Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants

1. WELCOME Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants Celebrating 40 Years of Serving You    4th QUARTER REAL ESTATE ROUNDTABLE Babush, Neiman, Kornman & Johnson, LLP Certified Public Accountants & Consultants

2. JGTRRA Depreciation Overview Jenna Wiland, CPA Babush, Neiman, Kornman & Johnson, LLP www.bnkj.com

3. 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

4. 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

5. Section 179 • 2003 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

6. 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

7. 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

8. 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...

9. Bonus Depreciation • Numerical Example • Old Method30% Method50%Method • Improvements$5,000 $5,000 $5,000 • Bonus Depreciation 01,5002,500 • Depreciable Basis 5,000 3,500 2,500 • Depreciation (39 years) 128 90 64 • Total Depreciation $128 $1,590 $2,564

10. 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

11. Bonus Depreciation • Not eligible • Listed property with less than 50% business use • Binding contract prior to 9/11/01 (5/6/03) • Used goods

12. 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

13. Bonus Depreciation • Federal purposes only • Georgia does NOT accept • 30% or %50 bonus depreciation • Increase in Sec. 179 • Other states vary

14. 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

15. 1031 ExchangesGeneral RulesRelated Party ExchangesTenants In Common Beth Thames, JD Bill Johnson, CPA/ABV Babush, Neiman, Kornman & Johnson, LLP www.bnkj.com

16. 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

17. 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

18. 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”)

19. Related Party Rules -1031 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

20. Related Party Rules -1031 Exchanges • Does not apply to sales related to • Death • Compulsory or involuntary conversion

21. Rev Ruling 2002-83 • 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”

22. 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

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

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

25. Example3 A Taxpayer B Related Party Property 2 Property 2 Property 1 FMV $150 AB $50 Property 2 FMV $150 AB $150 Qualified Intermediary Property 1 $150x Property 1 $150x C Third 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 2002-83.

26. Example 4 A Taxpayer B Related Party Property 2 Property 2 Property 1 FMV $150 AB $50 Property 2 FMV $150 AB $150 Qualified Intermediary Property 1 Property 3 Property 1 Property 3 $150x $150x C Third Party Property 3 Ruling 2002-83 seems to indicate that if the related party does not cash out, nonrecognition treatment could still apply.

27. 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

28. 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

29. 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.

30. Code Section 301.7701 • 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

31. Code Section 301.7701 • Business entity with two or more members is classified for federal tax purposes as a corporation or a partnership

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

33. IRS Rulings • 1975 Rev. Rul. 75-374 • 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. 79-77 • Three person co-ownership of a commercial building did not constitute a partnership for the same reasons

34. 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 • Manager’s (usually the sponsor) • participation in potential profits • and losses

35. 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

36. Rev. Proc. 2002-22 • 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

37. Rev. Proc. 2002-22 • 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

38. Rev. Proc. 2002-22 • 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.

39. Rev. Proc. 2002-22 • 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.

40. Rev. Proc. 2002-22 • 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

41. Rev. Proc. 2002-22 • Possible downside to TIC exchanges • Does the TIC meet the like kind rules of Rev. Proc 2002-22? • 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?