Real Estate Advantages by Lechter & Sutton
Ref: Lechter & Sutton (2006). Real Estate Advantages: Tax and Legal Secrets of Successful Real Estate Investors. Business Plus.
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Summary
A Guide to Real Estate (RE) Investing.
In the US, overall appreciation over the past 4 decades has been above 6% annualized.
The laws benefit the risk-takers, the doers, who spur the economy. Therefore, if you invest capital into your community by buying real estate, you are rewarded with tax breaks so that you can maintain and continue investing while at the same time, you provide a valuable social service.
The government learned its lesson a generation ago that it does a very poor job of providing low-cost housing. It is more efficient to encourage the private sector through tax advantages to perform this service than for the government to muddle its way through the important community need of housing.
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Renting RE
The IRS considers your rental property as a business and gives you several deductions. One is the payment you make on the interest of your debt service. In addition, there are the phantom deductions- the passive loss from component depreciation and from building depreciation, which are computed at an annual rate.
IRS Publication 527: Residential Rental Property
If you rent your vacation home for < 15 days in a year, your rental income is tax free.
Landlords Liability (Duty)
Understand and meet the requirements for duty of care.
Duty to Inspect: A reasonable inspection is required every time the landlord renews, extends, or first enters into a rental agreement. Negligence in inspecting the premises at such times leaves the landlord vulnerable later on to being charged with foreknowledge of an unsafe condition that the landlord should have found during the inspection. Any dangerous or unsafe conditions MUST be reported to the tenants.
Carry enough insurance to cover unforeseen claims.
Protect yourself legally.
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Buying & Selling RE
Primary Residence Exclusion: If you own a house and live in it for at least 2 of the past 5 years, you can sell it without have to pay any taxes on the gain.
Capital Gains exclusion is capped at $250,000 ($500k if married).
If your AGI is under $100k, you can offset up to $25k of your ordinary income from losses in RE. Above $100K is a graduated scale up to $150K.
1031 Exchange: You can defer taxes if you reinvest all the proceeds from the property into a new property.
It must be an investment property and you must hold title to the old property in the same way you take the new title.
You have 45 days to find a new property and 180 days to buy it. What you buy MUST be on the 45-day list.
You cannot touch the money in between the sale of your old property and the purchase of your new property. By law, the money has to be held by an independent third party called a qualified intermediary.
In order to pay no tax, you must buy equal or up, and reinvest all of the cash from the sale of the old property into the new property.
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RE Depreciation
Personal Property Items: Items that can be removed without damage or disablement to the structure or its operation and maintenance. In general, personal property in residential rental properties falls into either 5 year of 7 year schedules for depreciation.
Building items: Include the structure and the components such as those that relate to the operation and maintenance of a building, such as ceilings and roofs, walls and windows, electrical and plumbing, central AC and heating systems, chimneys and bathtubs, sinks and lighting fixtures, fire escapes and stairs, floors and doors, landscaping and paving. Without a cost segregation, the value of these items is depreciated over 27.5 years in a residential rental property, and over 39 years in a nonresidential, or commercial real property.
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RE Definitions
Homestead Exemption (FL): As long as your house sits on an acre or less, creditors cannot touch your house. Whether fully encumbered or paid off, creditors cannot force a sale of your house in FL. Homestead protects against seizure, forced sale, creditor claims, credit card balances, accidents, etc.
A person can possess but one valid homestead at a time. And their homestead must be their principal residence.
Mortgage Interest Deduction: Only available on your personal residence and one designated second home.
Pro Forma: contains the property's sale price and operating costs, such as utilities and taxes, insurance, repairs, and business expenses; and it projects the property value and income based on such market factors as a full occupancy rate.
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RE Ownership Types
Fee Estate (aka Fee Simple Absolute): Absolute ownership for an indefinite period of time.
Life Estate: Title holder grants a tenant possession of the property, lasting the tenants lifetime. The lifetime tenant is responsible for taxes and repairs until his or her death, at which time the possession of the house reverts back to the title holder.
Estates at Will: Owner grants tenant use of property for a fee. Use terminates at the will of the fee owner once he or she has given the tenant proper notice.
Leasehold Estates: Owner grants tenant the right to possess the property for a predetermined amount of time.
Lease: Fixed Term Tenancy.
Rental: Periodic Tenancy.
RE Property Types: Land, Land Improvements, Personal Property, and the Structure of Buildings.
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RE Title
Joint Tenancy: Shared property ownership, used most commonly by married couples. Allows for undivided ownership; each tenant owns the entire property and is granted all rights to use and occupy the property.
Tenancies in Common: Most common form of shared property ownership. Each partner owns a separate fractional interest in the property.
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How to hold RE
Before purchasing a property, determine your expectations for it, including what your positive cash flow must be to make it a viable investment.
Organize an LLCs and/or LPs in either NV or WY and properly qualify them to do business in the state you own rental properties.
Incorporate your primary residence as a single member LLC; simply do not apply for an EIN and instruct your CPA to flow all the LLC tax items onto your personal tax return. The single member LLC is considered disregarded for tax purposes because there is only one member. And with only one member, the tax flows from the LLC directly to the member.
When you buy an investment property, set up a separate bank account to handle the income and the expenses.
Build a Team of Advisors: RE Broker, RE Lender, Escrow Officer, Appraiser, Home Inspector, RE Attorney, RE Accountant, Insurance Agent, Prop Manager, Handyman, Cleaning Service, Landscaper, Roofer, Plumber.
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RE as a Business
RE Professional: Qualified RE investor under US Tax Code 2064; provides significant savings.
Must perform at least half of all worked hours (min ~14.5h per week, 750h per year) in the tax year in RE property trades or businesses.
Deductions (IRS Section 162(a)): Computer Software, Internet Services, Cell Phone, Auto, Meals Out, Dry Cleaning, Tuition, Seminars, Furniture, Home Costs, etc.
Depreciation (IRS Section 179): a certain amount of expenses per year for depreciable business assets is allowed to be deducted as business expenses.
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