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Babush, Neiman, Kornman & Johnson, LLP

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JGTRRA Depreciation Overview

Jenna Wiland, CPA

Babush, Neiman, Kornman & Johnson, LLPwww.bnkj.com

Two Recent Law Changes

Job Creation and Workers Assistance Act of 2002 (JCWAA)

30% bonus depreciation Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)

50% bonus depreciation Increase in Sec. 179 deduction

Section 179 Qualifying Property

Tangible MACRS only Off the shelf computer software (NEW) Acquired by purchase

May not include Property held for investment or outside US Air conditioning/heating units Personal property used for lodging such as apartments, but motels do qualify Less than 50% business use No real property

Section 179

2003 Limits$400,000 spending limit before reduction$100,000 Maximum deduction through 2005

You can cherry pick assetsChoose longest lifeGet out of mid quarter

Limited to taxable income (can carry forward excess)

Limitations apply to pass through taxpayer also

Bonus Depreciation

30% (9/11/01-5/5/03) & 50% (5/6/03-1/1/05) Qualifying property

Must be new, tangible propertyMACRS recovery of 20 years or lessOff the shelf softwareWater utility property Qualified leasehold improvement

Bonus Depreciation Special rules for leasehold

improvements Nonresidential rental real property (office, retail, warehouse etc…) Interior portion of the building Occupied exclusively by lessee Lessee can not be related party Building must be at least 3 years

old

Bonus Depreciation

Special rules for leasehold improvements May not include

Building enlargement Structural component benefiting common area Internal structural framework of building

May include carpeting, painting, wallboard, upgrades etc...

Bonus Depreciation

Numerical Example

Old Method 30% Method 50%Method

Improvements $5,000 $5,000 $5,000

Bonus Depreciation 0 1,500 2,500Depreciable Basis 5,000 3,500 2,500Depreciation (39 years) 128 90 64Total Depreciation $128 $1,590 $2,564

Bonus Depreciation

AutomobilesLuxury autoLuxury auto limits

No bonus $ 3,06030% $ 7,66050% $10,710

6,000 pounds gross vehicle weight50% business use testCommuting miles are not business

Bonus Depreciation

Not eligible

Listed property with less than 50% business use

Binding contract prior to 9/11/01 (5/6/03)

Used goods

Bonus Depreciation Allowed on trade-in Allowed for 1031 exchange (special rules) No income limitation (may create a loss) Must elect out by class (5year/7year/etc…) May combine with Sec. 179

Bonus Depreciation

Federal purposes only Georgia does NOT accept

30% or %50 bonus depreciation Increase in Sec. 179

Other states vary

Bonus Depreciation/Sec. 179

Recapture rules apply if dispose or business use drops below 50% No AMT effect if take bonus depreciation Consider hiring classification expert (cost segregation report) See your tax advisor

1031 ExchangesGeneral RulesRelated Party ExchangesTenants In Common

Beth Thames, JD

Bill Johnson, CPA/ABV

Babush, Neiman, Kornman & Johnson, LLPwww.bnkj.com

1031 Exchange Requirements Property must be “like-kind” Cost of replacement property

must equal net sales price of

property sold (Maximum gain to

extent of under investment) Mortgaged property exchanged

for mortgaged property results

in gain to extent of net reduction

in debt

1031 Exchange Requirements Must identify replacement

property within 45 days (can be

more than one property) Must close on replacement

property within 180 days Exchange must be simultaneous

or must use intermediary Interest in a partnership can

not be exchanged

Related Party Rules & History Rationale for deferral on exchange of like-kind properties: perception that recognition is inappropriate if remain invested in the same kind or class of property No “cashing out” of the investment has occurred Previously related parties could act together to cash out of high basis/low gain property & hold low basis/high gain property (“basis shifting”)

Related Party Rules -1031 Exchanges

Exchange of property between related parties requires a 2 year holding period of both properties Earlier than 2 year sale triggers gain on property still held! Does not apply where there is no “basis shifting” or tax avoiding motive

Related Party Rules -1031 Exchanges

Does not apply to sales related to Death Compulsory or involuntary conversion

Rev Ruling 2002-83 Using unrelated qualified intermediary by related parties for an exchange is not afforded no recognition treatment. Transaction structured to avoid related party rules by using qualified intermediary. Transfer of relinquished property to qualified intermediary in exchange for replacement property formerly owned by related party is not afforded no recognition treatment. Taxpayer has “cashed out”

Related Parties

Family members Corporation and greater than 50% shareholders Two corporations part of same controlled group (greater than 50% common ownership) Other greater than 50% related party ownerships

AB

RelatedParty

Property 1FMV $150

AB $50

Property 2FMV $150AB $150

Property 1

Property 2

Example 1If neither A or B disposes of property relinquished or received within 2 years of transfer, nonrecognition treatment applies.

Example 1

AB

RelatedParty

Property 1FMV $150

AB $50

Property 2FMV $150AB $150

Example 2

If neither A or B disposes of property relinquished or received within 2 years of transfer, nonrecognition treatment applies.

QualifiedIntermediary

Property 1 Property 1

Property 2Property 2

ATaxpayer

Property 1FMV $150

AB $50

Property 2FMV $150AB $150

Example 3

QualifiedIntermediary

Property 1 $150x

Property 2Property 2

CThird Party

Property 1

$150x

BRelatedParty

Transaction does not qualify for nonrecognition treatment. Taxpayer A, via relationship to B, has cashed out of the property and will recognize $100 in gain. Rev. Ruling 2002-83.

ATaxpayer

Property 1FMV $150

AB $50

Property 2FMV $150AB $150

Example 4

QualifiedIntermediary

Property 1 Property 3

Property 2Property 2

CThird Party

Property 1

$150x

BRelatedParty

Ruling 2002-83 seems to indicate that if the related party does not cash out, nonrecognition treatmentcould still apply.

Property 3

Property 3

$150x

Fractional Interests in 1031 Exchanges

Advantages for using fractional ownership to complete 1031 exchange Increased opportunities to identify replacement property within 45 days Ability to buy into institutional grade properties Potential to diversify into multiple properties with fewer dollars Professional management

TIC Central Characteristics

Each owner is deemed to own a physically undivided part of the entire parcel of land

Each TIC is entitled to a proportionate share of the benefits derived from the whole

IRS Rulings

Concern over the fractional interest replacement property being considered a partnership interest has prevented investors from being able to buy larger and maybe more attractive properties.

Code Section 301.7701 Provides whether or not an arrangement is separate from its owners is determined by Federal not State law Joint venture arrangements may create a separate entity (Partnership) for federal tax purposes if the participants

Carry on a trade or business Divide the profits

Mere co-ownership of maintained property, kept in repair, and rented or leased does not constitute a partnership

Code Section 301.7701

Business entity with two or more members is classified for federal tax purposes as a corporation or a partnership

Code Section 761

Term “partnership” includessyndicates, groups, pools, joint ventures or other unincorporated organizations which carry onany business, financial operation or venture.

IRS Rulings 1975 Rev. Rul. 75-374

Two-person co-ownership of an apartment building that was rented to tenants did not constitute a partnership for federal tax purposes

Co-owners employed an agent to manage the apartments, collect the rents, pay expenses and provide the tenants with customary services of an apartment building

1979 Rev. Rul. 79-77Three person co-ownership of a

commercial building did not constitute a partnership for the same reasons

IRS Rulings

1987, 1991 & 1993, the IRS was successful in classifying co-ownership of leased property as a partnership

Factors that influenced the decision Limitations on the co-owners’ ability to sell their interest Manager’s (usually the sponsor) participation in potential profits and losses

IRS Rulings 1990s investment companies (Sponsors) began offering TIC interests to complete 1031 exchanges

Investors receive a deed for a portion of the dirt, rather than a share in an entity Sponsors applied for revenue rulings to approve the use of TICs for replacement property in exchanges

2000 the IRS placed the issue on its list of “no-rule” areas

Rev. Proc. 2002-22

Addresses the use of fractional interest as replacement property Removes the issue from the “no- rule” list Specifies conditions under which the IRS will consider a request for a ruling in this area Does not provide a safe harbor for fractional interest

Rev. Proc. 2002-22 Ruling lists 15 conditions for obtaining a ruling

Each co-owner must hold title to dirt as a TIC under local lawThe number of co-owners must be limited to no more than 35, husband and wife are treated as one co-ownerThe co-owners must not file a common tax returnThe co-owners must not have previously held the property as a partnership

Rev. Proc. 2002-22

Ruling lists 15 conditions for obtaining a ruling

Any decision that has a material effect on the property must be approved unanimously. Material effect includes the decision to sell, sign a new lease and to create new financing. All other decisions require a simple majority vote.

Rev. Proc. 2002-22 Ruling lists 15 conditions for obtaining a ruling

Each co-owner must be able to transfer or mortgage their interest without approval. Program sponsor may receive a right of first refusal. Normal restrictions by a lender are not prohibited. No related lender All revenue and expenses must be shared proportionally. Requires separate accounting.

Rev. Proc. 2002-22

Ruling lists 15 conditions for obtaining a ruling

Sponsor may own the property for only six months before 100% of the interests are sold Management agreement must be renewable annually and must be at a market rate

Rev. Proc. 2002-22 Possible downside to TIC exchanges

Does the TIC meet the like kind rules of Rev. Proc 2002-22? How do you manage the property with many owners making decisions without having documents that look like a partnership? Need to compare fees to lowered capital gains taxes. Need to look at 25% rate on depreciation recapture. Must have good economic prospects with the acquired real estate. May want to invest in several TIC deals. What is liquidity of deal?