late November, the IRS issued long-awaited final regulations (TD 9644) on the Net Investment Income Tax. Beginning in 2013, this tax generally applies to individual income tax returns with income greater than $200,000 and trust and estate income tax returns returns with income greater than $12,000.

In general, the Net Investment Income tax is a 3.8% tax on the lesser of

  1. Net investment income, or
  2. The excess of the taxpayer’s modified adjusted gross income (MAGI) above $200,000 for singles (S) or $250,000 for married couples filing jointly (MFJ).

Net Investment Income includes:

  1. Interest, dividend, royalty, annuity and rental income
  2. Net income from a business where the taxpayer does not materially participate
  3. Business income from trading financial instruments or commodities
  4. Gains from the sale of investment or passive property

The above listed Net Investment Income amounts may be reduced by investment advisory fees, related taxes, and investment interest expense.

A change made in the final regulations, which will make many taxpayers happy, is in the area of self-rental income. The final regulations allow income derived from a self-rental arrangement to be excluded from the new tax. The IRS defines self-rental income as 1) income derived from property used in a trade or business in which the taxpayer materially participates, or 2) a rental property that has been properly grouped with a trade or business activity and the resultant grouped activity is a non-passive activity with respect to the taxpayer.

As many small business owners separate their real estate from their operations for liability reasons, the final regulations provide relief to them, as the IRS now recognizes their activities as one “business” as a whole.

While the final regulations remove the need to regroup self-rental income with the trade or business where the taxpayer materially participates, the regrouping should still be considered, as it would permit the current deduction of any future losses that may be generated by the property.

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