Real Estate Tax Deductions to Know

The Passive Activity Loss (PAL) Rules, introduced in 1986, are to prevent taxpayers from using "paper losses" (like depreciation) from investments to offset their highly taxed Active Income (like wages or business profits). It's called the "bucket rule" because IRS divides all your income and losses into 3 buckets. 1. Active: Wages (W-2), Salary, Business Profit (Schedule C) where you Materially Participate. Can be offset by losses from other Active activities. 2. Portfolio: Interest, Dividends, Royalties, Capital Gains from investments (stocks, bonds). Cannot be offset by Passive Losses. 3. Passive: All Rental Activities (RE), or Business Activities where you DO NOT Materially Participate (e.g., a limited partner). Passive Losses can ONLY offset Passive Income. If your rental property generates a $20,000 tax loss (due to depreciation), you cannot use that loss to reduce the tax on your $100,000 W-2 salary (Active Income). The $20,000 loss is suspended and carried forward. An activity is passive if it is: - Any Rental Activity: Rental real estate is passive by nature, regardless of how much time the owner spends on it. - A Trade or Business in which the taxpayer does not Materially Participate. Material Participation is defined by the IRS using 7 tests, the most common of which is working more than 500 hours in the activity during the year on a regular, continuous, and substantial basis. While losses are generally suspended, there are 2 main ways to free them up: 1. Individuals whose MAGI < certain threshold can deduct up to $25,000 of passive RE losses against their Active and Portfolio income. - The owner must "Actively Participate" (a lower standard than Material Participation, usually met by making management decisions like approving tenants or deciding on repairs). - This $25,000 allowance is phased out for taxpayers with MAGI between $100,000 and $150,000. If your income is over $150,000, this exception disappears entirely. 2. This is the "Holy Grail" exception for full-time RE investors. If a taxpayer qualifies as a RE Professional, their rental activities are NOT automatically considered passive. - To Qualify: a) > 50% of the personal services performed by the taxpayer in all trades or businesses during the year are performed in real property trades or businesses. b) The taxpayer performs > 750 hours of service during the year in real property trades or businesses (such as development, construction, brokerage, or property management). - If the taxpayer meets the REP tests and can show Material Participation (e.g., meeting the 500-hour test) in the specific rental properties, those losses become Active Losses and can offset W-2 income or business profits without limit. Q: What happens to the total amount of "suspended" passive losses when a taxpayer finally sells the entire passive activity (e.g., the rental property) in a fully taxable transaction? Follow @thetaxsaaab on Instagram.

The 𝐜𝐨𝐦𝐦𝐨𝐧 𝐪𝐮𝐞𝐬𝐭𝐢𝐨𝐧 I get from preparers regarding the 𝐩𝐮𝐫𝐜𝐡𝐚𝐬𝐞 of a 𝐧𝐞𝐰 𝐚𝐬𝐬𝐞𝐭 is about the 𝟐𝟎𝟎% 𝐃𝐁 or 𝟏𝟓𝟎% 𝐃𝐁 depreciation 𝐫𝐚𝐭𝐞 and how it applies. Let’s understand what this means. When we use the 𝐆𝐞𝐧𝐞𝐫𝐚𝐥 𝐃𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 𝐒𝐲𝐬𝐭𝐞𝐦 (GDS), which is the most 𝐜𝐨𝐦𝐦𝐨𝐧 𝐦𝐞𝐭𝐡𝐨𝐝, we come across the concept of 200% DB and 150% DB for 𝐩𝐞𝐫𝐬𝐨𝐧𝐚𝐥 𝐩𝐫𝐨𝐩𝐞𝐫𝐭𝐲 (movable assets). 𝐃𝐁 stands for "𝐃𝐞𝐜𝐥𝐢𝐧𝐢𝐧𝐠 𝐁𝐚𝐥𝐚𝐧𝐜𝐞", meaning the asset depreciates 𝐦𝐨𝐫𝐞 in the early years and less in later years. 𝐒𝐭𝐫𝐚𝐢𝐠𝐡𝐭-𝐋𝐢𝐧𝐞 𝐌𝐞𝐭𝐡𝐨𝐝 (SLM) follows a 𝐬𝐢𝐦𝐩𝐥𝐞 calculation. For example, if an asset has a $𝟏𝟎,𝟎𝟎𝟎 value and a 𝟓-𝐲𝐞𝐚𝐫 useful life, the depreciation is calculated as $10,000 × 20% = $𝟐,𝟎𝟎𝟎 𝐩𝐞𝐫 𝐲𝐞𝐚𝐫. This continues for 5 years, after which the asset is fully depreciated. Now, let’s talk about 𝟐𝟎𝟎% 𝐃𝐁, also called the 𝐃𝐨𝐮𝐛𝐥𝐞 𝐃𝐞𝐜𝐥𝐢𝐧𝐢𝐧𝐠 𝐁𝐚𝐥𝐚𝐧𝐜𝐞 method. As the name suggests, this method applies 𝐃𝐨𝐮𝐛𝐥𝐞 the straight-line method (SLM) in the 𝐞𝐚𝐫𝐥𝐲 𝐲𝐞𝐚𝐫𝐬. However, the IRS requires switching to SLM when SLM gives a 𝐡𝐢𝐠𝐡𝐞𝐫 𝐝𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 amount. 𝐒𝐨𝐮𝐧𝐝𝐬 𝐝𝐢𝐟𝐟𝐢𝐜𝐮𝐥𝐭? Let’s understand this with a 𝐬𝐢𝐦𝐩𝐥𝐞 example. If an asset has a $𝟏𝟎,𝟎𝟎𝟎 value and a 𝟓-𝐲𝐞𝐚𝐫 useful life, the straight-line rate is 𝟐𝟎%, so the 𝟐𝟎𝟎% 𝐃𝐁 𝐫𝐚𝐭𝐞 is 𝟒𝟎% which is double of SLM. In the 𝐟𝐢𝐫𝐬𝐭 year, depreciation is $𝟏𝟎,𝟎𝟎𝟎 × 𝟒𝟎% = $𝟒,𝟎𝟎𝟎. In the 𝐬𝐞𝐜𝐨𝐧𝐝 year, the remaining value is $6,000, so depreciation is $𝟔,𝟎𝟎𝟎 × 𝟒𝟎% = $𝟐,𝟒𝟎𝟎. In the 𝐭𝐡𝐢𝐫𝐝 year, depreciation is $𝟑,𝟔𝟎𝟎 × 𝟒𝟎% = $𝟏,𝟒𝟒𝟎. In the 𝐟𝐨𝐮𝐫𝐭𝐡 year, depreciation would be $𝟐,𝟏𝟔𝟎 × 𝟒𝟎% = $𝟖𝟔𝟒, and for the 𝐟𝐢𝐟𝐭𝐡 year, the remaining balance would be $𝟏,𝟐𝟗𝟔. Now, 𝐥𝐨𝐨𝐤 𝐜𝐥𝐨𝐬𝐞𝐥𝐲. In the 𝐟𝐨𝐮𝐫𝐭𝐡 year, the 𝐝𝐞𝐩𝐫𝐞𝐜𝐢𝐚𝐭𝐢𝐨𝐧 is $𝟖𝟔𝟒, and in the 𝐟𝐢𝐟𝐭𝐡 year, it is $𝟏,𝟐𝟗𝟔. It is not possible for the depreciation in the 𝐟𝐨𝐮𝐫𝐭𝐡 year to be 𝐥𝐨𝐰𝐞𝐫 while being 𝐡𝐢𝐠𝐡𝐞𝐫 in the 𝐟𝐢𝐟𝐭𝐡 year, as this 𝐜𝐨𝐧𝐭𝐫𝐚𝐝𝐢𝐜𝐭𝐬 the 𝐩𝐮𝐫𝐩𝐨𝐬𝐞 of the 𝟐𝟎𝟎% 𝐃𝐁 method, which is 𝐝𝐞𝐬𝐢𝐠𝐧𝐞𝐝 to 𝐚𝐜𝐜𝐞𝐥𝐞𝐫𝐚𝐭𝐞 depreciation in the 𝐢𝐧𝐢𝐭𝐢𝐚𝐥 𝐲𝐞𝐚𝐫𝐬. To 𝐜𝐨𝐫𝐫𝐞𝐜𝐭 this 𝐢𝐦𝐛𝐚𝐥𝐚𝐧𝐜𝐞, the IRS suggests 𝐬𝐰𝐢𝐭𝐜𝐡𝐢𝐧𝐠 to the 𝐒𝐋𝐌 method in the 𝐟𝐨𝐮𝐫𝐭𝐡 year. At that point, the remaining balance of $𝟐,𝟏𝟔𝟎 is 𝐞𝐯𝐞𝐧𝐥𝐲 𝐰𝐫𝐢𝐭𝐭𝐞𝐧 𝐨𝐟𝐟 over the 𝐥𝐚𝐬𝐭 𝐭𝐰𝐨 𝐲𝐞𝐚𝐫𝐬: $𝟐,𝟏𝟔𝟎 ÷ 𝟐 = $𝟏,𝟎𝟖𝟎 per year. This ensures the asset is fully depreciated by the end of its useful life. 𝐍𝐨𝐭𝐞: The goal is to explain the concept and logic in a simple way. To keep the calculations easy, I have made several assumptions, such as not using the half-year convention. #ustax #ustaxation #cpa #cpafirms #learning #depreciation #taxseason

Accounting for Fixed Assets: 1. Initial Recognition: Fixed assets are recorded at their cost on the balance sheet. This includes the purchase price, installation costs, transportation costs, and any other costs necessary to bring the asset into working condition. • Example: If a company purchases a machine for $100,000, and the transportation and installation costs are $5,000, the total cost of the fixed asset would be $105,000. 2. Depreciation: Fixed assets (excluding land) lose value over time due to usage, wear and tear, or technological obsolescence. This decrease in value is recorded as depreciation in the income statement and accumulated depreciation on the balance sheet. Common methods of depreciation: • Straight-Line Depreciation: The asset’s value is depreciated evenly over its useful life. • Formula: (Cost of Asset - Residual Value) ÷ Useful Life • Declining Balance Depreciation: Depreciation is higher in the earlier years of the asset’s life and decreases over time. • Units of Production Depreciation: Depreciation based on usage or production levels. • Example: A machine with a cost of $100,000, a residual value of $10,000, and a useful life of 10 years would have an annual depreciation of: (100,000 - 10,000) ÷ 10 = 9,000 So, $9,000 would be charged annually as depreciation. 3. Impairment: If a fixed asset is no longer expected to provide future economic benefits greater than its carrying amount, it may be considered impaired. In this case, the asset is written down to its recoverable amount. 4. Disposal: When a fixed asset is sold, scrapped, or no longer in use, it is removed from the balance sheet. The difference between the asset’s carrying amount (its original cost minus accumulated depreciation) and the proceeds from disposal is recorded as a gain or loss. • Example: If a company sells a machine for $30,000 that has an accumulated depreciation of $70,000 and an original cost of $100,000, the book value (carrying amount) would be $30,000. If the sale price is $30,000, there is no gain or loss on disposal.

Depreciation Recapture: Usually, when an entity invests in Fixed Assets (personal or real property), they get a deduction of depreciation expense on the purchased assets. This expense helps them reduce the ordinary/rental income (depending on the nature of the business). Now, suppose if the entity disposes these fixed assets after certain years of use. What will be the effect of Gain/Loss on Sale? Most of us would think that it will be Captial Gain/Loss and will be taxed at preferential rates, right? But the answer is no. When the asset is disposed of for Gain, the amount of depreciation already claimed on the asset until the date of disposal (i.e. Accumulated Depreciation) is recaptured as an Ordinary Gain instead of considering full gain as Capital Gain. Hence, no preferencial Tax Rate benefit for the portion of depreciation already claimed. These assets are generally classified as section 1231 Assets. Section 1231 assets generally are: - Any Personal or Real Property used in trade or business AND - Held for more than 12 months Section 1231 assets are further classified into two types: Section 1245 Assets: - Any Personal Property used in trade or business AND - Held for more than 12 months Section 1250 Assets: - Any Real Property used in trade or business AND - Held for more than 12 months Any gain from the above two types of properties is recaptured and is taxed at Ordinary Rates to the extent of Depreciation Expense already claimed on them. Any gain in excess of depreciation will be treated as Section 1231 Gain (i.e. Capital Gain) and will br reported on Schedule K, Line 10 (Form 1065) or Line 9 (Form 1120S). If any of these assets are sold at loss, the entire loss will be classified as 1231 Loss and will be reported as Ordinary Loss allowing deduction against ordinary income. Section 1231 Loss can only be offset against Section 1231 Gains. For more such posts, kindly follow Saloni Desai #depreciation #recapture #irs #section1231 #section1245 #section1250 #ordinarygain #capitalgain

We're building a $20M apartment building with $8M of investor equity. In Year 1, our investors are projected to receive over $5M in bonus depreciation, a paper loss equivalent to ~65% of their initial investment. Here's a quick playbook on how that works, and the "super-move" that can make those tax savings permanent. How Bonus Depreciation Works: Normally, you write off a building over 27.5 years. But through a Cost Segregation Study, we can identify parts of the asset with shorter lifespans (like appliances, flooring, and site work) and accelerate decades of deductions into Year 1. Who can use this loss? ➡️ Passive Investors: Can use the deduction to offset other passive income (e.g., from other rentals or partnership K-1s). ➡️ Real Estate Professionals (REPs): Can use the deduction to offset all income, including W-2 or active business income. (Any unused losses can be carried forward to future years.) The Catch: Depreciation Recapture That giant $5M deduction isn't a free lunch forever. When a property is sold, the IRS can "recapture" the depreciation you claimed and tax it at rates up to 25%. But there are two powerful ways to plan for this. The Solutions: Deferral vs. Elimination Path #1: The 1031 Exchange (The Deferral) You can sell the property and roll the proceeds into a new one. This defers both capital gains and the depreciation recapture tax. You're essentially kicking the can down the road. Path #2: The Opportunity Zone (The Elimination) This is the super-move. If the project is structured within an OZ fund from day one and held for 10+ years, our investors get: ✅ No capital gains tax on the sale. ✅ No depreciation recapture. The upfront $5M deduction becomes a permanent, tax-free benefit. This isn't theory—this is the exact structure we're using for our current $20M project. For the investors and CPAs here: When you're evaluating a deal, how much weight do you put on the after-tax benefits like bonus depreciation and its exit strategy?

A client came to me last year after their CPA told them: Report short-term rental income on Schedule C. That would’ve triggered 15.3% self-employment tax. On all of it. Here is what happened: When your average guest stay is under 7 days, the IRS doesn’t treat it like a rental. But that doesn’t mean it belongs on Schedule C. Unless you’re providing hotel-like services (concierge, daily cleaning, meals), it still qualifies for Schedule E which has no self-employment tax. In this case: - $120K in STR income - CPA said Schedule C → ~$18,000 in extra tax - We showed why Schedule E was correct - $0 in SE tax, with all deductions preserved I’m not saying every STR belongs on Schedule E. But it is important to get someone who knows the nuances before you overpay the IRS.

Not everything you buy can be depreciated - and getting this wrong can cost you. Depreciation is a powerful accounting tool, but not every asset qualifies. Understanding which assets cannot be depreciated is critical for accurate financial reporting, tax planning, and decision-making. Non-depreciable assets typically share one key trait: They do not lose value over time in a predictable way, or they have an indefinite useful life. Here are the most common examples: 1. Land Land is never depreciated. Why? Because land does not wear out, get used up, or become obsolete. In many cases, it actually appreciates over time. Important note: Buildings, parking lots, landscaping, and other improvements on land are depreciable - but the land itself is not. 2. Certain Intangible Assets Assets like: →Goodwill →Trademarks with indefinite life →Brand value These are not depreciated. Instead, they may be amortized (if they have a finite life) or tested for impairment. 3. Personal-Use Assets → Assets used purely for personal purposes - such as a personal residence or private vehicle - cannot be depreciated for business or tax purposes. (Only the business-use portion qualifies if an asset is used partly for business.) 4. Investments →Stocks, bonds, and other financial investments do not depreciate. Their value is realized through capital gains or losses, not depreciation. Why this matters: ❌ Depreciating a non-depreciable asset can lead to incorrect financial statements ❌ It may trigger compliance issues or tax penalties ✅ Proper classification improves credibility, accuracy, and tax efficiency Depreciation isn’t just an accounting entry - it directly impacts profit, taxes, and strategic decisions. Knowing what not to depreciate is just as important as knowing what you can. #Accounting #Depreciation #Finance #TaxPlanning #FixedAssets #FinancialReporting #CFO #BusinessFinance

Sorry lenders Sorry handymen Sorry landscapers Sorry electricians Sorry plumbers Sorry roofers Sorry architects Sorry inspectors Sorry engineers... but you’re all not in a “real property trade or business” according to the IRS when it comes to REPS. This is a very common misunderstanding, so let me explain this. The IRS only defines 11 specific types of activities that fall into the “real property trades or business”. 👉 development 👉 redevelopment 👉 construction 👉 reconstruction 👉 acquisition 👉 conversion 👉 rental 👉 operation 👉 management 👉 leasing 👉 brokerage Let's use a lender for example. Someone might say, "Isn’t a lender part of the acquisition process, or brokering the deal together". That then takes us to a tax court case where this very type of question was asked, and the IRS scrutinized this business in T.C. Summary Opinion 2017-66, Kurt Hickam and Michelle Hickam v. Commissioner. To save you the headache of reading through this yourself, this mortgage broker lost, and REPS was denied. The moral of the story is, just because you THINK you’re in a real property trade or business, it doesn’t really matter. It’s whatever the IRS and the tax court judge believe is a real property trade or business based on the law and regulations. So be careful claiming REPS without doing your homework or working with a tax professional. If you’re not confident about claiming REPS, but think you might be able to qualify, work with specialists who know these tax court cases and the tax code. So who generally qualifies being in a "real property trade or business"? ✅ Realtors/Brokers ✅ Flippers ✅ Wholesalers ✅ Property managers ✅ General contractors who construct new buildings ✅ Developers REPS can be confusing and complex, so don't go at this alone if you're unsure. --- If you found this helpful, consider resharing ♻️ and follow me for more content like this. Send me a DM if you are a real estate investor looking for a CPA that specializes in real estate. 👋 P.S. If you know someone who needs to see this tag them below.

Combining two of the most powerful real estate tax strategies: §121 + §1031. Before we dive in, quick refresher on both: - §121 lets you exclude up to $250K of gain ($500K for married couples) on the sale of your primary residence. - §1031 lets you defer gain on investment property if you roll the proceeds into another property. One basic 1031 rules to keep in mind: You must reinvest all the cash proceeds (not just the gain) into the new property. Any cash you take out is taxable gain. (this is called "boot" in 1031 language) Example: If you sell a property for $1M with $900K gain (basis $100K), buy a new one for $900K, and pocket $100K cash, that entire $100K boot is taxable. Now, at first glance, these two sections don’t play together: - 1031 is strictly for investment/business property, - 121 is for your primary residence. But here’s how they can intersect: §121 doesn’t require the property to be your primary residence at the time of sale. It just needs to have been your primary residence for 2 out of the last 5 years. So picture this: - You meet the 121 requirements. - You move out and convert the house to a rental property. - Then you sell… Now you qualify for both: - 1031, because it’s now investment property. - 121, because you hit the 2-out-of-5 rule. Back to our example: Assuming you qualify for the $250K §121 exclusion (single filer), instead of rolling the full $1M into a new property to avoid tax… You can pull out $250K cash and 1031 the remaining $750K into a new investment property. Result? $0 taxable gain. Even with the $250K boot! This is the rare exception where boot isn’t taxed. As long as the boot does not exceed the 121 exclusion, the boot gets covered by the exclusion (then 1031 defers the rest). This isn’t a grey area. It’s straight from Rev. Proc. 2005-14, with clear examples. Go read it if you're bored or nerdy. (I read it and I'm not bored.) Most people won’t be able to use this, but if your ducks line up in a row… It’s a game-changer. Have you pulled this combo off? I'd love to hear from you. if you have any questions on the Rev. Proc., comment or DM me. Lets talk tax! Tagging some 1031 experts Leonard Berkowitz Bernard Reisz CPA Barry Neustadt, CPA Samuel S. Sontag

Turn real estate into a tax advantage. Most people see property as cash flow. Smart investors see it as a tax strategy. Here’s how real estate legally reduces taxes: 1. Depreciation → Deduct a portion of the property's value from taxable income each year. This reduces taxes owed without requiring any cash expense. 2. Mortgage interest → The interest paid on a loan for the property can be deducted from taxable income, providing the biggest benefit in the early years of the loan. 3. Operating expenses → Costs like repairs, maintenance, and insurance can be subtracted from rental income. This directly reduces the amount of profit subject to tax. 4. Cost segregation → This strategy allows investors to break down property into parts that can be depreciated more quickly, so deductions come sooner. 5. 1031 exchange → This rule lets investors sell one property and buy another while deferring payment of capital gains taxes. Taxes are not owed until selling the new property without reinvesting. 6. Rental loss offsets → If expenses exceed rental income, the loss may reduce taxes on other income, especially for high earners. Specific rules apply to qualifying for this benefit. 7. Capital gains advantage → When property is held for over a year before selling, profits are taxed at lower long-term capital gains rates. 8. Pass-through benefits → Some property owners may qualify for the Qualified Business Income (QBI) deduction, which allows a portion of rental income to be deducted, improving after-tax returns. 9. Estate planning perk → When heirs inherit property, its value is reset to market value, so capital gains taxes on appreciation during your ownership are avoided. Real estate isn’t just about earning more. It’s about keeping more, legally. Which of these strategies do you want to explore next? Follow me Marc Henn for more. We want to help you Retire Early, Supercharge Your Cash Flow, and Minimize Taxes. Marc Henn is a licensed Investment Adviser with Harvest Financial Advisors, a registered entity with the U. S. Securities and Exchange Commission.