Tax Traps for New Real Estate Investors

     Perhaps one shouldnt be surprised that new real estate investors fall into the same tax traps again and again. Real estate burdens investorsespecially new investorswith some tricky tax accounting.

     But just because some other newbie makes these mistakes, that doesnt mean you need to. You just need to know where the traps are so you avoid them. And here are the biggest real estate tax traps you dont want to fall into:

     Tax Trap 1: Passive Loss Limitation

     On paper at least, real estate often loses money. Even if the rent pays the mortgage and the operating expenses, the books still show a loss because you get to write off a portion of the purchase price through depreciation each year.
If a rental house that cost $275,000 breaks even on cash flow, for example, you might also get a $10,000 annual depreciation deduction. If your marginal tax rate is 28%, that depreciation should save you $2800 annually.

     Sounds sweet, right? Well, it isor should be. Except that the U.S. Congress labeled real estate investment a passive activity and said that, except in a couple of special circumstances, you cant write off passive activity deductions unless overall you show positive passive income.

     This passive loss limitation rule means that many real estate investors dont get to use tax saving deductions from real estate or least not annually.

     Two loopholes, courtesy of Congress, do exist that let you write off deductions from real estate even if overall you show a loss from real estate investing. If youre an active real estate investor with adjusted gross income below $100,000, you can write off up to $25,000 of passive losses annually. (If your income is between $100,000 and $150,000, you get to write off a percentage of the $25,000. Ask your tax advisor for the details.)

     Here is the second loophole: If youre a real estate professional, Congress says the passive loss limitation rule doesnt apply to you when it comes to real estate. A real estate professional, by the way, is not someone whos licensed as an agent or broker. The law instead creates a time-based test: A real estate professional is someone who spends at least 750 hours a year and more than 50% of their time working as a real estate agent, broker, property manager or developer.