Still the Best Tax Break There Is, is for Real Estate Investors | USTaxAid

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Still the Best Tax Break There Is, is for Real Estate Investors

Written by Diane Kennedy, CPA on December 20, 2020

Richard and I met at a real estate investment seminar. So, you could say we’ve been investors together from the moment we first met. 
My initial plan was to take the money I made from working as a CPA and invest it in real estate. I looked for ROI (return on investment). Richard’s plan was to buy fixer uppers, fix them up and rent them out. Richard looked for undervalued properties that he knew he could transform.
In good times and in bad times, real estate has proven to be a great investment for many people. There are 3 unique advantages that real estate can provide:  

Cash flow,  

Appreciation (both passive and active), and 

Tax breaks.  

Today, I want to talk about the tax breaks.  

Real Estate Tax Breaks
If you have a business, you have things you normally buy that become legal tax deductions. That’s a good deal because you’re spending cash anyway for things like a cell phone, computer, ISP, and the like. Real estate provides phantom expenses. You get a legal tax deduction that doesn’t cost you any cash.
But note one thing. If you have a business expense not real state investment expense you are spending cash.  

In the case of real estate, you get a deduction for the legal tax deductions you have associated with the real estate plus you get a deduction for depreciation. It doesn’t cost you cash and yet you still get to take a deduction. That’s why I call it a phantom expense.  

In most cases, you can have real estate that puts cash in your pocket and yet legally provides a loss deduction on your tax return. 
But it gets a little complicated with that loss.
If the adjusted gross income (AGI) on your personal return is under $100,000, you can take a real estate loss of up to $25,000. There are two more caveats, though. You need to have sufficient basis and you need active participation.  

If your AGI is above $150,000, you can’t take any real estate loss against your other income.  

If your AGI is between $100,000 and $150,000, the amount of loss you can take phases out. But again, you need sufficient basis and active participation.  

Now we get to the greatest tax break for real estate investors, if you qualify. The real estate professional tax loophole. 

Real Estate Professional  

Here’s how it works. If you’re single, you alone must qualify. If you’re married filing jointly, either you or your spouse can qualify. If you’re married filing separately, you can’t use the real estate professional loophole. 
There are 3 parts to the real estate professional status.
#1: You (or your spouse, if filing jointly) must have 750 or more hours of real estate activities per year PLUS you need to have more hours in real estate activities than any other trade or business. You can’t combine hours with your spouse. Only one person can qualify for this.  

#2: You AND your spouse, if applicable, can combine hours for this one. You must have material participation with each property. If you have a property manager there is only one way to qualify – you must have 500 hours or more in material participation. If you don’t have a property manager, you can qualify with the 500-hour test or either of two other possible tests, 100 hours of material participation and a) more than anyone else or b) more than everyone else combined.  

#3: Each property must stand alone to qualify for material participation. You can make an election to aggregate your properties, though, so that you only have to pass one test. There is a downside to this though that occurs if you sell the property at a loss, so make sure you talk it over first with an experienced real estate accountant before making this decision 

There were a number of terms that need further explanation to fully understand the real estate investment tax loss rules.  

Real Estate Tax Definitions 

“Active participation” is a lesser standard than “material participation.” You need to show that you are overseeing aspects of each real estate investment. Someone else can be doing the work, but you need to show that you are involved. 
This is currently something the IRS is hitting hard in audit. They want to see proof that you have active participated if it’s required and you are taking a loss against other income.  

“Basis” refers to either equity basis or debt basis. For equity basis, you need to prove that you have put in sufficient cash to cover the accumulated total of the losses that you have deducted. Debt basis refers to the amount that the real estate investment owes you personally (i.e.the money you loaned to the business) and if you used money borrowed from an outside party, that you personally guaranteed the loan.  

“Material participation” is a tougher standard to meet with the 500 hours, the 100 hours or more than anyone else or 100 hours or more than everyone else hourly requirement.  

We discuss the real estate professional tax loophole and associated strategies as part of the Home Study Course, and of course, during the coaching classes. 
We will be covering an important real estate tax, accounting or asset protection Home Study Course during the first monthly coaching class at 5 pm Pacific time Wednesday of each month. They are always at 5 pm Pacific and if you can’t make the class live, the classes are recorded. 
Join us by going to Wednesday Coaching and signing up today. 

2 Comments

  1. Diane says:

    http://www.bajacalrealestate.com.
    I own two brokerages, one CB in the US and the other in Mexico. I need to know which is the best country to write off expenses.

    Thanks

    Diane

  2. Diane Kennedy says:

    Hi:

    Your MX earned income will need to be reported in MX. You’ll need to file Mexican tax law for that. Your US income return will need to show both the MX and the US income, but you do get a tax credit for the taxes you pay in MX.

    So you don’t double pay taxes.

    As far as where to take the deductions, my suggestion is that you talk to a Mexican accountant or attorney to help you determine your tax liability in MX. What is your tax rate going to be?

    Then compare that to your US marginal tax rate.

    If there is a choice on tax write offs and they can be deducted in both MX and the US, then choose the one that gives you the best benefit.

    Since another country, MX, is involved, you will likely find there are some things are deductible in one country versus another.

    If you’d like a referral to a MX attorney and accountant that we have used, please drop a note to: https://www.ustaxaid.com/contact-us/ with best contact info

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