On the topic of debt

[Alan L.]

Real estate has been a great investment for the past decade. Back in the mid 80s there were quite a few foreclosures, as apartments and office buildings were half empty due to over building. Before that, people made incredible amounts of money on real estate.

However real estate is not really a tax saving device at all, due to a number of tax provisions that limit the amount of losses you can deduct. The one that gets most investors is the passive actvity rules under section 469.

Basically, you net all your net income and net losses from all of your real estate rentals and other activities in which you do not materially partipate. If it nets to a loss, you can't deduct that net loss against salary and other income. It carries over indefinitely until there is passive income to offset it against, or until you get out of the particular deal.

An exception to the above rule is that if you qualify as a real estate professional, then rental activities in which you materially participate are not considered passive. Another exception is that you CAN deduct up to $25K per year if your income level is not too high for this benefit to be phased out.

So, you want to just buy land and make payments and deduct the interest and taxes? First of all the interest is investment interest which is deductible only to the extent of investment income (dividends, interest, most capital gains). And the sustained interest deduction is available only as an itemized deduction. Taxes are not deductible for purposes of the parallel tax system called the alternative minimum tax, which can come into play.

You will seldom ever be able to deduct more than your cash outlay for a given year, as you could years ago in some of the tax shelters that were available.

Pretty boring stuff, but very important. Don't go into real estate deals to save taxes, because they don't.

 

[john4nh]

Allen thanks for the reply.

I do materilally particiapate. Iam not clear on why you say it not a good tax saving strategy. I believe that it has two purposes. One you can deduct all repairs, mileage, advwertising etc. Also the properties are de-apprciated over (I believe my case 15 or 20 yrs) time. There is also the 20 something thousand you get everyyear to the purchase of equipment tools etc. that you use on the rental.

The second reason is in 20 or so years you have a property that someone else paid for (you maintained) that you can sell for cash or keep renting and waiting on those checks. I see it as a 401k, I do not believe I would get rich, but if I got enough of these going I wouldnt be so dependant on a regular job.

I have heard about the 80's, I have people that were neck deep in rental property then. They survived by lowing rents and hanging tough. Iam working on being in the position to buy if that happens again. Today I looked at a foreclosure-long story though, but good deal.

THe part about the cash outlay is exactly what I mean that why Outlay it to the govt when you can outlay it to yourself? The govt. has this all set up. I read once where a senator or congress man once said ( If your in real-estate and you pay taxes you must be a genuis)

Please tell me more about the 25k depending on income? If you dont mind. Thanks Allen Iam new to this but have some mentors Iam trying to follow.

 

[DUMBDOG]

The twenty thousand that you said you get for the property for tools etc., to write off in the year of purchase.

This does not apply to rental property.

In addition, if you have purchased the property in the last couple of years the depreciation factor is longer than 15 or 20 years, it will vary if it is commercial or residential.

 

[john4nh]

Dumbdog Icant quote any rules to you, but only go by what I was told to do by my CPA and what questions to ask by my mentors. The depreciation I know we didnt set it up longer then 20 years. Iam curious if Iam getting bad info from my people? They are all doing it this way. I dont need tax trouble that is for sure. The 20k+ I asked specfically about and was told yes it can be used for rental property, Do you know where I can look for that info? The CPA who handles my taxes used it last year to buy a tractor to maintain her rental properties. Is this not right? I bought lots of tools etc. to maintain my properties and wrote some off last year.

 

[DUMBDOG]

First of all, go to this link.

<A target="_blank" HREF=http://www.irs.gov/pub/irs-pdf/i4562.pdf>http://www.irs.gov/pub/irs-pdf/i4562.pdf</A>

This is the Internal Revenue Service publication for depreciation.

As far as the section 179 deduction that you were referring to, it only applies to a trade or business. Rental property is not a trade or business. You can still take all of the deductions associated with the property, such as mileage, from your place of business to work on the property. If you have a regular job, this is considered your place of business, and you can only deduct the mileage from there to the rental if you go there from work and running around to pick up supplies etc. You can also take any other expenses such as adveritsing, supplies, taxes, etc.

A quote from the Internal Revenue Code:

"(1) Section 179 property



For purposes of this section, the term ''section 179 property'' means any tangible property (to which section 168 applies) which is section 1245 property (as defined in section 1245(a)(3)) and which is acquired by purchase for use in the active conduct of a trade or business. Such term shall not include any property described in section 50(b) and shall not include air conditioning or heating units"

A quote from the Internal Revenue Code regarding "defintion of Trade or Business":

"Sec. 1402. - Definitions


(a) Net earnings from self-employment



The term ''net earnings from self-employment'' means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(8) from any trade or business carried on by a partnership of which he is a member; except that in computing such gross income and deductions and such distributive share of partnership ordinary income or loss -

(1)

there shall be excluded rentals from real estate and from personal property leased with the real estate (including such rentals paid in crop shares) together with the deductions attributable thereto, unless such rentals are received in the course of a trade or business as a real estate dealer; except that the preceding provisions of this paragraph shall not apply to any income derived by the owner or tenant of land if


(A)

such income is derived under an arrangement, between the owner or tenant and another individual, which provides that such other individual shall produce agricultural or horticultural commodities (including livestock, bees, poultry, and fur-bearing animals and wildlife) on such land, and that there shall be material participation by the owner or tenant (as determined without regard to any activities of an agent of such owner or tenant) in the production or the management of the production of such agricultural or horticultural commodities, and

(B)

there is material participation by the owner or tenant (as determined without regard to any activities of an agent of such owner or tenant) with respect to any such agricultural or horticultural commodity;

As you can see that rental income is not a trade or business unless you are a professional and pay self employment taxes on it and unless it is a trade or business it does not qualify for the section 179 deduction.

In the publication, it is specifically stated that the term for depreciation for residential property is 27.5 years, commercail property is 39 years. (see page 5 of the instructions for form 4562)

If the CPA you are using is telling you anything other than this, they are wrong or extremely out of date. I would start a search for some good tax advice, if you are audited, these people will get you into trouble.

Ignorance of the law is not an excuse with Internal Revenue Service.

Just think, I used to charge a hundred dollars an hour for this kind of advice.

 

[DUMBDOG]

Another question for you, john4nh, is this person a real CPA or someone who just does taxes on the side? In either case, some continuing education or even the free course that the IRS puts on for free each fall would appear to be in order.

 

[cowboydoc]

I have to disagree with you Alan. I most certainly can deduct my losses against my income with my land. It's the best tax shelter that I have. I can buy new land with the income from my practice and it goes off my bottom dollar. As a private individual this may not be true but it's easy to incorporate and make the land part of the corporation. If you do that all of your investment, taxes, interest etc. is 100% deductible if you are using it for the business. Our corporation even owns our house which is 100% deductible because it's a benefit for us for working for the corporation as we're an ESOP.

 

[cowboydoc]

John,
If you are a business and have yourself set up that way then you can take the deductions. If you aren't setup as a business then you can't take the deductions. I'm sure your account has you setup as a legitimate business. You can have a regular job and also have your business as well. You just have to do the right paperwork.

 

[Wingnut]

No, you're not alone, Gary.

I got myself in mild credit card trouble several times when I was young (they're not as easy to get/keep/screw around with in Canada) and had to take out personal (i.e. higher interest) loans to get rid of them. That cured me of any desire to borrow. I have no problem paying interest if I need a loan .... I am paying to use some one else's assets .... but I don't like it and avoid it.

When they transferred me to the US, it was mildly traumatic .... I had just finished paying off my 30 year mortgage on my 80 acres ... in 7 years (mortgage interest is not a tax benefit in Canada) ... and had no other bills besides utilities. I had a 2 year old Camry that was paid for and pretty well everything I needed or wanted. I sold everything (including the Camry at a loss because of US Customs) and had enough to put down a down payment on 8 acres in Michigan (sold prime ag land and bought crap!) We bought a new vehecle and, although I first financed it ... I hated the payments ... same as the Kubota ... tried making payments but kept looking at the interest, so quickly just depleted savings and paid them both off. The only thing financed, other than the mortgage, is the Goldwing I bought in June .... I'm paying less interest than I'm getting on the savings ... so I'll grit my teeth and make payments.

I prefer not to owe anything, since that way I do not have to worry about making payments on time and do not have to pay extra to buy something. Whereas I might be agreeable to pay $16k for a new motorcycle, I do not want to pay $2k more for the convenience of buying "on time".

I do use my credit cards all the time ... put $5k on them last month .... checks in the mail to pay them off ... interest on loans is bad enough, credit card interest rates are nuts!

One good thing about wishing to avoid debt .... one starts to look at things (like a sports car, for example) and think ... "do I NEED it or do I WANT it ... and how much will I actually USE it?" /w3tcompact/icons/grin.gif Haven't gone to the dealership to sit in one yet ... I learned my lesson with the GL1800.

 

[MJB]

I'm with Wingnut on this one./w3tcompact/icons/smile.gif I generally don't buy anything unless I have the money to pay for it already sitting in the bank account. Just a few months ago I paid off my 15 year mortgage in 8 years. Now I am entirely debt free. I did even better on my tractor. When I bought it I put $10k of the cost on my GM credit card (5% earnings toward my next new truck/w3tcompact/icons/smile.gif) and wrote a check for the remainder. When the credit card bill came due the next month I paid that off as well. In effect, GM gave me $500 toward my next new truck just for the priveledge of lending me $10K for about 6 weeks. Gotta love that./w3tcompact/icons/laugh.gif