Accounting for Real Estate

P&N can assist you in choosing the right business entity for rental properties. Investing in rental properties involves financial risks, but forming a separate business entity offers significant advantages. 

A Limited Liability Company (LLC) combines features of a sole proprietorship and a corporation. It shields personal assets from business liabilities, limits personal liability, and provides tax flexibility.

LLCs allow rental income to flow directly to your personal tax return, avoiding corporate-level taxes. You can deduct property-related costs like mortgage interest and repairs. Operating as an LLC conveys commitment and professionalism to tenants and partners.  LLCs are preferred for their liability protection, tax flexibility, and ease of management. Consider S Corps for shareholder protection and tax benefits, especially for real estate professionals.

Legal Structure: How real estate owners pay taxes depends on the structure of their business.  At P&N, we can evaluate your situation and recommend the right entity for your business.

Sole Proprietorship – A sole proprietorship is the simplest form of business, where the owner and the business are one.

Limited Liability Company (LLC) – An LLC combines the liability protection of a corporation with the flexibility of a partnership.

Partnership – A partnership involves two or more individuals or entities sharing ownership and responsibilities.

S-Corporation – An S-Corporation is a pass-through entity that combines features of

corporations and partnerships.

UNDERSTANDING ACCELERATED DEPRECIATION

As a real estate owner or investor, P&N can help you understand the tax implications of property ownership.  One powerful tool at your disposal is accelerated depreciation, which allows you to optimize your tax position while managing your real estate assets. 

Depreciation is an annual deduction from pretax net income that enables real estate investors to recover the cost basis of their properties over time. It compensates for wear and tear, deterioration, and obsolescence. While residential rental properties are typically depreciated over 27.5 years, accelerated depreciation allows investors to front-load depreciation expenses during the initial years of ownership.

How Does Accelerated Depreciation Work?

Cost Basis and Components: The cost basis includes the property’s purchase price minus the value of the land or lot. Additionally, capitalized costs (such as replacing a roof or closing costs) contribute to the cost basis.

Evenly Spread vs. Accelerated Depreciation: Under regular depreciation, expenses are evenly spread over the holding period. However, with accelerated depreciation, investors can further reduce pretax income during the early years.

Examples of passive activities in real estate include owning rental properties, where the income and losses related to them are generally considered passive. Expenses such as mortgage interest, insurance, maintenance, and depreciation contribute to these losses. Additionally, investments in limited partnerships or other real estate ventures where you have limited involvement fall under passive activities.

The IRS imposes rules on passive losses, including:

Exceptions to the passive loss rules include:

• $25,000 Allowance: If you actively manage the real estate and earn less than $100,000 during the year, you can deduct up to $25,000 in passive losses against ordinary income.



• Real Estate Professionals: Real estate professionals who materially participate in their real estate activities are not subject to the same passive loss rules. They can use real estate losses to offset income from other active sources.
  

Material participation is a key factor. If you actively manage the real estate (e.g., handle day-to-day operations), your losses may not be strictly passive. Real estate professionals who meet specific qualifications can also avoid the passive loss treatment.

When you sell a property held for business or investment purposes and exchange it for a new one with the same purpose, you can defer capital gains tax on the sale. The proceeds from the sale must be held in escrow by a third party and used to buy the new property—without receiving them directly. To qualify, the properties being exchanged must be considered like-kind in the eyes of the IRS. This term doesn’t mean they have to be identical; it refers to properties that are of a similar nature (e.g., an apartment building for raw land or a ranch for a strip mall). 

If used correctly, there’s no limit on how frequently you can do 1031 exchanges. You can roll over gains from one investment property to another, allowing your investment to continue growing tax deferred. When you eventually sell for cash, you’ll pay only one tax at a long-term capital gains rate (currently 15% or 20%, depending on income). Some lower-income taxpayers may even pay 0% capital gains tax. 

The 1031 provision primarily applies to investment and business property, but it can also be used under specific conditions for a former principal residence.  Remember that while 1031 exchanges allow you to defer taxes, they don’t eliminate them entirely.

Strategic Advisory for Real Estate Growth

Stay ahead in the competitive real estate market with our proactive advisory services. Gain insights into market trends, identify growth opportunities, and make informed decisions specific to real estate. Presti & Naegele is your strategic partner for navigating the ever-changing landscape of the real estate industry.

STREAMLINE FINANCIAL OPERATIONS WITH QUICKBOOKS EXPERTISE

Efficient financial operations are the backbone of successful real estate ventures. Our QuickBooks assistance is tailored specifically for real estate professionals, simplifying bookkeeping processes and allowing you to focus on managing and growing your property ventures. Experience the ease of streamlined financial operations with Presti & Naegele.

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