7 Tax Saving Opportunities for Real Estate Investors

DavidE.Gibbs,CPA,CCIFP,CRE,MBA

ealestateinvestorsmustthinkaboutthetaximplicationofanytransaction.Investorscansave a substantial amount of money on their taxes if they implement the right tax planning strategies. Here are sevenrecommendations to consider:

1. Establish a self-directed IRA account. Holders of a self-directed IRA may fund real estate purchases from their IRA. There is no penalty for being under age 65. The non-financed portionofthepurchaseisshelteredfromtaxesbytheIRA.Acustodianortrustcompanymust administer the self-directed IRA. Other rules apply.

2. Holdpropertiesformorethanayear.Investorswhoownpropertiesformorethanayearare taxed at the capital gains rate instead of their ordinary income tax rate. The capital gain tax rate is 0%, 15%, or 20%, depending on the investor’s tax bracket. If the investor lives in the property for at least two years, the first$250,000 of capital gains are tax-free for singles and $500,000formarriedcouples.Holdingpropertyformorethanayearalsoreducesthechance that the IRS will classify the investor as a “dealer.” Earnings for dealers are generally subject to double FICA taxes because they are considered self-employed. The investor would pay 15.3% towards social security and Medicare taxes instead of 7.25%.

3. Defertaxeswithalike-kindexchange.IRCSection1031allowsinvestorstodeferpayingtaxes on the gain from the sale of a property if the proceeds are reinvested in a similar property.

There is no limit on the number of times or frequency of doing a 1031 exchange. Business or investment properties generally qualify.

4. Qualify as a real estate professional. Rental activities and income are generally considered passive income unless the investor qualifies as a real estate professional for tax purposes.

Thenitistreatedasnon-passiveincome.Lossescanbedeductediftherealestateprofessional

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materiallyparticipatesintherentalactivity. More than50%oftheperson’stimeand750 hoursmustbespentonrealestateactivities. Holding a realestatelicenseisnot required. Other rules apply.

5. Write off ordinary and necessary business expenses. Ordinary and necessary business expenses are generally deductible forfor-profitentities.TheIRSdefinesan ordinary expense asonethatiscommonandacceptedin a tradeorbusiness. A necessaryexpenseisonethatis helpful and appropriate. An expense does not have to be indispensable to be considered necessary. The cost of goods sold, capital expenses, and personal expenses must be treated separately. Other rules apply.

6. Depreciateproperties.According to the IRS, thelifespanof a residentialbuildingis27.5years.

Ownerscandeduct1/27.5oftheproperty’sbuildingvalueeachyearforthefirst27.5yearsthey own it. Capital improvements to the property can also be depreciated. However, when the propertyissold,theownermayowetaxesfor“depreciationrecapture”onprofitsthey previouslyavoidedpayingtaxesonthroughdepreciation.Landcannotbedepreciatedorthecosts ofclearing,planting,andlandscaping.Thoseactivitiesareconsideredpartofthecostoftheland andnotthebuildings.Realestateinvestorsthatacquiredrenovated orbuilt a buildingshould consider a costsegregationstudytodetermineifthepropertyqualifiesforaccelerated depreciation.Personalpropertyacquiredaspartof a buildingmaybe eligibleforimmediate expensingbyclaiming100%bonusdepreciationunderTCJA.

7. TakeAdvantageofthe20%Pass-ThroughDeduction.A provisionoftheTaxCutsandJobsAct (TCJA) of 2017 allows small business owners to deduct 20% of domestic qualified business income (QBI) from a pass-through entity. The deduction is taken on the net amount of qualified items of income, gain, deduction, and loss forany qualified trade or business of the taxpayer. The deduction cannot exceed taxable income. Rules apply.

There are manyothertaxelectionsthatrealestateinvestorscouldconsider.It would help if you consideredcontemplated transactions before recommending one tax savings strategy over another. In certain circumstances, taking a deduction for one reason may not make sense when lookingat every transaction’s tax implications.

AbouttheAuthor DavidE.Gibbs,CPA,CCIFP,CRE,MBA,isthepartner-in-chargeofthefirm’s Real Estate Services Group. He works with real estate professionals in variouscommercial, industrial, and residentialsectors. Clientsbenefitfrom David’sprofoundknowledgeoftheuniquetaxelections for real estate professionals. David holds the well-respected Certified Construction Industry Financial Professional (CCIFP) designation from the Instituteof CertifiedConstruction Industry FinancialProfessionals(ICCIFP), as well as the elite Counselors of Real Estate (CRE) designation. He can be contacted at 610.828.1900 or david.gibbs@mccarthy.cpa.

David Gibbs, CPA, CCIFP, CRE, MBA

This article will be published in the fall issue of New Jersey CPA magazine.