After a blockbuster fourth quarter in investment sales spurred by imminent capital gains increases, real estate professionals are scrambling to make sense of the new real estate tax terrain as a number of other changes hit the industry.
Though accounting experts across the city are offering some tips and tricks to reduce exposure, most believe that the changes, against their warnings, will continue to guide real estate investment decisions.
“High tax rates impact investment behavior,” said Maury Golbert, a partner with Berdon LLP, noting the mad rush in investment sales in the fourth quarter of 2012 in anticipation of the capital gains increases as a prime example. “There’s no doubt that a lot of that was driven by what people perceived about the coming changes.”
Capital gains increases will affect almost everyone in real estate, and certain rules, including the definition of a “real estate professional,” have gotten hairier.
Some property owners are also faced with an additional 3.8 percent rental income tax, known as the Net Investment Income Tax (NIIT) or the “Medicare Tax,” on interest, dividends, annuities, royalties and rents.
Luckily, “real estate professionals,” as defined by the IRS, are exempt from the Medicare Tax as long as they meet certain conditions, the most important being that they actively dedicate 750 hours per year and more than half their time on the business.
“It would be unfair to tax them the extra 3.8 percent,” said Neil Sonenberg, a partner at Rosen Seymour Shapss Martin & Company LLP.
But in one of the many finer details in current legislation, that also means family members and investors in a business would be subject to the tax if they don’t meet the new rules, and will thus pay the Medicare Tax on their investment income (if gross income exceeds $250,000 for married couples or widows with dependent children, or $200,000 for single individuals or heads of households).
“Now the IRS might challenge some people who always thought of themselves as real estate professionals,” said Matthew Bonney, a partner with accounting firm Citrin Cooperman, noting that new rules this year also ask owners to compartmentalize repairs, meaning that an electrical job might be written off while a plumbing job might not. “What we’ve all taken for granted will be taken into the light now … and the IRS has a reason to challenge.”