4 things real estate investors should know at tax time. Insights from a principal federal tax analyst on potential tax breaks for real estate investors.

Real estate investors often have a lot of questions once tax time rolls around especially if they’re new to the game.

That’s because while there are a number of tax breaks available to investors, like the depreciation deduction, Uncle Sam will also want its fair share of the income generated from investment properties. Real estate investors who aren’t sure what they owe at tax time would be wise to take their questions to a tax professional or certified public accountant (CPA) who can help them protect their investment and stay out of trouble with the IRS.

To help real estate investors cover their bases this tax season, I talked to Mark Luscombe (JD, LLM, CPA), a principal federal tax analyst at Wolters Kluwer Tax and Accounting, who had plenty of great tips for real estate investors filing in 2017.

Looking for ways to save on the taxes you pay on your permanent residence? Check out Part One of this special two-part real estate series for tax season 2017.

4 Things Real Estate Investors Should Know at Tax Time

Here’s what Luscombe had to say.

Q:  When is it worthwhile to take the home office deduction?  What are the current rules and regulations around it? Why wouldn’t you want to take a home office deduction?  What if you took it, but then don’t want it when you sell?

A: It is probably always worthwhile to take the home office deduction if the business otherwise has net income and you can meet the criteria. The main criteria are that the home office must be used exclusively and regularly as the principal place of business. For an employee, the home office must also be for the convenience of the employer, not the employee. Claiming the deduction normally requires calculating the direct expenses related to the home office (computer, files, second phone line, etc.) and a percentage of the indirect expenses (insurance, utilities, taxes, etc.).  Starting in 2013, a safe harbor became available to claim $5 per square foot up to a maximum of 300 square feet that meets the criteria for a home office, or a maximum of $1,500 per year, without having to document the actual expenses.

One issue with claiming the home office deduction is that, on the sale of the home, any depreciation claimed may be subject to recapture at a 25 percent tax rate.

Q:  What are the tax breaks available to owners of investment real estate?

A: Tax breaks that may be available to real estate investors include capital gains treatment on any gains rather than ordinary income treatment, depreciation deductions, interest deductions, and deductions for taxes, insurance, utilities, repairs, commissions, business expenses, home office and even mileage related to the real estate activities. There would also generally be no self-employment tax unless owned through a corporate entity. There could also be a limited deduction of losses in excess of income. If the real estate investor activities were sufficient, the classification could become that of a qualified real estate professional, which could convert capital gain treatment to ordinary income treatment, but also permit the full deduction of losses.

Q:  What are some tax mistakes investors often make?

A: There are a number of basic mistakes that real estate investors make:

  1. Failing to properly distinguish between repairs, which are immediately deductible, and capital improvements, which must be depreciated over a period of up to 27.5 years.
  2. Failing to comply with the passive loss rules, which generally make it difficult to deduct passive losses against other income.
  3. Failing to properly segregate personal expenses from expenses related to real estate activity.
  4. Failing to properly allocate overhead expenses.
  5. Failing to keep adequate records.

Q:  What mistakes do investors routinely make with their taxes?

A: See above. Investors who seek to use tax-deferred exchanges to postpone taxes on the transfers of property often fail to meet the timing requirements to make a like-kind exchange tax free.

Looking for ways to save on the taxes you pay on your permanent residence? Check out Part One of this special two-part real estate series for tax season 2017.

Ilyce Glink is the Publisher of ThinkGlink.com and the Founder/CEO of Best Money Moves, an employee benefit in the financial wellness space.

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