If you invested in real estate recently, now may be a good time
to review real-estate tax rules. A little planning may help you
take advantage of some tax breaks.
If you invested in real estate recently, now may be a good time to review real-estate tax rules. A little planning may help you take advantage of some tax breaks.
Tax law is a bit onerous if you invest in real estate for rental income or to realize capital gains from the sale of the property. The IRS differentiates between real-estate professionals and those who are passive investors. Most people are generally considered to be passive investors unless they spend more than 750 hours in real-estate activities and spend most of their working hours in the real-estate profession.
The classification of your real-estate activities as a professional or passive investor will have a major impact on your taxes. The biggest drawback is on the restrictions on the amount of losses that you can deduct as a passive investor. Passive losses can only be offset against income from other passive activities, such as income from certain partnership activities and rental income. The losses cannot be deducted against income from wages or investment income from dividends and interest. Therefore, if you have passive real estate losses, you may not be able to use those losses to reduce your taxable income in the current year. However, the IRS does allow you to deduct those losses when you sell the property, or you may carry forward the losses to future years to offset passive income.
Don’t forget to take depreciation deductions. Residential buildings are depreciated over 27.5 years. Commercial buildings are depreciated over 39 years. Land is not depreciable. Therefore, make sure that the cost of the property has a reasonable allocation between the building, improvements and land. Remember, also, if you sell real property that you owned for more than a year, some of the gain is taxed at lower capital gains rates.
For some investors, trading real estate in a “like-kind exchange” may be a great way to defer taxes. For more information on this strategy and other tax-wise real estate planning techniques, please contact our office.
Barbara Andres is a CPA and a partner with the accounting and business consulting firm of Bianchi, Lorincz & Company located in downtown Hollister.
