Real Estate Tax Deductions

Ask the expert

You may be entitled to a tax break and tax refund(s) if your property (house, vehicle, or business) was damaged or destroyed  by natural disasters (flood, earthquake, hurricane, volcano, tornado, or fire) and you were not fully reimbursed by your insurance or FEIMA, as was experienced by some of our clients during the aftermath of Hurricanes:-

*Ida in 2021

*Harvey in 2017

*Sandy in 2012

*Ike in 2008

*Katrina in 2005

*Andrew in 1992

*Fires & earthquake on the west coast (California, etc).

Real Estate taxation is a big niche market for Barry's Accounting Services. The firm provides services to clients in 13 states. Almost every client of the firm owns Real-Estate or Share Equity, with 95% of the firm's clients owning TWO or MORE properties Locally and in Other states. Hundreds of tax returns are prepared for them and absentee owners annually. You will receive straightforward answers, impeccable service, and results that are unmatched in this industry.

Clem Barry has worked in the real estate industry for many years. He has been practicing taxation for over 25 years, and he is also an insurance broker. He is always busy preparing pre-sale tax projections, pre-foreclosure tax projections, and/or financial statements and 421(a) & (b) city tax exemption audits for real estate owners and their attorneys seeking mortgage modification or maintaining city status.

 Overview

Business (Buy V's Lease).

Both buying and leasing of Real Eatate have Financial Benefits, Tax Benefits and Drawbacks that are too numerous to discuss here. However, the reality is 65% of businesses lease or rent office space and buildings. Buying Or Leasing is mostly dependent on the short-term and long-term strategic plan of each business. Here are some of the reasons why business lease/rent:-

#1)Lease payments are usually more Financially Feasible; and those payments are Fully Tax Deductible business expenses. When money from those Tax Breaks are invested wisely, the Return On Investment(ROI) is the same as, and sometimes better than owning a building ("Law Firms Leasing Doubles in NY City", Crain's New York Business, Page 06, October 25, 2021).

#2)Landlords prefer to Lease/Rent their buildings to commercial tenants because those buildings provide them with a recurring income stream; and they passed on those buildings to their heirs - (IRC 1239 and Estate Planning) instead of selling those buildings to their tenants/business owners.

#3)There is not enough commercial buildings available to sell to every small business or major corporations that want to own a building to house their business operations. Hence, many of those businesses, including Facebook, Apple, Google, etc are leasing more office space in high-rise buildings/office towers(Crains's NY Business, Pg 06, Nov. 29, 2021).

Buying Property ("A word to the wise is good enough")

#1) Make sure you understand the States Laws in the USA and the laws in Other Countries. Some States have Recourse Laws and some Countries may allow you to buy/own a house but not own the land. Hence, before you fall in love with a State or Foreign Country, make sure you understand the repercussions. That's very important!!

#2) Real Estate is Market Driven. You Real-Estate Broker should advise you to Pay Less than 100% (Pay about 75% to 90%) of the Appraisal Value (not the Selling Price) of a property in anticipation of changes in the Real-Estate Market or the Economy. Banks/Lenders will agree with that advice because they don't want their loan/mortgage to exceed the value of their collateral (the Appraisal Value of the property) if the country is hit with an economic recession.  

#3) Get your own appraiser and appraisal report.

#4) Get your own home inspector and inspection report.

#5) Get your own title search company and title search report.

#6) Get you own Real-Estate Attorney/Lawyer to watch your back.

The benefits of owning Residential property

#1) Mortgage interest and property tax are deductible.

#2) Appreciation in the value of the property.

#3) Capital gains exclusions of $250,000 or $500,000.

The benefits of owning Rental property

#1) A Maximum annual loss deduction of up to $25,000 loss for Active Part-Time owners.

#2) Annual loss deduction of 100% for Full-Time investors earning more than 50% of their salary from Real Estate as shown on their tax returns.

#3) The ability of all owners to use other peoples money (OPM) to create equity while adjusting debts with appreciation in the property's value and rents from tenants.

#4) Equity and Appreciation in the value of the property.

It is not unusual for taxpayers to own several rental properties locally and in other states. In order to enjoy the benefits (including the maximum tax breaks) and remain solvent, owners of rental property must be organized and they must operate the property like a business. They must have a system that is designed to record and monitor income and expenses and a plan that can help them maintain Cash Flow and adequate Working Capital (resource integration).

Kinds of Property and

Real Estate Transactions.

Those properties at issue are: - Residential (Single family, Condos, Co-ops, Vacation homes, and Time Shares), Mixed-use, Commercial, Industrial, and Undeveloped lands. The focus is on Banks Loans, Creative Financing and Acquisition(loan origination, processing, packaging, mortgage & insurance underwriting, loan warehousing and sale of loan/mortgage

Managing Real Estate Operation: - Adjusted basis, sale-leaseback, leasehold improvement, lease inducement payment, lease-term contracts, uniform capitalization, passive loss, debt restructuring, income from discharged of indebtedness, non-business bad debts, asset impairment, environmental remediation costs, riparian rights, cost segregation vs. total cost, Exchange & Transfer of rental property in Marital Dissolution, Transfer of property from a parent to a child, Section 121 exclusion for sale of property, Section 1031 Exchange of property, Contract Price, Sellers Concession, Second Mortgage, Adjusted Sale, Recapture of Depreciation (Sections 1231, 1245, 1250 gains), Installment Method of Reporting Gain, and Foreclosure, Repossession or  Disposition of property.

Tax Breaks For Residential Property

(Your Residence plus a Vacation Home)

Get Form(s) 1098 Mortgage Statement from your Bank or Lender. You should receive this form from every bank or mortgage company that you paid during the year. If you did not receive a form 1098 statement by January 31, call the bank or mortgage company for the information. The mortgage interest, Property Tax, Town Tax, School District Tax, County Tax, and/or Village Tax, and Points (loan origination and loan discount fees) that you paid are tax breaks.

If you own a CO-OP and you paid the monthly maintenance fee, you are entitled to a proportionate share of the Mortgage Interest and Real Estate Tax that the housing corporation paid on the building (IRC section 216). This is in addition to the mortgage interest tax deductions that you have received from your mortgage company or bank. You must report the actual figures on your tax return. Tax preparers are not allowed to put estimates of these amounts on your tax return.

Tax Breaks For Rental Property

Get Form(s) 1098 mortgage statement from your bank. You should receive this form from every bank or mortgage company that you paid during the year. If you did not receive a form 1098 statement by January 31, call the bank or mortgage company for the information.

1) You must report the amount of rent that you actually received or collected from each property during the year [IRC Sections 61(a)(5), 109, and 856(d)(1)].

2) You should prepare an itemized list of rental expenses that you paid during the year for each rental property you own (IRC Sections 163, 164, and 212), such as: mortgage interest, property tax, school district tax, county tax, village tax, water, gas/oil, electricity, insurance, eviction fees, advertising vacant apartment(s), extermination, cleaning and maintenance, boiler repairs, carpeting, management fees, and travel to the property. Minor repairs for plumbing, electrical, and carpentry are deductible in full in the year paid (Treasury regulation 1.162-4). Equipment and capital improvement such as new boilers, refrigerators, stoves, central air conditioning, new bathrooms, complete renovation of apartments and kitchen, including structural improvements made to the property, such as a new roof, sidewalk, driveway, garage, fence, and basement are depreciated and deducted annually over a period of 5-15 years [IRC 262 and 280(A), and Treasury regulation (regs.) 1.280A-3(d)(3)]. Lodging, meals, and utilities that you furnished to a Super and his dependents are treated as furnished as a condition of employment. These amenities are tax-free to the Super. They must not be included in his gross income and they are not deductible by you, the employer [IRC Section 119(a)(2)].

Sale, Foreclosure, or Destruction of your Residence

You do not have to pay tax on the FIRST $250,000 or $500,000 of Profit that you obtain from the Sale or Destruction of your Principal Residence by Hurricane, Tornado, Threats of Condemnation or Eminent Domain if you own the property for at least 5-years and lived in it for at least 2-Years. You can claim this exclusion Once every two years (IRC Sections 121 and 1033). You can receive a Reduced Exclusion if you sell your Principal Residence earlier and the sale was due to Divorce, Unemployment, Poor Health, Acts of Vandalism or Terrorism, A change in Employment; or Self-employment status that makes it difficult for you to pay your Mortgage and Living Expenses. A Reduced Exclusion is based on the number of days that you owned and occupied your residence divided by 730 days, or the number of months you owned and occupied your residence, divided by 24 months, multiplied by the exclusion of $500,000 or $250,000 based on your filing status at the time of the incidence or occurrence.

If your principle residence was destroyed or condemned, you may have to purchase a replacement property within two years to offset the recognized gains. If a lender has foreclosed on your property, your gain or loss for tax purposes is the difference between the net proceeds that the lender received at the auction and your adjusted basis in the property [IRC 856(e)(1) and 1001]. Your attorney or insurance company should give you copies of these settlement papers. Take the documents along with you at your tax interview.

You can deduct a maximum of $3,000 on your tax return annually if you paid a contractor or developer to build your house and you and other homebuyers lost your money because the contractor filed bankruptcy. This is a non-business bad debt [IRC Section 166(d)(1)(B)]. To qualify for this non-business bad debt deduction, you must show proof of contract, original cancelled check(s), and a letter from the bankruptcy court or from the contractor's attorney.

****Note: You can avoid losing your money to a contractor or developer by checking their history for lawsuits and bankruptcies and ensuring that they carry contractor's general liability insurance (CGL) and Payment & Performance bonds with your name endorsed on those policies. I am an insurance broker, so I know that.

Sale of rental or commercial property

If you sold a rental/commercial property, you may have to pay Capital Gains Tax on the profit or on the amount of the depreciation taken (IRC Sections 1231, 1245, & 1250 Recapture of Depreciation). However, you can avoid paying tax on Capital Gains and instead pay tax on Ordinary Income if you sold your rental property to a relative (IRC 1239). If you are not qualified to use this method, then you may use the installment sales method to spread the capital gains and your overall tax burden over several years if you received a down payment from the buyer and you hold a note or second mortgage from the buyer for the balance of the salling price — Seller Finance (IRC Section 453). You may also qualify for non-recognition of capital gains tax through a Section 1031 like-kind exchange transaction. The Like-Kind Exchange tax strategy allows you to reinvest the profit from your property into a new and similar property without paying capital gains tax. Section 1031 exchange transaction must be completed within 180 days (six months) after the transfer of the exchange property.

Section 1031 exchange, business, or investment property
In a section 1031 exchange transaction, the property you give up and the property you receive must be held for investment or for use in your trade or business. Machinery, trucks, land, office buildings, and rental houses are examples of qualified property. You can exchange an apartment building for another apartment building, retail building, or industrial warehouse of the SAME appraisal value.

Section 1031 exchange, not for principal residence
Section 1031 exchange rules do not apply to property that is used solely as a personal residence.

Tip: If you owned a personal residence for at least five years and lived in it for at least two years, and the residence was rented out to a tenant at the time of the exchange, then you can claim both the section 121 exclusion of $250,000 or $500,000 and the Section 1031 non-recognition of gain. Isn't this a nice loophole?

Section 1031 transactions are complex. It is important that you retain the services of a real estate attorney to construct your transaction within Section 1031 exchange rules because you can be audited and indicted for tax evasion. If you need help setting up a Section 1031 transaction, please call the following tax attorneys.

Question #1
Hi Barry, I am single. I sold my 4-family building in January 2005. The market price was $800,000, but the contract price was $725,000. I also gave the buyer $30,000 to help pay the closing cost. I received the building from my parents in 2004. They bought it in 1982 for $52,000 and made improvements totaling $100,000 over the years. We lived in one apartment and rented out the other three apartments from 1982 to 2004. My parents filed their tax returns every year and they included the rents and the operating expenses of the building. They have taken $85,650 in depreciation deductions. Am I in trouble with the government?

Answer
You are not in trouble with the government. You just have to pay the government what you owe. Gain or loss from the sale or transfer of a property is the difference between the adjusted selling price and the adjusted basis (total cost) of the property sold. The basis that your parents had in the property and the depreciation they have taken over 22 years were transferred to you when you received the property. This situation also holds true if the property was transferred to you in a divorce settlement. You do not have to pay capital gains tax for the apartment where you lived. Your profit for your apartment is $135,750 = ($173,750 - $38,000) and your Section 121 exclusion is $250,000. However, you have to pay federal and state capital gains tax on the profit/gain of $492,900 you received from the three apartments that your parents rented out for 22 years. Your profit of $492,900 was arrived at after the selling price was adjusted to reflect the seller's concession, your basis was adjusted, and recapture of depreciation was added back. You MAY be able to postpone paying federal and state taxes on $492,900 profit if you plan to buy a commercial property within two years after the sale of your property.

Question #2
Hello Clemson, my wife and I purchased our home for $365,000 at the height of the market in 2003. The asking price was $380,000. We spent $17,200 on renovation and our mortgages totaled $390,000. The appraised value of the house is now $380,000. We could not keep up with the monthly payments so the lenders foreclosed on the house. The house was sold at auction for $390,000. Are we entitled to receive money from the foreclosure?

Answer
Foreclosures [IRC Sections 108(a), 856(e)(1), and 1001(a)].
The IRS and the tax court have ruled that the value of a property sold in foreclosure is the amount of money the seller received for it from the highest bidder. The foreclosure sale has generated a capital gain of $7,800 ($390,000 - $365,000 - $17,200). The capital gain is not taxable because your section 121 exclusion is $500,000. You are not entitled to receive money from the foreclosure sale because the total amount of your mortgages is equal to the amount the lenders received at the auction.

Question #3
Hi Clem, I own ten acres of prime land in a busy city. I paid $200,000 for the land in 1978. The current value of the land is $800,000. In 2004, the state acquired a portion of the land and built a highway through it. I received $80,000, but the market value of the land is $88,000. Can I take $8,000 as a credit or deduction on my tax return?

Answer
Condemnation or eminent domain [IRC Section 1033(a)(2)(E)(ii)].
Real estate can be purchased/acquired at fair market value or at its appraisal value. The $80,000 you received from the state may be the lower of the two value systems. Ask the state which value system was used to calculate your compensation or you can initiate legal proceedings against the state for the additional compensation of $8,000. Current tax rules do not allow you to take a tax deduction or credit for $8,000. The value of the land acquired by the state is 10% of the value of the ten acres you own ($80,000/$800,000). You received $80,000 and the land cost you $20,000 (10% x $200,000). You have to pay capital gains tax because the acquisition has created a net taxable gain of $60,000.

Question #4
Mr. Barry, I am planning to develop, subdivide, and sell 30 acres of land that I purchased and held in my name 12 years ago for $156,000. The value of each lot will vary significantly. The subdivision costs and fees will be approximately $80,000 and the estimated sales price will be $2,800,000. I plan to sell all the lots in five years. How should I structure my transactions to minimize my taxes?

Answer
IRC Section 1237.
As an individual owner, you should sell five lots of two acres each for three years. If you sell more than five lots in the same year, then 5% of the sales price of each lot in excess of five lots will be taxed as ordinary income. A five-year delay after the sale of the first five lots will qualify an additional five lots or the remaining lots for 100% capital gains tax. An individual owner who subdivides land and sells off lots or parcels cannot defer reporting gain until the entire cost is recovered. The proper procedure is for you to apportion the cost equitably among the lots so that gain or loss can be determined on the sale of each lot.

Note: You could save a lot of money if you established an LLC or C-corporation for buying, holding, and selling real estate. You transfer, develop, and sell the land as part of the inventory of the corporation.

Question #5
Hi Clemson, I bought a beachfront residence with two acres of land for $1,200,000 in 1993. The value of the land was $125,000. My residence was damaged by a hurricane in 2003. I had a high insurance deductible and I properly deducted $20,000 as a casualty loss on my 2003 tax return. I made $80,000 repairs to the property in anticipation of converting it to a rental property. The house was rented out in January 2006. The market value of the property at the time was $1,100,000 and the value of the land was $100,000. What figure should I use to calculate the depreciation on the house for tax year 2006?

Answer
Treasury regulations (regs) 1.167(g)-1 and 1.168-2(j)(6). IRC Sections 1012 and 1016.
Your basis for depreciation is $1,000,000. When a personal residence (asset) is converted to business use, the basis for depreciation is the lower of the adjusted basis (total cost - land - loss) or the market value (FMV) when the property was converted. The adjusted basis is $1,135,000 ($1,200,000 - $125,000 - $20,000 + $80,000). Since the basis of the house is $1,135,000 and fair market value (FMV) is $1,000,000 ($1,100,000 - $100,000), the basis for depreciation is $1,000,000. You should use $1,000,000 to calculate the depreciation on your house.

Question #6
Hi Clem, a contractor wants to accept my residence as a trade-in and allowed me $340,000 towards a new residence priced at $400,000 that he owned in another state. I bought my house in 1990 and I have never rented it out. I have the following pieces of information:

What is the basis of my new residence in the exchange?

Answer
IRC Section 1034(a) and (e); Section 121.
The trade-in transaction you are talking about is Section 1034 transaction. Section 1034 rules were repealed in 1998. This transaction may cost you a small fortune in back taxes, interest, and penalty when the auditors pull your file three years later. Section 1031 like-kind exchange rule has been the new rule for several years and it does not cover property used solely as a primary residence. I strongly recommend that you take out a home equity line of credit to make a down payment on your new residence while you are searching for a buyer to purchase your current residence for $400,000. You can then use your tax-free profits or capital gains of $215,500 to reduce the balance owed on your new residence. Why tax-free? Because your Section 121 exclusion of $250,000 offsets your capital gains profit of $215,500.

Here is the answer to your Section 1034 trade-in transaction. IRC Section 1034(e) requires the basis of a new residence be reduced by the amount of gain realized on the sale of a former residence. The adjusted basis of your new residence is $246,500.

IRC Section 1034(a) has provided for the non-recognition of gain in the exchange. The adjusted basis of the new residence for future tax purposes is equal to the purchase price of $400,000 + $2,000 attorney's fee less $155,500 of non-recognized gain.

Question #7
Hi Barry, I am single, I bought a one-family residence in June 2005 for $315,000. I paid 3% down and closing costs of $19,800. The property valued $350,000 at closing. I received $35,000 cash back at closing and my mortgage became $340,550. I lost my job and I had difficulties paying my mortgage after my unemployment, severance pay, and savings ran out. I sold my residence in September 2006. The contract price was $380,000, but I had to give the buyer a seller's concession of $10,000 to qualify for a mortgage. I paid $29,200 in selling expenses including a 6% broker's fee. Am I entitled to receive some money back?

Answer
IRC Section 121.
You should have received a check for $250 at closing from the buyer's mortgage company. You own the house for about 15 months. Hence, most of your monthly mortgage payments went to pay the mortgage interest. Your attorney should have your money in his/her escrow account. Your capital gains is $6,000. The taxing authorities have recognized your special circumstance and have exempted you from paying capital gains tax. You are covered under the Reduced Exclusion Rules. Your reduced exclusion of $156,250 = (15 months / 24 months x $250,000) more than offset your capital gains of $6,000. Hence, you have a TAX FREE capital gains of $6,000. Here are the calculations:

The mortgage company should pay you ($380,000 - $39,200 - $340,550) = $250

Your tax-free capital gains is ($380,000 - $39,200) - ($315,000 + $19,800) = $6,000

Summary
Answers to those questions above can save you thousands of dollars in taxes. Please remember tax rules are subject to change; and those rules are changed frequently. Call us if :-

1)You own Real Estate and you would like to have your tax returns prepared.

2) You sell a Residential or Rental property.

3)The IRS or State is Auditing you.

NOTE:- If you aren't convince that we know Real Estate Taxation, then nobody will be able to convince you that they know it.