Tax Tips- Real Estate

Easton Tax

Delaware Statutory Trusts is an Alternative to 1031 Exchanges

Delaware Statutory Trusts (DST) is an alternative to 1031 exchanges. 1031 exchanges refer to locking in one or several replacement properties within 45 days of selling an investment property and completing the new purchases within 180 days. The profit from the sale can be tax deferred. Selling a home can be fast in a seller's market, but it may not be fast to sign on a new property within 45 days in any market. You can solve the problem by buying DST in lieu of a new property. When you decide to sell the DST, you can also buy 1031 exchanges. There are many DST options in the market of various property types and locations. As a type of securities, DST requires to be bought and sold through registered broker-dealers or investment advisors. The basic requirements for DST include the family’s net assets >$1M, and the annual family income >$300,000 for two consecutive years ($200,000 for singles) plus other requirements that come with 1031 exchanges.

How Real Estate Can Help You Save on Taxes

Real estate investments can help you save on taxes in many different ways, specifically as follows:

Depreciation of rental properties. The house or building can be depreciated across years: 27.5 years for residential, 39 years commercial, and 40 years foreign rentals. Depreciation offsets the rental income to some extent. If your highest tax rate is 37%, the rental depreciation saves you 37% of federal tax plus state tax. When you sell the property, the profit requires depreciation recapture. The tax rate for depreciation recapture is up to 25%, and the rest of the profit is long term capital gains (highest rate 20%). You can see depreciation, a non-cash expense, helps you in two ways: delay tax and reduce the rate.

Itemized deductions. Loan interests from personal houses can be deducted up to $750,000 (loan balance). Property taxes are limited to a maximum deduction of $10,000. Loan interests and property taxes from rentals have no such limits.
1031 exchange. Current tax law allows for a temporary waiver of capital gains tax in exchange of a similar property. If you sign to buy property B within 45 days after you sell property A, the profit from the A sale can be exempt, instead you pay taxes when you sell property B in the future.
Until 2026 any capital gains reinvested in real estate Opportunity Zones, or Qualified Opportunity Fund, can be tax deferred or completely exempt when you hold >10 years. Opportunity Zones refer to low-income or underdeveloped areas identified by the Treasury Department.
Qualified business income deduction. Until 2026 qualified real estate income has 20% net income tax exemption. The basic requirements to qualify include the rental being a trade or business, and you spending >250 hours annually managing the property which may include the time you spend or your property spend on advertising, selecting tenants, maintenance, etc.
Expenses deductions. In addition to direct expenses, you can also deduct indirect expenses, such as office expenses, travel costs to the rentals, lawyer and accountant fees.
No self-employment tax on rental income.

Tax Strategy - Augusta (14-Day) Rule

The Augusta Rule (aka.14-Day Rule) is a tax strategy that business or property owners can use for large tax deductions. This rule allows someone to rent out their properties tax-free for 14 days or less in a year regardless of the profit. For example, someone could rent out his vacation home in Florida for board meetings for a large sum of $30,000, or properties located near golf courses for tournaments for $25,000. The rule originated in the 1970’s from Augusta, GA where residents rented their homes during the annual golf Masters Tournament. Today the Augusta Rule can apply in many tax scenarios anywhere in the US.

Primary Limitations of the Rule: 1) the rent must be a fair amount. Quick online research for similar properties can be used as proof; 2) the property must be in the US; 3) the total duration rented for the year must be <=14 days. As with most tax strategies the burden of proof is on you. Therefore, you must be able to prove the property usage meets the requirements in case of an IRS audit. The records of usage can include meeting agenda, attendees, photos.

Common Misuse Scenarios: 1) inability to substantiate the claimed activities with adequate documentation; 2) you can’t use this strategy if your home is your primary place of business; 3) if you get paid rent for your home office, you’ll likely violate the 14-day rule. Talk to your accountant.