Real Estate and AMT: Rental or Investment Property
The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate because almost all the tax rules that apply to real estate are different for the AMT than they are for the Regular Tax. This article on real estate and the AMT will address those situations in which the individual owns the real estate as an investment, usually as rental property. The differences in tax treatment between the Regular Tax and the AMT can be significant.
The interests paid on the mortgage contracted to acquire the property are fully deductible, both from the Regular Tax and the Alternative Minimum Tax. Unlike itemized deductions that allow a tax benefit for personal expenses, tax law generally allows all deductions that a taxpayer must make to earn business income. Therefore, the limitations discussed in the previous article on home mortgage interest do not apply.
However, if the principal of the rental property is used as collateral for an additional loan, for example, a second mortgage, the taxpayer must analyze how the proceeds from that loan are used to determine the interest deductibility. If the proceeds are used for a car loan or to finance a child’s education, for example, then the interest is non-deductible personal interest. If the proceeds are used to improve the rental property, the interest is deductible.
Tip: Taxpayers better keep personal loans separate from business loans. Mixing the two creates record keeping challenges and can result in disputes with the IRS.
Property taxes paid on rental or investment properties are allowed in full for both Regular Tax and Alternative Minimum Tax purposes.
Planning idea: If you have the opportunity to pay your property tax bill either this year or next, do so in a year when you have enough income from the property not to result in a rental loss. This strategy can help prevent the passive loss of activity limitations described below from activating.
Example: In Florida, property tax bills are mailed in October and paid according to the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%. If you have a property loss in 2010 but expect to generate income in 2011, don’t pay your bill in November or December; Waiving that small discount could help you avoid the stop-loss rules.
Depreciation of property held for investment is allowed. The part of the cost attributable to the land is not depreciable, but for the building itself and the furniture, appliances, carpets, etc. you can take a deduction for depreciation.
Real property (this is the legal definition of a house or other building) held for rental / investment can only be depreciated for regular tax purposes under the “straight line” method, over a useful life of 27.5 years. Therefore, a property with $ 275,000 allocated to the building would depreciate at a rate of $ 10,000 per year.
Personal property (this is the legal definition of things like furniture, appliances, carpets, and the like) can be depreciated for regular tax purposes under an “accelerated” method over a useful life of five years. An accelerated method allows for a higher deduction for depreciation in the early years, in recognition of a factor of obsolescence or decline in value seen in new properties (automobiles are a good example).
However, for AMT purposes, personal property can only be depreciated using the straight-line method. Therefore, an AMT element will be generated in the first few years if the accelerated method is used.
Planning Idea: For personal property, consider choosing the straight-line method for regular tax purposes. While forgoing a small tax benefit for the higher depreciation in the early years, it could mean avoiding paying the AMT.
Active / Passive Investment Rules and “At Risk” Rules
A taxpayer who is not “active” in managing investment property cannot use rental property losses to offset other income such as wages and salaries, dividends, interest, capital gains, and so on. Instead, these losses are deferred until the taxpayer sells the property or generates passive income from this or other sources of passive investment.
Similarly, the risk rules deny the use of this type of loss to the extent that the taxpayer has acquired the investment with borrowed money and has no personal liability for the debt.
If these loss limitations apply, consider the planning ideas mentioned above to minimize the losses that occur each year. Anyway, they are not doing you any good.
Several different AMT issues can arise in the sale of rental / investment properties. One is that your profit or loss may be different for the AMT than it is for regular tax purposes. This would occur if different depreciation methods were used. For example, if personal property was depreciated using an accelerated method for regular tax purposes, then the basis in that property when calculating the gain or loss on sale would be different because the straight-line method had to be used for minimum tax purposes. alternative.
Gains from the sale of investment properties are generally capital gains, although some of it may be treated as ordinary income depending on the accelerated depreciation method used. Capital gains per se is not an element of AMT, but can nonetheless result in payment of AMT. This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can result in exemption reduction, which in turn increases taxable income for purposes of the Alternative Minimum Tax.