Tag: real estate

Tax Court Holds that a Trust can Qualify for the "Real Estate Professional Exception" of Section 469(c)(7)

Proskauer

The Tax Court recently handed down its decision in Frank Aragona Trust v. Commissioner, ruling that a trust can qualify for the real estate professional exception of Section 469(c)(7). By taking into account the actions of the trustees, a trust can be considered to be materially participating in real estate activities. This means that losses from real estate activities can be treated as nonpassive and therefore deductible in determining the trust’s taxable income. This decision is especially relevant to trusts that own business as it affects the application of the passive activity loss rules in Section 469 and whether income from those activities is subject to the new 3.8% net investment income Medicare surtax under Section 1411.

The Frank Aragona Trust (the “Trust”) was a Michigan trust that owned several pieces of real property and was also involved in the business aspects of developing and maintaining the property. The Trust had six trustees, three of whom were also employees of Holiday Enterprises, LLC (the “LLC”). The LLC was owned 100% by the Trust. The LLC also employed other professionals.

The Trust had losses in 2005 and 2006 from its real estate activities and deducted those losses(on the basis that they resulted from nonpassive activities) on its income tax returns. In issuing a notice of deficiency for those tax years, the Service determined that the real estate activities were passive under Section 469 and therefore any related losses were not deductible.

In general, real estate rental activity is considered passive regardless of whether the taxpayer materially participates in the real estate business. However, there is an exception for “real estate professionals” under Section 469(c)(7). Before the Tax Court, the Trustees argued that the Trust was a “real estate professional” as defined in Section 469(c)(7) so that the losses were considered to be from nonpassive activities and therefore deductible. To qualify for the real estate professional exception, a taxpayer must pass two tests. First, more than one-half of the personal services performed in a taxable year must be performed in real property trades or businesses in which the taxpayer materially participates. Second, the taxpayer must perform more than 750 hours or services during the taxable year in real property trades or businesses in which the taxpayer materially participates. The Service argued that the regulations to Section 469(c)(7) define “personal services” as “work performed by an individual in connection with a trade or business [emphasis added].” Because the trust was not an individual, it could not perform personal services and therefore did not fall under the Section 469(c)(7) exception.

The Tax Court rejected the Service’s argument that the trust could not be considered an individual under Section 469(c)(7) and the associated regulations. Further, the Court found that the Trustees’ participation in the real estate activities met the material participation requirements of Section 469(c)(7) because they were regular, continuous and substantial. The Court determined that the participation of the Trustees should be considered in determining whether the taxpayer (the Trust) materially participated in the real estate activities. The Service argued that the activities of the Trustee should only apply if they are performed in their capacity as Trustees (as opposed to employees of the LLC). Here, the Court looked to Michigan law, under which trustees are required to administer trusts solely for the benefit of the trust beneficiaries. The Court explained that the Trustees could not simply stop acting as Trustees because they were also employees of the LLC, so that their activities in other capacities could be considered in whether the Trust was a material participant in the real estate activities.

In summary, a trust may be able to qualify for the real estate professional exception of Section 469(c)(7). If the trust qualifies for the exception, losses from the associated real estate activities may be deductible on the trust’s income tax return. This distinction has increased importance with the application of the new 3.8% net investment income Medicare surtax under Section 1411.

Article By:

Albert W Gortz
George D Karibjanian
David Pratt
Mitchell M Gaswirth
Andrew M Katzenstein
Henry J Leibowitz
Of:
Proskauer Rose LLP

 

U.S. Tax Court Rejects Internal Revenue Service's (IRS) Restrictive View of Trust Material Participation

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The U.S. Tax Court recently issued a taxpayer favorable opinion regarding how a trust materially participates in its activities. The court’s holding will make it easier for trusts to currently deduct expenses against non-passive income and to exclude income from the reach of the new 3.8% net investment income tax.

In Frank Aragona Trust v. Comm’r, the court held that in determining whether a trust materially participates in its activities, the activities of the trustees, including their activities as employees of the businesses owned by the trust, should be considered. The court’s opinion directly conflicts with recent IRS guidance that only a trustee’s time spent acting in a fiduciary capacity counts toward the trust’s material participation – a standard that would be very difficult for most trusts to meet. See Technical Advice Memorandum 201317010.

In Frank Aragona Trust, a Michigan trust owned rental real estate activities and engaged in holding and developing real estate. The trust conducted some of its activities directly, and others through its wholly-owned business, Holiday Enterprises, LLC. The trust had six trustees, three of whom worked full-time for Holiday Enterprises. The IRS argued that the participation of the trustee-employees should be disregarded. The court disagreed and concluded that the participation of the trustee-employees should be counted and further, that the participation of the trust’s six trustees was sufficient to meet the material participation standard. The court based its decision, in part, on the fact that Michigan law requires trustees to “administer the trust solely in the interest of the trust beneficiaries” even when they are participating through a business wholly-owned by the trust. This decision provides helpful authority for trusts, their trustees and their advisors in navigating the complex passive activity loss and net investment income tax rules.

However, the decision in Frank Aragona Trust does not answer all of the outstanding questions regarding material participation of trusts. In recently finalized regulations implementing the net investment income tax, the Treasury Department and the IRS requested public comments on rules regarding material participation of trusts, which indicates that the IRS may finally undertake a formal project to provide long-awaited guidance on this issue.

Article By:

Michala P. Irons
Randal J. Kaltenmark
William M. Pope
Douglas S. Robson
Howard J. Rubin
Of:
Barnes & Thornburg LLP

It’s That Time of the Year Again Re: Wisconsin Property Taxes

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It’s time to open up the unwelcome envelope with your property tax bill inside. Property taxes are necessary, of course, for roads and schools and all of the other services your property receives, but you should take some time to make sure that you are not paying more than your fair share of these taxes.

Wisconsin’s State Constitution has a provision requiring that all real estate be taxed “uniformly.” Regular real estate and personal property is taxed by the local municipality. Property which is used for manufacturing purposes, is taxed by the State of Wisconsin, in an effort to make sure that manufacturing property throughout the State is taxed in the same manner. Land which is in agricultural use enjoys a separate “use value assessment” system, which not only allows a lower assessment for land in that use, but also requires a per-acre penalty if that land is removed from the ag use, as defined by those statutes.

Of course, each of those taxing categories is controlled by pages of regulations containing definitions and limitations which are too complicated to insert into this article. Be aware that if you bought a parcel during calendar year 2013, your tax assessment may rise next year to the sale price named on the Transfer Tax Return filed with that deed, and you will receive a notice next spring of that increased assessment. The notice will tell you the procedure for contesting that new higher assessment and the time period, usually very short, during which you must file an appeal or lose the opportunity for another year. However, if your tax assessment should have been reduced and was not, you might not receive a notice at all, which means you must affirmatively seek out the date for filing the tax challenge and the forms needed to preserve the right to challenge. You must affirmatively notify the assessor if you demolished a building, lost a tenant, suffered a casualty loss, signed new leases for lower rents or had to offer rent concessions to renew a lease, or moved a parcel of land into or out of ag use, if you want to be sure the tax assessment is properly calculated for the actual use of the land and actual income from it. We can help you evaluate behind the scenes if the property is accurately assessed, and if it is not, file and defend a claim for you. We often charge a nominal amount for the investigation and then take the tax challenge on a contingency basis so you are only billed if we secure a tax savings for you.

Article by:

Nancy Leary Haggerty

Of:

Michael Best & Friedrich LLP

One Day Left to Share Your Comments about the Closing Process with the Consumer Financial Protection Bureau (CFPB)!

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On January 3, the Consumer Financial Protection Bureau (“CFPB”) issued a notice and request for information in the Federal Register regarding the real estate closing process. Specifically, the CFPB is interested in knowing the consumer “pain points” associated with mortgage closing and how those pain points might be addressed by market innovations and technology.

The bureau wants input from consumers, mortgage lenders, housing attorneys, settlement closing agents, real estate agents, fair lending and consumer advocates – basically anyone and everyone with closing experience. This is your chance to share your perspective, whether good or bad, and help the closing process to be a smoother and more consumer friendly one for your future purchase, sale or refinance. The information collected during the comment period will be used to help the CFPB come up with future improvement initiatives. This is part of the larger “Know Before You Owe” project, which is intended to help consumers understand and navigate the home-buying process.

The CFPB has made it easy to share information by listing seventeen specific questions they would like responses to, including:

1. What are common problems or issues consumers face at closing? What parts of the closing process do consumers find confusing or overwhelming?

2. Are there specific parts of the closing process that borrowers find particularly helpful?

3. What do consumers remember about closing as related to the overall mortgage/home-buying process? What do consumers remember about closing?

4. How long does the closing process usually take? Do borrowers feel that the time at the closing table was an appropriate amount of time? Is it too long? Too short? Just right?

5. How empowered do consumers seem to feel at closing? Did they come to closing with questions? Did they review the forms beforehand? Did they know that they can request their documents in advance? Did they negotiate?

6. What, if anything, have you found helps consumers understand the terms of the loan?

7. What are some common errors you have seen at closing? How are these errors detected, if at all? Tell us about errors that were detected after closing.

8. What changes, diverging from what was originally presented at closing, often surprise consumers at closing? How do consumers react to changes at closing?

9. How, if at all, do consumers typically seek advice during closing? In person? By phone? Online?

10. Where and to whom do consumers turn for advice during closing? Whom do they typically trust?

11. What documents do borrowers usually remember seeing? What documents they remember signing?

12. What documents do consumers find particularly confusing?

13. What resources do borrowers use to define unfamiliar terms of the loan?

14. What, if anything, would you change about the closing process to make it a better experience for consumers?

15. What questions should consumers ask at closing? What are the most important pieces of information/documents for them to review?

16. What is the single most important question a consumer should ask at closing?

17. What is the single most important thing a consumer should do before coming to the closing table?

You can submit answers to these questions, along with your own additional comments, online by visiting this webpage:  http://www.regulations.gov. But time is of the essence! The comment period closes tomorrow, February 7th. Hurry and let your opinions be known!

 

Article by:

Brittany C. MacGregor

Of:

McBrayer, McGinnis, Leslie and Kirkland, PLLC

Prospective Waivers of the Fair Market Value Defense Held Invalid in Arizona Court

Lewis Roca Rothgerber

In an opinion issued last week, the Arizona Court of Appeals held that commercial borrowers and guarantors ‎cannot prospectively waive their right to limit their damages in a deficiency action on the basis of the fair market value of property ‎sold through a trustee’s sale, potentially impacting any loan agreements that provide for such ‎waivers.‎ The holding does not affect most residential loans, for which lenders are generally precluded from recovering deficiencies.

Background

A.R.S. § 33-814(A) provides that borrowers, and by extension guarantors, are entitled to a credit ‎on the underlying debt for the greater of the trustee’s sale price or the fair market value of the ‎trust property at the time of the sale, as determined by the court at a priority hearing. The ‎purpose of these provisions is to protect borrowers from inequities that may result if the property ‎is sold below market value. In an effort to avoid litigation, lenders sometimes include language ‎in loan documents stating that borrowers and guarantors waive the ability to seek a determination ‎of market value.‎

The Arizona Court of Appeals Abolishes Prospective Waivers of the Fair Market Value Defense

A prospective waiver of a fair market defense hearing was at issue in CSA 13-101 Loop, LLC v. ‎Loop 101, LLC., No. 1 CA-CV 12-0167, 2013 WL 4824461 (Ariz. App. Sept. 10, 2013). In that ‎case, a lender made a $15.6 million loan, which was secured by a deed of trust. In the note and ‎guaranty, the borrower and guarantors waived “the benefits of any statutory provision limiting ‎the right of [lender] to recover a deficiency,” including the benefits of A.R.S. § 33-814. Even ‎more specific, the deed of trust stated that the sales price at the trustee’s sale would conclusively ‎establish the fair market value of the property and that the borrower and guarantors waived their ‎ability to seek a fair market value determination.‎

Following a default, the lender initiated a trustee’s sale, at which the lender’s assignee purchased ‎the property with a credit bid of $6.15 million. At the time, about $11.2 million remained due on ‎the note. The lender’s assignee then brought a deficiency action against the borrower and ‎guarantors for the difference. The borrower and guarantors counterclaimed, asserting that the ‎credit bid was unreasonably low. The court denied a motion to dismiss the counterclaims, ‎holding the borrower and guarantors were entitled to a fair market value hearing ‎notwithstanding the written agreements to the contrary. ‎

The Court of Appeals affirmed, holding that the deed of trust statutes impliedly prohibit ‎prospective waivers of fair market value hearings. The court relied on the purpose of the deed of ‎trust statutes, the comprehensiveness of the protections, and the legislative history, which the ‎court stated was to protect borrowers from the unfairness that results if a property is sold at a ‎trustee’s sale below its market value. According to the court, allowing parties to prospectively ‎waive the protection of a fair market value hearing would effectively undo the statutory scheme ‎and undermine an important purpose of the deed of trust statutes.‎

Conclusion

Arizona’s appellate courts have shown increased interest of late in foreclosure-related cases. ‎Earlier this summer, Division One of the Arizona Court of Appeals abolished prospective ‎waivers by borrowers of the residential anti-deficiency protections under A.R.S. § 33-814(G) based on public ‎policy grounds. Parkway Bank & Trust Co. v. Zivkovic, 232 Ariz. 286, 304 P.3d 1109 (App. ‎‎2013). In another decision out last week, Division Two of the Arizona Court of Appeals, citing ‎Parkway Bank, declined to consider whether a guarantor can waive same the protections of A.R.S. § ‎‎33-814. First Credit Union v. Courtney, No. 2 CA-CV 2013-0005, slip op. (Ariz. App. Sept. 12, ‎‎2013). Lewis Roca Rothgerber continues to monitor the developments in this evolving area.‎

Lenders, borrowers, and guarantors should consider how these recent decisions affect their ‎existing and prospective lending relationships.

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