Tax Deduction for Investment Property
In the United States, the Internal Revenue Code generally allows individual income tax payers to take one of two tax deductions related to investment property. Taxpayers may deduct costs related to investment property directly from taxable income when the investment property is classified as rental real estate. If the taxpayer cannot classify the property as rental real estate, taxpayers may claim investment interest costs as an itemized deduction.
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Rental Real Estate
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Taxpayers may deduct expenses related to investment property as rental real estate costs from the point the investor actively begins seeking to rent the property. For example, an investor who purchases an investment property, refurbishes it and then begins to seek tenants cannot immediately deduct costs related to the acquisition and refurbishment of the property as rental real estate. The costs must be capitalized and included in the basis, or total cost, of the property. Most costs subsequent to the completion of the refurbishment, however, are deductible.
Schedule E
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Individual income tax payers deducting rental real estate costs related to investment properties do so on Internal Revenue Service Schedule E of Form 1040, U.S. Individual Income Tax Return. Schedule E aggregates the income and expenses related to the operations of all the taxpayer's rental real estate properties. Net income or loss from Schedule E is then added or subtracted from all other forms of gross income on page one of Form 1040.
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Limitations
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Generally, individual income tax payers are limited in the amount of deductions they may claim annually related to rental real estate activities. The IRS currently limits deductions for losses related to aggregate rental real estate activities to offset ordinary income up to $25,000 annually. Taxpayers with modified gross incomes above $100,000 see the limitation $25,000 value further reduced. Taxpayers classified by the IRS as "real estate professionals" can avoid the limitation, although the designation typically applies to only a small number of individuals who primarily deal in rental real estate as their trade or business.
Other Investment Expenses
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Taxpayers who are not eligible to deduct costs related to investment property as Schedule E rental real estate costs, may deduct investment interest expenses on Schedule A, Itemized Deductions, of Form 1040. Taxpayers may deduct investment interest expenses only up until the amount of net investment income. Investment income, for purposes of computing the deduction, includes all sources of investment income, such as interest, dividends, or capital gains from stocks and bonds. Total itemized deductions may be limited for higher-income taxpayers.
Capital Gains
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For taxpayers who cannot deduct costs as Schedule E rental real estate or investment interest expense, the costs are typically added to the basis, or cost, of the investment property. When the investment property is sold, these costs are deducted from the gross income generated by the sale. Income or loss is then included as income to the taxpayer in the year the property is sold. Losses, however, if not offset by other investment income, may be limited.
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References
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