Real Estate

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Real estate is a powerful wealth building tool that brings with it some awesome tax advantages. As an investor in real estate, you require a professional tax firm who can advise you through the tax implications of your transactions, so you can adequately analyze them and make decisions. Further, if you raise private capital from multiple investors, you need someone who is an expert in partnerships (and LLCs taxed as partnerships).

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In General

Leasehold Improvement Property

Improvements made to a building or other real property subject to a lease are depreciable. Under MACRS (the Modified Accelerated Cost Recovery System), the term of the lease is irrelevant. MACRS improvements to the interior of nonresidential real property can be depreciated over 15 years if placed in service before January 1, 2014, provided the building was at least three years old. Without this rule, the improvement could be treated as 39-year MACRS property. Bonus depreciation may be taken on leasehold improvement property.

Leases

Ordinarily, the lessor takes depreciation; the lessee can deduct rental payments. The owner of property may decide to engage in a sale-leaseback transaction, where the owner sells real or personal property to a buyer, who leases it back to the seller. If the transaction is bona fide, the seller-lessee can free up capital in the property, and can deduct rental payments to the buyer-lessor. This may provide a larger deduction than depreciation and interest. The lessor can also depreciate the property. However, a sale-leaseback may be recharacterized as a financing device, if the seller retains the economic risks of ownership; this may diminish the seller’s tax benefits. The IRS and the courts have identified several factors to consider when characterizing the transaction.

The tax treatment of amounts paid to cancel a lease may vary. A lessor that pays to cancel a lease for its own use generally has to amortize the payment over the unexpired term of the lease. However, a lessor that cancels a lease so it can sell the property adds the payments to the property’s basis. A lessee that pays to cancel a lease so that it can make improvements or put up a new building must amortize the payments over the life of the new building or improvements.

If the lessor provides an option to buy, payments under the lease made after the option is exercised are treated as purchase price installments. If the lease is treated as a disguised sale, the payments are also treated as purchase price installments, not rent. The characterization depends on objective economic factors and whether the lessor retained sufficient indicia of ownership.

Deductible Mortgage Interest

The Tax Cuts and Jobs Act (Tax Cuts Act) has placed new restrictions on the home mortgage interest deduction, one of the most important tax breaks available for homeowners today. Because the potential for tax savings is so great, it may be useful to review the rules. As you'll see, they are quite complex and full of pitfalls as well as opportunities.

Home acquisition. Like the vast majority of Americans, you generally can fully deduct the interest paid on a loan if the proceeds are used to buy or build a residence (a main home and one vacation home). This type of financing is called acquisition debt; it can't exceed an aggregate of $1 million for all interest to be deductible, and must be secured by your home.

Vacation Home - 15-Day Rule

Rental of Vacation Home or Residence

If you rent out your vacation home or primary residence for part of the year, whether or not that income is taxable can depend on how many days the property is rented out. In the same sense, deducting certain expenses in relation to this rental income also depends on how many days the property is rented out.

When is the rental income not part of gross income on the tax return? When are expenses related to the rental not deductible?

Minimum Rental Use

If you rent the property for fewer than 15 days during the year, you are not allowed deductions directly attributable to such rental, but that's because of a bigger benefit: no rental income is includible in gross income. Deductions allowed without regard to whether or not the home is used for business or the production of income (e.g., mortgage interest, property taxes, or a casualty loss) may still be taken.

So, for this special rule, if you use a dwelling unit as a residence and rent it for fewer than 15 days. In this case, don't report any of the rental income and don't deduct any expenses as rental expenses.

For example, if you decide to rent out your personal residence on Airbnb for only 14 days out of the whole year, you do not have to report this rental income as part of your gross income on your tax return and any rental expenses incurred cannot be used as deductions.

Home Office

Home Office Deduction

Individuals who use part of their personal residences for business may be able to deduct expenses for the business use of their home. This is known as the home office deduction. The tax-saving opportunities available to you will depend not only on the type of work you do at home but where in the home you perform it.

What Does Not Qualify as a Home Office?

You won't get any home-office-type deductions unless you regularly and exclusively use a room or specific area in your home or apartment for business.

If you're an employee who regularly comes home from the office with a loaded briefcase, catching up on paperwork at home won't do you any tax good. Employees qualify for home-office deductions only if they work at home for the convenience of their employer. So there are no deductions if you decide on your own to do office work during evenings and weekends, or work a couple of days a week at home because you'll get more done. And even if your employer requires you to work at home, you don't get any extra deductions unless you also get by the home-office hurdles.

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Sale of Primary Residence

Generally, taxpayers may exclude up to $250,000 ($500,000 for married couples filing a joint return) of gain from gross income on the sale or exchange of their principal residence. Below is some information you may find useful in determining possible exclusions when you sell your home.

This exclusion applies if the taxpayer has owned and used the property as a principal residence for periods aggregating two years or more during the five years immediately preceding the sale or exchange of the residence.

The exclusion applies to only one sale of a principal residence in any two-year period. The two-year ownership and use periods do not have to be concurrent for the exclusion to apply.

What is the "Two-Year Ownership and Use Periods" Requirements?

A taxpayer is treated as owning and using the property as his or her principal residence during any period that a deceased spouse owned and used the property as a principal residence before death if:

That spouse is deceased on the date the property is sold, and
The taxpayer has not remarried at the time of the sale of the house.

Like-Kind Exchange

A well-known, but sometimes overlooked, way to alter investment holdings without paying tax at the time of the transaction is through the use of "like-kind" exchanges. If you think you will be engaging in activity that constitutes a like-kind exchange, here is some information that might apply to your situation and be beneficial for tax planning.

What is a Like-Kind Exchange?

In a like-kind exchange, investment property is traded for other investment property. The person transferring one piece of property receives different property but keeps the same basis as that for the old property. That way, the gain is deferred while other tax attributes are preserved.

What Are the Tax Benefits of a Like-Kind Exchange?

Like-kind exchanges generally result in a postponement of gain recognition for business and investment property owners. The tax savings from participating in a like-kind exchange can be substantial. A like-kind exchange provides a wonderful alternative to selling the property outright. The sale of the property may cause you to recognize a gain on the sale, requiring you to pay taxes on this gain.

Real Estate Professional Vr. Passive Activity Losses

Passive Activity Losses

The so-called "passive activity loss rules" have developed into a complicated set of guidelines since their inception in the mid-1980s. However, if you keep in mind the general principles that drive loss limitations in this area, you will have a good foundation for selecting investment strategies that take full advantage of, rather than solely react to, the current tax rules.

Generally, losses from passive activities may not be deducted from other types of income (for example, wages, interest, or dividends). To the extent that the total deductions from passive activities exceed the total income from these activities for the tax year, the excess (the passive activity loss) is not allowed as a deduction for that year. A disallowed loss is suspended and carried forward as a deduction from any passive activity in the next succeeding tax year. Any unused suspended losses are allowed in full when the taxpayer disposes of his entire interest in the activity in a fully taxable transaction.

Special rules apply to rental real estate activities in which a taxpayer actively participates. Losses and credits that are attributable to limited partnership interests are generally treated as arising from a passive activity. However, losses from working interests in oil and gas property are not subject to the limitation.

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