TAXES, TAXES, TAXES

Over 2.3 million second homes were bought in the United States last year.  Some were bought as investment properties, while others were bought as vacation residences.  Properties bought strictly for personal use have a distinct benefit in that the combined interest from the mortgage debt can be deducted up to $1 million on a primary and secondary home.  The interest deduction is capped above $1 million of debt.

Not so for rental properties, which have much more convoluted tax benefits.  The first big area of misunderstanding is losses.  Many rental properties don't turn a profit.  With property values having appreciated over the last decade, many investors were willing to pay a premium for a home that would not turn a profit in order to cash in on the appreciation later.  Many investors assume that the losses would provide a deduction against income.  However, that type of assumption is an over simplification of the IRS code.  The IRS code considers rental losses to be "passive losses".  That means, for taxpayers with adjusted gross income in excess of $150,000.00 (or taxpayers that don't qualify as a "real estate professional^"1), rental property losses can only be written off against other passive activities; for example, other rentals or a limited partnership interest.  Passive losses that are not used are carried forward until the property is sold and then the losses can offset against any gain on the property and, if not fully used, can then be offset against ordinary income.  Hence, the tax benefit of a loss on property does not necessarily provide a short-term tax benefit to those individuals with substantial adjusted gross income (above $150,000.00) unless those individuals can qualify under the IRS code as a "real estate professional^"1.

TENANTS IN COMMON

We frequently get calls from clients that own rental properties and have found that they are not always living the utopian investor lifestyle that the investment magazines would have us all believe.  For many, being a landlord is a constant source of agitation and misery.  For others, the time to get out of their active investment properties and into a more passive, high yield investment is dictated by age and/or retirement needs.  But, many investors that want to convert their real estate investment to a passive investment, like a CD or Bond, cannot afford the capital gains bit they will pay to sell their investment.  Is there an alternative to buying another investment property?

Actually, there are a couple.  The first is very simple.  Give up the burden of managing by hiring a property management company.  Many of our clients have found this to be a viable solution.  For those with larger properties, the investment community has provided another solution, albeit not an inexpensive solution.  It is called a Tenancy in Common (TIC).  A tenancy in common interest in real estate is similar to a partnership interest.  When individuals take title to a property as tenants in common, they take a specific percentage of the property that will pass on to that individual's heirs or assigns.  The IRS has allowed the securities community to market interests in real property to real estate investors looking for replacement properties in a 1031 exchange.  Although it takes a securities license to sell these TIC interests, the IRS considers a TIC to be a qualified real property interest for a 1031 exchange.  Leave it to Wall Street to convince the IRS that an interest in real estate should be sold on by a licensed securities dealer.

TIC properties are marketed heavily these days.  There are significant brokerage fees involved and the minimum entrance fee is usually above $250,000.00.  Expect to pay a 15-20% commission in order to acquire a TIC.  The annual yields run anywhere from 6-8% and the properties being marketed tend to be large commercial and industrial buildings with substantial long-term leases.  Other pitfalls are that TIC's are not easily sold; there will be yearly maintenance fees; there could be special assessments charged to owners for capital improvements; and the investment is only as good as the underlying real estate and tenant(s).  You will need to consult your accountant and/or investment professional to review the offering statement for any TIC.  Be careful before investing in a TIC.

Should you wish to set up a seminar for your office to discuss these matters or other issues relating to 1031 exchanges, please contact Steven D. Rothberg, Esq, at Capital 1031 Exchange (215) 564-3722.