Chapter 17

Income tax advantages of r.e.

Interest on loans to purchase or refinance r.e. is tax deductible.

Personal loans not tax deductible.

It does not matter what you spend the loan for.

Property taxes are deductible.

Depreciation is deductible for r.e. as a business. Also called "cost recovery."

A bookkeeping and tax deduction for the hypothetical loss of building value.

This tax-shelters rental income without a cash expense or any real loss.

Land is not depreciated.

The depreciation time for residential r.e. is 27.5 years, and for non-residential, 39 years.

Uses the straight-line method.

Passive income and loss:

Active r.e. income: if you materially participate in income-producing r.e. activity, such as renting an apartment and managing it.

Portfolio income: interest or dividends from shares of stock or from bonds.

Passive income: income from r.e., including partnerships, when you don't actively participate in the r.e. operation.

Examples: limited partners and rental income from r.e. above $25,000.

To qualify for the $25,000 exemption, you must have at least a 10% share, and your income may not be over $150,000.

The exemption phases at from $100K to $150K.

Also, r.e. professionals who spend at least 750 hours and more than 1/2 of business time in r.e. activity can use passive losses to offset other income.

Passive losses may only offset passive income, or offset a gain when the property is sold.

There is a lower tax rate on capital gains, and a tax exemption for capital gains of one's own residence.

For your principal residence, a single seller has a $250,000 exemption, and a married couple filing jointly has a $500,000 exemption.

Can be used every 2 years.

Chapter 18.

"Sensitivity analysis": estimate the effect of changes in assumption.

E.g. what if there is a recession?

What if there is an earthquake?

No capital gains tax is owed in a r.e. exchange of similar property - the tax is postponed. IRS code section 1031.

The gain is carried over to the new property.

If the owne dies, the property has a basis equal to the current market value. No tax is owed on previous gains.

Income taxes are different for r.e. dealer. A dealer buys r.e. for resale to a customer as his normal business.

Dealers may not take depreciation, capital gains, or tax-postponed exchanges.

The income tax requires one to establish a "tax basis."

"Basis" is a cost for tax purposes.

If you buy r.e., the basis is the cost, including part of the closing costs.

If you inherit r.e., the basis is the market value at the date of death.

To calculate the capital gain,

add the basis, capitalized closing cost, and capital improvements,

and subtract depreciation.

That is the adjusted cost basis.

From the selling price, subtract the adjusted cost basis, the closing costs, and carried-forward passive losses.

An installment sale spreads the revenue over several years, and thus also the taxes.