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4 Bulletproof Strategies that Let Real Estate Professionals Cut Their Federal Taxes
Realtors® and others in the real estate field see first-hand the steady increase in property values. Everyday, you assist both buyers and sellers to profit from it. You can spot the "good buys" and insider opportunities. But when you're the buyer, don't get so caught up in "the deal" that you forget to factor in the tax savings or costs that come with it.
Just as a property with critical easement problems deserves extra scrutiny, the same is true for any investment with tax complications. An investment (a real estate trade, for example) may look very different once the related federal tax consequences are calculated. Title defects shown by the title insurance report must be resolved before the closing. Be as careful to take into account tax scenarios that could diminish your true financial return going in.
I constantly travel the country, conducting 150 seminars a year for Realtors® and financial professionals. As a former IRS employee and tax expert (CFP and Enrolled Agent) I remind audiences that it's not how much you money make, but how much you keep that determines your true earnings. Being savvy about IRS rules helps you size up potential investments wisely, so you'll keep more of what you earn in the long run.
1. Depreciation Saves Money Several Ways
Depreciation is different than all other business expenses, since you don't have to actually spend those depreciation dollars to claim the expense. Yet depreciation gets to be added to the operating expenses, property taxes, and interest on the loan to offset the rental income. Since there's usually a tax "loss" during the first five to seven years a property is owned, that shelters your other income from taxes from the first year you own it.
Full-time real estate professionals may be able to deduct 100% of their rental property tax losses from their income. That's not true for people who spend less than full time as real estate professionals or rental property owners. Details are spelled out in the Internal Revenue Code 469(c)(7). The key factors for this deduction to apply according to IRS MSSP Guidelines (Feb. 1996) are this:
Beginning with the 1994 year, a taxpayer who meets ALL of the following can deduct current rental real estate losses in full regardless of how high his/her Adjusted Gross Income might be:
A. More than half of the taxpayer's personal services in all businesses must be in real property businesses. A real property business is real property development, construction, acquisition, conversion, rental, management, leasing, or brokerage .
B. The taxpayer must spend more than 750 hours a year in real property trades or businesses.
NOTE: For time to be counted in either of the above two tests, the taxpayer must materially participate in the activity.
C. The taxpayer must materially participate in each rental real estate activity unless he or she has filed an election to group all rental real estate activities as one (for purposes of materially participating). See your accountant for more detailed information on this issue.
2. Re-think Your Interest Costs
Do not justify running up your debts to generate tax deductions. For an individual in the highest bracket, for every dollar of interest paid, the tax savings is only 35 cents. This means you paid 65 cents for nothing. (For an individual in the 28% bracket you paid 72 cents for nothing.) Don't spend the money if the main reason you're buying it is to "buy" a tax write-off.
When in doubt, remember the saying: Borrow to purchase appreciating assets, pay cash for depreciating assets.
3. Pay off Existing Debts
The rate of return on the funds used to pay of a debt is equal to the rate of interest being charged on it. For example, when you pay off a credit card where you owe $5,000, which bears an 18% interest rate, you have just guaranteed yourself an 18% rate of return on that money.
Some of the best investments are the easiest. And here's a strategy that puts more funds into your pocket right away-that won't even cost you any taxes.
4. Deduct All your Equipment Purchases the First Year
The IRS permits you to write off up to $100,000 of equipment the first year you buy it (IRC 179 deduction). With the deduction limit so high, Realtors® can deduct all their purchases of equipment - and that's not limited to computers, desks, PDAs, etc. By significantly reducing your taxable income, the social security taxes that would be paid on it are also reduced.
Two concerns need to me kept in mind when you use this expensing election. Taxes saved must be repaid upon sale of the asset(s), but that amount will not be subject to social security taxation. The only exception regarding recapture (in the prior sentence) occurs when the business use of the asset falls to 50% or less.
About the author: Chris Bird Conducts 150 seminars a year for Real Estate and Financial professionals Wealth building, financial planning, residential rentals, tax strategies, accounting Certified Financial Planner (CFP) IRS Enrolled Agent Chris@ChrisBirdSeminars.com
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