Cashing Out Real Estate Profits Without A 1031 Exchange

Would You Volunteer To Pay Taxes?

Paying taxes on the sale of your real estate investment is indeed voluntary. You do not need to volunteer to pay the IRS more than it deserves…

But if you MUST cash out your investment property there are a few ways to reduce or defer your tax on the gain to minimize the impact on your bank account.

Section 1031 Alternatives

While growing your real estate portfolio, you likely used Section 1031 to avoid paying capital gains taxes when you acquired bigger and better properties.

But now, when you want to cash out, Section 1031 is not the vehicle of choice (since it requires you to invest your gains into a larger property).

So if you need the liquid cash for a reason other than investing in larger properties, your options are limited when trying to minimize your capital gains taxes.

So what do you do?

Here are three strategies we can help you with when you want to cash out some or all of your real estate profits: 

1. Use the combination of a charitable remainder trust and a wealth replacement trust to avoid taxes, increase personal cash flow, and increase the estate distribution to your children.

2. Use IRC Section 721 to invest the property in a real estate investment trust and defer taxes.

3. Use an installment sale to pay taxes slowly.

If you are considering selling your investment property at a gain and you are not sure how much you will pay in taxes and want strategies on how to minimize your taxes, book a call below.

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.

Can You Deduct Mortgage PMI On Your Tax Return?

If you own your own home, condo, apartment, or townhouse here is a heads-up on mortgage insurance that you may not have known about. Note the differences between residential and rental properties, we cover them below.

Personal Residence Mortgage Insurance

The deduction for mortgage insurance on a qualified residence ended on December 31, 2017.

But don’t give up on the deduction.

The personal residence mortgage insurance deduction is part of what is called “tax extenders,” and it’s highly possible that lawmakers will reinstate the deduction retroactively for all of 2018 and 2019. That’s the good news.

The bad news is that to claim the retroactive deduction your accountant will need to amend your 2018 tax return if they determine that the deduction will save you a substantial amount of money.

Rental Property Mortgage Insurance—IRS Mistake

Online at the IRS’ “Frequently Asked Rental Property Questions”, you will find the following incorrect question and answer: 

• Question: Can you deduct private mortgage insurance (PMI) premiums on rental property? If so, which line item on Schedule E?

• Answer: No, you can’t claim a deduction for private mortgage insurance premiums.

This is wrong!

The cause for the error comes from IRS Publication 527, Residential Rental Property (Including Rental of Vacation Homes), where on page 1 in the “What’s New” section, the IRS states that the deduction for mortgage insurance premiums expired and you can’t claim that deduction for premiums after 2017 unless lawmakers extend the break.

The mistake that the IRS makes in its publication and FAQ is that the expiration of the mortgage insurance deduction applies to your qualified personal residence, not your rental property.

Rules for Rental Property Mortgage Insurance

You generally treat mortgage insurance on rental property loans and mortgages as an ordinary and necessary business rental expense that you deduct on Schedule E against the income from that rental property.

Depending on the type of loan, you could pay the mortgage insurance either in a lump sum or annually as you make your mortgage payments.

How you treat the mortgage insurance premiums depends on how the proceeds of the loan are used, rather than on the character of the property that you mortgage. For example, you could take a mortgage on your personal residence and use the proceeds from the loan for a rental property, an investment, or personal purposes.

A Tax Planning Note

You deduct the mortgage insurance on the rental properties over the period of benefit. For example, if you make a one-time payment, you amortize the mortgage insurance over the life of the loan.

If you make annual payments because of, say, a mortgagor requirement of a loan-to-equity ratio or other formula, you deduct the mortgage insurance premiums as you pay them (again, for your rental properties).

If you are considering converting your home into a rental property and would like my advice on the conversion, please contact me below.

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.

Converting Your Home Into a Rental Property: Tax Issues

Converting Your Home Into a Rental Property

The simple maneuver of converting your personal residence to a rental property brings with it many tax rules, mostly good when you know how they work.

The first question that arises when you convert a personal residence into a rental is how to determine the property’s tax basis for depreciation purposes during the rental period and for gain/loss purposes when you eventually sell.

Oddly enough, two different basis rules apply: 

1. If, after conversion to a rental, you sell at a gain, your basis on the conversion date is the usual computed amount (cost of home plus improvements, minus depreciation—such as from a home office).

2. If, after conversion to a rental, you sell at a loss, your basis on the conversion date is the lesser of the computed basis or the fair market value.

Once you’ve converted a former personal residence into a rental, you must follow the tax rules for landlords. Here is a quick summary of the most important things to know:

• You can deduct mortgage interest and real estate taxes on a rental property.

• You can also write off all the standard operating expenses that go along with owning a rental property: utilities, insurance, repairs and maintenance, yard care, association fees, and so forth.

• Finally, you can also depreciate the cost of a residential building over 27.5 years, even while it is (you hope) increasing in value.

Rental Real Estate Losses

If your rental property throws off a tax loss, things can get complicated.

The so-called passive activity loss (PAL) rules will usually apply. In general, the PAL rules allow you to deduct passive losses only to the extent you have passive income from other sources, such as positive income from other rental properties or gains from selling them.

Eventually your rental property should start throwing off positive taxable income instead of losses, because escalating rents will surpass your deductible expenses. Of course, you must pay income taxes on those profits. But if you piled up suspended passive losses in earlier years, you now get to use them to offset your passive profits.

Prior Losses Can Offset Future Positive Income

Another nice thing: positive taxable income from rental real estate is not hit with the dreaded self-employment (SE) tax, which applies to most other unincorporated profit-making ventures. The SE tax rate can be up to 15.3 percent, so it’s a wonderful thing when you don’t have to pay it.

One other good thing is that your net rental profits may qualify for the Section 199A deduction.

Another good thing is that if your rental property rises to the level of a trade or business, your rental profits avoid getting socked with the 3.8 percent net investment income tax (NIIT).

Taxes When Selling Rental Real Estate

When you sell a rental property that you’ve owned for more than one year, the profit (the difference between the net sales proceeds and the tax basis of the property after subtracting depreciation deductions during the rental period) is generally treated as a long-term capital gain.

Always keep in mind the good news here. You don’t pay the taxes on the property appreciation until you sell.

Remember those suspended passive losses we mentioned above? The suspended losses are ordinary losses. When you sell a rental, you can find two great benefits: 

1. Gains are tax-favored capital gains.

2. And then, to the extent of your gains, you release suspected passive losses that offset ordinary income.

Avoid Paying Taxes on Real Estate Capital Gains

And always keep this in mind: rental real estate owners can avoid taxes indefinitely using Section 1031 exchanges (named after the applicable section of our beloved Internal Revenue Code).

The tax code totally mislabeled the 1031 exchange. It’s absolutely not an exchange or a swap. It works like this:

1. You sell your property.

2. You buy a new, more expensive property.

3. Your Section 1031 exchange intermediary (such as a bank) handles the paperwork, and that makes the taxes go away.

If you are considering converting your home into a rental property and would like my advice on the conversion, please contact me below.

Get a Free Tax Savings Consultation

Pinewood Consulting’s CPAs will help you assess your tax savings potential through a free consultation. Book yours today with Chad Pavel, CPA.