The final regulations under IRC Section 1411, Investment Income 3.8% Medicare Tax, were issued last week. I posted the proposed regulations relating to the tax earlier this year.
The regulations now include provisions favorable for rental real estate operations. This a major change from the proposed regulations issued last December. The 3.8% investment income Medicare tax applies to net rental income, unless the income is derived from a 1) non-passive and 2) trade or business rental activity.
Three rules make a rental real estate activity non-passive:
- The re-characterization rule, whereby a taxpayer rents the real estate to an activity that he or she materially participates in.
- The grouping rule, whereby a taxpayer groups the rental real estate activity with a trade or business activity that he or she materially participates in.
- The real estate professional rule, whereby the taxpayer qualifies as a real estate professional and materially participates in the rental real estate activity.
Prior to the issuance of the final regulations, it was unclear what was needed for a rental real estate activity to qualify as a trade or business. The second prong of the test above. The final regulations make it clear that in all three of the above situations (rules), the rental real estate activity constitutes a trade or business and therefore, the net income is not subject to the 3.8% investment income Medicare tax. In order to qualify under the last rule, a 500 hour material participation test is required.
The IRS actually listened to our comments on the proposed regulations requesting this change. AWESOME.
I had a great Thanksgiving. Our family, 6 children and spouses and 9 grandchildren, came over for a great meal cooked by Janny. The grandkids had a blast with Nanna and Pa. So did Nanna and Pa. We were able to FaceTime Jim, our son in the army too. AWESOME.