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De-Mystifying Your Tax Questions on Real Estate Investing

De-Mystifying Your Tax Questions on Real Estate Investing

3 min read
Amanda Han

Amanda Han has been a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax...

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As both real estate investors and tax strategists, we have been working with real estate investors our entire professional careers. It’s amazing how much has changed over the past decade. Very often our new clients would get themselves involved in real estate deals as a way to begin building some passive income towards retirement. Most investors know that real estate investing comes with some GREAT tax saving benefits. However, a lot of people are often confused as to what tax loopholes they can actually use and just exactly how to use them correctly. Of course, it’s no wonder that a lot of people are frustrated when it comes to taxes and real estate. The US tax code is one of the most complex in the world and it just keeps getting more complex by the day. The tax laws have changed so much over the years that many people are confusing new laws and rules with outdated and incorrect ones.

Myth vs Fact

I wanted to take this opportunity to clear the air with some of the most common misconceptions when it comes to real estate and taxes to hopefully provide you with some guidance on maximizing your tax benefits:

Myth: You can write off all of your real estate losses on your tax return.

Fact: The answer is yes and no. Although you can capture all of your real estate expenses on your tax return, you may or may not actually get an immediate benefit on those expenses to offset your current tax liability. There are a number of strict rules that determine how much you can write off against your tax return and when your real estate expenses will actually offset your tax liability. See the next example on how you can potentially deduct all of your real estate losses.

Myth: Anyone investing in real estate will qualify as a Real Estate Professional (REP) to deduct all of their real estate losses.

Fact: The Real Estate Professional status is a great tax loophole that allows investors to bypass myth #1 and to be able to take unlimited tax write-offs on their investment properties. However, there are two rules you must meet before you can qualify as a Real Estate Professional.

First, an individual must spend more time on real estate activities than non-real estate activities during the year. Second, an individual must spend more than 750 hours during the year involved in real estate activities in which the individual materially participates. Remember, you must meet both requirements to qualify as a REP. On the other hand, there is a misconception that in order to qualify as a real estate professional, one must have a realtor’s license. That is a false assumption since there are no licenses that are required for a taxpayer to receive the benefits of being a REP.

Myth: You cannot write off the entire purchase price of improvements for your investment property. It must be capitalized and depreciated over its useful life.

Fact: This actually depends on when you made the improvements for your property. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 provides a temporary 100% bonus depreciation deduction for certain types of improvements made to qualified improvement properties placed in service after September 8, 2010 through December 31, 2011.

Myth: You can’t claim a home office deduction if you own real estate because it is a red flag for IRS Audits

Fact: This is not entirely true. There are certain rules and guidelines you must meet before you can claim a home office deduction. You may take a deduction for home office expenses as long as the space you claim is exclusively used for business (i.e., a separate room, not your family room) and you regularly do some type of business in that space. If you own a real estate business or invest in a number of real estate properties and manage over these properties in your home office, you may qualify to take this deduction. As long as you qualify for this wonderful tax loophole, why not take advantage of it?

Stay Informed

It is clear that there is great value in keeping yourself educated and up to date with law changes. This could mean savings of hundreds to thousands of dollars to you year after year. Take for example the Unearned Income Medicare Contributions Tax for this year. This new tax is assessed on Net Investment Income such as rental income for another 3.8% on top of all the regular taxes you already pay!  Of course, we are already working diligently to come up with creative tax strategies to minimize or eliminate this new tax burden for our clients. Be sure to work with your advisor to ensure you are aware of the new changes. Ask them to help you plan and strategize so that you can avoid these taxes when the time comes too.

Photo: JD Hancock