Page 2 - The Real Estate Trade or Business Exception from IRC Section 163(j)

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COLUMNS I Tax Practice & Procedure

n income, deduction, gain, or loss from Similarly, items of income, gain, deduc- IRC Section 469(c)(7)(C)
transactions used to hedge interest bear- tion, or loss, including interest income that Taxpayers are allowed deductions for
ing assets or liabilities, or from other is properly allocable to an exempted trade certain business and investment expenses
derivatives that alter a taxpayer’s effec- or business, are excluded in determining under IRC sections 162 and 212. IRC sec-
tive cost of borrowing; the section 163(j) limitation. The taxpayer tion 469(a)(1) disallows deduction for pas-
n debt issuance costs; must allocate tax items between exempted sive activity losses and credits. A passive
n guaranteed payments for the use of and nonexempted trades or businesses to activity loss is the excess of the aggregate
capital under IRC section 707(c); determine the section 163(j) limitation. losses from all passive activities for a tax-
n income from factored receivables; Proposed Treasury Regulations section able year over the aggregate income from
n commitment fees, to the extent that 1.163(j)-10 provides special rules for allo- all passive activities for that year [section
amounts have been borrowed; cating tax items. The taxpayer must gener- 469(d)(1)]. A passive activity always
n substitute interest payments on secu- ally compare the basis in the assets used in involves the conduct of a trade or busi-
rities lending or sale-repurchase transac- exempted trades or businesses and the basis ness, or the expenses of which are
tions; in the assets used in nonexempted trades or deductible under section 212, in which the
n ordinary gain from IRC section 1258 businesses to determine what portion of taxpayer does not materially participate
conversion transactions; interest expense and interest income to allo- [section 469(c)(1), (6)(B)].
n ordinary income from bond issuance cate to the exempted trades or businesses. A rental activity is treated as a per se
premiums by an issuer or a bond premi- The proposed regulations contain an passive activity, regardless of whether the
um deduction by a holder; anti-avoidance rule, which provides that taxpayer materially participates [section
n ordinary income or loss arising from any arrangement entered into with a prin- 469(c)(2), (4)]. Rental activity is defined
contingent payment debt instruments, as any activity where payments are prin-
including foreign currency contingent cipally for the use of tangible property
payment debt instruments; and [section 469(j)(8)]. Under section
n interest on a notional principal con- In particular, the scope 469(c)(7)(B), rental activity of a taxpayer
tract’s significant nonperiodic payments who qualifies as a real estate professional
for noncleared swaps. and definition of “real is not a per se passive activity under sec-
Consistent with section 163(j)(3), the tion 469(c)(2), but is treated as a passive
proposed regulations would not subject tax- estate trade or business” activity unless the taxpayer materially par-
payers that meet the gross receipts test of remains unclear, and the ticipated in the activity [Treasury
section 448(c) to section 163(j). A business Regulations section 1.469-9(e)(1)].
generally meets the gross receipts test of reference to the same A taxpayer qualifies as a real estate pro-
section 448(c) when it is not a “tax shelter” fessional if the following conditions are met:
[as defined in section 448(a)(3)] and has definition under IRC sec- n More than one-half of personal ser-
had average annual gross receipts of $25 tion 469 is equally vices performed in trades or businesses
million or less in the previous three years. by the taxpayer during such taxable year
IRC section 163(j)(7) and Proposed unhelpful. are performed in real property trades or
Treasury Regulations section 1.163(j)- businesses in which the taxpayer mate-
2 exempt certain trades or businesses rially participates; and
from the application of section 163(j). n Such taxpayer performs more than 750
These include— cipal purpose of avoiding the rules of hours of services during the taxable year
n providing services as an employee, section 163(j) or the proposed regulations in real property trades or businesses in
n certain real property trades or businesses, may be disregarded or recharacterized by which the taxpayer materially participates.
n certain farming businesses, and the IRS to the extent necessary to carry The term “real property trade or busi-
n certain regulated utility trades or out the purposes of section 163(j). ness” means any real property develop-
businesses. Under section 163(j)(7)(B), a “real prop- ment, redevelopment, construction, recon-
The proposed regulations provide that erty trade or business,” as defined in section struction, acquisition, conversion, rental,
the term “trade or business” has the same 469(c)(7)(C), may elect not to be treated as operation, management, leasing, or bro-
meaning as under IRC section 162. a trade or business for purposes of section kerage trade or business [IRC section
Interest expense that is properly allocable 163(j). The discussion immediately below 469(c)(7)(C)]. As the IRS noted in CCA
to an exempted trade or business is not details the scope of a “real property trade 201504010, “these terms are not defined
subject to the section 163(j) limitation. or business” in section 469(c)(7)(C). in section 469 or the regulations. Absent

64 AUGUST 2019 / THE CPA JOURNAL