A Real Estate Investor must chose an investor classification from three allowable classes. Each class provides certain benefits and requirements that should be considered when determining the best tax strategy.
One of the often cited benefits for investing in real estate is the tax treatment. Investors are able to expense, interest payments, operating expenses, capital improvements and depreciation.
Depreciation is an accounting expense that is realized when filing and paying income taxes. Expenses lower the taxable income, benefiting the real estate investor taxpayer with a lower tax obligation.
Investor Classification Options
Passive: This is the least beneficial. Allows the investor to take real estate losses and depreciation to the extent of the income generated from real estate.
Active: An investor who materially participates in the investments and owns at least 10% of the investment, can count upto an additional $25,000 of losses against ordinary income. Additional losses for real estate investors phase out when the adjusted gross income breaches $150,000 for a married couple filing jointly.
Professional: This is the most advantageous for tax purposes. To qualify, the real estate investor must spend the majority of their time in real estate, and a minimum of 750 hours per year. The professional classification allows the investor to expense all of their real estate expenses for the year.
The ability to count expenses against income should not be the sole reason for choosing a classification. In all three cases, unrecognized losses can be carried forward and used against future gains realized when the property is sold.
Additional considerations include whether or not to create an LLC or S Corp. The difference will determine if income is subject to self employment tax or a distribution.
In all cases, real estate investors should seek counsel of a tax professional to determine the best option to meet their goals.
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Camuso CPA PLLC