Section 163(j)

Technical topics regarding tax preparation.
#1
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I have a service-based partnership owned 50% by the active manager and 50% by an investor. Annual revenues are $250k (accrual basis).

Although this entity has no interest expense, are you telling me that if it had interest expense, it would be subject to Sec 163(j)?
 

#2
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I thought $25,000,000 was the trigger for 163(j)
 

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I thought that if a business had average annual gross receipts of $25 million or less for the 3 prior tax years, then it was considered a small business taxpayer and not subject to the section 163(j) limitation.

That is about the only thing I think I know about Sec. 163(j).
 

#4
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I thought $25,000,000 was the trigger for 163(j)


It is, but only if you’re not a tax shelter…
 

#5
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Guess I need to look up the definition of tax shelter for 163(j)
 

#6
Coddington  
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Dig into the section 1.448-1T regs. While section 1256 uses the word "allocable", the 448 regs use the word "allocated". In other words, the regs have always required a loss year for the syndicate tax shelter rules to be triggered. The AICPA has comments both this year and last year that address this issue. The comments last year are more specific.
-Brian

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SourceAdvisors.com

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#7
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If this were your “tax shelter” client, raise your hand if you would actually have them on the accrual method…
 

#8
sjrcpa  
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I've got a number of real estate LLCs that are on accrual method b/c they are "tax shelters"
 

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Same as srjcpa over here
 

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In other words, the regs have always required a loss year for the syndicate tax shelter rules to be triggered.


Yes, which means that we might be flip flop between cash and accrual from year to year. And we might be subject to 163(j), or not, from year to year.

Same as srjcpa over here


Indeed. So how do you do it with 50/50 two-man partnership where only partner is “active” (and the partnership might only own 1 residential rental and only $12k of annual rents are collected) – (1) partnership would be on accrual, correct and (2) partnership would be subject to Sec 163(j), right?
 

#11
sjrcpa  
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Seems to be correct. I'm still puzzling/muddling through this for 14 real estate LLCs under common management.
 

#12
Coddington  
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Assuming that we're just talking about syndicate tax shelters, the best solution is to do everything within the taxpayer's power to avoid a loss year. Elect out of bonus depreciation. Elect ADS depreciation. No section 179. No DMSH. Make the section 1.263(a)-3(n) book conformity election to capitalize repairs. Etc. Maybe even give up otherwise allowable deductions.

For the $12k partnership in Jeff's example, this may not be possible. If this small partnership has one rental property where the annual depreciation, by itself, exceeds annual rents, there isn't much that can be done. Not that having to use accrual would be a huge burden. When tax prep time rolls around the taxpayer should have all the A/P for December. A/R shouldn't be a big issue for prepaid rents. Due to the addback for depreciation, you'd need a situation where the entity’s interest deduction is quite large relative to rents, and perhaps has negative cash flow for there to be a big problem under 163(j).
-Brian

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SourceAdvisors.com

Opinions my own.
 

#13
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Jeff-Ohio wrote:Indeed. So how do you do it with 50/50 two-man partnership where only partner is “active” (and the partnership might only own 1 residential rental and only $12k of annual rents are collected) – (1) partnership would be on accrual, correct and (2) partnership would be subject to Sec 163(j), right?


From what I have read, yes.

BUT, my head is a foggy mess. My situation is three partners, two of which are limited but 100% of everything flowing through the partnership, including losses, are allocated to the "managing" partner. They do not meet requirements for safe harbor under 199A. But, I fail to see how they could also qualify as a tax shelter (namely, syndicate, since 100% of profit and losses go to one partner). Seems they are then an excepted trade or business for 163(j), no? Similar scenario you raised--$12k rental income, but total losses amount to $6300, inclusive of depreciation and about $3400 in interest, and excludes over $5k in capitalized repairs that satisfy definition of improvement/betterment.
 

#14
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If all the losses are allocated to the general partner, they are not a tax shelter. Even if it is a loss year for the partnership as a whole and there are more than 35% limited partners, those losses must be allocated to the limited partners for it to be a syndicate. We need to keep in mind that the section 448 tax shelter definitions come from the 1980s and were aimed at that generation of tax shelters, i.e. ones involving the allocation of (excessive) losses to limited partners.
-Brian

Director of Tax Accounting Methods & Credits
SourceAdvisors.com

Opinions my own.
 

#15
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BUT, my head is a foggy mess.


Isn’t this whole thing a foggy mess? We have a provision in the law that says if you have a partnership (or S-corp) – big or small - where 35% of the losses go to “limited entrepreneurs,” we have a “tax shelter” and we have to use accrual. And because we’re a tax shelter, the $25m gross receipts exception to Sec 163(j) doesn’t apply.

Does anybody know what a “limited entrepreneur” is?

Has the professional literature done a good job of explaining the $25m rule – and how it might be worthless to many “small businesses” given the definition of “syndicate?”

Is this change of accounting method city? Are we back to the big mess we had with the Sec 263(a) Regulations…but worse…because we might have to flip flop from year-to-year depending on profitability and the make-up of the owners?
 


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