Tax Preparation Blog

Title: 

Tax Traps for New Real Estate Investors

Word Count:

845

Summary:

Real estate belongs in every investors portfolio, but make sure you don't fall into these common tax traps. So says CPA and bestselling author Stephen L. Nelson.

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Article Body:

Perhaps one should not be surprised that new real estate investors fall into the same tax traps again and again. Real estate burdens investors; especially new investors with some tricky tax accounting.

But just because some other newbie makes these mistakes, that does not mean you need to. You just need to know where the traps are so you avoid them. And here are the biggest real estate tax traps you do not want to fall into:

Tax Trap 1: Passive Loss Limitation

On paper at least, real estate often loses money. Even if the rent pays the mortgage and the operating expenses, the books still show a loss because you get to write off a portion of the purchase price through depreciation each year.

If a rental house that cost $275,000 breaks even on cash flow, for example, you might also get a $10,000 annual depreciation deduction. If your marginal tax rate is 28%, that depreciation should save you $2800 annually.

Sounds sweet, right? Well, it is or should be. Except that the U.S. Congress labeled real estate investment a passive activity and said that, except in a couple of special circumstances, you can not write off passive activity deductions unless overall you show positive passive income.

This passive loss limitation rule means that many real estate investors do not get to use tax saving deductions from real estate, or at least not annually.

Two loopholes, courtesy of Congress, do exist that let you write off deductions from real estate even if overall you show a loss from real estate investing. If you are an active real estate investor with adjusted gross income below $100,000, you can write off up to $25,000 of passive losses annually. (If your income is between $100,000 and $150,000, you get to write off a percentage of the $25,000. Ask your tax advisor for the details.)

Here is the second loophole: If you are a real estate professional, Congress says the passive loss limitation rule does not apply to you when it comes to real estate. A real estate professional, by the way, is ‘not’ someone who is licensed as an agent or broker. The law instead creates a time-based test: A real estate professional is someone who spends at least 750 hours a year and more than 50% of their time working as a real estate agent, broker, property manager or developer.

Tax Trap 2:  Capitalization of Improvements

The next mistake that new real estate investors make? Thinking they can write off the amounts they spend to improve the property. Sometimes you can. Often you can not.

Here is why: Any expenditure that increases the life of the property or improves its utility needs to be depreciated over the next 27.5 years (if the property is residential) or over 39 years (if the property is nonresidential).

You can not, therefore, write off the money spent improving or renovating a house, except through depreciation.

I have seen new real estate investors in tears about this wrinkle. Some investor draws, say, $20,000 from his IRA or 401(k) to  fix up some rental. He figures he will be able to write off the $20,000 as a tax deduction in the year improvements are made.

No way. Instead, he will have to write off the $20,000 at the rate of a few hundred bucks a year over the next three or four decades.

The trick with renovation, if you want to call it that, is to keep the property well maintained as you go. Repainting, new carpeting, general repairs; these items should all be all deductions in the year of expenditure (er, subject to the passive loss limitation rule discussed as the first tax trap.)

Tax Trap 3: Missing the Section 121 Exclusion

Here is the final tear-jerker. And I see it several times a year. Someone decides that rather than sell their principal residence when they ‘move up’ to a larger new home, they are going to turn the original home into a rental.

This is a disastrous decision most of the time because of Section 121 of the Internal Revenue Code . Section 121 says that if you have owned a home and lived in a home for at least two of the last years, you will not pay any tax on the first $250,000 of gain on the sale ($500,000 of gain in the case of someone who is married and filing a joint return).

By converting a principal residence to a rental property, you turn tax-free gain into taxable gain if you do not sell the property in the first three years.

Two quick notes about goofing up the Section 121 exclusion. If you do not have appreciation in your old principal residence, you are not losing any Section 121 benefit by converting to a rental.

Second, if you do have a lot of appreciation in your old principal residence and want to use that equity to acquire a rental property, consider this: Sell the old principal residence when you move out so the gain is excluded from taxable income. Then use the tax-free proceeds to purchase another rental, perhaps even the house next door.

Title: 

What are the Tax Benefits of Donating Real Estate To A Church Or Charity?

Word Count:

515

Summary:

Rules for donating real estate for tax deductions

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Article Body:

Copyright 2006 National Real Estate Network LLC

Most people think that donating real estate to a charity is for the rich. This simply is not true.  I have worked with individuals, charities, and small corporations for years with the donations process.  For many people and companies is about the able to rid themselves of unwanted property. They simply want out. They are tired of property taxes, insurance costs and the liability exposure.

The following are the rules that apply for real estate donation:

Individuals:

The following rules apply if the donated property is owned in your own name, with your spouse or other persons: If you have held the property for more than one year, it is classified as long-term capital gain property. You can deduct the full fair market value of the donated property. Your charitable contribution deduction is limited to thirty percent (30.00%) of your adjusted gross income.

Excess contribution value may be carried forward for up to five years. If the property has been depreciated, the fair market value must be reduced by its accumulated depreciation through the date of contribution. Fair market value is most commonly determined by an independent appraisal.

If you elect to deduct your cost basis of the donated property you are allowed a deduction of fifty percent (50.00%) of your adjusted gross income. Excesses here again can be carried forward up to five years. Which method you elect is dependent on the cost basis in the property donated, your tax bracket, the age and health of the donor and whether you plan to make future contributions. Corporate Donors

The following rules apply if a corporation makes your contribution, these rules apply:

If you have a controlling interest in the corporation and the property has been held for more than one year, the corporation can deduct up to ten percent (10.00%) of the net profit of the corporation. Excess contribution amounts can be carried forward up to five years. The fair market value here must be reduced by the amount of accumulate depreciation. If the corporate has elected "Subchapter S" status, then the contribution allowed will be reported on the individual shareholders K1 and may be deducted on the individual return. Partnerships, S-Corporations and Limited Liability Companies

The following rules apply if a partnership, S-Corporation or limited liability company is making your contribution:

The corporation may not claim a deduction for the property donated. Rather, the contribution passes to the individual shareholders on a pro-rated based on their percent ownership in the S corporation. The shareholder can claim this deduction on their individual tax return. The same limits and carry forward rules will apply.

Partnerships and limited liability company contribution rules are the same as an S corporation with one exception the partners or member can claim a deduction even if they have no basis in the partnership or limited liability company.

Real estate investing by nature is risky. You can win, lose, or break even. We cannot guarantee a profit or loss. We do not provide legal, accounting, or contracting advice.

* Please consult your Tax Master Professional for your specific tax benefit.

Investing and financing

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Another portion of the statement of cash flows reports the investment that the company took during the reporting year. New investments are signs of growing or upgrading the production and distribution facilities and capacity of the business. Disposing of long-term assets or divesting itself of a major part of its business can be good or bad news, depending on what's driving those activities. A business generally disposes of some of its fixed assets every year because they reached the end of their useful lives and will not be used any longer. These fixed assets are disposed of or sold or traded in on new fixed assets. The value of a fixed asset at the end of its useful life is called its salvage value. The proceeds from selling fixed assets are reported as a source of cash in the investing activities section of the statement of cash flows. Usually these are very small amounts.

Like individuals, companies at times have to finance its acquisitions when its internal cash flow isn't enough to finance business growth. financing refers to a business raising capital from debt and equity sources, by borrowing money from banks and other sources willing to loan money to the business and by its owners putting additional money in the business. The term also includes the other side, making payments on debt and returning capital to owners. it includes cash distributions by the business from profit to its owners.

Most business borrow money for both short terms and long terms. Most cash flow statements report only the net increase or decrease in short-term debt, not the total amounts borrowed and total payments on the debt. When reporting long-term debt, however, both the total amounts and the repayments on long-term debt during a year are generally reported in the statement of cash flows. These are reported as gross figures, rather than net.

What is forensic accounting?

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Forensic accounting is the practice of utilizing accounting, auditing, and investigative skills to assist in legal matters.  It encompasses 2 main areas - litigation support, investigation, and dispute resolution.  Litigation support represents the factual presentation of economic issues related to existing or pending litigation.  In this capacity, the forensic accounting professional quantifies damages sustained by parties involved in legal disputes and can assist in resolving disputes, even before they reach the courtroom.  If a dispute reaches the courtroom, the forensic accountant may testify as an expert witness.      

Investigation is the act of determining whether criminal matters such as employee theft, securities fraud (including falsification of financial statements), identity theft, and insurance fraud have occurred.  As part of the forensic accountant's work, he or she may recommend actions that can be taken to minimize future risk of loss.  Investigation may also occur in civil matters.  For example, the forensic accountant may search for hidden assets in divorce cases.

Forensic accounting involves looking beyond the numbers and grasping the substance of situations.  It's more than accounting...more than detective work...it's a combination that will be in demand for as long as human nature exists.  Who wouldn't want a career that offers such stability, excitement, and financial rewards?

In short, forensic accounting requires the most important quality a person can possess: the ability to think.  Far from being an ability that is specific to success in any particular field, developing the ability to think enhances a person's chances of success in life, thus increasing a person's worth in today's society.   Why not consider becoming a forensic accountant on the Forensic Accounting Masters Degree link on the left-hand navigation bar.

Who uses forensic accountants?

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Forensic accounting financial investigative specialists work with financial information for the purpose of conveying complicated issues in a manner that others can easily understand.   While some forensic accountants and forensic accounting specialists are engaged in the public practice of forensic examination, others work in private industry for such entities as banks and insurance companies or governmental entities such as sheriff and police departments, the Federal Bureau of Investigation (FBI), and the Internal Revenue Service (IRS).

The occupational fraud committed by employees usually involves the theft of assets.  Embezzlement has been the most often committed fraud for the last 30 years.  Employees may be involved in kickback schemes, identity theft, or conversion of corporate assets for personal use.  The forensic accountant couples observation of the suspected employees with physical examination of assets, invigilation, inspection of documents, and interviews of those involved.  Experience on these types of engagements enables the forensic accountant to offer suggestions as to internal controls that owners could implement to reduce the likelihood of fraud.       

At times, the forensic accountant may be hired by attorneys to investigate the financial trail of persons suspected of engaging in criminal activity.  Information provided by the forensic accountant may be the most effective way of obtaining convictions.  The forensic accountant may also be engaged by bankruptcy court when submitted financial information is suspect or if employees (including managers) are suspected of taking assets.  

Opportunities for qualified forensic accounting professionals abound in private companies.  CEOs must now certify that their financial statements are faithful representations of the financial position and results of operations of their companies and rely more heavily on internal controls to detect any misstatement that would otherwise be contained in these financials.   

In addition to these activities, forensic accountants may be asked to determine the amount of the loss sustained by victims, testify in court as an expert witness and assist in the preparation of visual aids and written summaries for use in court.