More On Tax Planningfrom The Advisor's Professional Library
- Charitable Giving Charitable giving can reduce your clients’ tax liabilities. However, the general and verification rules for the deduction of charitable gifts must be understood in order to take full tax advantage of such gifts.
- Annuities: Estate Tax The value of certain types of annuities may be included in an estate’s value. Understanding the intricacies of these inclusions is a critically important aspect of estate planning.
Continuing with the theme of how I employ tax planning in my advisory practice (part of AdvisorOne’s Special Report, 22 Days of Tax Planning Advice for 2012), in this post we'll examine the tax issues to remember when a client buys a home.
As we all know, housing prices have experienced a severe decline over the past four years. Even so, according to the Case-Shiller index, they are still above the 2000 level. In some portions of the country, mainly the areas which experienced the greatest run-up, prices have fallen more sharply. All this presents a great opportunity for those with the courage and financial resources to step up to the purchase window. In this post, we'll examine some of the tax consequences of becoming an owner of rental real estate.
A person’s tax basis is essentially the net cost of an investment asset. In real estate, it includes the amount you pay for it in cash, in debt obligation, in other property or in services. In addition, if you paid sales tax on the property, it may be added to your basis if you did not deduct state and local general sales taxes as an itemized deduction on Schedule A (Form 1040).
A few other additions to basis include: freight charges to obtain the property and installation and testing charges. Also, if the previous owner owed real estate taxes, and you paid them and were not reimbursed, these taxes are added to your basis. However, if this is the case you cannot receive a deduction on the taxes you paid. Other fees that are added to basis include: abstract fees, charges for installing utility services, legal fees, recording fees, surveys, transfer taxes, title insurance and any amounts the seller owes that you agree to pay, such as back taxes or interest, recording or mortgage fees, charges for improvements or repairs, and sales commissions.
The following are settlement fees and closing costs you cannot include in your basis in the property. They include: fire insurance premiums, rent or other charges relating to occupancy of the property before closing, charges connected with getting or refinancing a loan such as: points (discount points, loan origination fees), mortgage insurance premiums, loan assumption fees, cost of a credit report, and fees for an appraisal required by a lender.
Basis is important for a number of reasons, most notably that when you dispose of the property, you will subtract the adjusted basis from the net sales proceeds to determine the amount subject to taxation.
During the year you will collect rent and incur out-of-pocket expenses related to the property. For instance, assume you collect $2,000 each month and have $1,000 in expenses. At this point your net rental income would be $1,000. However, after subtracting deprecation, assuming it was $900 per month, your tax exposure would be $100 each month, or $1,200 per year. You should also be aware that the basis of the property is reduced by the amount of depreciation taken. There are other factors that will raise or lower your basis, but time does not permit us to go too deeply into this. I suggest you contact a CPA for more information.
You may decide on an outright sale or you may consider a 1031 exchange. The 1031 exchange applies to investment properties and provides for the delay of the capital gains tax if done properly. Perhaps we will delve into this strategy in a future post.
Thanks for reading and have a great week!
See AdvisorOne’s Special Report, 22 Days of Tax Planning Advice for 2012, throughout the month of March.