Real Estate and Tax Issues (Part 1)

At some point the economy will pick back up and real estate will again be an attractive investment (if it is not already). There are several different possible tax considerations that you should understand before you jump (back) into the real estate market.

Second Home Only

If you have purchased a second home and do not intend to rent it out, you are entitled to deduct the real estate taxes and mortgage interest you paid on this residence. These deductions are claimed on Schedule A in the same manner that the deductions for your personal residence are claimed. You are not entitled to claim deductions for any repairs or maintenance, or depreciation, although any capital expenditures (such as for repairs or maintenance) can be added to your cost basis and used to reduce the overall gain (or increase the loss) if and when you sell the property.

Property Used As A Rental

In this large category, you will obtain the most favorable tax breaks available to holders of real property. There are a few possibilities and these depend upon the amount of time that you personally use the property for non-rental uses.

No Personal Use Time

If you did not use the property for your own personal use (other than making repairs, painting, etc.), you will find yourself in the most favorable tax situation. All rental income and expenses, including advertising, repairs, interest, taxes, utilities, dues, etc. are deductible. However, the most favorable deduction is depreciation. This will, in many cases, cause the rental property to show a tax loss for the year, as this is not an out-of-pocket expense but rather is a “paper” tax deduction.

There are special rules for rental property losses, as rental properties are considered to be a “passive activity” in most cases and, as such, there are limitations on the amount of the loss that you are entitled to deduct.

In general, the maximum loss permitted in any given year is $25,000, and this loss is permitted only if your total income for 2009 is less than $100,000. If your income is between $100,000 and $150,000, the loss is reduced and for any income above $150,000, there is no loss permitted. However, if you are unable to use a loss due to your income, this loss can be carried forward until your income does permit you to use it. Thus, you do not lose this valuable tax loss but instead must wait for the right time to be able to claim it. This assumes you do NOT qualify as a real estate professional (no limits for a RE pro). If your property is treated as a rental property for tax purposes, all income and expenses are reported on Schedule E of your tax return.