All Forum Posts by: Bruce D. Kowal

Whatever gives you an advantage in dealing with Customers.  Here in the Metro New York area, lots of people with Middle Eastern accents go by Mike, as in the name of the Prophet.  Make it easy.  "Sophie" is fine,  So is "Sally" or "Sue".   Chinese people rarely us their three syllable name, right?

As some readers of this Forum know, there are two types of participation for those seeking the use of real estate losses: Active Participation and Material Participation. For REI over a certain income limit, in order to use those losses to offset their salary income, they want to wear the Badge of Real Estate Professional.  And that's the easiest way to communicate this:  you want to meet the requirements to wear that Badge on your lapel collar.  Or on your ballcap.

Once you have that Badge, then you look at how many hours you are spending on your properties.  This is the broad view, ignoring for now the details of IRC Sec 469 (c)(7) and the associated Regs.

Now, getting that Badge means you have to have some involvement in the real estate business. Again, this is a broad description. A common way to get that Badge is to already be active in the real estate business. You may be the Owner of a Management Company, for example. Or you may be a salaried employee of an REIT, or local real estate developer. Now, pay attention: that work you perform as a salaried employee does count towards earning that Badge, BUT, and this is a big BUT:  you must be a 5% shareholder of the company paying you that salary.  IRC Sec. 469 (c)(7)(D)(ii)

Why?  The Code was amended early on in response to complaints from people who already were in that business.  They had "skin" in the game.  What Congress did with the 5% rule was to prevent someone, with no skin in the game, from benefiting simply by virtue of being an Employee.

At least that's how I read this.  

An exhaustive discussion can be found in the District Court decision in Stanley et al v. United States [W.D. Arkansas 2015].  This is a fascinating case, where all the requirements surrounding the Material Participation requirements are discussed.  Real cases, with real facts, are always easier to understand than an article which simply parses the Code and Regs.  Simply put:  any intelligent investor can read this and understand the issues.  And if you are on Bigger Pockets, you already have those mental attributes.

Are there any work arounds?  Sure there are.  I know of several.

What if you have already filed tax returns based upon being a salaried employee (with no ownership) and deeming that to help you get that Badge?  Well, now you have a problem.  To be sure.

[If you find this post worthwhile, don't forget to vote me a thumbs up!]

Here's the Big Picture, and it explains why real estate has tax advantages.  When you buy a property with less than 100% cash, you are effectively depreciating debt.  

Put 20% down in cash, and borrow 80%.  Bingo, you are depreciating debt.  

If not for that magic, most properties could not be held, as they frequently have negative cash flow.  The depreciation contributes to the overall tax loss, which offsets your other income, meaning less tax.  It helps you carry the property during hard times.

Yes, there is recapture of depreciation, but if the depreciable life is SL 27.5 years, the recapture is at a special 25% cap gain rate.  And your property did increase in value [we hope].  Don't lose sleep over recapture.  I never heard of anyone backing away from a real estate investment because he fretted over recapture.

Here's some fun reading:  What is Depreciation Recapture?

As for deferral of passive losses, Mr. Acharya is correct.

An important feature of the S Corp is the compensation, the W2 income paid to the Shareholder, and/or his family members.  A common tax avoidance scheme is to avoid the full burden of social security and medicare taxes by choosing a low amount of compensation.  IRS says the comp must be "reasonable".  The soc sec tax applies to the first $147,000 in 2022.  Unfortunately, the Medicare Tax, a combined tax of 2.9% is levied on all levels of compensation.  Talk to your CPA.  It's complicated.

Some fun reading on this topic:  S Corporation Reasonable Compensation

The alternative case, if you just love real estate, is to look at the returns from an REIT ETF. Such as Vanguard. If you can get a steady > 3% current dividend plus appreciation, with no management or hassle, then that should be the hurdle for all you real estate decisions.

Here is the page for the Vanguard ETF.  "VNQ":  Vanguard Real Estate ETF

For some folks, the rental real estate experience is similar to that of a Boat Owner:  The happiest moments for a Boat Owner occur when he buys the Boat, AND when he sells the boat.

There is a special rule that allows up to $25,000 in losses from real estate, as long as your Adjusted Gross Income is $100,000 or less. You must actively participate.  However, as the IRS says in Pub 925:  "Active participation. Active participation isn’t the same as material participation . . .Active participation is a less stringent standard than material participation. For example, you may be treated as actively participating if you make management decisions in a significant and bona fide sense. Management decisions that count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and similar decisions."

If you really want to get into this, here is an excellent article: Maximizing the Use of the Special $25,000 Rental Real Estate Loss Allowance

The Rules for Real Estate Professionals do exist, but I am assuming that you qualify for the $25,000 exemption.  However, those REPS rules, should you rise to that level, are discussed here: Real Estate Professionals: Avoiding the Passive Activity Loss Rules.

Which brings me back to my original assessment to keep it simple.  Unless your AGI is > $100k.

In any event, you now have some fun reading this weekend.

There are always a lot of unspoken facts and assumptions in this forum.

I was referring to the issue of tenancy in common and the continuity of title rules of §1031. There was apparently enough interest in TIC ownership NOT being classified as a Partnership, because it might run afoul of §1031 exchange rules, such that it prompted IRS to issue Rev Proc 2022-22 https://www.irs.gov/pub/irs-dr...

And an article on this in an authoritative publication.  Fractional Interests in Property

I don't see many TIC / fractional interests seeking §1031 exchanges. If someone could explain how this operates in the real world, and why it merited its own Rev Proc, that would clear this up.

And in particular, how would this affect the example given by Mr. Schwaegerle?

That sounds about right.  As long as you are making a good faith attempt at a fair allocation, and not shortchanging IRS, what you propose is sound.  That's what I would do.  In essence you have a partnership, and you can allocate P&L however you want, regardless of how much capital you put in.  

Perhaps other commentators here would disagree with me, but what you are proposing would withstand an IRS exam.

Be aware that if you should file a Partnership tax return,  a Form 1065, you will lose the ability to ever do a §1031 exchange.

Good grief!  I used to live in Rowlett in the early 1980's. In those Fox & Jacobs homes east of Dalrock Road.  Those homes are likely good candidates for what you plan to do.  My kids went to Rockwall Schools.  How's the water level on Lake Ray Hubbard?