Tax Benefits of Real Estate Ownership
There are many different types of investment real estate: rental houses, apartments, vacant land, commercial buildings, industrial, shopping centers or warehouses.
They all offer big tax incentives for investors who understand those benefits.
Many people believe that depreciation is the best real estate tax deduction of all. The IRS REQUIRES real estate investors to depreciate their investment properties.
Depreciation is a "paper loss" required for estimated wear, tear and obsolescence. However, land value is not depreciable. This applies to 100% of the money invested in buying vacant land and that part of the property value apportioned to land on an improved property. (That is, land with a building on it).
Residential income property is depreciated over 27.5 years on a straight-line basis.
Commercial property is depreciated over 39 years, also on a straight-line basis.
First-year 100% deduction
There is also the new first-year 100 percent tax deduction for up to $100,000 of business equipment purchased. This would include appliances. Sorry but you can't buy a brand new Mercedes and deduct 100% of the cost from your taxes in the first year. But there are special rules for work vehicles, such as trucks. Ask your CPA for more details.
Depreciation is a non-cash deduction
It reduces taxable income from the investment property. But, in contrast to property taxes, mortgage interest, utilities, insurance and repairs, it doesn't require any cash outlay. The depreciation expense deduction can result in a positive cash flow property becoming a loss maker for tax purposes.
Most investment properties go up in value every year, but on paper their value is going down.
Unfortunately, unused tax losses from investment properties cannot be carried back to prior tax years to claim a tax refund.
IRS Notice 88-94 allows use of suspended passive activity tax losses (assuming you do NOT qualify as a professional with material participation) from realty investment assets to offset profits from the sale of the property. The tax result is that you can use suspended property losses on an total basis, rather than property-by-property.
Recapture of depreciation benefits
The maximum capital gains tax rate was reduced to 15 percent in 2003 for assets owned more than 12 months. (If held for less than 12 months gains are taxed as ordinary income.)
However, the IRS requires that you "recapture" the tax saving from your income tax at a special 25 percent depreciation "recapture" tax rate when the property is sold.
Information provided by:
Stephen T. Evans, CPA, PA
