Pub. 12 2013-2014 Issue 4

N e w J e r s e y C o a l i t i o n O f A u t o m o t i v e R e t a i l e r s 25 new jersey auto retailer w w w . n j c a r . o r g paid in restoring property or replacing a capital asset for which depreciation was allowed or allowable. b. De minimis safe harbor election. Under this election, specif ied de minimis expenditures need not be capitalized. 3. Amounts paid to acquire or produce tangible property - Regs. 1.263(a)-2 a. All amounts paid to acquire or pro- duce real or personal property are re- quired to be capitalized. Expenditures for materials and supplies or amounts covered under de minimis safe harbor rules are excluded. b. Facilitative costs are amounts paid in the process of investigating or other- wise pursuing the acquisition. 4. Amounts paid to Improve Property - Regs. 1.263(a)-3 a. Amounts paid to improve a Unit of Property (UOP) owned by the taxpayer after it has been placed in service that result in a (1) betterment; (2) restora- tion; or an (3) adaptation b. The UOP determination is based upon the functional interdependence standard. c. A building improvement is an amount paid for a betterment, resto- ration or adaptation to the building structure or to the building's structural components. d. In the case of a taxpayer that is a lessee of all or a portion of a building (such as an office, floor, certain square footage), the UOP is defined as each building and its structural components subject to the lease and structural components associated with the leased portion. e. An amount paid for routine main- tenance on a UOP is deemed not to improve that unit of property and may be expensed. Net Investment Income Tax The final regulations for Net Investment Income Tax include the following “special rules” applicable to many dealers: 1. Self-charged Interest - When an indi- vidual makes a loan to a pass-through entity conducting a trade or business in which the individual materially participates, the interest income paid by the entity to the individual would be included in net invest- ment income. However, the individual’s al- locable share of the interest expense deduc- tion of the pass-through entity would not be permitted to reduce his net investment income because the expense was generated in a trade or business that was not passive to the individual. To prevent this result, the final regulations provide that, in the case of self-charged interest received from a non passive entity, the individual may exclude an amount equal to the individual’s allocable share of the flow-through entity’s deduction from their net investment income. Note that the “special rule” will not apply to a situation where the interest deduction is taken into account in determining self-employment income subject to SE tax. Example: An individual loans $100,000 to ABC Company, an S corporation in which he owns a 30% interest. ABC Company is not a passive activity to the individual. The company, which conducts a trade or business, pays $8,000 of inter- est to the individual during 2013. Barring a rule to the contrary, the $8,000 of inter- est income recognized by the individual would be included in net investment income. The $2,400 of interest expense is deducted by the company and allocable to the individual, however, it would not be included in the computation of the individual’s net investment income, because the company conducts a trade or business that is non passive to the individual. Under the final regulations, the individual may exclude $2,400 (his 30% share of the company’s $8,000 interest expense deduction) of the $8,000 interest he receives from the company from the computation of net investment income. The remaining $5,600 of interest income must be in- cluded in the individual’s net investment income. 2. Self-charged Rent - Under passive activity rules (Section 469), rental activi- ties are treated as passive, regardless of the owner’s level of participation. However, when an individual rents property to an activity in which the individual materially participates, any net rental income gener- ated by the property is re-characterized as non-passive income. The final net invest- ment income (NII) regulations provide that if rental income is re-characterized as non-passive by the self-rental rules – or if the rental property is properly grouped with a trade or business under Reg. Section 1.469- 4(d)(1) – the rental income is deemed to be derived in the ordinary course of a trade or business. As a result, the income will be excluded from net investment income. Example: A and B each own 50% of an LLC that rents a building to ABC Company, an oper- ating S corporation that is also owned 50/50 by A and B. The LLC generates $20,000 of rental income. For taxable income purposes, the income is re-characterized as non-passive. Under the final NII regulations, the rental income will be treated as having been earned in the ordinary course of a trade or business. As a result, A and B can exclude from net investment income their $10,000 share of the LLC’s rental income. If you are subject to the Net Investment Income Tax and any of the above situations affect you, you should discuss its impact in calculating NII with your tax professional. Robert J. Brown, CPA is a senior partner with The Mironov Group, Edison, New Jersey, he has been working with automotive dealers for over 25 years in all areas of tax & accounting. Bob can be reached at 732-572-3900 or RBrown@mironovgroup.com.