Rental Real Estate Tax Savings

One consequence of the downturn in real estate is that there are a lot of new people that are proud owners of rental properties. Some of these owners may have reluctantly been forced into a position they never intended ... being a landlord. During the hot housing market, when prices were skyrocketing, many people made money "flipping" properties by purchasing with the intention of a quick fix-up and then reselling quickly. There are a lot of flippers that got stuck with a property or two. Some have just walked away from their property and associated mortgage, collectively causing further market disruption. Others are riding out the slump by renting out their properties.

Regardless of whether owning one or more rentals was a conscious decision or was forced upon us, it's a good idea to review the tax benefits of rental real estate. The savings on taxes may help to dull the economic pain of a depreciating investment. Of course real estate investors are looking forward to the market hitting bottom and getting back to normal.

Government created tax laws are ever changing and often defy simple accounting logic. Ronald Reagan's Economic recovery Tax Act of 1981 provided for special accelerated depreciation rates to stimulate the economy. Unfortunately, it stimulated the economy a little too well, especially in the real estate area. People were investing in real estate simply for the tax losses and limited partnerships became all the rage ... and why not? A $10,000 investment in a leveraged real estate partnership could generate as much as $100,000 or more in losses for tax purposes. Capital was flowing into real estate simply for the tax benefit. An oversupply of commercial and residential buildings was created as a result.

Finally recognizing the folly behind the stimulus package, the government took the lucrative tax incentives away with the Tax Reform Act of 1986. Accelerated depreciation schedules were eliminated and a new passive loss limitation rule was implemented in order to put a stop to abusive tax shelters.

The real estate boom created by the tax incentives of the 1981 tax law came to an abrupt end with the 1986 act that took away the enticement and then some. As the artificial tax motivated demand for real estate dropped we experienced a real estate bust. More than 1,000 savings and loan institutions failed as loans made by the institutions that were collateralized by real estate went bad.

The latest Real estate boom and bust was caused by a combination of easy money (subprime loans) and artificially low interest rates from the Federal Reserve designed to stimulate the economy.

Passive loss rules generally prevent the current deduction of real estate losses. However a taxpayer that exhibits active participation may be eligible to write off as much as $25,000 under a special loss allowance. To write off more than $25,000 requires the taxpayer to materially participate in the real estate business. Tax laws are always changing so it's best to check with the IRS and/or your accountant for the proper tax treatment for your situation.