Recent Developments on the Net Investment Income Tax
Over the last several months, much has been written about the Net Investment Income Tax (NIIT) and the associated negative tax implications for real estate investors. The majority of our writing has focused on tax implications for individuals; however, the NIIT can be even more burdensome for taxpayers owning real estate indirectly through a trust. Individuals are subject to the NIIT if their adjusted gross income exceeds $200,000 ($250,000 for joint filers) while trusts are impacted by the NIIT when fiduciary income exceeds $11,950.
Individuals wishing to avoid the NIIT have been advised to focus their energy on meeting the material participation requirements for real estate professionals, but until recently it has been unclear whether or not this strategy could work for a trust. However, on March 27, 2014, in the case of Frank Aragona Trust v. Commissioner, the Tax Court ruled that a trust can indeed “materially participate” in real-property trade or business and thus limit their exposure to the NIIT. In making its decision, the Tax Court ruled that the personal service hours performed on behalf of the trust by the trustee were counted toward determining whether the trust satisfied the real estate professional criteria including the 750 hour threshold.
The IRS has taken the position that personal services must be performed by an individual, and not a trust. Yet, the Tax Court considered the fact that the trustees of the trust were individuals, the work performed in fulfilling the real estate business was performed by individuals, not the trust.
As you might suspect, this case offers a number of planning opportunities for trusts to maximize the benefits of business losses and to avoid the NIIT. Please contact your Anders advisor to discuss how this recent Tax Court ruling affects you.