As you begin to gather documents for your CPA in late January and early February, it’s likely one of the first things you’ll do is assemble the accounting and tax information associated with your real estate and/or investment partnerships. This is a great time to review your calendars and time logs and quantify the time spent working on these businesses during the previous year.
Often times, a taxpayer’s time spent on these types of activities is miniscule and the related income is considered to be passive as defined by IRS guidelines. As you know, income earned from passive activities is subject to the additional 3.8% Net Investment Income Tax (NIIT). However, if you combine all of the time spent on your various investment activities throughout the year, it’s possible that you can make an election to group activities and mitigate your exposure to the NIIT.
The IRS allows the grouping of activities using any reasonable method. There are five key factors provided to help taxpayers determine if activities can be grouped for income tax purposes. These factors, in no particular order, include:
- Similarities and differences between types of trade or business
- Extent of common control
- Extent of common ownership
- Geography
- Interdependency of activities
Grouping activities, a common technique for real estate professionals, can prove to be a solid tax saving technique in all industries. Generally speaking, grouping elections are irrevocable, but taxpayers who have previously grouped activities have the opportunity to re-group activities in 2014 or the first year they are subject to the NIIT. This can serve as a great opportunity for taxpayers to adjust previous groupings if they are no longer beneficial.
Because the grouping elections are generally irrevocable, a decision to group activities shouldn’t be made in a vacuum; there could be long term negative implications associated with an ill-advised election. Be sure to consider the big picture and make sure you’re not making a grouping election to save 3.8% NIIT now at the expense of 39.6% deductions in the future.
Contact your Anders advisor to discuss how a grouping election can reduce your tax liability.
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