Real Estate Tax Planning
Buying or selling real property always carries extensive tax implications. Because, sales or purchases of real estate generally involve significant amounts of money, the impact of tax errors that occur, or opportunities that are missed in the transaction, are exaggerated. Therefore, it is imperative that real estate transactions be fully and thoroughly analyzed for their tax ramifications in advance of their closing. Among the more common tax issues buyers or sellers of real property face are:
- For most taxpayers, real property is a capital asset and therefore gives rise to capital gains or losses on disposition. However, for taxpayers who sell real property as a regular part of their business, real estate can give rise to ordinary gain or loss. Depending on the taxpayer’s specific circumstances, classification of gain or loss as capital, as opposed to ordinary, can be advantageous or disadvantageous. Effective planning strategies can lead to characterization of the gain or loss in the manner most beneficial to the taxpayer.
- Often, taxpayers will not want to hold real property directly, but instead prefer to establish an entity to hold it. There are various non-tax reasons for doing this. For instance, an individual seeking to rent a house or apartment building to tenants will often title the property in a corporate entity’s name for liability reasons. Additionally, investments in real estate are often facilitated by offering shares in an investment entity, rather than dividing ownership of the property directly. Ownership of real property through an entity has tax implications. Partnerships (generally including LLCs) and corporations are subject to different tax regulations, and distributions from those entities are treated differently for tax purposes. In choosing the type of entity through which to own real property, tax considerations are paramount.
- While land is not depreciable, buildings and their components are. Residential and non-residential real property structures are generally subject to longer depreciation schedules (and thus less favorable to taxpayers) than personal property. However, buildings in their entirety are not considered real property. Different fundamental components of a building, such as the heating and cooling system, exhaust systems, and electrical systems, are treated as personal property, and thus subject to more favorable depreciation schedules. Identifying which portions of a building are subject to shorter depreciation schedules can result in significant tax savings.
- Under the Internal Revenue Code, exchanges of “like-kind” property can occur without the recognition of gain or loss, even if the values of the exchanged properties are different. This provision can be used to change an investment in real estate into a wide variety of other real property-based investments.
- Foreign purchasers of real property in the United States face unique tax rules applicable to their ownership of foreign property. For instance, generally, rental income earned by a foreign property owner is taxed at a flat 30 percent on the gross amount of the income, without the right to take deductions for ordinary and necessary expenses incurred in renting the property. The Internal Revenue Code allows foreign owners of real property to deduct expenses from their rental income in exchange for acquiescing that the rental income is effectively connected to a U.S. trade or business. This election is generally beneficial, but ultimately, each taxpayer’s individual circumstances must be analyzed to determine whether to make the election. Additionally, in certain circumstances, sales of U.S. real property interests by foreign owners can create tax liability at ordinary rates, rather than capital rates, regardless of whether the property is a capital asset in the hands of the taxpayer. This is the product of FIRPTA, a law enacted about 35 years ago in response to the growing foreign ownership of U.S. real property. Certain ownership structures can be utilized to avoid or reduce FIRPTA’s effect.
Construction of residential and commercial real estate in South Florida is booming. Real estate investment and development will be key drivers of local and national economic expansion going forward, and real estate investors stand to realize significant returns. However, it is crucial that real estate investments and other transactions be undertaken with full knowledge of the potential tax consequences and with a strategy in place to maximize potential tax benefits and minimize potential tax costs.
The attorneys at Fuerst Ittleman David & Joseph are experienced in guiding clients through a wide variety of real estate transactions, from deals involving a single property to development of large commercial and residential complexes. Our corporate, tax, and real estate attorneys possess the knowledge, experience, and insight needed to ensure your real estate transactions are structured in a manner that maximizes your investment, provides liability protection, and is as tax efficient as possible.
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