Specialized Real Estate Tax Considerations
Real estate professionals, property investors, and property managers require specialized accounting reports and financial planning. As real estate-related businesses have unique considerations — such as commissioned-based income, property depreciation, amortization, rental income, passive losses, cost segregation, 1031 exchanges, pass-through deductions — it’s critical that your CPA can guide you through your tax and planning options. Our experience includes:
- Guidance about structuring your business entity with operations, investment, and tax implications in mind
- Mitigating risk exposure and tax efficiencies regardless if the real estate market is hot or cold
- Navigating compliance and tax regulations specific to real estate holdings such as 1031 exchanges, depreciation schedules, and property taxes
- Tapping our professional network to solve tangential issues such as insurance, estate planning, and retirement planning
Experience with Real Estate Businesses
ARR & Co has years of real estate accounting experience, helping clients such as:
- Real estate professionals
- Individual investors
- Multi-investor partnerships
- Tenancies in common
- Office/retail ownership
- Property management companies
- Property developers
On Call Advisory Services
Do you have the necessary checks and balances in place for your real estate business? What financial threats and opportunities are lurking in your financials? What are the best financial vehicles to accumulate wealth for the long term? These are just some of the questions we can answer for you. Benefit from our 30+ years of experience to get the answers you need exactly when you need them.
Real Estate Tax FAQ
The answer really depends on the market, specifically the cost of the property, how you’ve financed the purchase, and the rental market rates. Due to depreciation (what you can deduct on your taxes is different from a cash deduction), it’s not uncommon for a real estate investor to have a positive cash flow but negative taxable income. For example, you have a property that rents for $4,000 a month and you can depreciate $1,500 a month. You will have a positive cash flow (net $2500 a month) while receiving the benefit of minimizing taxes. It’s important to note that each taxable situation is different. To accurately answer this question for you, we’ll need to know more about the rental property, your financial picture, and then discuss your tax minimization options.
Often creating an LLC to hold real estate investments is an excellent practice. Yet it really depends upon the number of properties in the portfolio, their value, and your liability exposure. Forming an LLC is a financial investment, first by filing the articles of incorporation paperwork, establishing bank accounts and its accompanying accounting books, and then preparing annual tax returns. In California, there’s a minimum state tax of $800. You can see how these expenses can add up, especially if you hold each property separately.
Let’s use an example of a $10 million dollar rental property such as an apartment building. Something occurs and you are sued. Your liability insurance may not be enough and litigants can go after what the LLC holds. The good news is that assets held outside of the LLC can’t generally be reached. Therefore it’s a business decision to determine your liability exposure and how many LLC entities you need based upon your real estate investment portfolio. We can help you navigate the entity choices for a real estate investment portfolio as well as proactive tax planning and projections.
There are two types of income related to real estate investments. The first is passive income — the income generated from rents — and the second is related to capital gains — the income derived from the property’s increased value minus the purchase price.
With regard to passive income, the IRS sets a limitation on the amount of losses you can take. Essentially, you can’t take losses that exceed your passive income. For example, you earn $100,000 in rental income and you have a net loss (from adding in depreciation) of $150,000. You’re limited to the $100,000 loss in a tax year. You can carry the $50,000 loss forward to another tax year. Lastly, passive income is taxed at ordinary tax rates.
Next, let’s review capital gains and your tax liability. The income you receive when selling a long-term asset at a gain is taxed. The federal tax rates tend to be more favorable (15-20%). Currently, California doesn’t have a separate capital gain tax. You’ll be taxed at your regular state tax rate. Ultimately your capital gains tax liability is calculated on the dollar amount the property sold for minus your capital basis (original purchase price plus capital improvements).