Real Estate Tax Considerations

Real Estate Tax Considerations For The Investor

There is no more Byzantine human invention than the complex tax codes, and among the most complicated are the laws surrounding real estate investing. So, what follows is NOT to be considered legal advice — consult your attorney or tax accountant before making any decisions.

Well, now that the rear is covered, what considerations should the real estate investor keep in mind? Since laws vary between countries, and between states within the U.S., any general advice would be worthless. But here are a few particulars that apply in many areas.

Many investors still believe they can purchase a residential home, not take up residence, make repairs and then sell for substantial profit. And that's often true. But profits can be lowered by neglecting current tax law. The rule they're mis-remembering applied only to property used as a personal residence and, in the U.S., is no longer law.

In 1997 that rule was replaced by one that allows for tax-free sale of a personal property, occupied for two years or more. Investment income, whether from stock sales or real estate is considered capital gain. If the asset was held for a year or less it's a short-term gain, taxed at ordinary income tax rates — sometimes as high as 35 percent. Hold the asset more than a year and any sales is now a long term capital gain, taxed (usually) at 15 percent. One day more or less could make a 20 percent difference.

If you keep the property for 730 days, not necessarily sequential, as a residence and you can pay no tax at all — provided the money is reinvested in a home of equal or greater value. (There is a one time exemption.)

For the investor not looking to occupy the property, there is an alternative, in the U.S. — the 1031 exchange.

As long as you trade an investment or business property for another of "like kind", you can defer any tax owed. "Like kind" is defined somewhat loosely. You can swap undeveloped land for developed land, a residential rental home for commercial property, etc. The only restriction is the exchanged property has to be an income producing asset, not a personal one.

You have 45 days to identify up to three replacement properties and must close within 180 days. You must also find a neutral intermediary — a "facilitator or accommodator" — to hold funds and keep records.

Keep in mind this option is not tax avoidance, merely tax deferral and can't be used in conjunction with your personal residence. See your tax accountant or attorney before taking advantage of this.

For married couples, tax law changes allow a profit of up to $500,000 on the sale of the personal residence, $250,000 for singles, with no tax penalty.

Mortgage interest deductions continue to be one of the best write offs, with up to $1 million loans qualifying, as well as any points or loan origination fees.

Always keep accurate records and consult with professionals before making any investment decisions. This is especially true for those lucky enough to have inherited property, or those involved in estate sales and trusts. Their fees will be more than paid for by avoiding penalties and unexpected taxes.