Home > Strictly TAXES! > Is Now The Time To Consider Owning Real Estate Rental Property?

Is Now The Time To Consider Owning Real Estate Rental Property?


Does the decline in real estate values present a business opportunity? Real estate rentals historically have been a popular long-term investment. If you believe that this market eventually will rebound from its current slump, this may be the time to consider such an investment. This article will explain some of the tax ramifications of renting residential real estate.

One of the biggest benefits of owning rental property is that the tenants, over time, buy the property for you. In addition, if structured properly, the allowable depreciation deduction will help to shelter the rental income and you will be able to benefit in the short term with legitimately favorable tax deductions. Another historical benefit of real estate rentals is property appreciation.

Before acquiring a rental property, there are several things to consider. Here are a few:

  • After-tax cash flow
  • Losses to offset income from other sources (Wages, etc)
  • Potential for long or short term appreciation
  • Property condition (with an eye on when you might get stuck with a large repair bill)
  • Debt reduction
  • Type of tenants
  • Potential for rent increases or re-zoning
  • Whether there is an HOA restriction on renting your property, etc.

Rental real estate income is business income but is not subject to Social Security taxes. (A tax savings of roughly 16%) Real estate rentals are also considered passive activities (Your property generates income without you having to be there to run things, as you would in a business for example). Generally, passive activity losses are deductible only to the extent of passive activity income. However, where there is active participation by the taxpayer in managing the rental, the taxpayer can deduct up to $25,000 of losses each year as long as his or her Adjusted Gross Income (AGI) for the year is less than $100,000. For higher-income taxpayers, the $25,000 loss exception is ratably phased out between an AGI of $100,000 and $150,000. For most taxpayers, this can be a beautiful thing. You can actually have cash flow every month (the money you take home after all expenses are paid) and yet show a legitimate rental loss on your tax return! This loss will help to reduce other taxable income that you may have, such as wages. There is also a special allowance for real estate professionals. (Call this office for details if you are a real estate professional)  Any losses not allowed under these two exceptions are not lost but suspended and carried forward indefinitely to tax years in which your passive activities generate enough income to absorb the losses. To the extent your passive losses from an activity are not used up in this fashion, you will be allowed to use those losses in the tax year in which you sell your rental property.

When a rental property is sold, it is treated as a capital asset. The gain or profit from the sale (except for depreciation recapture) is taxed at capital gains rates. Recaptured depreciation (Contact us for details), depending upon your tax bracket, can be taxed up to 25%. Besides outright selling of a rental, there are a number of options such as exchanging the existing rental for another while deferring the gain and avoiding current taxes, selling the property in an installment sale (which spreads the taxable gain over multiple years), or even converting the property to personal use (which forestalls the taxable gain until the property ultimately is sold).

Buying, operating, and selling a rental property can have profound tax ramifications and provide some interesting options not available to other investments. Please contact this office prior to the purchase or disposition of a rental property so that the tax impact can be analyzed prior to making a financial commitment.

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Categories: Strictly TAXES!
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