A few Investment Real Estate Tax Tips

All of these tax tips are current and in effect at the time of this writing. However, as with all matters tax-related, verify with your tax advisor before attempting to use them - you know how Washington loves to tinker with things.

  • In order to claim many of the tax benefits associated with owning investment real estate, you must be actively involved in the property's management. Actively involved - according to the IRS - means that you set the rents, approve tenants, and decide on capital improvements. It doesn't mean that you can't hire management help; it simply denotes that you must remain in control.
  • Tax depreciation is an accounting procedure that creates a loss in value for the purpose of tax deduction. It has absolutely nothing to do with whether a property has actually gained or lost value in the marketplace. Straight-line depreciation is used to reduce the value of the property by set equal amounts each year over its established economic lifetime (27½ years for residential investment real estate; 39 years for nonresidential investment property). Land, however, is never depreciable.
  • Each time that ownership changes hands, a property is again "put in service" and the depreciation schedule starts over from the beginning. For residential investment property for example, it makes no difference whether a rental home is two years old or 85 years old when you buy it; according to the IRS, it has an economic lifespan (in other words, for depreciation purposes) of 27½ years from the date that title passes from the previous owner to you.
  • Investment property losses (which, of course, have limits) that are disallowed in one tax year can be saved and applied to reducing rental- or other passive income (income derived from rental property or other enterprises that you're not actively involved in) that you might earn in future years. If you don't get the opportunity to use disallowed losses during the time that you own the property, you can deduct the total losses that were unused when you sell the property - with some restrictions. Be sure to consult with your tax advisor in this area.
  • Carefully consider your holding time before selling a quick-turnaround property. The reason is that short-term (assets held for less than a year) capital gains are taxed at the same rate as your ordinary income. Therefore, selling a property after ten or eleven months of ownership could actually cause you to lose a significant tax reduction. If possible, hold your property for at least twelve months to reap the long-term capital gains tax break.
  • People who buy and sell multiple properties in a year can be designated to be "dealers" by the IRS. Avoid such designation if at all possible. Dealers do not get capital gains tax benefits because all profits on property they sell are considered to be ordinary income. Furthermore, a dealer cannot depreciate property (even if it's held for the long term) and all rents are additionally counted as ordinary income. Most investors who buy and sell many properties a year do so in names other than their own, such as separate corporations or limited liability companies.

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