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Tax Info for the Real Estate Business Types-I

Laws and Regulations

Tax Info for the Real Estate Business Types-


Licensed Real Estate Agents - Real Estate Tax Tips

Employee or self-employed?

Most real estate professionals operate their business as a sole proprietorship. This means that you are not someone's employee, you haven't formed a partnership with anyone, and you have not incorporated your business.

Statutory Nonemployees

Licensed real estate agents are statutory nonemployees and are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:

  • Substantially all payments for their services as real estate agents are directly related to sales or other output, rather than to the number of hours worked
  • Their services are performed under a written contract providing that they will not be treated as employees for Federal tax purposes

This category includes individuals engaged in appraisal activities for real estate sales if they earn income based on sales or other output.
Sale of Residence - Real Estate Tax Tips
Do you qualify to exclude your gain?

You may qualify to exclude from your income all or part of any gain from the sale of your main home. Your main home is the one in which you live most of the time.

Ownership and Use Tests

To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:

  • Owned the home for at least two years (the ownership test)
  • Lived in the home as your main home for at least two years (the use test)


If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).

  • If you can exclude all of the gain, you do not need to report the sale on your tax return
  • If you have gain that cannot be excluded, it is taxable. Report it on Schedule D (Form 1040)


You cannot deduct a loss from the sale of your main home.


Worksheets are included in Publication 523, Selling Your Home, to help you figure the:

  • Adjusted basis of the home you sold
  • Gain (or loss) on the sale
  • Gain that you can exclude

Reporting the Sale

Do not report the sale of your main home on your tax return unless you have a gain and at least part of it is taxable. Report any taxable gain on Schedule D (Form 1040).

More Than One Home

If you have more than one home, you can exclude gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is ordinarily the one you live in most of the time.

Example One:

You own and live in a house in the city. You also own a beach house, which you use during the summer months. The house in the city is your main home; the beach house is not.

Example Two:

You own a house, but you live in another house that you rent. The rented house is your main home.

Business Use or Rental of Home

You may be able to exclude your gain from the sale of a home that you have used for business or to produce rental income. But you must meet the ownership and use tests.


On May 30, 1997, Amy bought a house. She moved in on that date and lived in it until May 31, 1999, when she moved out of the house and put it up for rent. The house was rented from June 1, 1999, to March 31, 2001. Amy moved back into the house on April 1, 2001, and lived there until she sold it on January 31, 2003. During the 5-year period ending on the date of the sale (February 1, 1998 - January 31, 2003), Amy owned and lived in the house for more than 2 years as shown in the table below.

Five Year Period

Used as Home

Used as Rental


16 months


22 months


22 months


38 months

22 months

Amy can exclude gain up to $250,000. However, she cannot exclude the part of the gain equal to the depreciation she claimed for renting the house.

Environmental Cleanup Costs
This deduction provides businesses with an incentive to clean up certain sites that are contaminated with hazardous substances. Refer to the section on Environmental Cleanup Costs in Publication 535, Business Expenses.

Rental Income and Expenses - Real Estate Tax Tips
When are you required to report rental income and expenses?

You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property.

Expenses of renting property can be deducted from your gross rental income. You generally deduct your rental expenses in the year you pay them. Publication 527, Residential Rental Property includes information on the expenses you can deduct if you rent a condominium or cooperative apartment, if you rent part of your property, or if you change your property to rental use.

When to Report Income

Report rental income on your return for the year you actually or constructively receive it, if you are a cash basis taxpayer. You are a cash basis taxpayer if you report income in the year you receive it, regardless of when it was earned. You constructively receive income when it is made available to you, for example, by being credited to your bank account.

For more information about when you constructively receive income, see Publication 538, Accounting Periods and Methods.

Advance Rent

Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use.


You sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year's rent and $5,000 as rent for the last year of the lease. You must include $10,000 in your income in the first year.

Security Deposits

Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.

If an amount called a security deposit is to be used as a final payment of rent, it is advance rent. Include it in your income when you receive it.

Expenses Paid by Tenant

If your tenant pays any of your expenses, the payments are rental income. You must include them in your income. You can deduct the expenses if they are deductible rental expenses. See Rental Expenses in Publication 527, for more information.

Example One:

Your tenant pays the water and sewage bill for your rental property and deducts it from the normal rent payment. Under the terms of the lease, your tenant does not have to pay this bill.

Example Two:

While you are out of town, the furnace in your rental property stops working. Your tenant pays for the necessary repairs and deducts the repair bill from the rent payment. Based on the facts in each example, include in your rental income both the net amount of the rent payment and the amount the tenant paid for the utility bills and the repairs. You can deduct the cost of the utility bills and repairs as a rental expense.

Property or Services in Lieu of Rent

If you receive property or services, instead of money, as rent, include the fair market value of the property or services in your rental income.

If the services are provided at an agreed upon or specified price, that price is the fair market value unless there is evidence to the contrary.


Your tenant is a painter. He offers to paint your rental property instead of paying 2 months' rent. You accept his offer. Include in your rental income the amount the tenant would have paid for 2 months' rent. You can include that same amount as a rental expense for painting your property.

Personal Use of Vacation Home or Dwelling Unit

If you have any personal use of a vacation home or other dwelling unit that you rent out, you must divide your expenses between rental use and personal use. See Figuring Days of Personal Use and How To Divide Expenses in Publication 527. If your expenses for rental use are more than your rental income, you may not be able to deduct all of the rental expenses. See How To Figure Rental Income and Deductions in Publication 527.

Passive Activity Losses - Real Estate Tax Tips
Your losses may not be currently deductible.

Generally, a passive activity is any rental activity OR any business in which the taxpayer does not materially participate. Nonpassive activities are businesses in which the taxpayer works on a regular, continuous, and substantial basis. In addition, passive income does not include salaries, portfolio, or investment income.

As a general rule, the passive activity loss rules are applied at the individual level. Although Internal Revenue Code Section 469 was enacted to discourage abusive tax shelters, its impact extends far beyond shelters to virtually every business or rental activity whether reported on Schedules C, F, or E, as well as to flow through income and losses from partnerships, S- Corporations, and trusts. Generally, the law does not apply to regular C-Corporations although it does have limited application to closely held corporations.

There Are Two Kinds of Passive Activities:

  • Rentals, including both equipment and rental real estate, regardless of the level of participation
  • Businesses in which the taxpayer does not materially participate on a regular, continuous, and substantial basis

Types of Income and Losses

Income and losses on a tax return are divided into two categories:

  • Passive: Rentals and businesses without material participation. A limited partner is generally passive due to more restrictive tests for material participation. As a result, limited partners will generally have passive income or losses from the partnership  
  • Nonpassive: Businesses in which the taxpayer materially participates. Also, salaries, guaranteed payments, 1099 commission income and portfolio or investment income are deemed to be nonpassive. Portfolio income includes interest income, dividends, royalties, gains and losses on stocks, pensions, lottery winnings, and any other property held for investment

Passive Activities

Income and losses from the following activities would generally be passive:

  • Equipment leasing
  • Rental real estate (with some exceptions)
  • Sole proprietorship or farm in which the taxpayer does not materially participate
  • Limited partnerships with some exceptions
  • Partnerships, S-Corporations, and limited liability companies in which the taxpayer does not materially participate

Nonpassive Activities

Income and losses from the following activities would generally be nonpassive:

  • Salaries, wages, and 1099 commission income
  • Guaranteed payments
  • Interest and dividends
  • Stocks and bonds
  • Sale of undeveloped land or other investment property
  • Royalties derived in the ordinary course of business
  • Sole proprietorship or farm in which the taxpayer materially participates
  • Partnerships, S-Corporations, and limited liability companies in which the taxpayer materially participates
  • Trusts in which the fiduciary materially participates

Income From Self-Rented Property

It has been common tax practice for shareholders in closely held corporations to personally own the building (and sometimes equipment and vehicles as well) and rent it to their corporation. For additional information on tax treatment, see the Passive Activity Losses Audit Technique Guide (PDF).

Rehabilitation Tax Credit - Real Estate Tax Tips
Taking credit for history.

The rehabilitation credit applies to costs you incur for rehabilitation and reconstruction of certain buildings. Rehabilitation includes renovation, restoration, and reconstruction. It does not include enlargement or new construction.

Generally, the percentage of costs you can take as a credit is:

  • 10% for buildings placed in service before 1936
  • 20% for certified historic structures

The rehabilitation credit is increased for qualified rehabilitation expenditures paid or incurred after August 27, 2005, and before January 1, 2009, on building located in the Gulf Opportunity zone as follows:

  • For pre-1936 building (other than certified historic structures) the credit percentage is increased from 10% to 13%.
  • For certified historic structures, the credit percentage is increased from 20% to 26%.
  • See Publication 4492 for additional information for Taxpayers Affected by Hurricanes Katrina, Rita, and Wilma.

See the instructions on Form 3468, Investment Credit (PDF), for more information.

Topical Tax Briefs

Late Submission of "HPC Application" (PDF)

Property Leased to a Tax-Exempt Entity (PDF)

Use of the Rehabilitation Tax Credit by Lessees (PDF)

Rehabilitation Tax Credit Recapture (PDF)

Allocations of Tax Credit (PDF)

Differences Between the Historic Rehabilitation Tax Credit and Low-Income Housing Tax Credit (PDF)

IRS Connection

Get Frequently Asked Questions (PDF) about the Tax Aspects of Historic Preservation.

Installment Sales - Real Estate Tax Tips
Time is on your side.

An installment sale is a sale of property where you receive at least one payment after the tax year of the sale. If you dispose of property in an installment sale, you report part of your gain when you receive each installment payment. You cannot use the installment method to report a loss.

General Rules

If a sale qualifies as an installment sale, the gain must be reported under the installment method unless:

  • You elect out of using the installment method
  • You are not a qualified accrual method taxpayer

Involuntary Conversions - Real Estate Tax Tips
Destroyed, stolen, or condemned property?

An involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges.

Reporting Gain or Loss

Gain or loss from an involuntary conversion of your property is usually recognized for tax purposes unless the property is your main home. You report the gain or deduct the loss on your tax return for the year you realize it. (You cannot deduct a loss from an involuntary conversion of property you held for personal use unless the loss resulted from a casualty or theft.)

However, depending on the type of property you receive, you may not have to report a gain on an involuntary conversion. You do not report the gain if you receive property that is similar or related in service or use to the converted property. Your basis for the new property is the same as your basis for the converted property. The gain on the involuntary conversion is deferred until a taxable sale or exchange occurs.

Like-Kind Exchanges - Real Estate Tax Tips
Defer your gain under Internal Revenue Code Section 1031.

Generally, if you exchange business or investment property solely for business or investment property of a like-kind, no gain or loss is recognized under Internal Revenue Code Section 1031. If, as part of the exchange, you also receive other (not like-kind) property or money, gain is recognized to the extent of the other property and money received, but a loss is not recognized.

Section 1031 does not apply to exchanges of inventory, stocks, bonds, notes, other securities or evidence of indebtedness, or certain other assets.

Like-Kind Property

Properties are of like-kind, if they are of the same nature or character, even if they differ in grade or quality. Personal properties of a like class are like-kind properties. However, livestock of different sexes are not like-kind properties. Also, personal property used predominantly in the United States and personal property used predominantly outside the United States are not like-kind properties.

Real properties generally are of like-kind, regardless of whether the properties are improved or unimproved. However, real property in the United States and real property outside the United States are not like-kind properties.

Commercial Property Owners and Leaseholders Qualify for Energy Efficiency Tax Deduction
New section 179D allows a deduction to a taxpayer who owns, or is a lessee of, a commercial building and installs property that satisfies energy efficiency requirements.

The commercial building deduction appears at new section 179D, which was enacted in the Energy Policy Act of 2005. The provision allows a deduction to a taxpayer who owns, or is a lessee of, a commercial building and installs property as part of the commercial building.s interior lighting systems, heating, cooling, ventilation, and hot water systems, or building envelope.  Certification must be obtained to verify that the property installed satisfies the energy efficiency requirements of section 179D.

Note: These provisions, originally set to expire 12/31/2007, have been extended through 12/31/2008 as set forth in the Tax Relief & Health Care Act of 2006.

Notice 2006-52 (PDF) sets forth interim guidance pending the issuance of regulations that explains how commercial building owners or leaseholders can qualify for a tax deduction.  The Notice establishes a process to certify the required energy savings in order to claim the deduction.

The amount deductible under section 179D may be as much as $1.80 per square foot of building floor area for buildings that achieve a 50-percent reduction in energy and power costs.  Notice 2006-52 provides that buildings that achieve a reduction in energy and power costs of less than 50-percent may, nevertheless, qualify for a deduction of 60 cents per square foot of building floor area if the building achieves a reduction in energy and power costs of 16?-percent.

Before claiming the deduction, the taxpayer must obtain a certification that the required energy savings will be achieved.  Refer to the attached notice which prescribes the content of that certification and the qualifications that must be met by the person providing the certification.

The Department of Energy will create and maintain a public list of software that must be used to calculate energy savings for purposes of providing the certification.  The notice provides a process that software developers must use if they desire to have their software included on that list.

Avoiding Problems - Real Estate
This section contains important information on recordkeeping and warns you of fraudulent real estate schemes.

Unless you are a professional bookkeeper, you probably don't like to spend valuable business time keeping records. But keeping good records can actually help you save money.

Why should I keep records?
Good records will help you monitor the progress of your business, prepare your financial statements, identify source of receipts, keep track of deductible expenses, prepare your tax returns, and support items reported on tax returns.

Everyone in business must keep records.  Keeping good records is very important to your business.  Good records will help you do the following:

  • Monitor the progress of your business
  • Prepare your financial statements
  • Identify source of receipts
  • Keep track of deductible expenses
  • Prepare your tax returns
  • Support items reported on tax returns

Monitor the progress of your business
You need good records to monitor the progress of your business. Records can show whether your business is improving, which items are selling, or what changes you need to make.  Good records can increase the likelihood of business success. 

Prepare your financial statements
You need good records to prepare accurate financial statements.  These include income (profit and loss) statements and balance sheets.  These statements can help you in dealing with your bank or creditors and help you manage your business. 

  • An income statement shows the income and expenses of the business for a given period of time.
  • A balance sheet shows the assets, liabilities, and your equity in the business on a given date. 

Identify source of receipts
You will receive money or property from many sources.  Your records can identify the source of your receipts.  You need this information to separate business from nonbusiness receipts and taxable from nontaxable income. 

Keep track of deductible expenses
You may forget expenses when you prepare your tax return, unless you record them when they occur.

Prepare your tax return
You need good records to prepare your tax returns.  These records must support the income, expenses, and credits you report.  Generally, these are the same records you use to monitor your business and prepare your financial statement. 

Support items reported on tax returns
You must keep your business records available at all times for inspection by the IRS.  If the IRS examines any of your tax returns, you may be asked to explain the items reported.  A complete set of records will speed up the examination. 

What kinds of records should I keep?

You may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Except in a few cases, the law does not require any special kind of records. However, the business you are in affects the type of records you need to keep for federal tax purposes. Your recordkeeping system should also include a summary of your business transactions. This summary is ordinarily made in your business books (for example, accounting journals and ledgers). Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is the main source for entries in the business books.

Supporting Business Documents

Purchases, sales, payroll, and other transactions you have in your business will generate supporting documents such as invoices and receipts. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. These documents contain the information you need to record in your books. It is important to keep these documents because they support the entries in your books and on your tax return. You should keep them in an orderly fashion and in a safe place. For instance, organize them by year and type of income or expense. For more detailed information refer to Publication 583,  Starting a Business and Keeping Records.

The following are some of the types of records you should keep:

  • Gross receipts are the income you receive from your business. You should keep supporting documents that show the amounts and sources of your gross receipts. Documents for gross receipts include the following:

    • Cash register tapes
    • Bank deposit slips
    • Receipt books
    • Invoices
    • Credit card charge slips
    • Forms 1099-MISC

  • Purchases are the items you buy and resell to customers. If you are a manufacturer or producer, this includes the cost of all raw materials or parts purchased for manufacture into finished products. Your supporting documents should show the amount paid and that the amount was for purchases. Documents for purchases include the following:

    • Cancelled checks
    • Cash register tape receipts
    • Credit card sales slips
    • Invoices

  • Expenses are the costs you incur (other than purchases) to carry on your business. Your supporting documents should show the amount paid and that the amount was for a business expense. Documents for expenses include the following:

    • Canceled checks
    • Cash register tapes
    • Account statements
    • Credit card sales slips
    • Invoices
    • Petty cash slips for small cash payments

    Travel, Transportation, Entertainment, and Gift Expenses
    If you deduct travel, entertainment, gift or transportation expenses, you must be able to prove (substantiate) certain elements of expenses.  For additional information on how to prove certain business expenses, refer to Publication 463, Travel, Entertainment, Gift, and Car Expenses.

  • Assets are the property, such as machinery and furniture, that you own and use in your business. You must keep records to verify certain information about your business assets. You need records to compute the annual depreciation and the gain or loss when you sell the assets. Documents for assets include the following:

    • When and how you acquired the assets.
    • Purchase price
    • Cost of any improvements.
    • Section 179 deduction taken.
    • Deductions taken for depreciation.
    • Deductions taken for casualty losses, such as losses resulting from fires or storms.
    • How you used the asset.
      When and how you disposed of the asset.
    • Selling price.
    • Expenses of sale.

    The following documents may show this information.

    • Purchase and sales invoices.
    • Real estate closing statements.
    • Canceled checks.

How long should I keep records?

The length of time you should keep a document depends on the action, expense, or event the document records. Generally, you must keep your records that support an item of income or deductions on a tax return until the period of limitations for that return runs out.

The period of limitations is the period of time in which you can amend your tax return to claim a credit or refund, or that the IRS can assess additional tax. The below information contains the periods of limitations that apply to income tax returns. Unless otherwise stated, the years refer to the period after the return was filed. Returns filed before the due date are treated as filed on the due date.

Note: Keep copies of your filed tax returns. They help in preparing future tax returns and making computations if you file an amended return.

  1. You owe additional tax and situations (2), (3), and (4), below, do not apply to you; keep records for 3 years.
  2. You do not report income that you should report, and it is more than 25% of the gross income shown on your return; keep records for 6 years.
  3. You file a fraudulent return; keep records indefinitely.
  4. You do not file a return; keep records indefinitely.
  5. You file a claim for credit or refund* after you file your return; keep records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later.
  6. You file a claim for a loss from worthless securities or bad debt deduction; keep records for 7 years.
  7. Keep all employment tax records for at least 4 years after the date that the tax becomes due or is paid, whichever is later.

The following questions should be applied to each record as you decide whether to keep a document or throw it away.

Are the records connected to assets?
Keep records relating to property until the period of limitations expires for the year in which you dispose of the property in a taxable disposition.  You must keep these records to figure any depreciation, amortization, or depletion deduction and to figure the gain or loss when you sell or otherwise dispose of the property.

Generally, if you received property in a nontaxable exchange, your basis in that property is the same as the bases of the property you gave up, increased by any money you paid. You must keep the records on the old property, as well as on the new property, until the period of limitations expires for the year in which you dispose of the new property in a taxable disposition.

What should I do with my records for nontax purposes?
When your records are no longer needed for tax purposes, do not discard them until you check to see if you have to keep them longer for other purposes.  For example, your insurance company or creditors may require you to keep them longer than the IRS does.

How long should I keep employment tax records?
You must keep all of your records as long as they may be needed; however, keep all records of employment taxes for at least four years.

Internal Revenue Service (IRS)

Keep all records of employment taxes for at least four years after filing the 4th quarter for the year. These should be available for IRS review. Records should include:

  • Your employer identification number.
  • Amounts and dates of all wage, annuity, and pension payments.
  • Amounts of tips reported.
  • The fair market value of in-kind wages paid.
  • Names, addresses, social security numbers, and occupations of employees and recipients.
  • Any employee copies of Form W-2 that were returned to you as undeliverable.
  • Dates of employment.
  • Periods for which employees and recipients were paid while absent due to sickness or injury and the amount and weekly rate of payments you or third-party payers made to them.
  • Copies of employees' and recipients' income tax withholding allowance certificates (Forms W-4, W-4P, W-4S, and W-4V).
  • Dates and amounts of tax deposits you made.
  • Copies of returns filed.
  • Records of allocated tips.
  • Records of fringe benefits provided, including substantiation.

How should I record my business transactions?
Purchases, sales, payroll, and other transactions you have in your business generate supporting documents. These documents contain information you need to record in your books.

A good recordkeeping system includes a summary of your business transactions.  Business transactions are ordinarily summarized in books called journals and ledgers.  You can buy them at your local stationery or office supply store. 

A journal is a book where you record each business transaction shown on your supporting documents.  You may have to keep separate journals for transactions that occur frequently.

A ledger is a book that contains the totals from all of your journals.  It is organized into different accounts. 

Whether you keep journals and ledgers and how you keep them depends on the type of business you are in.  For example, a recordkeeping system for a small business might include the following items. 

  • Business checkbook
  • Daily summary of cash receipts
  • Monthly summary of cash receipts
  • Check disbursements journal
  • Depreciation worksheet
  • Employee compensation records

What is the burden of proof?


The responsibility to prove entries, deductions, and statements made on your tax returns is known as the burden of proof. You must be able to prove (substantiate) certain elements of expenses to deduct them. Generally, taxpayers meet their burden of proof by having the information and receipts (where needed) for the expenses. You should keep adequate records to prove your expenses or have sufficient evidence that will support your own statement. You generally must have documentary evidence, such as receipts, canceled checks, or bills, to support your expenses. Additional evidence is required for travel, entertainment, gifts, and auto expenses.

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Tax Info for the Real Estate Business Types-I