This month’s small business update includes the following:
- Recent legal developments have created uncertainty around BOI filing deadlines, and it’s important to understand your options and responsibilities
- Deducting your rental property tax losses against your other income is tricky
- If you buy and sell real estate, you need to know the difference between being classified for tax purposes as a real estate dealer versus a real estate investor
File Your BOI Report Now or Wait?
An update on the Corporate Transparency Act (CTA) and its beneficial ownership information (BOI) reporting requirements.
Background on the CTA
The CTA requires many smaller corporations and LLCs to file a BOI report with FinCEN, identifying and providing contact information for the individuals who own or control the entity. This report is used solely for law enforcement purposes and is not made public.
Initially, businesses in existence before 2024 were required to file by January 1, 2025, while new businesses formed in 2024 had a 90-day filing deadline. However, recent court rulings have disrupted these deadlines.
Current Status
As of January 1, 2025, a nationwide injunction is in place, delaying all BOI filing requirements. While the injunction is active, you are not required to file a BOI report, and no penalties apply for non-filing.
The injunction impacts the following entities:
- Businesses formed before 2024 with a January 1, 2025, deadline
- New businesses formed in 2024 with a 90-day filing deadline
- Businesses with changes requiring updates to previously filed reports
Voluntary Filing Option
Although filing is not currently required, you may file voluntarily. This can simplify compliance by avoiding last-minute deadlines if the injunction is lifted. Should the injunction end, deadlines may resume with little notice, so being prepared is essential.
Takeaways
While the CTA remains under judicial review, you are not obligated to file your BOI report. But it may be prudent to prepare now by gathering the necessary information. If you have already filed, no further action is needed unless there are reportable changes.
Can Real Estate Professional Status Free Up Old Passive Losses?
Deducting your rental property tax losses against your other income is tricky, as you likely know. You have to get the tax law to treat you—say, a computer engineer—as a tax-code–defined real estate professional.
Let’s say you get there. Does that status allow immediate use of suspended passive losses? Unfortunately, the answer is no. Here’s why.
Understanding Passive Loss Rules
The tax code limits passive loss deductions to passive income, with any excess carried forward to future years.
You release the carried-forward losses when you:
- have offsetting passive income from the same or other passive activities, or
- completely dispose of the activity generating the loss.
Real Estate Professional Status
Qualifying as a real estate professional under IRS rules requires meeting two tests annually:
- Spend more than 50% of your work time in real property trades or businesses.
- Perform at least 750 hours of your work in real property trades or businesses.
Material Participation
Additionally, you must materially participate in the rental activity to create non-passive losses.
The Two-Part Solution
Meeting (1) the real estate professional test and (2) the material participation standard allows current-year rental losses to offset non-passive income, such as wages or business income.
Impact on Prior Passive Losses
Qualifying as a real estate professional is not retroactive. Suspended passive losses from prior years remain subject to the original rules.
You can use the prior suspended losses in the following ways:
- To offset passive income from the same or other passive activities
- When you completely dispose of the activity that created the suspended passive losses
Key Takeaways
Real estate professional status offers valuable tax benefits for your rental properties but does not free up prior passive losses. Annual testing is required to maintain this status.
Are You A Real Estate Dealer Or Investor?
If you buy and sell real estate, you need to know the difference between being classified for tax purposes as a real estate dealer versus a real estate investor.
Real estate dealers are in the business of buying and selling real property—property is their inventory.
Real estate dealers typically include (but are not limited to),
- Real estate flippers—people who buy homes, fix them up, and resell them quickly;
- Real estate speculators, who buy and sell many properties each year;
- Subdividers, who buy large tracts of vacant land, divide them into smaller lots, and then resell the lots piecemeal; and
- Real estate developers and home builders, who construct new houses and resell them soon after completion.
Real estate investors own property primarily to earn income from rents and/or long-term appreciation. Their real estate activity is not a business.
To make things even more complicated, you can own some property for sale as a dealer and other property as a long-term investment.
Whether you are a dealer is determined on a property-by-property basis. If you have dealer and investor properties, you should keep separate books, records, and bank accounts.
Why is this distinction important? Because dealers and investors receive very different tax treatment.
As business owners, real estate dealers pay taxes on their profits at ordinary income rates, which can be as high as 37%. They also pay self-employment taxes.
Real estate investors pay taxes on their profits at capital gains rates and pay no self-employment tax. If they hold their property for over one year, they pay tax at long-term capital gains rates of 0, 15, or 20%. They may also have to pay the 3.8% net investment income tax (NIIT).
The difference in tax rates can have a big impact if you sell real property at a substantial profit.
For example, if you earn a $100,000 profit from the sale of a property held for over one year, your taxes as a dealer could be as high as $51,130 (37% income tax + 14.13% self-employment tax). If you’re an investor, your taxes could be as high as $23,800 (20% capital gains tax + 3.8% NIIT). That’s a $27,330 difference.
Dealers may also not deduct depreciation, use installment sales, or defer tax through Section 1031 tax-deferred exchanges of their property
Things are not all bad for real estate dealers. Unlike investors, they may fully deduct their losses.
Investors may deduct no more than $3,000 in losses from ordinary income (after offsetting gains against losses)
Unfortunately, the tax code does not provide a definition of “real estate dealer.” Instead, the IRS and the courts look at various factors, including:
- How many of your properties do you sell, and how frequently?
- Did you buy with the intent of reselling at a profit?
- Did you improve the property to increase its resale value?
- What is the extent of your sales efforts?
- How did you acquire the property?
- How long did you hold the property before selling it?
- How much time did you spend selling the properties?
- What portion of your income comes from selling your properties?
Contact your tax and financial advisors to determine the best moves for your situation.