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.
Licensed real estate agents are statutory nonemployees and are treated as self-employed for all Federal tax purposes, including income and employment taxes, if:
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:
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).
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:
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.
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.
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
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 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.
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.
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.
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:
Types of Income and Losses
Income and losses on a tax return are divided into two categories:
Income and losses from the following activities would generally be passive:
Income and losses from the following activities would generally be nonpassive:
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:
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:
See the instructions on Form 3468, Investment Credit (PDF), for more information.
Topical Tax Briefs
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.
If a sale qualifies as an installment sale, the gain must be reported under the installment method unless:
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.
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.