A Crash Course in Tax and Investment Property

by on March 3, 2012Jason Van Steenwyk

One way or another, Uncle Sam is going to get his cut. Count on it. And so will your state and local governments. That said, there are certain things you can do as a real estate investor to help manage your tax bill, and maximize your after-tax return on your investment.

In order to do so, however, you need to understand the primary ways in which investment real estate portfolios get taxed. You must also have a general grasp of some abstract concepts like calculating your tax basis, as well as the depreciation of capital investments. Hey, if this stuff were easy, we’d all be CPAs, right?

Warning: This article will only arm you with enough information to be dangerous. You can click on any of the links for more detailed information directly from the Internal Revenue Service. This article is not going to make you an expert. But you can become conversant with the basic terminology, so you can be better prepared for a meeting with your tax advisor.

Taxation of Rental Income

The IRS taxes the real estate portfolios of living investors in two primary ways – income tax and capital gains tax. (A third way, estate tax, applies only to dead investors, and will be left for another article).

Rental income is taxable – as ordinary income tax. That means you have to declare it as income on your tax return, and pay income tax on it by April 15th of the year after the year you receive it. (Corporations may have to declare this income quarterly).

Rental income receives better tax treatment than income earned from wages – you don’t need to pay FICA taxes on rental income, while you do have to pay FICA on wages you get from a W-2 (and double FICA on self-employment income!). It’s almost as if the system is rigged against the working man!

Your income is everything you get from rents and royalties on the property, minus any deductible expenses. You can’t deduct everything, though – you can only deduct mortgage interest and repairs you make that restore the property to its original minimally functional condition. You can’t deduct capital investments like new buildings, additions, or renovations. More on these later.

Capital Gains Tax

The second tax bill you need to worry about is capital gains tax. The IRS taxes you on any net profits you get out of a property when you sell it. If you’re “flipping” properties and you own the property less than a year, you pay short-term capital gains, which is the same rate as your marginal income tax rate. If you’re in the 28 percent tax bracket, you’ll pay a 28 percent tax on short-term capital gains. And you’ll like it, by God!

Ok, maybe not. But you’ll pay it. Unless you can hang on to the property for at least 12 months. In that case, you will qualify for more favorable long-term capital gains. Depending on your marginal income tax bracket, these taxes could range from zero to 15 percent. In every bracket, however, Uncle Sam takes a smaller cut out of long-term gains than out of ordinary income or short-term gains. And once again, we see the system favors the landlord investor over the worker.

Calculating Capital Gains

You pay capital gains tax on the difference between your selling price in the property and your tax basis. Your basis in a property is the total amount of dollars you have invested in the property for which you have not taken a deduction, from your purchase price to the amount invested in renovations and improvements (including labor costs on these projects!). If you have deductions associated with the property, you subtract them from your tax basis. If your basis is higher than your sale, you have a capital loss. You can subtract losses from a given year from gains to reduce your tax bill. If you have more losses than gains, you can “carry forward” these losses into future years, to cancel out capital gains in future years and then to cancel out up to $3,000 in income. (Note, if you take a capital loss on a property, you cannot buy the same or substantially identical property back for at least 30 days, under so-called “wash sale” rules.

How To Defer Capital Gains Taxes – Indefinitely! An Intro to Like-Kind Exchanges

The IRS provides an important exception to capital gains taxation, made-to-order for real estate investors: If you own an investment property, you can sell your property at a profit and roll your money over into another property within 60 days without having to pay capital gains taxes at all – a transaction known as a Section 1031 exchange, named for the section of the U.S. Revenue Code that allows it. It has to be a property of “like kind.” You cannot swap your rental property for a personal residence, or vice versa. For this reason, these exchanges are sometimes called like-kind exchanges.

The 1031 exchange makes it possible for real estate investors to defer paying capital gains tax almost indefinitely – which is another advantage over investing in mutual funds, stocks, bonds and other securities or collectibles. Outside of a retirement account, you have to pay tax on gains in these items by the April 15th in the year after you sold them.

Depreciation and Amortization

This is a broad concept, so we can only cover the very basics here. When you buy investment property – be it a building, a computer or a horse – the IRS knows that the item won’t stay young and new forever. Over time, the property will decrease in value. Depreciation is the process of claiming a deduction to compensate you for the property’s decrease in value during the year. Note: You can’t depreciate your personal residence. You can only depreciate investment property. For more information on the process of depreciation, see IRS Publication 946 – How To Depreciate Property.

Land, of course, doesn’t depreciate. But minerals underneath the land do. If you are extracting oil or other minerals, or timber, for that matter, from the land, you will account for the gradual loss in value through a process called depletion.

Likewise, when you make a purchase of investment real estate or capital equipment with a useful life of longer than a year (hopefully that applies to all your real estate!), the IRS knows you will be using that property to generate income for a long time to come. Except in certain circumstances, then, the IRS does not allow you to deduct the full cost of your investment in the first year. Instead, you must amortize your investment over a number of years. For cars, you have to spread your deduction out over five years. For real estate, you must spread the deduction out over 25 years. For more information on how to account for amortization and depreciation on your tax return, you can download the IRS instructions.

Passive Activity Rules

Again, these rules are complex. But in a nutshell, if you are a passive investor – meaning you are not working day to day in the business of managing your real estate investments – you are subject to passive activity rules. Basically, you can only deduct passive losses to the extent you can cancel out gains from passive activities. These rules restrict your ability to use passive activity losses to offset capital gains elsewhere in your portfolio. Congress implemented these rules in 1986 to eliminate tax loopholes and abusive tax shelters. So thank your parents and grandparents for ruining it for you. And their accountants.

Most individual investor landlords can deduct up to $25,000 per year in losses on rental properties, if need be. Hopefully you won’t have to make use of this provision much.

Property Taxes

Just as Uncle Sam takes his cut, so do his local nieces and nephews. Expect to pay property taxes to local and county governments each year.  Your local government will assess the market value of your property at its “highest and best use,” and charge you a percentage of that value every year. You can deduct property taxes against your rental income, though, provided the property tax is uniformly assessed throughout the jurisdiction and is not a special assessment.

Other Tax Deductions

Be on the lookout for opportunities to take deductions for these common real estate investment expenses:

  • Mortgage interest
  • Tax advice and preparation fees
  • Legal fees for business purposes (but not for personal reasons)
  • Mileage
  • Business use of your home (the home office deduction)
  • Advertising fees
  • Employees (but if they are working on capital improvements or renovations, you have to amortize their labor costs as part of your capital investment, rather than as a current year expense.)

Do you have a tax question? There’s a new tax column designed to answer questions directly from readers. Check it out, send us your questions, and we’ll do our best to find answers.

{ 187 comments… read them below or add one }

Mr. Baldwin April 21, 2014 at 1:36 am

I am very happy for that which is really useful for do course of tax property subjects. thanks for share it.

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Peter DAPRIX April 20, 2014 at 4:12 pm

I am handling my mother’s affairs now that she has turned 97. She owns a rental vacation property in France that I have been managing for her since 1991. If she were to sell the property and bring the cash value back to the US, does the 1031 apply to property in a foreign country if we were to reinvest it here by buying a property of equal or greater value? We could have the sale funds wired to a QI over here.

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Mr. Poul April 17, 2014 at 4:07 am

Except in certain circumstances, then, the IRS does not allow you to deduct the full cost of your investment in the first year.

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W. Barclay April 14, 2014 at 5:04 am

Our primary home is 230% underwater. If we elect to let it foreclose, can our mortgage holder seize either of our two investment/rental properties. If we remove the Homestead Exemption from the primary residence that will be foreclosed and Homestead one of the investment and move into it will it protect it from seizer?

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Stacy April 4, 2014 at 2:00 pm

In past we have had an accountant do our taxes but this has been another rough year for us as I lost my job and still have not found a new job. So i was trying to do my taxes on line and it’s asking me the property’s total basis, and basis of land only? I looked at my last year tax packet and it shows depreciation on schedule E but i can’t find anywhere a worksheet that gives these numbers? Where can I find them? Any help greatly appreicated, I am beside myself……trying to find……We live in state of illinois.

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A. Rodriguez April 14, 2014 at 7:31 am

The basis of the home should be in your tax return on form 4562. The old tax return should give you a depreciation schedule of the home. If you do not have it as for it.

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Danielle Anderson April 1, 2014 at 3:12 pm

I have a client that owns three properties – would have a huge capital gain tax if he sold and didn’t do a 1031 exchange; however, he does not want to buy another property. Instead he wants to pay off loans on a couple of his other investment properties. How would the taxing work in this case? He doesn’t want to “net” any money, instead wants to pay off other properties with the huge profit he’ll get from the sale of subject property???

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jason April 10, 2014 at 4:15 pm

no. his gains on his property would be taxable.
paying off a loan is reducing his liability but does not increase his expenses.

this is no different that putting the money in the bank
or paying off a credit card.

the tax is the same

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Margie March 22, 2014 at 12:37 pm

I purchased a new rental property in October 2013. The cost of the home was $164,000 and I have purchased it as a vacation rental in another town that takes me about 2.5 hours to get to. I have just listed it with a vacation rental firm called Vacasa. I invested about $20,000 in 2013 and another $15,000 in 2014 for upgrades/improvements, repairs and the cost of completely furnishing the place. My tax lady just told me that I would not be able to take any deductions for 2013 because I had not rented the house as yet. I was busy making all the repairs it needed in 2013 and didn’t realize that I was not going to qualify for any deductions?
Is there any advise that you can furnish me that will help me to deduct some of that money invested in 2013?

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Laura March 22, 2014 at 10:44 am

I paid for home improvements to my father house. He is 88 years old and I live take care of him. I replaced the roof and ceiling. Can I clim that on my taxes once I am not the home owner?

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A. Rodriguez April 14, 2014 at 7:32 am

You need to talk to a CPA or enrolled agent.

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Liz March 20, 2014 at 9:09 am

We moved from our condo in IL and rented it out in Nov. 2013. The tenant paid a years worth of rent up front (signed an 18 mo. lease) We bought a home in IN (did not file for homestead exempt. – missed deadline) Next yr we will only get 2 months worth of rent & the expenses will of course be appx the same. Do we claim the entire year’s rent for 2013? is our condo considered a rental for the full yr? Also, should which property do we claim as our own for tax exemp? we certainly pd more on the condo…
Not quite sure how to proceed…

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Hayden March 14, 2014 at 12:15 pm

My wife and her siblings inherited their fathers home when he passed away. We are going to purchase the house from her siblings and fix it up to sell. Will we have to pay capital gains on our profits or will our profits be taxed as normal income and taxed accordingly?

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yohan March 11, 2014 at 1:52 pm

Can I add to my 2013 tax filing any expenses (insurance and others) on a invesment property I closed on 12/30/2013?

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Dani March 4, 2014 at 8:34 am

My husband and I before we got married both had homes. We wanted to sell both and purchase together. We were able to sell his home but mine fell through and then the market crashed and I was forced to keep it and rent it in order to make mortgage payments. Now I want to sell it but because of the time passed it is now considered an investment property – even though I never intended it to be. The taxes are going to kill anything I would have made on the home. I was wondering if we allowed my daughter to live in it for a year while in college would it no longer be considered an investment and then if we sold avoid the Capital Gains tax?

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jerry February 28, 2014 at 7:58 pm

I own rental property with two people. How are the rental income, taxes, insurance and other expenses handled for tax purposes? Are they split three ways?

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Joseph February 12, 2014 at 12:33 pm

I own land on which there is a cell tower. The cell tower operator wants to do a perpetual buy out the of lease for a fixed sum. Part of the pitch is that the transaction would be taxed as a long term capital gain since it is perpetual.

Question: Is there a shorter time period (say 30 or 40 years) that would also qualify for treatment as a long term capital gain.

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sam February 11, 2014 at 6:16 pm

I bought my first town house on 1995 at $106,000. Then i moved to new house on 2011 and i rented my old town house at 2011 that time my town house price was $200,000 so when i file my tax return how i can depritiate my town house which value i have to use for depritiation bought price or at the time of rented 2011 price and every year what formula i have to use for depritiation.

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Brandie Buck February 9, 2014 at 2:58 am

HI
We bought a single wide trailer on a small lot, in Arizona, we cashed out Mutual Funds Stock and paid the penaltys on the money, We look to pay income tax? and stuff to IRS and State of Az this year. My question is, we have the money now as a realtime investment, vs being in stock we could potentially lose. My husband is allow ing a brother and cousin to live in the property without any rent as long as they can paythe utilities. He is thinking this helps them get back on their feet, he still as his money in investment, but we dont collect any rent money there fore we do not pay any additional taxes for income and everyone wins? I told him this could be trouble and the government wont like not getting tax moneys ? because we are not collecting rent. Are we going to be ok? or is this an issue?

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Steven Kuria February 7, 2014 at 4:43 am

Nice article about Tax and Investment Property thanks for sharing it with us.

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Mr.Tyler February 4, 2014 at 9:57 pm

There is nice info about crash property investment and some point to how to defer property tax.which is useful to property tax.so thanks and keep sharing…

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Bob January 30, 2014 at 8:07 am

I bought a flat in a building that was not built yet. However due to the economic crisis the developer did not go through with the project and I lost the first three payments that I made. Currently going through litigation but this will take a long time. Can I report this loss in my tax return. Thanks.

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Hal January 26, 2014 at 5:45 am

I am in the process of purchasing a property to be used as a rental. My question is how does the down payment (20%) factor into expenses?
The down payment will exceed rental income.

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A. Rodriguez April 14, 2014 at 7:24 am

No, your downpayment cannot be used as an expense. Yoou can only recoup back in simplified terms the cost of the home over 27.5 years for depreciation.

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Fenny January 24, 2014 at 7:08 pm

Hi I made a down payment of $12K to purchased the condo in the Philippines thinking I can rented out but something happen that I lost my $12K. Is there anyway I can write it off as loss in my tax return this year?

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Diane January 20, 2014 at 12:00 pm

I am a real estate broker and I also manage my own rental properties. Do I have any IRS write offs under property management, doing the work myself?

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A. Rodriguez April 14, 2014 at 7:25 am

As a real estate professional you get a better tax treatment because you qualify as an active investor and not subject to passive rules.

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Nurse nell January 20, 2014 at 6:39 am

I bought rental property in 2010 and didn’t have it up and fully rented until Jan 2013. We gutted the property to the studs and completely remodeled everything and brought everything up to code. I was told that we couldn’t do any tax preparation until it was fully rented so this is our first year claiming taxes on it. We have always been able to do our own taxes with our primary residence and another rental property that we have owned for the past 25 years. How difficult will it be for us to continue to do our own taxes bearing in mind this recent remodel? Should we hire a CPA? Are there publications out there that could help us?

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A. Rodriguez April 14, 2014 at 7:26 am

A remodel like this will be added to the basis of the house and not expensed. I suggest you talk to an enrolled agent or CPA.

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Abby W. January 3, 2014 at 2:48 pm

My parents owned a vacation home at the beach and their main home in FL. They put the vacation home into a trust that just expired at the end of 2012, at which time the property reverted to me and my 3 siblings.

At the advice of an attorney, we formed an LLC. Our goal was to make a business-like arrangement among all the siblings, and to enable us to rent the property back to my parents from late spring to early fall (about 5 months or so; they find FL too hot to stay all summer). They are paying us fair market rent (determined by a local realtor) because the attorney said that if they don’t, the IRS could come after them and say that the whole arrangement was false and being used to allow them to keep the home, but pretend to give it to us (and reducing inheritance taxes, etc.).

Now that I am looking at filing the LLC tax return for the first year, it is looking like the IRS will view the property as being used as a “home” (IRS Publication 527, p. 18) for personal use by the siblings, because even though our parents are paying a full market rent which is very high, they are related to us and do own a home of their own (a “main home”). In short, it looks as if we cannot claim any rental expenses because every day we rent to them is considered to be a day we are using it for personal use. Is this accurate?

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A. Rodriguez April 14, 2014 at 7:28 am

You need to hire an experienced CPA or Enrolled Agent that knows the issues with estate taxation, arms lenght rules, gift tax and others. Your issue is too complex to give an answer here.

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Kurt Neumeister January 2, 2014 at 8:38 am

My son has a duplex and is not there, therefore I have rented it in 2013. The deed is in both our names. Whose tax return do I declare the income?

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Vicki January 1, 2014 at 8:53 am

My husband and his sister own their deceased Mother’s home. The tax is paid out of an account that is supposed to be divided between them. The sister still has control of the account because she is trying to clean the house and get it ready to sell. So the account hasn’t been divided as yet. Can my husband claim 1/2 the property taxes since the house registered to both and the money paid for taxes is out of an account that will be divided?

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Saed January 10, 2014 at 5:42 am

Where’s the house located and how much are they looking for if you don’t mind me asking

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Tom Collins December 20, 2013 at 11:01 pm

I purchased a cottage at the beach on Sept 3rd. So far I have no rental income. I have only stayed in the property to maintain it ( cleaning, painting, maintenance of the house and grounds, etc). Without rental income can I take a deduction of expenses this year?

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Shalanda December 14, 2013 at 12:57 pm

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Rosina November 13, 2013 at 12:42 pm

i am going away for 2 months i want to subtle my apartment to cover my rent and the utility bills and i do not make not profit at all .. the money i pay the rent of the apartment is money my husband gives me . we filed the TAXed together and tax is paid for the money he gives me for the rent . but as I am not to be there for 2 months we want to rent is taxable ? as this come from money we already paid tax ?
thank you for replied
Rosina

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Rosina November 13, 2013 at 12:41 pm

i am going away for 2 months i want to subtle my apartment to cover my rent and the utility bills and i do not make not profit at all .. the money i pay the rent of the apartment is money my husband gives me . we filed the TAXed together and tax is paid for the money he gives me for the rent . but as I am not to be there for 2 months we want to rent is taxable ? as this come from money we already paid tax ?
thank you for replied

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Sharon October 21, 2013 at 3:24 pm

I have some property that an oil exploration company is leasing from me. I’d like to go and see what they’re really doing. I hear there’s drilling going on, but the company says that’s not the case. If I make the 700+mile round trip to check it out for myself, can I deduct any of the expenses for the trip?

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Heath November 9, 2013 at 6:23 pm

Yes. All expenses (in your case it would be a necessary expense related or attributable to the rental property) are deductible from gross income.

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Casper October 8, 2013 at 9:10 pm

Question regarding how to report expenses of a rental property which has been listed for sale. Publication 527 states that expenses of a rental property that is for sale and that is NOT offered for rent are not deductible. How are such expenses handled? Expenses included mortgage interest, property taxes, insurance, utilities, homeowner association dues, minor maintenance and repairs.
It would seem that these would be capitalized as carrying charges and added to the basis for gain/loss recognition on sale, although Pub 527 does not provide for that.
There are other provisions providing for capitalizing carrying costs for raw land and property under development, but that is not quite the same. In the case of these properties, an election to capitalize interest and property taxes is also required.
Can all expenses, including interest and taxes, be capitalized to basis for vancant rentals for sale. If so, would an annual election be required? I would think perhaps no election is required if they specifically cannot be deducted.
In our case we want to amend prior year returns to capitalize expenses deducted on rental houses for rent and not for lease to increase the basis for calculating the gain on sale. If an election were to be required we could not amend, as the 6-month window has passed on all years. It appears from Pub 527 that we erred in deducting the operating expenses, including taxes and interest so an amended return would be proper to exclude those items. There would be no effect on tax, as taxable income was negative and would still be negative, but we are looking to increase our loss carryover by restating the gain on sales in open years by retroactively increasing the basis for expenses deducted in error based on Pub 527.
What expenses can be capitalized by amendment for open years and would an election have been required. If an election is required we would not amend as the due date for an election has expired.

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Sandra Masters October 8, 2013 at 10:31 am

We paid $11,000 to refurbish a pool (new plaster) on a rental property. Can we write off the expense in one year, or do we have to account for the expense some other way?

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denise October 1, 2013 at 7:49 am

Hi I am Canadian bought property in Az with partnership with two other people I own 50% then the couple own 25% each We rent it out, we do file and claim renting income each year. My question to you is How much do we need to rent it out, Is there a percentage of renting it and percentage for personal use without getting our hands slap because within the year or two our personal use might outweigh or rental use but it will still get rented when we are not using it, is there such a thing? Thank you will wait for reply ASAP

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Zaida Travieso September 5, 2013 at 12:29 pm

I sold an investment property on July 11. I bought this property over 25 years ago, the buying price was $60,000, and we sold it at $255,00, this amount includes closing cost realtors commission and some other small expenses, we claimed depreciation on this property in our tax declaration every year. Do we have to pay Capital Gain taxes? what is the percentage? and are there any exemptions that we can to pay less Capital Gain taxes.

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murine dixon August 23, 2013 at 4:58 am

I have an investment property that was rrented out but now I decided not to rent it anymore. I have spent over $8000 renovating it. How do I list it on my income tax returns? Do I have to now only claim the interest and the property taxes on this property or do I continue to do it as an investment property with no income from it if that is even possible on the irs form?

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Mary August 21, 2013 at 11:29 am

Good afternoon; I own a house (bought it back in 1994). During the time that I was living there and it was my primary residence, the home had a house fire that caused major damage and roughly $100K in renovations were completed (paid for through the insurance). I still own this home, but it is now a rental property. It’s been rented for about 10 years. I see that regarding capital gains/capital improvements, it shows on some sites that: If your home is damaged in a fire or natural disaster, everything you do to restore your home to its pre-loss condition counts as a capital improvement. – Can you tell me if this applies with Capital gains taxes considering that this is no longer my residence, but is now a rental property and that the renovations were paid for through the insurance claim? Thanks so much.

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vickie richeson August 13, 2013 at 2:15 pm

I am renting and my landlord approached me about buying but did not give me an answer when I asked about owner financing. I am preparing a formal offer and would like to know what the benefits would be for them to finance rather than to sell outright. Would this be of benefit to them on capital gains? I do not have the credit to finance the home.

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Victor Martindale August 13, 2013 at 1:38 pm

I am selling a commercial piece of property which is in my mother’s Trust (she passed away 2 years ago) and I am the Trustee. My brother’s and father’s % goes into their trust as they cannot take principal only net income off the principal. We did get a stepped up in basis so the gain will be about $80,000 after all the expenses out of a $1,500,000 sale. My question is whether the gain would be considered net income as opposed to principal which must go into their Trust. If the Gain is considered net income then I guess I could make a distribution to my brother and father (their % of the $80,000) and they would pay capital gains. It seems that if I could not make that distribution to them then their % of the $80,000 would go into their Trust and they would end up paying capital gains but wouldn’t have the money to do it. What is your thought?

Victor

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Dee August 12, 2013 at 11:23 am

I have 2 rental properties which I have paid off. They have appreciated a lot the last 4 years. I now need to cash out some equity in one of these properties for unexpected personal expenses. My questions:
1. Would IRS allows me to use that equity to used for different purpose?
2. If not, is it legal NOT to file with IRS about the refinance in my rental expenses because I can absorb the mortgage interest and because I use the cash for different purpose?
Thank you for your advice in this issue.

Dee

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Jason Van Steenwyk August 12, 2013 at 2:10 pm

Hello, and thanks for writing!

To answer your first question, you can use the equity to do whatever you want! However, you can only defer capital gains under Section 1031 if you take the equity and transfer it over to another ‘like kind’ investment. Do a bit of research on this before you do it to make sure you don’t accidentally disqualify yourself from the 1031 exchange because of some technicality.

Alternatively, you can find something you can sell at a loss, the same year, and use the capital losses to offset gains. However, if you just don’t have any money losing investments at all, that’s hardly something to complain about!!

Looking at things another way,

You can potentially take the equity you’ve generated and put it in a tax deductible investment vehicle… an IRA, a 401(k), Solo 401(k), a SEP, or what have you. You’d still be liable for capital gains, but you might be able to work out a tax deduction to offset ordinary income from some other source. It depends on how soon you need the money. 401(k) and SEPs have higher contribution limits than IRAs, and more permissive income criteria.

I’m not sure I understand your second question. A refinance is not normally a taxable event. Loans, unless forgiven, are not normally taxable as income. Are you asking can you choose to claim the higher interest on the older loan, and just not tell the IRS that your actually not paying the higher interest?

Don’t play that game. Seriously. It’s not ethical and could get you in trouble. The IRS will know what your interest is because they get a copy of a Form 1099 from the lender spelling out what the deductible interest you’re being charged is. This is not something that you can hide against a determined investigation. And if they find a discrepency like that one, they’ll start pulling threads and uncover everything else, too.

As for the purpose you use a loan for, that’s fact dependent. Interest on home equity loans SECURED BY YOUR PERSONAL RESIDENCE is deductible, up to a loan amount of $100,000. Interest on loans taken out for bona fide business purposes is tax deductible no matter how big the loan, and no matter how great the interest – provided it’s for a legitimate business expense. If you start playing games taking out loans against business properties for personal use, you run into a tax thicket that you’ll need a tax expert to walk you through. For example, depending on the circumstances, you might have to treat the whole thing as a distribution, taxable as dividend income. Or if you use the money to buy, say, a car, and then you use the car only 50 percent for business purposes and 50 percent for yourself, then you might only be able to deduct half the interest, etc.

So get a tax expert and walk through that scenario with him or her.

Thanks for reading!!

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Dee August 14, 2013 at 2:06 pm

Good afternoon,

Thank you so much for your patience and understanding, and most of all, your sound advices.

I’m sorry for being a little confused with my 2nd question. I did not mean to cheat the system. I just wanted to check with you if it’s legal that I skip reporting closing costs and mortgage interest as expenses for my tax because I use the cash out for personal issue. Thanks for your warning that IRS would find out anyway with my 1099 forms and I may face whole load of other issues from IRS. I may now need to sell one of the rental properties to address my personal problem.

Again, thank you so much for your explanations and thoughtful advices. Please continue providing general public your professional .

Dee

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Melissa August 1, 2013 at 5:57 pm

My mom needs to down size her owned home of responsibilties (cleaning size, maintence, etc…), because of age and money. I was thinking of turning her home into a vacation rental and finding a nice 55 and up community for her to live in and I manage the property. What’s the best steps should I take…?

Thanks

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gg July 23, 2013 at 9:53 pm

If we want to buy an investment house but not want to rent it out, before we sell it, do we have to report taxes on it?

Since we will not intend to rent it out, there will be no income from owning the house, will we still have to file tax returns every year for this ?

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Marie July 21, 2013 at 7:28 am

I am married and the house that we live in was built by my father 11 years ago. Costs of home was $150,000.00. (there is no mortgage on home) For the past 10 years we have been paying in cash rent to my father. This includes taxes and a 5% interest on 150,000.00. when we moved to this home my father said after we pay off the loan we would own it..it’s worth (home) on zillow $300,000.00. The only names listed on the deed were both my parents, and after 10 years of paying into this home and getting older and nothing to write off..I had a arguement w/ parents on adding my name n husband’s name on deed..well, I can’t tell u how pissed and mean my father became..I know he has been getting tax breaks on this property for the past 10 years..taxes as of now r $8000.00 a year..and included in the rent we paid..$1305.00 –he included the taxes and insurance n interest we paid–10 years ago we paid $1000.00 a month and of course every year when taxes or insurance went up so did the rent..we never had anything in writing and I wish we did..I thought we were going to own this home or at least that’s what my father said before it was built..he made this offer too good to be true–we moved from new jersey where we owned a home..and had some debt to pay off when we moved in this home and didn’t put any money down..we spoke many times to him about even purchasing this home at costs(balance of what we paid so far) which I asked and he was like u figure it out..we wanted to have write offs at the end of the year…we never got much back..my husband and I are hardworking people with 2 children ages 22 and 15. and he would say to my husband the house it not for sale. My father is nothing but a greedy person who is always out for himself and making a profit for himself..we had a falling out a week ago where he signed the house over to me for $1.00..and I added my husband’s name — he is not speaking to us…since then and my husband when over and argued on why his name is not on home..my father thinks everyone is after his money–and I told him we want the house we are paying and living in since we r getting older I’m 49 and my husband is 55..we wanted write offs…and plus the house needs some repairs that we put into like painting entire inside, new railing on front porch that costs us $2000.00..a shed, a fence, we framed out the basement to finish off (never did)..new counter costs $2800.00..my father built my older sister’s home at costs years ago, but they had a mortgage and it was in her/husband’s name–than they sold it got a profit and my father built another home for them–than they sold it (couldn’t afford home) made a profit and downsized…I totally feel betrayed with all this..I am not being greedy..I have explained how I felt to him and his logic is you will get the house when we die..I said how many more years am I paying for this home?? we r getting older and have nothing in our names (except cars..retirement fund)..he said he doesn’t want any of his son in laws to get anything..he has a will that we never saw and always threatens us that he’s not going to leave anything to us when he argues with us..(long story)..he owns the house he lives in –plus he owned this home for 10 years..(but as I said –he finally signed it over to me) …I am at wits end and feel very hurt with his behavior..plus he said some very mean things before he signed over the house..(at first he had my name on both homes for a while with both his name, and my mother;s and mine) on his home because he was mad at my sisters’ at the time..he thought I was not going to sign back his house to him and that’s when he transfered the home over to me…what does anyone think of all this????? I live in Pennsylvania..and also used his accountant for a few years–who i know fed many things in his head–but my father is always out for the $$$$$$…thank you..

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WENDY September 10, 2013 at 8:55 am

He sold it to you for a dollar..that is fabulous. Create a new deed where you grant the deed to yourself and your husband as Joint tenants with rights of survivorship. You will have the taxes to write off…no mortgage..hooray for you!

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Doug January 28, 2014 at 11:49 am

Financially speaking you are very lucky, You have basically paid off a $300,000. home in ten years. Thanks to your dad! Cut your Dad some slack, he has definately been generous to you and your husband for many years. Don’t bite the hand that feeds you! I think you and your husband should call Dad and genuinely thank him for all he has done for you.

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Rob March 10, 2014 at 12:19 am

Based on the information you gave I think you owe your dad about $120,000 and an apology.

$1,000/month is about right for a $150,000 loan at 5% + tax/insurance and i’ll assume from your post that you didn’t have $30,000 cash lying around so you would of had to pay PMI. If the property value doubled in the ten years (and thus the taxes), ending at about $1,300/month also sounds about right. If you had a loan at a bank, after 10 years under this scenario you would still owe over $120,000 on your $150,000 house…so yes…call dad…say sorry.

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Pam Hindman July 11, 2013 at 7:16 pm

I purchased 80 acres of land for 60, 000 and put 15,000 down from an insurance check I received that wasn’t taxable and financed 45, 000 with the bank and pay onky the monthly interest on the land which is 250.00 a month my question is I don’t feel that the 15, 000 should be included in the capital gains I am selling the land one year and day after I bought it for 96, 000 , what do u think?we did spend a lot of time cleaning up the property with heavy equipment owned by our company but nothing else but if we had to hire it out it would have been a lot.

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Paul July 15, 2013 at 7:24 am

you can’t deduct your time so in my opinion you make 36k on improving this property. My guess is that you’d have to pay long term capital gains for 36k.

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Jeff July 10, 2013 at 7:00 pm

Hi Jason,

Thanks for the great info!

I am considering buying a property (personal residence) “subject-to” an existing mortgage. I thought I had heard somewhere along the way that there may be negative income tax consequences to buying “subject to”. Any input on this will be greatly appreciated.

Thanks and God Bless, Jeff

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Chris June 20, 2013 at 8:22 pm

My husband and I have owned a small house in the mountains since 1991, we rebuilt the house do to fire in 2005. We now have it as our primary residents, (less than a month) we have not sold any property since 2005. Our question is if we sell the property in less than a year will we still have to pay capital gains tax?

Any information would be appreciated,
Chris

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Regan June 13, 2013 at 4:03 pm

Way cool! Some very valid points! I
appreciate you penning this post and the
rest of the site is extremely good.

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Lori May 15, 2013 at 2:21 pm

forgot to mention that neither one of us live in the house. its a two family rented out. both units are rented.

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Lori May 15, 2013 at 2:07 pm

parents gave us income property. we give them half the rent per month. their in their 80′s so we know they need the money. when and if we sell, can we write off along with the mortgage balance plus the 1/2 mths. rent we give to them each month.

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Phil May 13, 2013 at 8:31 am

We are considering buying a property primarily for investment/rental. We were going to take a mortgage on our primary residence to pay for it. If I can show that the money went to pay for the investment house, can I deduct the interest, or does the loan have to be on the rental property?

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lee May 7, 2013 at 3:39 pm

can anyone give me advise. I bought a house at a tax auction and it needs total rehab, from electric service to water lines and roof and sideing. can I turn around and sell this after and not have to claim the money made as income? Or would IO be better off liveing in it for a couple years as my first home and then sell it and not have to claim it as income when sold????

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Jeff Schiro May 7, 2013 at 5:17 am

I think one could make a case either way. I seem to recall that when the Big 10 finished their season before Thanksgiving, they had teams that would steadily move up the polls as other teams played a game the next week, then the conf championships would knock a few others down a peg. Say, a team would be at 6 or 7, then find themselves in the top 3-4 by the time everyone else beat up on one another. A downside was that by the time the bowls came around, they had not played for 50 days, but they cashed the check nonetheless.

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A Loder May 5, 2013 at 11:03 am

I have owned a rental home for over 25 years. The last 8 my daughter has lived in and paid rent. This was claimed as income for me. I want to sell her 1/2 of the home and carry the loan back. She will pay the mortgage to me and I will no longer collect rent or claim any expenses on my tax return. Are there issues I should be concerned with? I don’t want any red flags for the IRS. I would sell the entire house to her but I think the IRS will frown if I don’t sell for market prices.

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frank September 11, 2013 at 11:28 am

How would the IRS know what the market price would be. We just sold a house to our son for $100K less than market price.

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Stacy May 1, 2013 at 10:58 am

My husband, myself, his brother/wife, and his sister/husband purchased a townhome together back in 2003 for my husbands parents to retire in. We paid $78,000. The parents paid the mortgage/HOA which we considered as rent. My husband and I have the mortgage for this property in our names only. We have been claiming all the rental income and expenses/deductions & depreciation on our tax returns. We have taken a loss on the property each year. We just sold the property for $90,000. We don’t have any additional expenses/improvements that haven’t already been deducted on previous tax years. I know we will have to pay capital gains on the $12,000 profit plus the total depreciation we have taken on the property since purchasing it in 2003. Since we are co-owners with 4 other people on the deed, how do we split up the tax liability since no one else has claimed anything regarding this property on their taxes. Do my husband and I pay the full capital gains tax since we have been claiming all income/rental expenses? The settlement check after the sale was made out to all six people but we’re not sure how to subdivide it, Should we take out an estimated amount of taxes owed before disbursing it evenly. Help???

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Donna April 12, 2013 at 8:30 am

We bought some land about 10 years ago as an investment and just recently sold it. Is there a way to defer or lessen the taxes on capital gains. Also, is there capital gains on state taxes? We live in the state of N.C.
Thanks

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Burben Sullins April 7, 2013 at 8:02 am

I bought a condo in Alabama on a short sale. I have had it for six months. The question I have is: If I sale the condo today and reinvest it into a new condo, does the 1031 Exchange come into account

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Diane April 2, 2013 at 10:37 am

Many years ago I bought shares in a limited real estate partnership. Last year the partnership decided to take back all shares and either pay a nominal amount per unit or exchange for other stock. I opted for a legal class-action settlement that paid me approximately $700 less per unit than I originally invested. I know I need to account for the nominal dividends paid over the years but I have never rec’d a final K-1, though I can figure that out from old records. Do I need to list the loss on form 8949 or just on Schedule D?

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Todd graham March 26, 2013 at 10:57 am

If we rent our condo do we have to charge state taxes on it. also do we have to file arizona state taxes even if we are running a deficit in our income. Thankso

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Steve Hong March 17, 2013 at 3:41 pm

I buy land as invenstment using my LLC as the ownership. Do I have to report the purchase to the IRS and how do I deduct the expenses of owing the land (property taxes, hoa’s, etc.)? I was told to use Schedule E but without rental income or any attempt to lease the land, wouldn’t the IRS have an issue with that?

Thanks,

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Jerry March 14, 2013 at 12:52 pm

We own a realestate investing company and invest in many types of homes i many ways. We recently purchsed a home on a forclosure auction, in which the home was foreclosed on from a HOA.There is a sizable motrgage on the house, in which the owner of the mortgage has passed away. We have tried to work with the bank to sell the house but they never answer questions or call back. We have heard that if you pay taxes on a home for 7 years it then becomes yours. Is this true? If so, could we simply pay the taxes before the bank? Thank you.

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Judy Marable March 14, 2013 at 12:46 pm

I owned a house that my son lived in & paid the house payment on – this was considered the rental amount. On my taxes I considered this as a rental house & took the income & expenses on my taxes. I have owned it since 2003. My son moved & I sold the house in August 2012. I sold the house for $50K & I paid $40K for it in 2003. How do I determine the amount of capital gain to report on my taxes? If I use Turbo Tax will it prompt me for all the information to calculate the capital gain? Will the Deluxe Turbo Tax ask all the info to properly calculate or Should I use the Premier? Appreciate any information. Thanks

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Daine March 13, 2013 at 4:28 pm

I Co-own investment property with my ex He says that we had the option of one of us inheriting the capital gains Liability in a buyout. If he buys me he could take on the cost basis of the building. If we did this, I wouldn’t have to pay capital gains tax. Is this true? Is it even legal?

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Dave Williams March 8, 2013 at 12:45 pm

I am a licensed real estate agent. I own an investment property, which I purchased in 2008 for $272,000, cash – no mortgage. The property rents for $1580 per month. Right now, I could sell the property for only $230,000,, (which is approximately the depreciated value.) I could re-invest the proceeds, (approximately $220,000), and get another investment property for $215,000 – and rent it for $2,000 per month.

I know it sounds crazy, but my income would increase, but the obviously, the asset value is less. Any advice as to what I should do?

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Jason Van Steenwyk March 8, 2013 at 6:56 pm

Hello, Dave, and thanks for writing. Sorry you’re under water in the property.

From what you’ve shared, are you too sentimentally attached to the property and it’s clouding your judgment? People have natural biases against selling assets at a loss, which cause them to distort the decision-making process.

A few items to consider…
o You have a capital loss there of about $42,000. Do you have any other appreciated assets you can unload at the same time? You can use those losses to offset capital gains tax (tax-loss harvesting).

o If you don’t have something that’s appreciated you can sell to sop up the tax benefit of the capital loss, you can carry the loss forward and use it to offset $3,000 in income every year until you run out.

o Will you be dumping more money in taxes, maintenance, homeowners’ association fees, renovations, etc., in one property than another? I’m assuming it’s a wash, since you don’t mention it. If not, adjust the below information accordingly.

o Think of the properties in terms of “dividend yield.” Future appreciation potential is nice, but since you haven’t mentioned a compelling reason why you think one property would appreciate in value faster than another property, then I assume it’s a wash. So it comes down to this: Which property has a greater dividend yield on investment?

Well, here’s how to figure it:

Property #1 generates $18,960 per year on a value of $230,000. (Forget about the $272,000 figure. That’s a sunk cost. Don’t get emotionally attached to it. If $230k is the fair market value of the property that’s the number to use!)

That translates to an income yield of about 8.2 percent.

Property #2 generates $24,000 per year on an investment of $215,000, or about 11.2 percent.

PLUS you have $5,000 in cash left over.

PLUS $3,000 per year in carryforward capital losses. (The mathematical way to calculate that value is to calculate your expected tax bracket, multiply that by 3,000 per year, and then carry back the net present value of that sum over the next 16 years, which is how long it would take for you to eat up that capital loss at $3,000 per year, if you never had another taxable capital gain to offset).

So, mathematically, it’s not even a particularly close call. Unless there is a material fact you have not shared, it seems like Property B is the better one for you.

Is there anything else in the mix?

Jason

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Kevin April 23, 2013 at 10:42 am

I didn’t read any further than the first few sentences, but I think you have misunderstood the question. The original says it was purchased for cash (so he can’t be underwater in the traditional sense) and that the $230k was close to his depreciated cost basis (so he wouldn’t have a capital loss). Also pretty sure if you totally sell the property, it is not subject to the $3k limit to the capital loss.

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Jason Van Steenwyk May 2, 2013 at 4:16 pm

Hello, and thanks for writing! By “under water,” I meant ‘lost money,’ rather than “upside down,” but I concede that most people use “under water” these days to refer to owing more than the house is worth.

You can claim the entire loss, but if you don’t have gains elsewhere to write it off against, you can only write off $3,000 per year in against income and carry forward the remainder, I believe. If he’s depreciated his cost basis down to the approximate FMV of the property, then you are also correct, there wouldn’t be a capital loss to take. He’s already taken the benefit over the years in the form of depreciation. But property #2 still seems to offer the better ROI, even with no capital loss, which I figured was gravy, anyway. You are correct in pointing out that if the depreciated (book) value equals the actual selling price, there’s no capital loss to be taken. Thanks very much for writing!! Jason

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Butch March 7, 2013 at 3:05 pm

Last year I entered into a land contract on a rental property (dbl/ 2 apts) I’ve have owned since 1985. Due poor health and finances, I could not continue managing the property by myself, but it could not be sold normally due to negative housing market/ type of neighborhood, even though I tried for several years. It was agreed in the contract to allow the buyer to have total management and responsibility for all cost of repair and upkeep to the property. This included managing & collecting rents @ paying my existing mortgage payments incls. PITI to the bank until mortgage is satisfied ( apprx. 9 yrs). Then property will belong to the buyer. The land contract was finalized in August, 2012. Do I used only the 8 mos in reporting my rental income section and the buyer is responsible for his portion? Is this considered a sale by IRS? I used tax software for many years, but there is an answer to this issue in the software. Thank you, Butch

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Rosemarie March 6, 2013 at 11:36 am

I have a house in AK and live in CA. I have to pay the borough a portion of the cost to put in paved roads in my subdivision. Can I deduct this cost?

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Teri Boyle February 28, 2013 at 3:08 pm

I can’t find an answer anywhere. If I sold my rental property in 2012 but received a bill in 2013 from the new buyers for repairs. If i agree to pay this, how do I deduct this expense?

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Christy C February 24, 2013 at 4:19 pm

We have a townhome that’s paid off/ no mortgage and are renting it out at $1,900. We just bought a SFH and we are having a mortgage and monthly payment is at 1,823- with escrow and tax and all that will be about 2,400 a month.

I understand that my 1,900 will be taxed as marginal income.
Since we cannot deduct any mortgage interest from this already paid off property- should we try to set ourselves up as a LLC instead to get tax less? what’s the best way for us to get close to breaking even? Thanks

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Kathy Bouschor February 19, 2013 at 12:05 pm

Purchased 2 rental properties in Arizona in 2005.
Want to sell both of them. I owe way more than they are worth.
One is worth $110,000 and I owe $195,000. The other is worth $100,000 and I owe $203,000. I recently lost my job, my husband is in social security. Want to sell these but can’t afford a big tax bill. Our income for 2012 was not above $100,000 nor will it be in 2013. Will I owe a big tax bill if I see them at a loss?
I supposed the holders of the mortgages are going to have to agree to the sale at a loss also?
Thank you for any advise you can give me.

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Tony February 18, 2013 at 7:01 pm

My wife and I live and reside in Michigan. We purchased a home in Orlando Florida. Our son is living in the home and is paying the mortgage, utilities, insurance and taxes. Everything is in my name. Once my son establishes credit and has enough for a down payment, he is purchasing the home from us (minus what he has already paid toward the mortgage). We are also renting out one of the rooms to one of his coworkers, I understand we have to count his rent as income. I have a couple questions:

1. Do we have to count what our son is paying toward the mortgage and taxes as rental income even though we will be deducting this amount from the cost of the house when he purchases it from us?

2. Can we count travel to Orlando as an expense if we perform repairs on the home (painting and landscaping)?

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Mark February 18, 2013 at 10:30 am

Have residental rental property in indiana and am now selling on contract. How is this to reported to IRS? I still officially own it and have responsibiltiy for a mortgage and taxes. Do I continue to report as a rental until the the actually title transfers at some future point in time?

Thank You

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kyle February 16, 2013 at 9:40 am

My father owns 1 LLC and so do I. I wanted to know if my father has owned the property under his company since 2011, will I have to pay short term or long term capital gains on that same property if he signs the property over to me?

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Michael February 15, 2013 at 9:12 am

I recently purchased an investment property in Georgia. I live in Pennsylvania.Can appraisal fees,airline cost, hotel stays,car rental,etc. associated with buying the property be taken as a deduction?

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bill February 14, 2013 at 3:47 pm

how do i go about filing for tax deferment on a real estate investment for retirement. or do you need to file for retirement account purchase

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Hoot February 14, 2013 at 6:40 am

I bought 3 unimproved lots in 1987 for $12,000. I Aug 2012 I traded it for a Harley motorcycle at agreed value of $18,000. No cash changed hands. No improvements had been made to the property but some interest on the loan was paid and there were costs involved in making the trade. It was not bought as investment property as we had intended to retire there. What is my tax liability and do I show the trade as long term capital gains? THANKS, Hoot

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sharon weinberg February 10, 2013 at 6:46 am

I purchased in 2012 a second home in Florida. Its being rented out. Can I deduct my closing costs for the purchase of this investment property on my 2012 tax return

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Tracy Troszak February 8, 2013 at 10:53 pm

I have sold my home on a land contract and still retain a mortgage. Can I deduct the full mortgage payment on my taxes or just the interest paid?

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David Hunter February 4, 2013 at 12:01 am

can i deduct the difference if my mortgage is more than rent i collect on the property?

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jeff February 13, 2013 at 1:45 pm

thats called a loss… and that doesnt sound very desireable. but with a rental property, you report all expenses and then all rent revenues. If there is a loss, that usually just gets subtracted from your overall total taxable income for the year. You need to file a schedule E however and auto software will subtract that loss from your income totals making your taxable income less.

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cindy May 1, 2013 at 4:19 pm

Not true because you can not deduct your mortgage to begin with! Your mortage has zero to do with taxes on a rental propery. The interest on the mortgage you can deduct.

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Accidental Landlord February 3, 2013 at 4:54 pm

I received an offer from my company to relocate for a promotion. I had to make the decision in 1 week. I took the promotion and moved. We couldn’t sell the house and decided to attempt renting it out. Kept lowering the price every 3 days until we finally got people looking at the place. We had to take a 2 year lease at $1550 per month on a 3 bedroom 2400 sq ft townhome. Here is my question, which when approaching a so called “tax adviser” makes me nervous when there is a pause. How do I file in this scenario.
Mortgage payments: 1900.00 (includes escrow for real estate taxes and insurance)
Rental income: 1550.00
HOA fees: 100/mo
I used a tax software for the last 2 years and this seemed to just cancel itself out.
1900 – 1550 = (-350) then hoa = ($-450.00) per month in losses

I don’t even want the property but I am upside down by $70,000 and it has been on the market since we left with one showing every 6 months due to the comps in the area.

I do not do this rental activity for profit. I only did it b/c we couldn’t sell the home but I wanted to move for a promotion. Any insight is greatly appreciated. Any suggestions of a resource for me to use in assistance with this, even at cost, would be appreciated.

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jeff February 13, 2013 at 1:53 pm

There is no intent for profit, but you are still in essence running a rental business. IRS doesnt really care. You cant deduct mortgage interest anymore since this is not primary residence anymore. You dont need any special business names. Your property is essentially the name of your rental business. You will however file a schedule E, business income using the tax software, report your expenses (all payments, HOA fee, and repairs) and revenue associated with the rental, and any loss will get subtracted from your total taxable income on your main form. turbotax tax act and other all do this. You can deduct the mortgage interest on your new primary property however if you own a 2nd house…

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Jason Van Steenwyk February 13, 2013 at 2:55 pm

Hello, Jeff, and thanks for participating.

He can’t take the personal residence mortgage interest deduction once it’s not his personal residence. But once it becomes an investment property, I believe he can deduct the mortgage interest as a business expense, no? And this one wouldn’t be limited to the 2 percent of AGI threshold, and would not have to exceed his standard deduction to do him any good, I believe. It comes right out of rental income.

Jason

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cindy May 1, 2013 at 4:26 pm

The bottom line here folks is you can deduct mortgage interest on rental property! Not your actual mortgage on anything PERIOD! Interest only

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Nancy February 3, 2013 at 1:11 pm

My husband I purchased a home for $27k and put $7k into renovation. We then sold it to another couple for $56k with owner financing. They paid 0 down and we will be holding the mortgage for 35 months with a balloon payment due at that time. My question is, are the renovations deductible for 2012? Their will be no capital gains until the new owner refinances in 2015 when we should realize profit at that time. We are both employed full time, however I’m also a Realtor and file as a business owner. Thanks!

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Cindy February 7, 2013 at 3:57 pm

The $7k is added to the basis of the property. Are you charging interest on the mortgage? You do realize you will have to report the owner financing on your income taxes.

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Gracie February 3, 2013 at 12:46 am

I was 1 of several investors in a flip property. The house sold last year, and I (as did everyone) receive a portion of our investment but lost most of it. Do I claim this as “other” income? Can I deduct the loss?

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Barb January 27, 2013 at 2:13 pm

My daughter moved in with me in 2010 and in late 2012 I added her name to the deed on the house. She pays the real estate taxes and mortgage interest. Since I no longer itemize deductions, can she claim the real estate taxes and mortgage interest on her taxes for 2012?

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Gary January 26, 2013 at 10:56 am

for a real estate “dealer”, are real estate taxes and insurance deductible if the property is still owned at year end? or are they inventory costs?

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walden January 25, 2013 at 10:42 am

I am married and file jointly with my wife in NJ. I purchased a two family house and spent about $40,000 renovating the rental apartment – I live in the other part of the home. I have a full time job but spent most of my nights and weekends working on the house, making countless trips o HD, Loewes, etc. (In excess of 750 hours) I have receipts for everything, pictures and can document a time log if i must. The apartment was only rented for two months so my cost/loss is significant compared to rent collected. I have a full time job but spent every moment of my spare time rebuilding. Can I claim this as a loss as a real estate professional? Or should I claim the max loss of 25,000 given that the apartment only rented for two months? What would you do? Thanks!!!

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Randy January 28, 2013 at 6:04 am

Walden – I heard that it had to be your primary occupation as well – min 750 hours AND you can’t have worked more at any other job. Sounds like 25k will be your limit. Best of luck!

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Russ February 3, 2013 at 4:20 pm

Walden,
The majority of your costs are going to be capitalized and you will not be able to expense them for the 2012 tax year. In essence any cost of improvement (and you can’t include your self labor costs) to the rental apartment to put it in service will be added to the basis of the property and then depreciated over 27.5 years. You also need to assess the cost of the land and subtract that from your basis. You can depreciate major items (appliances, etc) separately over their useful life (typically 5-7 years).
I can tell you that if you go the real estate professional route and try to deduct 25000 you will most likely be audited and have significant penalties. That is one of the huge red flags the IRS looks for since many people abuse it that don’t understand tax law.
I would recommend saying you are an active participant and there is no way you can claim a loss of 25000. The only legal expenses for 2012 you will have are the prorated cost of mortgage interest and property taxes as well as depreciation and any other minor costs related to renting the apartment (advertising, lease fees, etc..)

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cindy May 1, 2013 at 4:36 pm

I agree with Russ 100%

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Jenel January 24, 2013 at 7:45 am

I own a double in NYS in which I have always lived in the lower half of. I had recently gone through divorce and now would like to sell the rental property and move to a single family home. Would I owe tax money out at the end of the year next year if I sold the home?

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Susan Raspitha March 6, 2013 at 12:35 pm

I have the same question.

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Mark January 22, 2013 at 7:28 pm

If you own your house free and clear can you setup a LLC and transfer the house to it and then take mortgage through the LLC you made and make mortgage payments to the LLC for tax purposes?

Thanks

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robert January 30, 2013 at 4:34 am

Good question! I have a rental property in California and want to do the same thing. Is it legal? Please reply.

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Dave Siegel April 7, 2013 at 6:18 pm

I’m not a tax professional, so these are just my thoughts, but…

Your LLC will have to pay interest on this mortgage it gets and it will owe taxes on whatever it receives from you in the way of mortgage payments. You are just setting yourself to pay double taxes.

Why not just take out a mortgage on your home at 3% and invest the proceeds? You’ll get your mortgage deduction and should be able to beat a 3% return on investment even if you are fairly conservative.

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Tim January 22, 2013 at 12:38 pm

Jason,

My situation is as follows: My wife and I own our own home. My wife holds the mortgage on a family home she lived in before we were married – because she was the responsible, creditworthy one in the family. Family members continue to live in this property and contribute to the expenses, including the mortgage, monthly. My wife has lived with me in our own home full time since leaving the family home. Is this family home a 2nd home, or an investment property as far as the IRS is concerned? The banks wants to call it an investment property for refinance purposes, but how do you declare income fairly?

Thanks in advance!

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Heidi January 20, 2013 at 5:05 pm

Jason,
My situation is a little different, so I would appreciate your guidance.
I bought a house in another state; I intend to move into it as soon as I can find a job in that area — or, if I can’t find the right kind of job in that area, I intend to move into it when I retire (in, say, 13 years).
In the meantime, I am renting it out, and actively collaborate (long-distance, with occasional site visits) in its management with an agent who lives near the house. The rent I collect falls short of the mortgage, never mind the taxes, insurance, mtce., and fees for the agent.
Questions:
1. For tax purposes, what is the classification of the house? It is not a property which I am renting for profit — is it still a “rental property”?
2. Is this necessarily a Schedule E situation?
4. If it is a Schedule E situation, can I / do I recharacterize the house when I move into it myself? How does one do this?
3. If it is not a Schedule E situation, do I just eat the net losses each year it is rented?
Reading through the tax code, I find lots of info on converting a residence to rental use, but nothing about the reverse.
Thank you in advance for your guidance.
Wanting to get this right,
Heidi

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Babu June 14, 2013 at 10:17 am

Heidi,

We are in exact same situation and would like to know if you have gotten any responses or found out more about that.

Thank you.

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Charles Morgan January 11, 2013 at 1:59 pm

Jason… I love the clarity of your posts; thank you.
I could not find an answer to this particular question: we bought an old house last year in order to rent it as a vacation rental, but it needed a lot of work in order to get it ready for rental. We began advertising right away (last year, shortly after we bought it) since we knew that our restoration of the house would make it ready for rental this coming spring. Work on getting the house ready (a lot of repair/restoration work!) began last fall and should be finished in april, just in time for our first rentals.
Three questions: 1) last year, we spent a couple thousand dollars on marketing the house for rental. Are those costs deductible against the rental income that will begin this spring?
2) i’m travelling to the house in order to do painting and purchase items to get it ready for the first rentals. Are these travel expenses deductible?
3) What, if anything, is deductible from all the (expensive) work, the purchases, etc. that we undertook to turn this historic building into a livable rental property?
Of course, i won’t hold you to any particular answer, but would love your thoughts on this. Many thanks. Charlie

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Karen January 1, 2013 at 6:23 pm

Jason,
I have a question. My husband and I purchased a home in Florida in 1982. We lived in the property for 23 years. In 2005, we purchased another home in the same city and have lived in at the new property for 7 years. For the first two years after we purchased our new home our daughter lived in the original property where she was raised as a child. For the past 5 years the house has been empty. We would like to put it on the market. What will our tax liability be?
Will the property be considered a rental? Thanks.

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Saraah December 31, 2012 at 8:05 pm

Hi, We purchased a property about 7 months ago as our main residence. We have spent around 40k completing renovations on the property but due to work commitments we need to move, will we be charged capital gains if we sell the property before 12 months? Thanks

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George December 29, 2012 at 7:17 am

I own a rental home that I lived in for 13 years. The house is fully paid off with no liens. The house has been rented for two years and I live in another home that has a mortgage. My question is can I take a loan off the rental home, pay down my primary residence and most importantly, deduct the loan interest against my rental income????

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shelia December 13, 2012 at 10:28 am

i co-own a house with my sister, and my father lived in it by himself for 8yrs. my dad did not pay rent, and he died 2 mo. ago. we are selling the house at a loss of 35-40 grand. since we never lived there and did not recieve rent can we still claim a loss on our taxes? we do not want to rent, we just want to get rid of it.

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Karen Pierce December 11, 2012 at 11:09 pm

We are purchasing a home with cash. How should I go about closing on the house since a bank will not be involved. Do I need an attorney or can I do this by myself? I will have a survey and title search done.

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Kat December 11, 2012 at 9:18 am

Hello,

I have a question, if a family member (who already has a house) purchases another someone in the family who can’t get the mrtge, what are the tax implications for the one buying the house? The one who will live in it will pay the mrtge or ‘rent’ to the other party. This is is NJ

Thanks for any information

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Meghan Cooley December 14, 2012 at 2:30 pm

I want the answer to this question as well…Anyone?

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Ben December 10, 2012 at 2:12 pm

We sold our home in August of 2012. We had lived in it for 10 years. I understand that we will not have to pay cap gains tax in the equity, but does the equity count towards our taxable income? I need to know this because I am preparing to sell some stocks and wants to be sure I stay under the limit of the tax bracket I am in for 2012 in order to avoid cap gains taxes.

Thanks for your quick reply!

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Lynda Zika December 8, 2012 at 9:16 am

Hi, we are selling unimproved land that we have owned 5 years. Are we able to deduct maintenance and Homeowners association fees and taxes that we paid over the 5 years. We are making 2 thousand on the sale but have paid at least 3500.00 per year in taxes and maintenance. We take the standard deduction on our personal income tax so we did not declare the taxes yearly.

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Elaine December 7, 2012 at 3:13 pm

I own a condo in Atlanta but recently moved across the country. I would like to rent it out but the lease list is full and my HOA will not allow it. I have a very good friend that I trust to move in. I’ve been advised that there are a few legal ways to get around this: form a corporation or make the renter 1% owner. Which route do you advise? Thanks.

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Marie December 4, 2012 at 3:33 pm

Hello,

My Father passed away in August 2012. He placed his home in a trust for myself, my brother and sister. I have been appointed executer of his estate. At the time of his passing his house payments were around $900. a month on a $60,000 balance on his mortgage. My husband and I are refinancing the house so we will have more affordable payments while we make repairs and list the house to sell. Since we already have a mortgage on our home the mortgage company is financing the new mortgage on my Father’s house as an investment loan. Once the house sells my husband and I will collect from the sale the costs we paid for the monthly mortgage payments and repairs. We plan to split the overall profit with my siblings. Since we refinanced the property will it be subject to taxes ?

Thanks,

Marie

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Lana December 3, 2012 at 12:06 pm

Can i write off association fees on a rental property?

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Lee Del Valle December 8, 2012 at 9:32 am

Yes, because it is a cost of doing business and it is also making you money.
If it were your personal residence the answer would be no, only the taxes would be. Since it is rental property it is considered normal to have expenses to offset the rental income. Feel free to contact me if you require additional information.

-Lee

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Carolyn November 26, 2012 at 8:28 am

I have a questions regarding a real estate investment purchase. My husband took money out of his investments to purchase a foreclosed property. We purchased it for $33,000 and it is valued at $60,000. I am not sure which IRS form to use to report the purchase. We also are in the process of renovating it. Can all the costs of the renovations be deducted? Thanks for your help.

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HANK November 19, 2012 at 3:07 pm

i bought a cottage going to rent out but it needs repairs inside an i need to put in a well can i write that off in the first year

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Lee Del Valle December 8, 2012 at 9:47 am

Repairs such as painting and fixing upping you can write off up to $25,000 per year, but only if you will be actively managing the place. Depending on the cost of the well, you may be able to write off. Its a big ticket item it could also be considered to have a benefit of more than one year meaning it should be considered an asset that adds value to your cottage and the asset should be amortized like say over 26.5 years. Its a judgement call on the cost of the well.

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david November 15, 2012 at 1:59 pm

I am in the same situation as barb. I would also like to know if capital gains tax or gift tax is required.

thank you

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Al November 15, 2012 at 10:22 am

Jason,
There is a potential sale of my business properties for $1.4M, of which I personally own and rent back to my business. One property was bought in the early 70s for $75K. The other property was purchased in 2008 for $630K. Rental income and all property’s expenses have been paid through my business and I have received K-1s for my personal tax return. Since the business has been paying for everything over the years, what effect will that have on my capital gains.

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barb November 4, 2012 at 6:51 pm

Hi, in 1996 our father signed his house over to the three children. He died this year. We have an offer on this property. He lived in the house and no rent was ever charged. It is selling for $250,000. The house was built in the 60′s at a price of $25,000. No one appraised it in 1996. We are told we need to pay capital gains on everything and use the $25,000 value from when it was built. What way would we need to do capital gains on this property. It seems eveyone and the lawyer states about $250,000 minus $25,000. This does not make sense. I would love to use this money to sell our house we are living in and the profit to buy an nicer home. How could this be achieved? We did live in the other house growing up, but not since it was put into our names. Thanks

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Ron November 8, 2012 at 8:02 pm

I think this would fall under the estate tax which is tax exempt up to 5 million. This will be lowered to 1 million in 2013 unless congress does something.

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marilyn November 15, 2012 at 5:14 pm

It is not part of an estate if the father already signed the house over to his three children. Lawyer is correct. Cost basis is $25000.

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Ron October 27, 2012 at 8:25 am

Hello,

My wife purchased a townhouse in 2002 for $85k (before we were married) and lived in it until we were married in 2003 when we bought a house together. She has been renting it out since then. We now owe about $35k on it and would like to sell it to buy a second home . The second home would be rented out for part of the year . FMV on her townhouse is about the same $85k that she paid for it. If we sell it for the same $85k (zero profit) will there be any tax penalty and would we be limited on time before we had to purchase the second property?

Thanks,
Ron

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Morrey Thomas October 22, 2012 at 6:59 am

Jason;

Thanks for your great tips. My mom is the owner of a prime beachfront lot my dad bought in the 1970. The lot was deeded in her name when bought for $250k, and now has a value of $2M. If sold, we understand the computation of cap gains, but will the value of the sale count toward her annual income? If so, this will force the additional 3.8% tax since obviuosly her AGI will be over $200k.

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Brian November 29, 2012 at 12:57 pm

See if they buyer is interested in owner financing. If so you only pay taxes on the % of the money that is principle on the sale. She would have to pay capital gains on the interest but she should be able to defer the priniciple down to small enough pieces to keep her under the AGI cap.

Make sure the law has not changed but my wife and I owner financed a home and only pay tax on the amount that is priniciple paid in any year. Even $2 million broken down over 30 years is small enough to get under the limit.

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Tracey October 20, 2012 at 7:51 am

We are renting out our townhouse. Then we are renting a home to live in across town. Are there any tax deductions as landlords AND renters?

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dave October 17, 2012 at 2:34 pm

Interesting stuff ! I’ve got an unusual situation for you. I purchased a residential lot as an investment property back in ’06. The economy crash cost me my job and I was forced to retire. Unable to make payments on note for lot, lender has offered to settle for $22K on $112K note (balloon mortgage) but will report difference on 1099.
Can this phantom income be considered investment income as I have interest payments from prior years as carryover expense to help offset. Any suggestion ?

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Erin October 16, 2012 at 6:19 pm

My husband and I purchased a home on Dec 29, 2006. We lived in the home until Jul 31, 2011 and it became a rental property on Aug 1, 2011. The net on our Schedule E for our 2011 1040 form was a loss, and will be for 2012 as well. We meet the ownership and use rules to exclude any gains, but I’m not sure if we have a gain or loss. We did not have the property appraised at the time of the rental conversion, but had a real estate agent do a market analysis which would tell us what we should list the house for. We aimed on the lower end of her range and declared the FMV as 64,700. The house sold for 68,500, less selling costs of 3727.50. Then we claimed depreciation of 819 in 2011 on the property. So, I believe we have a gain, unless I file an amended return for 2011 with an increased FMV. In that case, we could end up with a loss, since I believe we really did understate the value of the home.

My questions are mainly, if we leave 2011 as it was, how do we exclude the slight gain on the sale of the house, and do we need to pay capital gains taxes on the 819 we claimed in depreciation last year? And do we claim depreciation on it on our Schedule E this year?

Or, if we amended our 2011 return, can we then claim a capital loss on our 2012 taxes? We will have net loss on our Schedule E for both years.

Thank you!

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RD January 1, 2013 at 7:35 pm

You cannot just declare a FMV, you would need to have the actual basis of the home at the time of the conversion, in 2011, which would be your actual cost basis when purchased plus any “capital improvements” made on the property from the time of purchase until conversion time. This would then form your basis in the property. You would have your basis less your depreciation for 2011/2012, to form your actual cost basis. If your selling price less expenses is more than your new actual cost basis, you would have a long-term capital gain, assuming you sold it more than 12 months after conversion.

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Ann H. October 14, 2012 at 11:22 am

Hi Jason,

Great article! Simple question re: figuring capital gains on sale of principal(and only) residence for 6 yrs: In figuring the “amount realized” from the sale, can I include paying off my 1st & 2nd Mortgages on the property as “selling expenses”? Thanks for your answer!

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Rick October 8, 2012 at 6:37 pm

Hi Jason -

I am a beginner real estate investor from New York City. I currently own and rent a property in Tampa and am in the process of closing on another just outside of Jacksonville. Both of these properties are financed by conventional personal investment property loans with 20% initial down payment. Two questions have arisen from this situation:

1. If needed, would I be able to write off any losses that were incurred on the Tampa property against revenue generated from the Jacksonville property?

2. These properties are under my personal name. I would like to form an LLC, but the mortgage company will not allow that. I also spoke with a lawyer and he shared the same concern. Do you have any advice of how I can give myself this proper protection, without jeopardizing my mortgage?

Thanks in advance for any help you can offer.

Best,
Rick

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Randy October 5, 2012 at 10:44 am

Hi Jason,
First of all, great responses!! I enjoy reading your blog…I have a question for you. I have stock losses which take over 100 years to recoup at the 3k yearly rate…a friend said to me when I sell my investment property, which will have 200k profit, I could offset that profit with my losses and pay no capital gains tax, is he right? Property is in MT and i live in CA, wouldnt think that makes any difference? I like to be informed before I bring it up with my tax guy. Thanks

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Jason Van Steenwyk October 8, 2012 at 1:42 pm

Hello, Randy! Thanks for writing!

Sorry about your stock losses. Yuck.

At first glance, this seems like a pretty straightforward illustration of capital gain vs. loss offsets. Is everything a long-term gain and long-term loss? Or are there short-term gains and losses mixed in?

The details vary according to the nature of the losses and gains, whether short or long -term. But generally speaking, you should be able to offset your entire gain on the property with the capital losses from your stocks.

An exception might be if you owned one in a C corp and the other outside of it, or if you were classified as a dealer by the IRS because you were buying and selling properties all the time, which would cause the IRS to classify your gains as income.

I defer to your tax advisor about issues specific to state law in Montana or California. Actually, I defer to him on EVERYTHING related to taxes, but these are the issues to bring up.

Hope that helps!

Jason

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Marcel October 3, 2012 at 7:14 pm

Hi,
I have a property that I have both lived in and rented, I lived in it for 5 years and rented it for 2 and it sat empty for 1 year. I would like to sell but can’t break even. If I rent it out again and then sell it can I declare the loss against my other rental income? And is there a limitation of $3,000 per year. I actively managed all my rentals.

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Fred October 2, 2012 at 8:18 pm

Jason – My wife is a independent real estate agent. Prior to the crash, we purchased land that we were going to build a rental property on. After the crash we changed directions and worked a rental home purchase, using the property and cash together to make up the final price. We now have a $350K long term capital loss on the lot that we can recognize. Does my wife being a real estate agent offer her any tax advantages with loss recognition?

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Jason Van Steenwyk October 2, 2012 at 9:30 pm

Hello, Fred, and thanks for being a reader! It looks like from the reaction to this column I should cook up some more tax-related columns.

As far as I know, there is no intrinsic tax advantage just to being a real estate agent when it comes to realizing a capital loss on a property.

BUT… if your wife is classified by the IRS as a DEALER, then those losses may not be classified as capital losses at all. Rather, they are categorized as ORDINARY losses, not capital losses. Which means you can deduct your ordinary losses against incom without the $3,000 per year annual limit that applies to capital losses that you can’t net out against capital gains for that year.

For more on that idea, see my column on the taxation specific to flipper-deaers, here: http://www.realestate.com/advice/taxation-of-real-estate-flipping-26154

No… let’s look more broadly at your picture: If your wife’s income is closely tied to the real estate world, then what happens next time it crashes? Well, if you’re invested mostly in real estate, then you take a hit on your investments and your household income at the same time. The danger is similar to that experienced by Enron employees who had most of their 401(k)s wrapped up in company stock when Enron shares collapsed. Sure, it’s likely to be less catastrophic… real estate doesn’t become worthless overnight like a share of stock. But if you’re leveraged, your EQUITY in the property sure can!!! If you’re not careful, this could leave you upside-down in properties that you need to sell when your income is down.

Not saying this is you, but this is just one issue that popped out that might benefit someone reading it: Be very careful about relying on a single asset class or industry for both your income and your retirement savings. It’s ok to take a hit on one or the other from time to time. It’s inevitable. But be very wary of putting yourself in a situation where BOTH your savings AND your income will get clobbered at the same time.

I expect to deal with this idea more in a future column. The basic ideas are asset allocation and diversification, though. William Bernstein has some great writing on the subject. Understand the mathematical concepts of “covariance” and “correlation coefficient”

Thanks!

Jason

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Tyler October 2, 2012 at 3:31 pm

Hello I have a question. I bought a house for $40k and put about $20k into it. I’m positive I can sell for no less than $79k for about a $19k profit before taxes, fees, commission etc. Well I put a lot more money into the house than I anticipated and now don’t have much money in saving, which I don’t like. I have not moved into the house, I live with my brother but planned on moving into the house when it was complete. I have owned it for 3 months now but have not moved in.

My question is under section 1031 do I qualify if I purchase another home within 60days and do the same thing, but actually move into this one, or does that qualify as a “like kind” exchange and I will still owe the taxes?

Thanks

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Jason Van Steenwyk October 2, 2012 at 4:49 pm

Hello, Tyler!

Thanks so much for writing.

Section 1031 would apply specifically to investment property. If you never moved in, and are selling at a profit, you can probably justify categorizing it as an investment property, it looks like.

But if you actually move into one… and use it as your personal residence, then it doesn’t qualify as a like kind exchange. You’re swapping an investment property for a personal property, and that won’t work for IRS rules.

If you’re a member of the frequent flippers club, special rules apply, since the IRS considers you to be a dealer, buying and selling INVENTORY, like anyone else who buys wholesale and sells retail.

Also, not that whle you need to own and live in the property for 3 of the last five years to qualify for the capital gains exclusion on a personal residence, you don’t have to live in it that long to disqualify it as an investment property. Live in the property too long and the IRS will think it’s a vacation home or mixed personal use. That would erode the tax advantages of it being investment property, but not gain you the advantages of it being personal property.

Lastly, if it’s in a self-directed IRA or other retirement account, you can’t stay in it at all. (But strangely enough, your brother can – so long as he’s not married to one of your parents or grandparents or one of your children or grandchildren.)

Get a CPA’s eyes on this one, though. It’s pretty fact dependent, and doesn’t lend itself well to a comment-thread type answer.

Thanks,
Jason

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Randy January 28, 2013 at 6:12 am

I’ve read that you can sell a home that’s been used solely as investment property for a year and a day, even if you were using it as your primary residence prior to the investment use. I’m buying a second home now and converting my current home to 100% rental. After a year and a day I’ll have the option to do a 1031 exchange and trade up to a bigger investment property.

Good luck!
Randy

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Jay September 30, 2012 at 2:12 am

Hi,
My wife and I have a rental property we are considering selling. For the past few years, we have earned more than the $150k limit to deduct passive income losses. I have been calculating depreciation as part of the “non-deductable losses.” If we sell and do not replace the property, are those “non-deductable losses” added back to the depreciated cost basis to calculate the gain/loss or do I have to depreciate the property and and not add back the losses?

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Jason Van Steenwyk October 2, 2012 at 8:51 pm

Hello, Jay!

Thanks for writing. This one had me scratching my head, too.

So on this question, I did what I advise ALL real estate investors to do… early and often: Go to a licenced tax expert who deals with these specific tax issues all the time.

In this case, I forwarded your question to a CPA who practices in Palm Beach County, with a local firm. Her firm doesn’t advertise, so she didn’t want her name or firm mentioned, but here is her response to me, verbatim:

*******
“Sounds like the calculated depreciation is part of his suspended loss that will be released when he disposes of the activity. Depreciation taken ( suspended or released) should lower the cost basis of the property when calculating the sale gain or loss.. The reader said he was taking depreciation each year but was “non deductible”. It was just trapped by the limitation. There are two things going on here: sale on Schedule D and eventual release of suspended losses on Schedule E.”

*********
This is Jason again: So, in layman’s terms, it doesn’t matter whether the depreciation you took was suspended along the way, or was above or below your passive activity limits. Any depreciation you take along the way does, in fact, get subtracted from your tax basis in the property.

Now, to expand on that a little bit… If you have suspended losses that are finally unleashed from the sale of a property, and the losses are large enough, these can possibly generate net operating losses that you can carry back or carry forward to other tax years. Definitely get your own accountant with some green eyeshades on this one. Hopefully one with a good deal of experience with real estate investors.

Investors in Florida,California, and parts of Arizona and Nevada have an advantage in seeing tax advice, though, since,accountants in these areas have, over the last several years, built up a great deal of experience and expertise in accounting for real estate losses.

Best of luck to you, and thanks for reading! Keep coming back!

Jason

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Winnie September 20, 2012 at 1:26 pm

Hello,
I have question. I live in New York and buy a investment property in California. For the rental income or capital gain, do I need to pay both NY & CA? I own the property for more than 2 years. If I sell it, where can I find out what is my tax rate since it is from zero to 15%.
Any other question, I have another 2 properties bought 3 years ago in CA that I share with my aunt (live in CA, ratio is 50/50. Since I didn’t want to get involve with all the documents and tax issue, so we only put my aunt and uncle name on the title. But I did pay half of the property price and all other expenses. My aunt is getting old now and have no child, and she will make a will and says these 2 properties will belongs to me after she pass away. But I have to pay estate tax at that time. What should I do now? Should we an LLC, S-corp or C-corp now and change the properties under it?? And what kind of company should I form? LLC? S-corp? C-corp?

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Jason Van Steenwyk September 30, 2012 at 5:38 am

Hello, Winnie! And thanks for writing!

I regret I’ll have to punt on this one, just because it’s wrapping too many issues for me to answer usefully in a comment post, and because it’s so specific to your situation you would probably be much better off working with a licensed professional in your state.

If you think your aunt will be liable for estate taxes when she passes, there are some things she can do now to possibly mitigate that tax liability. For example, a strategic gifting program, transfer of the house to an irrevocable trust to get it out of her estate, permanent life insurance, possibly with premium financing, etc. These are going to be incredibly dependent on your individual situation (and hers) so I’d have to refer you to a licensed tax expert and an estate planning expert in your state.

Thanks,

Jason

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Katy September 17, 2012 at 10:55 pm

Hello!
Is there any way to avoid paying the capital gains tax if you invest the “gains” into home improvements? Ex: Sell a house for 900k, but another “like” property for 700k — to avoid paying tax on the 200k difference, can you invest in home improvements (obviously these are structural improvements/upgrades and nothing decor-related). Any advice is appreciated!
Thanks! :) , Katy

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Jason Van Steenwyk September 30, 2012 at 5:20 am

Hi, Katy! Thanks for your note. I don’t give “advice.” Only *information.* So it’s up to you to take the information and use it to guide your conversation with a tax professional licensed in your state, who can give you advice given your particular overall information.

From your question, though, you seem to be confusing the sales price of a house with your capital gain. They aren’t the same. You won’t be charged capital gains tax on the full 900k for the first house.* Only on the difference between that price and your tax basis in the property.

More generally, though, no… you should generally expect to declare a liability for capital gains in the same year you realize profit in that house. (You might consider realizing as much gain as you can before cap. gains tax rates go up at the beginning of 2013). Your improvements in the new place are added to your basis in the new place (subject to depreciation over time), and you get credit for these when you sell the new place.

You can theoretically reduce your capital gains in the old place by throwing money at improvements. But why would you? According to the Cost. vs. Value Survey that Remodeling Magazine puts out every year, those big improvements don’t add value to the house over and above their costs, in the aggregate.

I wish you many more capital gains tax bills in the future, and congratulations on the problem, because having headaches over how to pay tax on gains is always better than having to claim a tax benefit from capital losses.

Thanks very much for reading, and tell your friends!

* unless it’s in your self-directed IRA or 401(k) or other self-directed retirement account, you’re taking the money or asset out of the self-directed account, and you have no tax basis in the property because everything you put in it was with pre-tax or tax-deductible dollars!

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Christi September 16, 2012 at 3:08 pm

Can my Mom save capital gains tax from sale of her primary residence through monetary gifts to her children?

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Jason Van Steenwyk September 17, 2012 at 5:27 pm

Hello, Christi, and thanks for writing.

Monetary gifts to children might be a good asset protection strategy, and a good estate tax strategy. You use the term “monetary gifts.” Do you mean your mother wants to gift cash from the proceeds of the sale of the house? Or does she want to ‘gift’ her children an ownership interest in the house? Can you describe what you’re planning to do in a little more detail?

Thanks,

Jason

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Christi September 23, 2012 at 6:12 pm

Thanks Jason. My Mom will realize a 55k gain upon sale next week. I want to see if I can help her reduce the capital gains tax she will have to pay on that.

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Jason Van Steenwyk September 30, 2012 at 5:04 am

Hello, Christi,

Thanks again for your note. Unless I’m missing something, capital gains tax might not be a problem at all, if it qualifies for exemption on capital gains on the sale of primary residence. If your mom is single, she is exempt from taxes on the first $250,000 of gains (twice that for married couples). So she doesn’t have to do anything except have lived and owned in the house for two of the last five years. (Special rules apply for military families, in some situations).

IRS Publication 523, Selling Your Home, also details some other rules if she only partially qualifies for the personal residence capital gains tax exclusion. She may be able to get a partial exclusion.

Thanks,

Jason

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Lilly September 12, 2012 at 5:00 am

Trying to calculate capital gains tax I’ll owe, if I sell a rental property. The House value is approx. 400,000. and the loan is 160,000. It’s an older home with the master bedroom was expanded when it was purchased. Please advise. Thank you, Jason!

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Jason Van Steenwyk September 15, 2012 at 5:39 am

Hello, Lilly, and thank you for writing.

I can’t help you calculate it with the numbers given, I’m afraid.

When did you buy the home?
What did you put down?
What have you spent on renovations and improvements (for which you did not take a tax deduction)? That information will let you calculate your approximate tax basis in the home. Capital gains tax is the percentage applied to the difference between the sales price and your tax basis in the property… that is, what youv’e got “in it.”

Your capital gains tax FOR THIS YEAR is either 5 percent or 15 percent, depending on your income, for long term gains. If you will have held the home for a year prior to selling, long term rates will apply. (If it’s a short-term holding, figure you’ll pay ordinary income tax rates on the gain.)

Remember, though… Unless Congress acts, capital gains taxes are slated to go UP at the end of 2013… from 15 to 20 percent for the top bracket for long term rates. That is, taxes will be 33 percent higher if you sell AFTER January 1 than before.

So if you sell, try to do it sooner, rather than later.

Note: If you do a Section 1031 exchange, you can defer the tax. So no capital gains taxes due on the sale if you roll the sales proceeds right over into another ‘like kind” rental property.

Hope that helps! And thanks for reading!

Aloha,
Jason

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Rob September 9, 2012 at 12:11 am

Hi,
I would like to know if it is better to pay off the 22K mgt. on a rental, first, or 150k on my primary home.?
Thanks.

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Stephanie R September 10, 2012 at 11:07 pm

Rob – We here at realestate.com think it would be best if you seek the advice of an accountant and/or attorney. Thank you.

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Jason Van Steenwyk September 10, 2012 at 11:18 pm

While I can’t provide specific advice – that’s best left to qualified professionals who understand your specific situation much better than I do – here are some of the considerations to look at.

1. What are the interest rates on the loans? I assume they’re all tax deductible – either as business expenses for the rental, or as a primary home mortgage interest deduction for your primary residence.

2. Is one rate higher than the other? That would suggest paying that one down first. BUT…

3. What are the bankruptcy rules in your state? If you got sued for some reason, and had a judgment against you, some states provice unlimited asset protection to equity in your home. Your business assets, though, might be fair game. So you can short-circuit a later judgement by building up home equity.

4. Is your state a recourse or a non-recourse state?

5. Can you invest the cash at a higher after-tax rate than the after-tax interest rate? If so, maybe you’d rather not pay down the loans ahead of schedule at all.

6. Do you have an adequate cash cushion? Say, six months worth of expenses in the bank? Maybe you should do that first rather than pay down loans. If you lose your job, you will need the savings. You will have a nuch harder time borrowing against equity if you don’t have an income.

All this is very fact-dependent. You should absolutely seek the services of a qualified professional who can go over your unique circumstances with you.

Hope that helps!
Jason

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Dean September 5, 2012 at 9:37 pm

I recently paid off multiple tax liens for 2004 through 2010 in Arizona. My question, can I write off the taxes owed and percentage earned by the people who owned the tax liens in question. Also, I had to pay off the attorney representing the party who had a lien on my property, is this a write off for fed and state taxes?

Thank you,

Dean

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Stephanie R September 5, 2012 at 10:52 pm

Dean – After speaking with our writer about your tax lien concerns, she’s come to the conclusion that its best you seek the advice of an accountant and/or attorney. They will be better qualified to answer your questions, giving you the best suggestions possible. Thank you.

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Dliu August 7, 2012 at 8:35 pm

Jason,

Is any of the upfront fees tax deductible (attorney, title search, bank application) if deal falls through?

Thanks
Danny

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Jason Van Steenwyk September 30, 2012 at 5:51 am

Hello, I’m sorry I missed this question when it came through.

Generally speaking, expenses like that are NOT deductible for a personal property. But they ARE deductible as ordinary business expenses if you’re running a real estate business.

So if the primary purpose of the property is for you to live in, then it’s all personal expenses and not deductible (they figure your standard deduction takes care of that stuff.)

If the primary purpose of the property is for BUSINESS, that is, to generate income or capital gains for you, then they are ordinary business expenses. Think Schedule C rather than Schedule A, because they aren’t miscellaneous itemized expenses. Schedule E is there for rental property expenses. Check the instructions for Schedule C and E for more specifics, as well as the IRS Publication 535 “Business Expenses.”

Thanks again,

Jason

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Dliu August 7, 2012 at 6:54 pm

I was purchasing a foreclose property, deal feel thru due to seller bank’s wanting 10% more than contract price.

Is any of the fees (lawyer, bank application, title search) tax deductable in NYC?

Thanks
Danny

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kevin July 30, 2012 at 9:34 pm

Question regarding a family trust buying real estate, and leasing it out (commercial RE AND residential).

What arms length considerations are necessary for establishing leases etc.,?

this blog rules!

thanks
Kevin

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Sarah Sypher May 17, 2012 at 6:26 pm

Jason – is there a tax benefit to forming an LLC, S-corp or C-corp to buy and sell investment property or hold rental properties over a sole proprietorship if the entity is a single owner?

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Jason Van Steenwyk May 18, 2012 at 5:59 pm

Hello, Sarah, and thanks for your question. That’s a great question, and deserves its own article. Actually, people have written books about this stuff.

There is, in fact, an upcoming Flippin’ Insider column dealing with precisely this issue. We publish one per week, but there is a backlog of several columns, so be on the lookout for “Should I Form a Corporation?” in the coming weeks for a longer treatment.

The things to be aware of: The most important reason to form an entity is for limited liability protection, rather than the tax advantages. In fact, you could argue that there’s not much tax advantage to forming a C corp, for most people, at all, because of an issue called double taxation. Any income the C corp takes in is taxed at the max income tax rate, currently 35 percent. Then when you take a dividend, you get taxed AGAIN at your personal income tax rate (for qualified dividends, unless your corp. is overseas). The effective tax bite can be as high as the mid-40 percent range, depending on the circumstances. (There are advantages to C corps, though in the areas of capital formation, finding equity partners, selling shares to potential buyers, etc).

For S corps and LLCs, the potential tax advantage lies in possibly saving on Social Security taxes by taking part of your income in the form of dividends, rather than salary. Salary gets Social Security/Medicare tax imposed on it; dividend income does not. But you can’t abuse the priviledge by taking all your money in the form of dividends. The IRS is wise to that ploy and will disallow it. If you are the owner-employee of a corporation, you have to pay yourself a salary that is “reasonable.”

LLCs are a function of state law, not federal. There used to be some issues with single member LLCs being questioned, so I would refer you to an attorney licensed in your state to discuss the finer points of single person LLCs.

This is a very general overview, though, and there’s a lot more to it. Stay tuned for the column-length treatment of your question. And please send along more!

Thanks for being a reader!

All the best,

Jason Van Steenwyk

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Sara October 8, 2012 at 9:38 am

Hi Jay, would love to know your thoughts on this too. Patiently awaiting your blog on ‘Should I form a Corporation’… ;)

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Jason Van Steenwyk October 8, 2012 at 2:24 pm

Dear Sara,

No need to be patient! Here it is:

http://www.realestate.com/advice/should-i-form-a-corporation-for-flipping-houses

Thanks so much for reading,

Jason

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Nurtacc March 26, 2012 at 2:44 am

Tax liens can be found across the U.S. There are basically 3 property tax enforcement systems used in the United States, tax liens, tax deeds, and redemption deeds. Which system is used in a particular county depends on state laws. California is a tax deed state. Arizona is a tax lien state. Texas is a redemption deed state. Tax deeds are properties that have been foreclosed on by the county due to delinquent taxes. Liens earn interest rates. Deeds are to acquire property.

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Abigail March 5, 2012 at 6:12 am

This blog is cool

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Slaveq March 26, 2012 at 3:52 am

Tax liens and tax deeds haven’t had much, if any effect on real atsete value, or foreclosures. The main reason is that there simply isn’t enough property tax based foreclosures to change anything. Counties are very slow to foreclose on property. It usually takes many years. No one wants to lose a property to foreclosure, especially when the amount owed is a small percentage of the overall value. Usually a lender or home owner will pay what’s owed to avoid foreclosure.

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Justin Robins March 3, 2012 at 11:08 pm

Isn’t that the truth!

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