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 depletion, 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.
{ 125 comments… read them below or add one }
Way cool! Some very valid points! I
appreciate you penning this post and the
rest of the site is extremely good.
forgot to mention that neither one of us live in the house. its a two family rented out. both units are rented.
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.
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?
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????
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.
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.
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???
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
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
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?
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
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,
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.
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
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?
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?
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
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.
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
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
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?
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?
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
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.
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)?
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
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?
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?
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
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
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
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?
can i deduct the difference if my mortgage is more than rent i collect on the property?
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.
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.
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.
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…
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
The bottom line here folks is you can deduct mortgage interest on rental property! Not your actual mortgage on anything PERIOD! Interest only
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!
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.
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?
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?
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?
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!!!
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!
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..)
I agree with Russ 100%
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?
I have the same question.
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
Good question! I have a rental property in California and want to do the same thing. Is it legal? Please reply.
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.
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!
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
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.
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
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.
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
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????
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.
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.
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
I want the answer to this question as well…Anyone?
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!
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.
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.
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
Can i write off association fees on a rental property?
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
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.
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
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.
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
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.
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
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.
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.
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
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.
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.
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?
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 ?
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!
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.
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!
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
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
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
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.
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?
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
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
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
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
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?
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
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?
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
Hello!
, Katy
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!
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!
Can my Mom save capital gains tax from sale of her primary residence through monetary gifts to her children?
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
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.
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
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!
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
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.
Rob – We here at realestate.com think it would be best if you seek the advice of an accountant and/or attorney. Thank you.
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
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
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.
Jason,
Is any of the upfront fees tax deductible (attorney, title search, bank application) if deal falls through?
Thanks
Danny
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
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
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
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?
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
Hi Jay, would love to know your thoughts on this too. Patiently awaiting your blog on ‘Should I form a Corporation’…
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
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.
This blog is cool
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.
Isn’t that the truth!