"Real Estate Investment Tax 101"

You may think that the only impact of real estate investment tax policy is on the expense side of the ledger, but that's not true. In fact, it's the tremendous investment property tax benefits that really put real estate at the head of the class of long-term investment options.

REAL ESTATE INVESTMENT TAX BENEFITS

The main rental property tax benefit is the ability to deduct expenses from your personal income to reduce your overall tax liability (more on this below). The impact is more money in your pocket in the form of a smaller tax payment or a larger refund.

The best part is that you can deduct "expenses" that you may not even pay cash for, including:

• Expenses you finance
• "Phantom" expenses such as depreciation

Few if any of the traditional investment vehicles have these kinds of tax benefits. Even though Uncle Sam will always find a way to tax investment property, in essence, much of your financial benefit is sheltered.

INVESTMENT PROPERTY TAX EXPENSE CATEGORIES

Your real estate investment tax expenses will generally fall into the following categories:

• Property tax
• Capital gains tax
• Transfer tax

Note that this website does not include any detail on transfer tax because each state has different rules and regulations around this. Essentially, it's a form of sales tax – it's a way to tax investment property when it changes hands. The specific amount and who must pay it tend to vary. Your agent will know the specifics so you'll want to ask him about it.

THE NEED FOR A GOOD TAX ACCOUNTANT

When it comes to this stuff, I know just enough to be dangerous. I'm certainly no investment property tax expert and so I strongly suggest that you get an accountant if you don't already have one.

A good accountant may charge $300-$500 to file your annual tax returns, but it is well worth it. Here's why:

• Your federal tax return will be more complex due to the additional schedules and details required for your real estate activity, which increases the odds of making an error.
• A good accountant will help you squeeze out the maximum number of tax deductions, which usually more than pays for the cost of his/her services.
• You'll have access to expert real estate investment tax advice whenever you need it. Setting up an LLC, gifting a property, or setting up a trust are examples of situations beyond the annual filing of taxes where your accountant will be able to provide valuable guidance.

HOW TO FILE TAXES ON REAL ESTATE ACTIVITY

One way or another, the Fed is going to tax investment property. But the way it'll be taxed might vary.

Your rental property tax will flow through your personal federal tax return if:

• You are holding title in your own name, or
• You are holding title in the name of a single-person LLC (highly recommended)

These are the most common ways to hold title, and if either describes your situation then your accountant will not have to file separate tax returns for your "business." Your rental property tax deductions will be offset against your regular employment income as part of your personal federal tax return.

If, on the other hand, you are holding your properties in another way (partnership, multi-member LLC, S-corporation, etc.), it is likely that your accountant will have to file separate returns for your real estate investment tax.

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