The Complete Tax Guide for Real Estate Investors: A Step-By-Step Plan to Limit Your Taxes Legally

By Jackie Sonnenberg

Many people invest in real estate, from second homes to apartment complexes, condos, townhouses, and commercial buildings and realize a profit from doing so. However, real estate investors have begun to discover that there are a plethora of tax issues associated with buying and selling real estate. The Complete Tax Guide for Real Estate Investors will take the mystery out of these tax issues and even provide you with tax planning strategies.

In this new book you will learn how to implement tax savings programs successfully to reduce or eliminate the resulting income tax from the sale of real estate, how to use the IRS tax code to your advantage through depreciation, how to set up annuity trusts and charitable remainder trusts, and how to avoid paying federal taxes. You will become knowledgeable about the different types of 1031 exchanges, including deferred exchanges, simultaneous exchanges, forward delayed exchanges, construction exchanges, reverse exchanges, two-party exchanges, and three-legged exchanges, as well as the advantages and disadvantages of each. Additionally, you will learn about capital gains taxes, tax and legal loopholes, recapture of depreciation, deferring taxes, reducing a home s tax basis, installment sales, tax liability, minimizing taxes on final divestment, stepped-up basis, taxation at the time of sale, and like-kind rules.

It does not matter if you are a first time investor or a veteran of the real estate market; you will find valuable information, along with tips and tricks, in this book. Tax issues can strain resources and drain profits, but if you implement the strategies in this book you will be able to limit your taxes, thereby increasing your earnings.

Atlantic Publishing is a small, independent publishing company based in Ocala, Florida. Founded over twenty years ago in the company president’s garage, Atlantic Publishing has grown to become a renowned resource for non-fiction books. Today, over 450 titles are in print covering subjects such as small business, healthy living, management, finance, careers, and real estate. Atlantic Publishing prides itself on producing award winning, high-quality manuals that give readers up-to-date, pertinent information, real-world examples, and case studies with expert advice. Every book has resources, contact information, and web sites of the products or companies discussed.

This Atlantic Publishing eBook was professionally written, edited, fact checked, proofed and designed. The print version of this book is 288 pages and you receive exactly the same content. Over the years our books have won dozens of book awards for content, cover design and interior design including the prestigious Benjamin Franklin award for excellence in publishing. We are proud of the high quality of our books and hope you will enjoy this eBook version.

• Language: English
• Publisher: Atlantic Publishing Group
• Release date: Sep 3, 2008
• ISBN: 9781601384539

Book preview

The Complete Tax Guide for Real Estate Investors

A Step-by-Step Plan to Limit Your Taxes Legally

By Jackie Sonnenberg

The Complete Tax Guide for Real Estate Investors: A Step-by-Step Plan to Limit Your Taxes Legally

Copyright © 2008 Atlantic Publishing Group, Inc.

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Web site: www.atlantic-pub.com • E-mail: [e-mail]

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ISBN-13: 978-1-60138-208-5

ISBN-10: 1-60138-208-1

Library of Congress Cataloging-in-Publication Data

Sonnenberg, Jaclyn L., 1984-

The complete tax guide for real estate investors : a step-by-step plan to limit your taxes legally / by Jackie Sonnenberg.

p. cm.

Includes bibliographical references and index.

ISBN-13: 978-1-60138-208-5 (alk. paper)

ISBN-10: 1-60138-208-1 (alk. paper)

1. Real estate investment--Taxation--Law and legislation--United States--Popular works. 2. Real property and taxation--United States--Popular works. 3. Tax planning--United States--Popular works. I. Title.

KF6540.S673 2008

343.7305’46--dc22

2008014254

LIMIT OF LIABILITY/DISCLAIMER OF WARRANTY: The publisher and the author make no representations or warranties with respect to the accuracy or completeness of the contents of this work and specifically disclaim all warranties, including without limitation warranties of fitness for a particular purpose. No warranty may be created or extended by sales or promotional materials. The advice and strategies contained herein may not be suitable for every situation. This work is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services. If professional assistance is required, the services of a competent professional should be sought. Neither the publisher nor the author shall be liable for damages arising herefrom. The fact that an organization or Web site is referred to in this work as a citation and/or a potential source of further information does not mean that the author or the publisher endorses the information the organization or Web site may provide or recommendations it may make. Further, readers should be aware that Internet Web sites listed in this work may have changed or disappeared between when this work was written and when it is read.

This Atlantic Publishing eBook was professionally written, edited, fact checked, proofed and designed. Over the years our books have won dozens of book awards for content, cover design and interior design including the prestigious Benjamin Franklin award for excellence in publishing. We are proud of the high quality of our books and hope you will enjoy this eBook version, which is the same content as the print version.

Table of Contents

Preface

Introduction

Chapter 1: What is Real Estate? Four Ways Defined

Chapter 2: Other Classifications of Real Estate

Chapter 3: Dealer Versus Investor: Know the Difference

Chapter 4: Types of Real Estate Investments and Strategies

Chapter 5: Time to Invest: Your Goals and Objectives

Chapter 6: What is the 1031 Exchange?

Chapter 7: Requirements for 1031

Chapter 8: 1031 and Tax-Free Exchanges

Chapter 9: Capital Gains: How They’re Helpful

Chapter 10: Stepped-Up-Basis: How It’s Helpful

Chapter 11: What is the Charitable Remainder Trust?

Chapter 12: What is the Private Annuity Trust?

Chapter 13: Never Too Early For Retirement Plans: IRAS

Chapter 14: Opening Accounts with IRA, SEP-IRA, or SIMPLE IRAs

Chapter 15: How an IRA Gives You Tax-Free Real Estate

Chapter 16: IRAs: Borrowing Money and Transactions

Chapter 17: Debt, Bankruptcy, and More

Chapter 18: The Best Tax Results: What Not To Do

Chapter 19: Steps to a Successful Tax-Free Investment

Chapter 20: How You Can Do All of This at Home

Conclusion: Wrap-Up: Take it From the Experts

Bibliography

Biography

More Great Titles from Atlantic Publishing

Preface

In this world nothing can be said to be certain but death and taxes.

- Benjamin Franklin

Except for death and paying taxes everything in life is only for now.

- For Now, Avenue Q

Well, there you have it.

Two quotes from two completely different sources, and yet they are both addressing the same subject: Taxes. They are boldly presented in comparison to death, the one thing that has no fun part to it.

The point is that is what to expect with taxation. Taxes will never go away and there can never be much wavering. However, there can be some, and there are ways for you to get around taxes. So, if your plans of operation include making some investments in real estate, then you are in luck. You just might be able to get around an abundance of tax dues on your activities, because this book will show you how to do all of that and more.

Whether you are a novice or an experienced veteran, there is never enough you can learn about the growing world of the markets. In the chapters to come you will encounter and review various tasks and objectives for the best planning strategies in real estate investing. Once you have identified yourself as a real estate investor, it is time to explore your potential plans. This book will explain what an investor does and all the different types of real estate to invest in and for what purposes. Explore all of the possibilities you can encounter during your experiences.

You will become familiar with all the options available and decide which suits you best. This book gives a step-by-step guide to successfully invest in real estate by paying little to no taxes, and shows exactly how it can be done in a variety of options. You will receive advice from real professionals in the field who have experience, you will learn to get the best tax results, and you will see how to maintain little to no money problems in the process.

Table of Contents

Introduction

What the book is about: the tasks and objectives that will be defined and explored and the many different possibilities that could come out of a real estate investment. The tax-free options and opportunities will be presented to the reader and he or she will become familiar with his or her goals.

CHAPTER 1: What is Real Estate? Four Ways Defined

There are four different ways real estate is classified, and the most common ways people use them for selling and investing in real estate. These classifications will explain exactly what the reasons are that people invest in real estate and how they are used in given situations.

CHAPTER 2: Other Real Estate Classifications

While the first chapter discusses the four essential classifications, this chapter takes on the rest of the possible categories that are not as common or popular. It explores all the categories real estate could belong to and gives the reader the knowledge of the vast variety and the opportunity for the many options he or she has.

CHAPTER 3: Dealer Versus Investor: Know the Difference

The status of a dealer and investor are very different, and it is important to understand the definition of both so the readers can properly identify themselves as one or the other. This chapter talks about how some investors are labeled dealers and tells how to steer clear from this practice and how to properly identify oneself as an investor.

CHAPTER 4: Types of Real Estate Investments and Strategies

People will be able to read about exactly what types of investments are out there and available to them. Based on their own personal ideas and notions, they can then make the decision for themselves, as to which kind(s) of investments they would like to do. Examples and situations will be presented to familiarize.

CHAPTER 5: Time To Invest: Your Goals and Objectives

The next step is the obvious most beginning step: to start investing. What are the intended goals? What objectives should you have in mind? Step-by-step this will cover four basic goals to get through investment and to make the right decisions.

CHAPTER 6: What is the 1031 Exchange?

The like-kind, or 1031, exchange is the most widely known and most used in real estate for tax deferral. It is defined, described how it is developed, and put into ways the reader can see how they are put to use.

CHAPTER 7: 1031 Requirements

Some things need to be done and taken care of before one can go ahead and perform the 1031 exchange. The basic and most important requirements are stated for the 1031 exchange. The rules are stated and then put into clear examples.

CHAPTER 8: 1031 and Exchanges

1031 exchanges come with many good advantages. This chapter explores exactly what these advantages are, put simply and constructively, and it provides sample situations and ideas.

CHAPTER 9: Capital Gains: How They are Helpful

This chapter defines capital gains and explains how they are used. It wants the readers to know the ways in which it is good, and the ways that can be not so good as well, and the readers have to be aware of both for their advantage.

CHAPTER 10: Stepped-Up-Basis: How It Is Helpful

What is a stepped-up basis? Now this is defined and told how it is put into use. Readers will see how they can use the stepped-up-basis with the option of jointly owned property with tenants in common, joint tenancy, and community property.

CHAPTER 11: What is a Charitable Remainder Trust?

This chapter talks about a tax-deferral and real estate planning device, the charitable remainder trust. It describes what it accomplishes, how it works, and the many benefits that come out of it, such as financial advantages and even philanthropic benefits. The different types are defined and requirements are explained.

CHAPTER 12: What is a Private Annuity Trust?

Private annuity trust is defined and described, and information about it is given from its online source www.privateannuitytrusts.com. Again, here in this part, many options and accomplishments are given and a study on how they work is presented. The reader will also learn the different names by which it is known and its dual planning option.

CHAPTER 13: Never Too Early For Retirement Plans: IRAs

How does setting up a retirement plan aid someone in investing? The Individual Retirement Account, or IRA, sets out to be a welcoming help involving your tax-free objective. There are steps given to follow to help you start an account.

CHAPTER 14: Opening Accounts with IRA, SEP-IRA, or SIMPLE IRA

IRAs come in different categories themselves. This chapter looks at the different types and what each entails. It explains how to open up a retirement account and sets up the steps to a qualified plan, and even more than one plan if desired.

CHAPTER 15: How an IRA Gives You a Tax-Free Real Estate

You have learned about what IRAs are and what they do, and even what types there are, and then how to open up an account with one. This chapter will explain why the IRA plan is a good option and how you can invest tax-free in real estate.

CHAPTER 16: Borrowing Money with IRAs

It is crucial to obtain a loan for the IRA plan. Now situations will be explored and the what if factor will kick in to ensure security and credibility. The reader will become familiar with borrowing money, the repayment of the loan, and what to do if there is a shortage of money.

CHAPTER 17: Debt, Bankruptcy, and More

Somewhere, sometime, there will be some hardship or predicaments in the middle of one’s investment plan. The reader will know firsthand what to expect and what to do in case of debt and bankruptcy, including cancellation of debt by lenders, and paying cash for all investments.

CHAPTER 18: The Best Tax Results: What Not to Do

With the previous options and objectives explained and demonstrated, now hints and tips can be given in relation to them and more. One in particular has to do with gifting real estate as a part of the tax planning. Later in the chapter comes advice on actions to avoid and look out for and samples regarding each situation and option.

CHAPTER 19: Steps to a Successful Tax-Free Investment

Nearing the end of the book, the reader now knows and understands all the many different options, opportunities, and decisions available to him or her. So with all of these in mind there are 24 steps to a successful tax-free investment listed and explained the reader can take in as motivation.

CHAPTER 20: How You Can Do All of This at Home

Everything that has needed to be said, explained, and defined is done, and now this chapter explores another option available to the reader and that is how he or she can take this objective in mind and work from home, setting up a comfortable, private, focused environment and not have to bother with traveling.

Table of Contents

Chapter 1

What is Real Estate? Four Ways Defined

You want to invest in real estate, and want to know the first steps and the best strategies to do so. You also want to save as much money as possible on those taxes, making sure you have your financial needs all straightened out so that there are no surprises on your way down the road. You are approaching step one of your plan, but before you do, you are going to go into an in-depth examination of what real estate is. It is classified into many different categories, with different circumstances and requirements, but all with the desired end result.

One of the first things that needs to be considered is if the property is qualified.

This is referring to property qualified to be sold and purchased, respectively. Of course, here this is referring to a specific exchange that is no stranger to the world of real estate investing, and one that is a major factor to whatever kind of real estate exchange you would like to make: It is the like-kind exchange, also known as the 1031 exchange. The 1031 exchange is a way of putting together sales of property so that neither the profit nor the gain is taxed. The property that is sold is then replaced with another property, hence the like-kind. This 1031 factor and all of its characteristics will be studied more later on in the book, but as of right now you will just look at where it qualifies and where it does not. Too often, many people in the field involve themselves in many exchanges, but do not know if they qualify for the like-kind treatment. If they do not, then the exchange does not take place. To save yourself time and money before going ahead, you have to establish the properties and where they stand regarding taxes first to see if they qualify. So, what you need to do is take a look at both the properties you are buying and selling and see if they qualify for the like-kind exchange.

Moving on with the real-estate classifications, you will learn what they are and what they mean for the people using them. There are four classifications of real estate for income tax purposes:

#1. For Business

#2. For Investment

#3. For Personal

#4. For Sale

These classifications are made the same time the contact is made.

Sometimes, when the sale of the properties takes place, it can have more than one classification. Here is an example: An exchange that can be both for personal and for business is someone who lived on a farm and just sold his or her entire land, home included. The home plus the farm estate is personal and business.

Discover immediately which ones qualify for the like-kind 1031 exchange and which do not. Classifications one and two are 1031 friendly, while three and four are not. However, that does not mean that they are not good investments to make. That is up to the intentions and judgments of the investor. All four are very common and familiar in the world of investing.

Now look at the major definitions of real-estate investment.

#1 Real Estate Held for Business or Trade Use

This is known as the 1231 real estate, and this is defined as property used in business or trade by the IRC section 1231.

The IRC (Internal Revenue Code) section 1231 deals with all the gains on the 1231 assets. These are taxed at capital gains rates except for depreciation recapture. Losses are tax deductible as ordinary income. Depreciation recapture refers to when, at a gain, a property is sold, and then this gain becomes ordinary income to the extent of depreciation that has been deducted beforehand. This could be property sold at a gain with declared accelerated depreciation The taxpayer then might be required to pay a tax at regular rates to the extend of accelerated depreciation, or sometimes for the whole depreciation taken.

Real estate used in business or trade has two types, owner occupied and just used in owner’s trade/business. When a property is rented, it counts as able to be used in a trade or business as well. Working with the 1231 exchange property, the net gains from this sale or exchange are taxed as long-term capital gains. The only way the gains can be ordinary income is when the period of holding is short. The net losses are still ordinary losses, however. In order to obtain the 1231 real estate, interest must be paid, and it will be deducted as business interest against the real estate business activity. Now as far as the exchange treatment goes, this classification of real estate does qualify for the 1031 like-kind exchange.

#2 Real Estate Held for Investment

This is known as the 1221 real estate investments of value by their individual characteristics.

Defined under IRC section 1221, real estate investment is a capital asset, meaning it is held for its appreciation of value from factors that are out of the owner’s actions or control. Examples of these are location and time passage. This is treated as a portfolio investment asset. An investment real estate can be a piece of raw land that is held for appreciation, for example. Whatever the property, if it is decided on and used, then it will never lose its label as an investment property. Even if someone has the notion in his or her head to develop the property but for some reason does not, it still maintains this classification.

There is a reason why this classification of real estate holds its own separate definition from that of business or trade use. The real estate that is used for business or trade is not used for investment, and neither is it for personal use, which we will get to next. Too often