Bring Your Tax Questions
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
Hey Folks,
April 15th is right around the corner and I constantly see the same tax questions pop up in the forums. Hopefully this thread can help serve as a running list of real estate tax questions and answers. Ideally, multiple tax pros will be providing support and answers and the question askers will read the thread in total before asking their specific question.
While the advice is meant to be helpful, the usual disclosures are in place. Specifically, any and all advice received in this thread should not be taken as tax or legal advice. I cannot provide advice that can be relied upon without having all details relating to your unique tax situation. Do not use any advice received in this thread as a basis to support your tax position.
Looking forward to questions!
Hi Brandon,
Thanks so much for such a detailed reply, it certainly has given me some things to think about.
Hi Brandon,
Thanks for the offer. Here are a couple of questions that I have.
1) I received a K-1 from a partnership investment. The K-1 has a loss due to improvement depreciation. Will this loss affect my DTI when I go and apply for a real estate loan? Basically, will the lender off-set the loss with my W-2 income and/or other passive income?
2) Which form do I use to file my K-1? Is form 8582 the right one to use assuming I'm using Turbo Tax to file my own taxes? Are there different forms to be used for an active partner compared to a passive partner?
Thank you.
Thanks Brandon. Here is a question. Where and how do you correctly write off expenses associated with wholesaling if you only did it to buy a property for yourself...
Basis of the propety, advertising expense, or not deductable?
Thanks.
@Account Closed
Good questions. In general, where you report this amount on Form 1040 depends on whether the amount is from an activity that is a passive activity to you.
For some basic knowledge: the partnership uses Schedule K-1 to report your share of the partnership's income, deductions, credits, etc. This is usually not filed with your tax return (special considerations may require you to file the K-1). The partnership files a copy of Schedule K-1 (Form 1065) with the IRS.
As for your questions:
1. Will a lender take into account the loss from your K-1 in their income calculation?
It depends. Lenders who have to abide by strict regulations due to the organization they are selling their loans to may take the loss into consideration. However there are lenders who will understand why the loss is actually a loss (depreciation) and they may not take it into account. From my understanding, there are lenders on BP who do just that.
2. Which forms do you use for income/losses and active/passive?
If your income (loss) was reported in Box 2: Net Rental Real Estate Income (Loss), then it is generally considered a passive activity unless you qualify as a real estate professional or materially participated in the activity.
If you determine the amount in box 2 to be a passive activity, report the loss on Schedule E if you meet ALL of the following criteria:
If you have a loss from a passive activity in box 2 and you do not meet ALL of the above conditions, follow the instructions for (and fill out) Form 8582 to figure how much of the loss you can report on Schedule E.
If you were a real estate professional and you materially participated in the activity, report box 2 income (loss) on Schedule E directly.
If you have income from a passive activity in box 2, report the income on Schedule E.
If Box 3: Other Net Rental Income (Loss) is a loss, follow the instructions for Form 8582 to figure out how much of the loss can be reported on Schedule E. If income is reported in this box, report on schedule E.
@Mike Landry Is that the only property you wholesaled or is it an active business and you just happened to wholesale your own property?
sorry I wasn't very clear. I'm not trying to wholesale...so no active business. I'm just marketing to find my own properties. I did purchase one in 2014 from some letters I sent out. I'm trying to figure out of the stamps and letters costs can be written off and where. Property is under schedule e if it matters.
@Mike Landry Generally, all costs to acquire a property will be rolled into the basis and depreciated over 27.5 years (unless the costs are associated with the loan - then amortized over the life of the loan). This would include advertising expenses.
Hi Brandon,
Thanks for the offer, this is more of a tax planning question. Is there any way to structure a note such that the "interest" it is not taxed at ordinary income rates. I am completely flexible about the way payment is received (I want the principal but happy for kids to benefit from interest).
I thought about letting adult children receive the interest (and pay tax at their rate), but was advised this was a related party and not legal. Since they would truly benefit from the "income" I can't understand why this is not legal.
Thanks again for your kind offer.
@Kathryn M. It depends. I would need more information about your tax position and the structure of the deal resulting in a note. Or at least some more background that alludes to the purpose of the note and future plans.
Hi Brandon,
I would like to creat the equivalent of a 15 year fixed note for real estate partner (shared ownership in property), but as note does not yet exist, I have some flexibility.
I believe the direct path would be a simple note that results in interest taxed at ordinary income rates (high), so I was just wondering if there were any creative solutions to perhaps effectively recast as the "interest". The only one I had thought of was letting the adult kids (lower marginal rate) fund the note or some portion of the note.
Thanks,
Kathryn
@Kathryn M. It would be difficult to simply "re-route" the interest, however you have a few options here. This is routinely called "income shifting" and takes some creativity but is perfectly legal.
First you need to determine whether or not you are in the business of making loans. If you are not in the business of making loans, then you report interest income on form 1040 or Schedule B if interest received is less than $1,500 or more than $1,500 respectively.
If you are in the business of lending money (you've done this before and you undertake these loans with the intent to profit) then interest received on loans is business income and reported on Schedule C.
In either case, a great way to shift income is to employ your children in some capacity and work it out so that the (reasonable) compensation they receive for their services equates roughly to the interest income you are receiving. While you will still receive and report the interest income, you can off-set it with the deduction for the expenses of your children's compensation.
You can also set the note up and then gift your children "fractional interest" of the note. In this case, you have done the prep work so you know everything is set up the way you want it to be. You children then receive the interest and are liable for reporting the interest on their taxes. Of course the downside here is that you are giving away your money - something to think about.
You can consider gifting them money prior to financing the note and instruct them on how to set everything up. Major downside here is that they may structure the note incorrectly or simply take your money and "run."
For gifting purposes, you are entitled to an annual gift exclusion of $14,000 ($28,000 if married) per child without having to file a gift tax return. So if you are going to extend an $84k loan and you have three children, you can set the loan up and gift each of them a third interest in the note without having to file a gift return. If you only have one child, you can still gift the full $84k, you just have to file a gift tax return. The difference between the value of the gift and your annual exclusion of $56k ($84-28k) is still not taxed (a common misconception) but rather decreases your annual gift exclusion of $5.43MM.
If you have a child under 18 you will need to watch out for the "kddie tax" on investment income if you decide to go the gifting route.
Your best bet will likely be to employ your children in some capacity and ensure they perform some level of work. You get the benefit of the services and they get to pocket some extra income.
Regardless of the method, if you are claiming any of them as a dependent you will need to be careful in how much income shifting you do. If you shift enough income to where you are no longer providing over half of the child's support, you will lose the ability to claim them as a deduction.
I hope this helps. Let me know if you have additional questions.
Hi Brandon,
Thanks so much for such a detailed reply, it certainly has given me some things to think about.
My question regards the treatment of my 1031 exchange expenses. I did not initially know I should bring cash to the closing of the relinquished property to cover "non-exchange" costs such as security deposits and prorated taxes, insurance, and prepaid rent. Since that closing, I have learned that the most conservative guidance is to treat these items as taxable boot since they were paid from the sale proceeds. Bummer; I was hoping for a tax-free exchange and hoped trading up in equity and debt would be enough to ensure this.
Now I'm reading that some accountants treat these items not as an expense but as non-recourse debt that has been assumed by the buyer of the property, and therefore can be netted against debt I assumed with the replacement property. Bye-bye boot, right? A Technical Advice Memorandum 8328011 supposedly describes this treatment of security deposits, although I have been unable to locate and read this document for myself. Is this considered an overly aggressive and possibly disallowed approach? If you had to argue for or against this position, what precedents would you refer to? No trying to break any rules, but do want to pay more taxes than I need to either.
On the replacement property, are seller-paid closing costs considered cash paid on my behalf to net against the loan origination (and other non-exchange) cash that was paid from the QI funds at closing?
Thanks Brandon and anyone else that has a thought on this.
Hi @Brandon Hall -
I realize this thread is pretty old, hope you are still reading it... This year will be the first year I have invested in Crowdfunding EQUITY deals (all past years were debt, mostly from PoL). For the debt deals, I received a 1099, and that is easily to report and understand. Now for these equity deals, I will receive a K-1. My question is will these equity distributions on the K-1 be capital gains? And if so, can I use other non-passive losses (like stock sales) to offset these gains? Or am I trying to make and apple into an orange? :-)
Your K-1 will show distributions and possibly separate capital gains or losses. For example, you might have $100 in distributions and $200 in capital gains/losses in your partnership. Losses are helpful as they offset your 1040 income and you didn't lose any hard cash (yet), but gains are taxed too and you also didn't receive the hard cash (yet).
The one thing I don't like about K-1s is they arrive late, often the 2nd week of April for me.
Jim.
Hi @Brandon Hall -
I realize this thread is pretty old, hope you are still reading it... This year will be the first year I have invested in Crowdfunding EQUITY deals (all past years were debt, mostly from PoL). For the debt deals, I received a 1099, and that is easily to report and understand. Now for these equity deals, I will receive a K-1. My question is will these equity distributions on the K-1 be capital gains? And if so, can I use other non-passive losses (like stock sales) to offset these gains? Or am I trying to make and apple into an orange? :-)
Jim, unless a property or other large item was sold, I doubt you will have capital gain to report until the property sells. All gains or losses will be ordinary in taxation but subject to passive activity rules.
@Jim Wagoner as Steven mentioned, the K-1 income will likely be considered ordinary income. Since you're crowdfunding, I highly doubt you materially participate in the real estate activity, meaning the income received (and reported via the K-1) is passive income. Such income can be offset by passive losses generated from other passive activities.
Thanks @Brandon Hall , @Steven Hamilton II, @James Mc Ree .
These answers have helped a lot. None of the properties have sold yet. As I now understand, I fully expect my "equity" distributions to be simple ordinary income and can't be used to offset any capital gains in my active investments in stocks. I was sidetracked by the term "equity deal".
Thanks again!
Thanks for taking time to share your knowledge. I read your BARRR article, which was very helpful, and it got me thinking on something else. I had a claim from Hurricane Irma on one of my properties. There were some shingles that blew off and a leak. I got a check from the insurance company for this, and they are estimating and paying for a new roof, not just a repair of that part of the roof.
Would the fact that this is due to insurance claim let me deduct it like a regular repair, or will I have to capitalize and depreciate? If depreciate is the right way, how do I account for the claim check so it doesn't show 3000 income but only allow me to depreciate the small percentage of the actual cost?
Hi Brandon,
Not sure if you are still doling out help and I appreciate your offer from 2 years ago. We have a single family property that we have in an LLC(which I run my flips out of). We have decided to keep it now for a rental. We will refinance with a 15 year loan(presently have an interest only construction loan) but want to put in another empty LLC that we own. My husband is worried that it will create a taxable event. As of now, it has not made a profit. Will there be tax consequences from the transfer from one LLC to another? Thank you. I have inquired with my CPA but she is out of town for another week and I want to get the ball rolling.
@Greg Martin if you report your expenses, you will also need to report your insurance reimbursement. Generally, if insurance has reimbursed you, you do not need to report the expenses nor the reimbursement. When there is a different between those two amounts is when we need to report.
@Evelyn Greenwood good question - in the vast majority of cases, refinances do not create taxable events and you have nothing to worry about. An example of when a refi would create a taxable event is when you a partnership LLC refinances a property and one partner withdraws monies in excess of his/her basis.
You can move money freely between LLCs, just make sure it's well documented. You need to accurately record the distributions and contributions.
The one tax issue you will likely need to tackle is the interest tracing rules. You need to reapply the capital you are pulling out via the refi to investment or business use, otherwise the interest on the cashed out funds is not deductible.
Thank you for your quick reply. I will pass this on to my husband and move forward with my plans to keep the property and move to another LLC.
Hi @Brandon Hall,
"The one tax issue you will likely need to tackle is the interest tracing rules. You need to reapply the capital you are pulling out via the refi to investment or business use, otherwise the interest on the cashed out funds is not deductible. "
Thanks for the input. Would you mind elaborating on the last sentence above. Perhaps with an made up example? Thanks!
P.S. Really enjoyed you on the POD Cast recently!!!
Hello all First post! My firm is purchasing a MF property from this couple in their mid 70s-80s. They purchased the property in 1992 and are looking to avoid paying capital gains tax on the property. What would be the best course of action to close this deal (besides 1031 exchange). They purchased this property for 2.2M and we are buying for 3M. Thank you!