- Acquiring or developing real estate for personal use, income, and / or capital appreciation.
- Direct or indirect ownership (e.g., indirect ownership via real estate investment trusts, or REITs, and REIT funds) of residential real estate (single family and multifamily), commercial real estate (retail, office, and industrial), mixed-use real estate, and raw land.
- Please reference “Controversial strategies with limited benefit, no benefit, or possible detriment” topic for discussion regarding real estate investment trust (REIT) index funds.
- Please reference “Clearly detrimental strategies and products that we do not utilize, recommend, or offer” topic for discussion regarding realty flipping.
- Appropriate applications of debt and leverage.
- Appropriate applications of insurance and utilization of legal entities to limit personal and business asset and income liability exposures.
- Recovery of capital (cost basis) via tax deductions for depreciation over the useful life of depreciable real property used in a trade or business or for the production of income and held > 1 year (Section 1231 assets) is accomplished utilizing straight line depreciation as dictated by the Modified Accelerated Cost Recovery System (MACRS), over a period of 27.5 years for residential rental real property and over a period of 39 years for commercial real property. Only the value of improvements to land may be depreciated, the value of land itself may not be depreciated. Unrecaptured Section 1250 depreciation upon the disposition of Section 1231 assets is taxable at ordinary income tax rates up to a maximum of 25%; notably, potential depreciation recapture is eliminated at death upon the disposition of Section 1231 assets owned directly by the decedent (or if a Section 754 election is made when section 1231 assets are held within a partnership, allowing reconciliation of inside cost basis with outside cost basis) consequent to step-to fair market value in basis for assets under Section 1014. Gains in excess of unrecaptured Section 1250 depreciation upon the disposition of Section 1231 assets are taxable at capital gains tax rates; conversely, losses are treated as ordinary losses (“best of both worlds” tax treatment). Additionally, the 3.8% net investment income tax (NIIT) may apply to unrecaptured Section 1250 depreciation and capital gains.
- Exchanges of real property involving non-recognition of gain or loss under Sections 721 and 1031:
- Non-recognition of gain or loss under Section 1031 is applicable to like-kind exchanges of real property held for investment or used in a trade or business or for the production of income. Non-recognition of gain or loss under Section 1031 is further applicable to like-kind exchanges of qualifying real property for interests in Delaware Statutory Trusts (DSTs), exchanges of interests in DSTs for qualifying real property, and exchanges of interests in DSTs for interests in alternate DSTs.
- Non-recognition of gain or loss under Section 721 is applicable to exchanges of real property for shares in Umbrella Partnership Real Estate Investment Trusts (UPREITs). Non-recognition of gain or loss under Section 1031 is not applicable to transactions involving shares in UPREITs. Exchanges under Section 721 generally involve a multi-step transaction:
- Exchange of suitable real property for a limited partnership interest in an operating partnership in which a REIT serves as sole general partner.
- Holding period in which the investor retains his or her limited partnership interest.
- Exchange of the investor’s limited partnership interest for equivalent shares in the REIT serving as sole general partner to the operating partnership.
- While exchanges of concentrated real property holdings on a tax deferred basis for interests in DSTs or shares in UPREITs may facilitate portfolio diversification, this potential diversification benefit may be diminished or negated by potential illiquidity and / or limited marketability of replacement holdings (generally not applicable to shares of publicly traded UPREITs), added fees associated with professional management and earned by parties involved in facilitating such transactions, loss of control by the investor in directing his or her investments, variable lock-in periods prior to the disposition of replacement holdings, and potential complexity of replacement holdings.
- Income derived from rental and real estate activities generally falls under the passive activity rules, unless an exception applies. Two notable exceptions include the real estate professional exception and the individual investor exception.
- Exclusion of gains from the sale of a principal residence under Section 121. Up to a maximum income exclusion of $250,000 for single filing status and $500,000 for married filing jointly status.
- Itemized deduction of home mortgage interest paid to a lender. Limited by the Tax Cuts and Jobs Act (TCJA) of 2017 to interest on a maximum of $750,000 of acquisition indebtedness for loans issued after 15 December 2017; for loans issued on or before 15 December 2017, the limit remains $1,000,000.
- Itemized deduction of real property taxes (ad valorem tax, or tax based on the value of the property) paid to state and local governments. Applies to all domestically owned real property (excludes foreign real property under TCJA 2017) and capped at a maximum deduction of $10,000 ($5,000 for married filing separately status) under TCJA 2017 when summed with state and local income taxes paid (alternatively state and local sales taxes paid, whichever is greater) and vehicle property taxes (ad valorem tax).
- “Defer, defer, defer, and then die!” The integration of depreciating Section 1231 assets, exchanges of real property involving non-recognition of gain or loss under Sections 721 and 1031, and step-to fair market value in basis for assets at death under Section 1014 may offer an effective tax reduction and estate planning strategy involving transfers of real property.
Your path to financial independence
I was early taught to work as well as play,My life has been one long, happy holiday;Full of work and full of play—I dropped the
Bentley Makkar
April 8, 2023
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