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JGTRRA Depreciation Overview Jenna Wiland, CPA Babush, Neiman, Kornman & Johnson, LLP

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 Limits $400,000 spending limit before reduction $100,000 Maximum deduction through 2005 You can cherry pick assets Choose longest life Get 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 property MACRS recovery of 20 years or less Off the shelf software Water 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, 500 Depreciable Basis 5,000 3,500 2,500 Depreciation (39 years) Total Depreciation $128 $1,590 $2,564

Bonus Depreciation Automobiles Luxury auto Luxury auto limits No bonus$ 3,060 30%$ 7,660 50%$10,710 6,000 pounds gross vehicle weight 50% business use test Commuting 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 Exchanges General Rules Related Party Exchanges Tenants In Common Beth Thames, JD Bill Johnson, CPA/ABV Babush, Neiman, Kornman & Johnson, LLP

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

Rev Ruling 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

A B Related Party Property 1 FMV $150 AB $50 Property 2 FMV $150 AB $150 Property 1 Property 2 Example 1 If neither A or B disposes of property relinquished or received within 2 years of transfer, nonrecognition treatment applies. Example 1

A B Related Party Property 1 FMV $150 AB $50 Property 2 FMV $150 AB $150 Example 2 If neither A or B disposes of property relinquished or received within 2 years of transfer, nonrecognition treatment applies. Qualified Intermediary Property 1 Property 2

A Taxpayer Property 1 FMV $150 AB $50 Property 2 FMV $150 AB $150 Example 3 Qualified Intermediary Property 1$150x Property 2 C Third Party Property 1 $150x B Related Party 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

A Taxpayer Property 1 FMV $150 AB $50 Property 2 FMV $150 AB $150 Example 4 Qualified Intermediary Property 1Property 3 Property 2 C Third Party Property 1 $150x B Related Party Ruling seems to indicate that if the related party does not cash out, nonrecognition treatment could still apply. 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 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 Business entity with two or more members is classified for federal tax purposes as a corporation or a partnership

Code Section 761 Term partnership includes syndicates, groups, pools, joint ventures or other unincorporated organizations which carry on any business, financial operation or venture.

IRS Rulings 1975 Rev. Rul 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 Three 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 Managers (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 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 Ruling lists 15 conditions for obtaining a ruling Each co-owner must hold title to dirt as a TIC under local law The number of co-owners must be limited to no more than 35, husband and wife are treated as one co-owner The co-owners must not file a common tax return The co-owners must not have previously held the property as a partnership

Rev. Proc 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 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 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 Possible downside to TIC exchanges Does the TIC meet the like kind rules of Rev. Proc ? 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?