Real Estate Taxes

Real Estate Income Tax Return

Income tax return reporting of rental real estate income and deductions depends on how the property is owned. For property owned by individuals, Schedule E of the Form 1040 Individual Income Tax Return is used.

Rental property owned by a partnership, LLC, corporation, or trust is reported on the entity’s income tax return on schedules that vary by type of entity. Typically, each rental activity is treated as a separate business activity with its own schedule of income and deductions – its own “P&L” – that is separate from the entity’s ordinary business income and deductions.

You need to work with a CPA firm with the knowledge and expertise to help you identify tax opportunities and maximize the benefits.

Tax Benefits of Real Estate Investing

We will outline some key tax rules on real estate. Real estate investing has long been an excellent tax strategy, primary because of depreciation deductions, Section 1031 Exchange, and special real estate depreciation recapture rules.

  • Tax law allows a deduction for “depreciation” of rental real estate buildings. This is generally considered a non-cash deduction and contrary to economic reality, since the value of the structure generally goes up, not down, over time. For a cash-flow positive property, some or all of the net positive cash flow is not taxable in the year received, but instead many years later. Some experts call this “phantom income”. For a cash-flow negative property, depreciation results in deductions greater than cash paid each year for rental property expenses. Some experts call this “phantom deductions”.
  • Net losses from a rental activity can be deducted in full against net income from another rental activity or passive investment (K-1), or, subject to the following limitations based on modified adjusted gross income, against other income.
  • Less than $100,000: can deduct $25,000 of rental real estate losses against other non-passive income.
  • Between $100,000 and $150,000: can deduct between zero and $25,000 of rental real estate losses against other income.
  • Over $150,000: all losses are suspended.
  • If net losses are not deductible in the year incurred, they are suspended and carried forward indefinitely until either there is positive income against which they can be deducted or the property is sold. If the property is sold, the suspended losses are ordinary losses which first offset other ordinary income that year before offsetting any capital gain from the property sale. Even with suspended real estate losses, the taxpayer is essentially creating capital gain income and ordinary losses in the year the property is sold.
  • Unlike most other investments, real estate can be sold without taxable income through a Section 1031 Exchange.
  • The ultimate tax strategy is to die owning real estate with large unrealized gains built in. Unless you die in the year 2010, the unrealized gains disappear when your heirs inherit the property with a cost basis equal to the Fair Market Value at date of death.
  • Benefits also apply for Alternative Minimum Tax (AMT).

We offer a free initial consultation for real estate businesses. Call us today at 714-533-2600 and to schedule a mutually convenient time to meet.


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