BiggerPockets


Avoid these TEN potential real estate tax traps

Mistake #1: Not understanding real estate passive losses


There are limits on the amount of real estate passive loss deductions you can take. You need to meet some minimum hour requirements of activity in the property. And if you are completely passive with the property, such as with a time share, limited partner interest or in some cases with a property manager, you may never be able to offset the passive losses with your active income.

Know the rules!

Mistake #2: Incorrectly filing as a Real Estate Professional


One of the things we offer to our members is a free review of their past tax return. I do the reviews myself, at least for now while I have time. I'm seeing all kinds of problems when it comes to taking the Real Estate Professional deduction.

It's a way to write-off passive real estate losses if your income is over $150,000, but there are rules! You can't just blindly take the deduction and expect the IRS to let it go. If you get caught in an audit (and chances are getting higher that you will), you'll have to pay back taxes, penalties and interest.

Correct problems now!

Mistake #3: Accelerating depreciation when it does you no good


One of the benefits of real estate ownership is that you get to take 'phantom' deductions. Depreciation is a phantom expense because it reduces your taxable income but doesn't cost you any real dollars.

When is it not a great deal? When you can't take the loss anyway due to real estate passive loss exclusions.

The only thing that makes it worse is accelerating depreciation for no good reason.

Cost segregation studies and accelerated depreciation are tools. You need a strategy FIRST before you start using tools.

Mistake #4: Relying on a business structure to change your deductions or income


Boy, I've seen a few of these mistakes lately. Unfortunately, some people have gotten the idea that if they form an S Corporation or an LLC it will mean they suddenly can take real estate passive losses. The fact is that the character of your income (passive, in this case) doesn't change if you put the investments into a flow-through entity. It will flow through to you as passive income, just as if it was in your name.

If you're worried you might have made this mistake, contact us for a free tax review.

Mistake #5: Failing to correctly identify yourself as a real estate dealer


If you're a real estate dealer, it means that you have a trade or business, not an investment. That means your income is subject to self-employment tax (unless you're holding it in a corporate structure) and you could have a tax issue if you sell a property on time.

Mistake #6: Going into an IRS audit unprepared


Unfortunately, I hear about the mistakes afterwards, when it's too late to do anything about it. Some of the problems I've heard about include:

Volunteering mistakes to the IRS,
Going in with a Real Estate Professional diary that shows exactly 750 hours
Being unprepared for the questions (all of the Audit Guides are available - it's a matter of just doing your homework first)
Giving Power of Attorney to negotiate to someone who negotiated a really bad deal
If you get an IRS notice, do NOT ignore it. Do NOT think it's trivial. Do NOT go in unprepared. Talk to an experienced professional ahead of time and hire the best representation you can afford.

Mistake #7: Ignoring Form 1099-A, Form 1099-C consequences


We had almost 500 people for this past Saturday's teleseminar "You Just Got a Form 1099-A (or Form 1099-C) - Now What?" It's clearly a topic effecting a lot of Americans today.

If you've had a foreclosure, deed-in-lieu of foreclosure,
short sale or loan modification, or are considering one, you really need to know the law.

Mistake #8: Not filing your returns

Over the past few months, I've talked to a number of people that haven't filed their tax returns for 3 or more years. The past few years seem to have created shell-shocked taxpayers. Businesses closed, real estate investment tanked and it seemed like it didn't matter if you filed or not because it was all losses anyway. Or, in other cases, there were some years of really high income (and high taxes as well) and the taxpayers were afraid to file the returns to show the amount of taxes they owed and no longer have the money for.

The problems don't go away. Catch up on past returns as soon as possible. You have a much better chance of negotiating with the IRS if you file before they catch you.

Mistake #9: Incorrectly investing pension money into real estate


Unfortunately, there are a lot of people giving bad advice when it comes to investing your pension into real estate. Can you do it? Sure. But you have to follow the rules. You can't just set up 'checkbook control' and hope for the best.

Mistake #10: Not having a tax strategy


What does it take to have a powerful tax strategy?

You need an experienced tax professional who understands and cares about your personal situation who then develops a strategy based on current law, works with you for successful implementation and follows through to make sure your tax return filing completes the strategy with the
right information in the right place
.

In today's world, you need to proactively plan for taxes and follow through with the right steps.

The author has permitted the reprinting and redistribution of this article.
See our Terms of Use for more information on reproducing it.