Tax Essentials for Real Estate Pros

Get to Know the Basics

The most important concept is to remember to get professional tax advice and involve a CPA to acheive the best results. The following are the basic top-of-mind reminders that may serve your clients. The list is by no means extensive. New rules and changes develop every year. Remind your clients to always seek professional advice and support when dealing with any matters outside your area of expertise.

1. Depreciation:

• Implications for Owner: Allows deducting a portion of the property’s cost (building and land) over its useful life (typically 39 years) from taxable income, reducing current tax burden.
• Summary: Track depreciation accurately and utilize tools like accelerated depreciation methods for maximum tax benefit.

2. Mortgage Interest Deduction:

• Implications for Owner: Interest paid on mortgages used to acquire or improve the property can be deducted from taxable income, lowering net taxable income.
• Summary: Optimize loan terms and prioritize interest-only periods to maximize the deduction.

3. Property Taxes:

• Implications for Owner: Property taxes paid to local governments are generally deductible from taxable income, offering tax relief.
• Summary: Stay informed about property tax assessments and appeal potential overvaluations to minimize tax burden.

4. Passive Activity Loss Limitations:

• Implications for Owner: Losses from rental properties may be limited or suspended if the owner doesn’t actively participate in management.
• Summary: Demonstrate active participation (property management, tenant relations) to utilize potential losses for tax purposes.

5. Capital Gains Tax:

• Implications for Owner: Profits from the sale of the property are subject to capital gains tax, with rates depending on holding period and income bracket.
• Summary: Minimize short-term holdings to qualify for lower long-term capital gains rates. Consider installment sales or Section 1031 exchanges to defer tax obligations.

6. 1031 Exchange:

• Implications for Owner: Allows deferring capital gains tax on the sale of a property by reinvesting the proceeds into a “like-kind” property of equal or greater value within a specific timeframe.
• Summary: A valuable tool for long-term investors seeking to upgrade or diversify their portfolio while minimizing tax impact.

7. Depreciation Recapture:

• Implications for Owner: Depreciation claimed on certain assets (land improvements) can be recaptured as ordinary income upon sale, creating a higher tax burden than capital gains.
• Summary: Accurately track asset depreciation and consider separating sale of land and improvements to minimize recapture.

8. Cost Segregation Studies:

• Implications for Owner: Detailed analysis of building components can identify shorter depreciation periods for specific assets, leading to increased current deductions and lower overall tax liability.
• Summary: Consider cost segregation studies for older or complex properties to potentially unlock significant tax benefits.

9. Leasehold Improvements:

• Implications for Owner: Costs of tenant improvements can be amortized over their useful life, providing deductions against rental income.
• Summary: Document and negotiate tenant improvement clauses effectively to maximize potential deductions.

10. State and Local Tax Rules:

• Implications for Owner: State and local laws regarding property taxes, deductions, and tax incentives can vary significantly.
• Summary: Consult with a tax professional familiar with local regulations to ensure compliance and utilize available tax benefits.

Remember: This information is general and does not constitute tax advice. Please consult with a qualified tax professional to discuss your specific situation and receive personalized guidance.