Private Client Services Update – Good News for Professional Service Providers
Behind every cloud there is a silver lining. The principles behind Treasury Regulation §1.469-2(f)(6) that prevented professionals who owned their offices from using the real estate to either generate passive losses or passive income to offset passive losses now has a new twist. With the addition of the 3.8% Net Investment Income or “Obamacare” tax on passive income, rental income from many real estate investments is now subject to an additional tax. However self-rental income from a property owned by professionals and leased to themselves for their business is not subject to the tax.
Many professionals (such as physicians, dentists, attorneys, accountants, and engineers) own their respective offices in an entity—usually a limited liability company—completely separate from their professional service entity—usually some type of professional corporation. The two entities, owned by the same or mostly the same group of professionals, then enter into a landlord-tenant relationship. This relationship is commonly referred to as a “self-rental activity,” and the rental income is commonly known as “self-rental income.” The ownership of the two business entities need not be identical to qualify for self-rental income.
Any professional who is an owner and material participant in the professional service entity and also owns any part of the office building will qualify as receiving self-rental income. A special Federal tax rule classifies self-rental income as active income, even if the owner-professional does not materially participate as a landlord (e.g., the owner-professional hires a third-party property manager to perform all “landlord” tasks). This special rule is commonly known as the “anti-PIG rule.”
The final Net Investment Income (NII) tax Treasury Regulations alleviated any concern that self-rental income would be subject to the NII tax by stating that self-rental income is, by rule (specifically, the anti-PIG rule), non-passive for NII tax purposes. Put another way, the owner-professional need not worry anymore about whether he or she materially participates in the self-rental activity itself for purposes of the NII tax. These taxpayer-friendly regulations thus exclude self-rental income from the NII tax.
Members of the Private Client Services Group are available to help service professionals apply the final regulations, and to counsel service professionals on how the NII tax in general could impact their personal and professional wealth-planning goals.
Robert C. Goodman Jr. is a partner at Kaufman & Canoles. His practice focuses on commercial transactions including mergers and acquisitions, sales of businesses, commercial and land leases, formation of business entities, major system procurements, and split-up of family businesses. In addition to his commercial work, he works closely with families and family businesses in generational and estate tax planning, other tax issues, family dynamics, and charitable objectives.
Ellis H. Pretlow is an associate in the firm’s Norfolk office where her practice focuses on trust and estate matters. Her estate planning work includes drafting advance medical directives, powers of attorney, wills, revocable and irrevocable trusts and often intersects with family business succession planning through the formation of closely held entities. Ellis also assists clients in the administration of estates and the taxation and administration of trusts.
The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2023.