3.8 % Investment Income Tax/Business Income of Real Estate Professional

[topgun]

Can rental income from a land lease be included in the business income of a real estate professional? Business income is not subject to the 3.8 % investment income tax. Rental income from a land lease is not passive income under IRC 469. Can a real estate professional include a land lease in his activity as a real estate professional?

Example:

If a real estate professional owns land that the R E professional leases to a Jack in the Box restaurant (triple net), can the rental income be included in the Real Estate Professional's trade or business income (and be excluded from the 3.8 % investment income tax)?

[Gretel]

Activities can either be grouped by similar activities or by location. If the lease of land fits one of these I don't know. If it does and grouping election is made than income follows this election.

[Burke]

If it is, then it is subject to SE tax. So it's a trade-off.

[topgun]

3.8 % Invest Inc Tax/R E Professional

Rental income is not subject to SE Tax. And grouping would not change this.

[Maribeth]

Just went to the Edward Jones seminar on the 3.8% tax last week. If the RE pro participates in one or more rental real estate activities for more than 500 hours during the year, then, yes, the income is considered business income and is not subject to the 3.8% tax.

The only material participation test for the safe harbor for the RE pro is the 500 hour test. So you may have to do a grouping election with the other rentals that they pro has in order to meet this test. Especially since it is a triple-net lease.

[New York Enrolled Agent]

Just went to the Edward Jones seminar on the 3.8% tax last week. If the RE pro participates in one or more rental real estate activities for more than 500 hours during the year, then, yes, the income is considered business income and is not subject to the 3.8% tax.

The only material participation test for the safe harbor for the RE pro is the 500 hour test. So you may have to do a grouping election with the other rentals that they pro has in order to meet this test. Especially since it is a triple-net lease.

Doesn't the Internal Revenue Code require 750 hours to be a Real estate professional?

[Maribeth]

The final regs provide the 500 hour safe harbor test. The RE pro must have participated in one or more rental real estate activities for more than 500 hours during the year, or had participated in such real estate activities for more than 500hours in any five taxable years during the preceding 10 taxable years.

I have to admit that with the 3.8% and with the repairs regs, I have had a constant headache all year.

[Bees Knees]

To clarify, a real estate professional for purposes of the passive activity loss limitation rules is one who performs more than 750 hours in a real property trade or business.

For purposes of the 3.8% net investment income tax, the regulations divide a real estate professional into two categories:

1) A real estate professional in a Section 162 trade or business.
2) A real estate professional in a rental real estate activity that is not a Section 162 trade or business.

Someone in a Section 162 trade or business is generally going to be subject to self-employment tax and thus not subject to the 3.8% net investment income tax. This is true regardless of hours spent in the activity. An example of a real estate professional in a section 162 trade or business would be a self-employed construction contractor. The real estate professional may perform less than 750 hours per year in the activity and thus be subject to the passive activity loss limitation rules. However, because it is a section 162 trade or business subject to SE tax, it is not a passive activity for purposes of the 3.8% net investment income tax.

The second definition of real estate professional applies to rental real estate activities (managing rental property) which is not a section 162 trade or business and thus is subject to the 3.8% net investment income tax, unless the taxpayer spends more than 500 hours per year in the activity. Again, the taxpayer may not qualify as a real estate professional for purposes of the passive activity loss limitation rules (which requires more than 750 hours of participation), but the safe harbor regulations allow the more than 500 hour participant to escape the 3.8% net investment income tax.

Interesting the code says a passive activity for purposes of the 3.8% net investment income tax is the same as a passive defined in Section 469, which is your standard passive activity loss limitation rules. However, the regulations decided to make the two different.

[John of PA]

FYI I just returned from a tax seminar with our regional IRS Liason and he said that IRS considers very heavily in criteria in selecting Real Estate Professionals for audit, whether they also have W-2 income. If you spend over 750 hours managing a rental property, how can you also hold down a full time job, it would be hard to substantite this to IRS. In general RE Prof. are not subject to the NII 3.8% tax.

[Burke]

For purposes of the 3.8% net investment income tax, the regulations divide a real estate professional into two categories:

1) A real estate professional in a Section 162 trade or business.

Someone in a Section 162 trade or business is generally going to be subject to self-employment tax and thus not subject to the 3.8% net investment income tax. This is true regardless of hours spent in the activity. An example of a real estate professional in a section 162 trade or business would be a self-employed construction contractor. The real estate professional may perform less than 750 hours per year in the activity and thus be subject to the passive activity loss limitation rules. However, because it is a section 162 trade or business subject to SE tax, it is not a passive activity for purposes of the 3.8% net investment income tax.

That is what I was referring to in my former post.