Alternative minimum tax is a very important consideration for taxpayers who own real estate, as just about all tax rules applicable to real estate are different for AMT and regular tax. This article on real estate and AMT will address situations where the individual owns real estate as an investment, usually as a rental property. The differences in tax treatment between the ordinary tax and the AMT can be significant.
Interest paid on the mortgage taken out to acquire the property is fully deductible for both ordinary tax and alternative minimum tax. Unlike itemized deductions which allow a tax benefit for what amounts to personal expenses, tax law generally allows all deductions that a taxpayer must make in pursuit of business income. Thus, the limitations mentioned in the previous article on mortgage interest do not apply.
If, however, the equity in the rental property is used as collateral for an additional loan – a second mortgage, for example – then the taxpayer must consider how the proceeds of that loan are used to determine interest deductibility. If the proceeds are used for a car loan or to finance a child’s education, for example, the interest is non-deductible personal interest. If the proceeds are used to improve the rental property, interest is deductible.
Suggestion – it is better for taxpayers to separate personal loans from business loans. The mixture of the two creates record keeping problems and can lead to disputes with the IRS.
Property taxes paid on rental or investment properties are permitted in their entirety for both ordinary tax and alternative minimum tax purposes.
Planning Idea – If you have the option of paying your property tax bill this year or next, pay it in a year when you have enough income from the property so that you don’t generate a rental loss. This strategy can help avoid triggering the passive loss of activity limitations described below.
Example – in Florida, property tax bills are mailed in October and are payable according to the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%. If you suffered a loss on the property in 2010 but expect to generate income in 2011, don’t pay your bill in November or December – forgoing this small rebate could help you avoid loss limitation rules.
Depreciation is allowed for property held for investment purposes. The portion of the cost attributable to the land is not depreciable, but for the building itself and the furniture, appliances, rugs, etc., a depreciation allowance may be taken.
Real estate (this is the legal definition of a house or any other building) held for rental / investment purposes can only be depreciated for ordinary tax purposes using the “straight-line” method, over a period of utility of 27.5 years. Thus, a property with $ 275,000 allocated to the building would be depreciated at the rate of $ 10,000 per year.
Personal property (this is the legal definition of things like furniture, appliances, carpeting and more) can be depreciated for ordinary tax purposes on an “accelerated” basis over a useful life of five years. . An accelerated method allows for a larger depreciation deduction in the early years, in recognition of a factor of obsolescence or decline in value that you see in a new property (cars are a good example).
For AMT purposes, however, movable property can only be depreciated using a straight-line method. Thus, an AMT item will be generated in the first years if the accelerated method is used.
Planning Idea – For personal property, consider choosing the straight-line method for regular tax purposes. While forgoing a small tax benefit from the larger depreciation of the early years, it could mean avoiding paying the AMT.
Active / passive investment rules and “at risk” rules
A taxpayer who is not “active” in the management of an investment property cannot use the losses of a rental property to offset other income such as wages and salaries, dividends, interest, taxes. capital gains, etc. Instead, these losses are deferred until the taxpayer sells the property or generates passive income from that investment source or other passive investment sources.
Likewise, the risk rules deny the use of these types of losses since the taxpayer acquired the investment with borrowed money and has no personal liability on the debt.
If these loss limits apply, consider the planning ideas mentioned above to minimize the losses generated each year. They don’t do you any good anyway.
Sale of the property
Several different AMT issues can arise when selling rental / investment property. The first is that your gain or loss may be different for AMT and for regular tax purposes. This would happen if different depreciation methods were used. For example, if the personal property were depreciated using an accelerated method for ordinary tax purposes, the basis of that property in calculating the gain or loss on the sale would be different because the straight-line method was to be used for the purposes. alternative minimum tax.
The gain on the sale of investment property is generally a capital gain, although part of it can be treated as ordinary income under the accelerated depreciation method used. Capital gains by themselves are not a component of AMT, but they can still result in AMT being paid. This is because the AMT exemption amount is being phased out for taxpayers at certain income levels, so this additional income may result in reducing the exemption, increasing taxable income for the purposes of the AMT. alternative minimum tax.