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Income Taxes and Real Estate

Income Taxes and Real Estate. Item Symbol Net Operating Income (NOI) - Depreciation (DEP) - Interest Expense (INT) - Amortized Financing Costs (AFC) = Taxable Income (TI) x Tax Rate (TR) = Tax Liability (TAX). Things to Remember.

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Income Taxes and Real Estate

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  1. Income Taxes and Real Estate

  2. Item Symbol Net Operating Income (NOI) - Depreciation (DEP) - Interest Expense (INT) - Amortized Financing Costs (AFC) = Taxable Income (TI) x Tax Rate (TR) = Tax Liability (TAX)

  3. Things to Remember • Repairs are an expense, improvements have to be depreciated • Maintenance is an expense, replacements must be capitalized. • Interest expense is only deductible in the year it was incurred. Prepaid interest must be amortized.

  4. Residential property can be depreciated straight-line over 27.5 years • Commercial property is depreciated over 39 years • Don’t forget the mid-month convention – property is assumed to be purchased in the middle of the month of acquisition regardless of when it was actually obtained.

  5. Depreciation • The original cost basis includes all costs associated with acquiring the property and transferring the title • Land value cannot be depreciated • The depreciable basis is the total value that can be depreciated over the recovery period • Depreciable Basis= Cost Basis- Land Amount

  6. Annual Depreciation= Depreciable Basis/ Recovery Period • mid-month convention

  7. IRS Income Categories • Active Income (e.g., salaries, wages, bonuses, and commissions.) • Portfolio Income (e.g., interest, dividends, and capital gains.) • Passive Income (e.g., rents from real estate, and royalties from oil and gas rights.)

  8. Passive Activity Loss Restrictions • Passive losses cannot be used to reduce active or portfolio income • Passive losses may be used to reduce other passive income • Passive losses not used may be used in future years or at the same time of sale • Active participants may deduct up to $25,000 in passive losses against other non-passive income, subject to limitations

  9. Rental activity is deemed passive by the IRS. • However, the IRS does differentiate between those that materially participate and those that don’t. • Material participation is more than 500 hours per year or more than 100 hours (and not less than any other participant.) • Losses not used are carried forward.

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