Real Estate Tax Deductions Part III

[Julio Gonzalez]

In the third and final segment of Real Estate Tax Deductions, I want to discuss At-Risk Rules, Basis Issues and Excess Business Losses.

At-Risk Rules

An At-Risk rule is a tax shelter that limits the allowable deductions that can be claimed by a taxpayer due to investing in at-risk activities that could ultimately result in financial losses. This ensures that taxpayers are not able to manipulate their taxable income as the losses claimed on the tax returns are valid. If your property has no risk or a limited risk, you may not be able to claim losses on your tax returns.

To calculate your at-risk basis, let’s say you purchased a property for $150,000 with a $127,500 mortgage with no risk for the $127,500 loan. You would only be able to claim 15% of your loss and write off the remaining loss in future years.

Issues with Basis

Your “basis” in a property is essentially your capital investment in a property for tax purposes. There are issues with your basis that can make it harder to sell a property. One such example is if you take too large of a bonus depreciation deduction so that your property does not have any remaining basis. If this occurs, you must pay back the bonus depreciation in the event you sell the property. However, this can be avoided in one of two ways. First, you can simply hold the property or you can do a 1031 exchange in which you either “swap” this property for a new property or you sell this property and purchase a new one within the same tax year. This would allow you to use the depreciation to offset the recapture tax and capital gains.

Excess Business Losses

An excess business loss is $250,000 (or $500,000 if filing a joint return) plus the amount by which your total deductions exceed your total gross income and gains. Let’s walk through an example. You purchase a building for $5,000,000 - 50% of the purchase price relates to the building and 50% relates to the land. Let’s say you had a cost segregation study performed in which you can write off at least ⅓ of the depreciable property (i.e. the building); $825,000. Of this $825k, you could take out $250,000 (if filing single) and rollforward the remaining $575,000 which is considered a net operating loss (NOL) carryforward. In future years, you are only allowed to use up to 80% of the net income towards the NOL carryforward. For example, in year 2, if you have $400,000 in net income, you could apply $320,000 of taxable income to your existing $575k NOL carryforward. This would continue to play out until there was no remaining NOL carryforward.

Our accounting industry is at a turning point in which CPAs should begin transforming from simply providing tax services to advising their clients on strategic tax strategies. There are so many tax benefits and deductions available to real estate investors, so be sure to reach out to your CPA in regards to these tax deductions. Or as always, I’m more than happy to answer any questions you may have!