1. Legal and Tax Considerations for Investment Properties Presented to: Presented by Jeffrey D. Cohen, Esq., C.P.A. The Cohen Law Firm, P.C. 6610 Gunpark Drive, Suite 202 Boulder, Colorado 80301 Telephone 303-733-0103 www.cohenadvisors.net jeff@cohenadvisors.net The Cohen Law Firm, P.C.1

2. Notice to Readers Legal Disclaimer - This material is to be used for general discussion only and is intended for continuing education purposes and is not intended to be used as legal or tax advice for any specific situation. It has been prepared based on current legal and tax law so the reader should make sure to ascertain if there have been any changes to the legal and tax law. Please consult your own legal or tax advisors for your specific situation. IRS Disclosures Under Circular 230 - The IRS requires us to inform you that any federal tax advice in this presentation and any attached documents is not intended or written to be used, and cannot be used, (1) for the purpose of avoiding federal tax penalties or (2) promoting, marketing or recommending any transaction discussed in this communication to another person unless we expressly indicate otherwise. The Cohen Law Firm, P.C.2

3. Table of Contents Purchasing Investment Property Converting a Primary Residence into an Investment Property Converting an Investment Property into a Primary Residence Operations/Tax Reporting of Investment Properties Sale/Dispositions/Transfer of Investment Property Q&A The Cohen Law Firm, P.C.3

4. Purchasing Investment Property How to hold property Individually Jointly Entity – Liability and Tax Impact (Outright or transfer) C-Corp/S Corp §§ 1371 & 1374 - Distribution of real estate - Built in Gains on Appreciation – Phantom Tax – Sale concern - §1031 exchange issues Personal Residence & Personal Use – Benefit to Shareholder Deemed Income/Dividend – Value of Use of Property The Cohen Law Firm, P.C.4

5. Purchasing Investment Property (Con’t) LLC/LLP Transfer Tax Basis §1031 Exchange Single Member LLC (SMLLC) Disregarded for Tax Purposes - Reg. §301.7701-3 Impact of Mortgage Purpose of Loan – Primary Residence or Rental Purposes – Mortgage Application Due on transfer clause (purchase individually and transfer to entity) Insurance Considerations The Cohen Law Firm, P.C.5

6. Converting a Primary Residence into an Investment Property Transfer to Entity Mortgage – Due on Transfer Clause – Transfer of Title Can Trigger Mortgage Due on Sale/Transfer Clause, the Right of Lender to Call the Loan and Demand Repayment in Full. SMLLC Impact – Due on Transfer/Sale Clause Generally Applies, but often not enforced for a SMLLC. SMLLC not disregarded for legal purposes. Title Transfer – Quit Claim Deed, General Warranty Deed, Special Warranty Deed § 121 Primary Residence Capital Gains Exclusion 2/5 Years – General Rule - Ownership and Use If transfer to Entity - Need to Transfer Property Back Out Prior to Sale (Built in Gains if C or S Corp.) SMLLC Exception – Disregarded for tax purposes The Cohen Law Firm, P.C.6

7. Converting a Primary Residence into an Investment Property (Con’t) Loss on Sale Allocation of Loss - Losses on a Primary Residence Not Allowed – Any Loss that Occurred While the Property was a Primary Residence is not Included in Loss Calculation. Tax Treatment – Basis is Lower of the Property’s Adjusted Basis or FMV at the Time of the Conversion from a Personal Residence – Reg. Sec. 1.165- 9(b)(2) Example: Taxpayer purchased a home for 100k and used it as a primary residence for 2 years. Taxpayer then converts the home to a rental property for two years before selling it. At the time of conversion to a rental, the fair market value was 80k. At the time of the sale, the value had dropped to 70K. Though the total loss it 30k, taxpayer would be limited to a maximum loss of 10k which is the fair market value at the time of conversion to rental, less the fair market value at the time of the sale. The Cohen Law Firm, P.C.7

8. Converting a Primary Residence into an Investment Property (Con’t) § 1031 Exchange with property used as primary residence Like Kind Property – Investment Property/Business Property – Does Not Apply to Personal Residence Basis Same as Property Exchanged, with Adjustments § 121 Exclusion Applies 2/5 Years – Realized Gain is Excluded up to § 121 Amount ($250k Single/$500k Married) and then any Remaining Capital Gain is Eligible for Deferral under § 1031, Depreciation Recapture Deferred. Example: Taxpayers purchase a home as a married couple for $100k and use it as their personal residence for 10 years. They then convert it to a rental property for 2 years before deciding to sell it. Taxpayers originally purchased the home for $100k and sell the home through a §1031 exchange for $700k. Since the taxpayers qualifies for the §121 exclusion 2/5 year test, they first use the $500k exclusion and then defer the remaining $100k gain and depreciation recapture with the §1031 exchange, paying no tax on the sale/exchange. No Set Time for Exchange After Conversion – Intent Test Based on Facts and Circumstances Tests – At least 1 Year is Generally Recommended. The Cohen Law Firm, P.C.8

9. Converting an Investment Property into a Primary Residence § 121 Primary Residence Ownership – Transfer from Entity to Personal SMLLC Exception 2/5 Rule – Exception for Prior Rental Use – § 121 Limits Exclusion – Gains Allocated over Qualifying and Non-Qualifying Use along with Depreciation Recapture. If § 1031 Exchange Occurred – Must Hold Property for 5 Years After Exchange and Use for 24 months as Primary Residence for §121 Exclusion to Apply. IRC§ 121(d)(10) Example: Taxpayer completes an §1031 exchange for a rental property held for investment and rents the property for 2 years. Taxpayer then moves into the home and uses it as his principal residence for 2 years. In order to get the §121 exclusion for any gain, the taxpayer must wait 1 more year, for a total of 5 years of ownership before selling the property. The Cohen Law Firm, P.C.9

10. Operations/Tax Reporting of Investment Property Tax Reporting Individual/SMLLC - Schedule E – Page 1 LLC/LLP – Form 8825 K-1 Issued to Members - Schedule E – Page 2 Record Keeping – Expenses Purchase Price – Allocation of tax basis (Purchase Price and closing costs): Building Residential – General Rule – 27.5 years Commercial – General Rule – 39 years Land – Non-Depreciable Improvements (New IRS Repair Regulations) (Cost Segregation Study) Yearly Expenses (Substantiation) The Cohen Law Firm, P.C.10

11. Operations/Tax reporting of Investment Property (Cont’) Deducting Net Loss – Impact of §469 – Passive Activity Loss Rules Real Estate Professional (REP) – 2 Requirements – Unlimited loss reporting Must Work at Least 750 Hours a Year in Real Estate and Over ½ of Total Working Hours in One or More Real Estate Property Businesses. Must Materially Participate in Each Activity – IRS Defines as Regular, Continuous and Substantial Activity – Subjective Test (Facts & Circumstances) – See §469 Election Active Management – Up to $25k Based on AGI Level – Any remaining loss is disallowed until sale of property Reduced at 100k AGI and No Benefit above 150k AGI Passive – No deduction until sale of property The Cohen Law Firm, P.C.11

12. Operations and Reporting of Investment Property (Con’t) Examine Each Rental Property §469 Election To Aggregate Rental Properties - §469(c)(7)(A) Pro –Tax Savings - Treat Similar Activities as One to Meet Material Participation Requirements to Avoid Passive Activity Rules for any of the properties and take Losses Con - Cannot Take Suspended Losses Prior to Election. Must Sell All Activities Before Suspended Losses Can Be Used Since the Group is Considered as a Whole. Deducting Net Loss – Impact of §465 – At Risk Rules General Rule – Only At Risk up to Tax Basis (cash funded) Exceptions – Debt Basis – Finance part of property Recourse – Individual is personally liable on loan Qualified Non-recourse - Financing generally includes financing for which no one is personally liable for repayment that is borrowed for use in an activity of holding real property and that is loaned or guaranteed by a federal, state, or local government or borrowed from a “qualified” person. Non-recourse Lease Agreement City of Boulder Special Rules Interest Bearing Account on Security Deposits Licensing & Inspection Required SmartReg Compliance Required by 2019 The Cohen Law Firm, P.C.12

13. Sale/Disposition/Transfer of Investment Property General Rule – Investor Status If Held for Less than 1 Year – Short Term Capital Gains If held for 1 Year or more – Long Term Capital Gains Holding period tacks for distributions from LLC/LLP Exceptions Depreciation Recapture – Character of Gain Changes - Ordinary Dealer Status – Character of Gain Changes – Ordinary Income/Self-Employment Dealer Status – Actively Engaged in the Trade or Business of Development and Sale of Real Estate, as Opposed to an Investor. Determined by Intent – IRS Looks to Duration of Ownership, Records of Intent, Extent and Nature of Sales Efforts, Number & Continuity of Sales to Determine Dealer Status. The Cohen Law Firm, P.C.13

14. Sale/Disposition of Investment Property (Con’t) §1031 Exchange – Defer Gain §121 Primary Residence – Avoid Gain (Up to $250k Single, $500k Married) Impact of Depreciation Recapture Death - §1014 – Avoid Gain Individual - Depreciation Taken Before Date of Death Not Recaptured LLC/LLP - §754 Election – Estate or Successor Partner Adjusts Inside and Outside Basis to FMV on Date of Death C Corp/S Corp – No Step Up Election For Corporate Assets The Cohen Law Firm, P.C.14

15. Questions?? Jeffrey D. Cohen, Esq., C.P.A. The Cohen Law Firm, P.C. 6610 Gunpark Drive, Suite 202 Boulder, Colorado 80301 Telephone 303-733-0103 www.cohenadvisors.net jeff@cohenadvisors.net The Cohen Law Firm, P.C.15