87
Over time, M & G will likely use one
or more of the above strategies to cre- ate more wealth for themselves. It is also possible that their creative accountants and attorneys could find additional ways to meet M & G’s financial needs using the building.
Tax preparation The U.S. Internal Revenue Code
defines rental real estate, regardless of the level of participation, as a passive busi- ness activity.11
As such, real estate income
and loss are treated differently on an indi- vidual’s tax return: While profits must be fully reported, losses may be limited in dollar amount. Rental income and loss are reported on the first page of Schedule E of an individual income tax return. In general, passive losses can only
offset passive gains: If an individual invests in a partnership that generates $5,000 in passive losses, he will need passive income of at least $5,000 from some other activity to be able to take those losses. However, real estate pas- sive losses are subject to more kindly tax rules than other passive losses. Current tax laws allow an investor to deduct net rental losses of up to $25,000 per year if two criteria are met: 1. Minimum of 10% ownership in the real estate
2. Active participation in the property, which typically consists of approval of capital expenditures and tenants The $25,000 loss phases out based on
income. For a modified adjusted gross income (MAGI)12
of $100,000 or less, the
allowable net loss is $25,000; for a MAGI above $150,000, the allowable net loss is zero; and for a MAGI between $100,000 and $150,000, the $25,000 allowable loss is reduced by $1 for every extra $2 of adjusted gross income (e.g., a $110,000 MAGI allows for a deduction of $20,000 of net rental loss). Any “unused” loss is carried forward until one of three conditions is met: 1. The owner uses the carry-forward loss in a future year.
Trends magazine, November/December 2010
2. The owner sells the property, in which case the untaken losses reduce the gain or increase the loss from the property.
3. The owner dies. There are some exceptions to the pas-
sive loss rules that bear notice. An indi- vidual designated as a real estate profes- sional is allowed to have unlimited deduc- tions. To be a real estate professional, the individual must spend a majority of his or her time in real property business,13 thus meeting two critical requirements: 1. The individual must work a mini- mum of 750 hours in the real estate industry annually.
2. The number of hours working in real estate has to be more than 50% of total hours worked in the year.14 It is possible to do very sophisticated
tax planning with real property, taking expenses and income in the years when it is most advantageous for the owner. The ability to shift income between years is in itself a sufficient reason for the entrepreneur to purchase real property.
Conclusion Owner-occupied commercial
real
estate provides an opportunity for large value creation in a variety of industries by providing an entrepreneur with the ability to extract additional cash from his business in a way that is tax-advanta- geous. A sophisticated entrepreneur can utilize real estate as a specialized vehicle to provide asset diversification, reduce tax liability, offset taxes from other invest- ment sources, and provide the opportu- nity to leverage and acquire other assets. It is recommended that business owners work toward the goal of owning the real estate associated with their business and rent from themselves. n
Alphonse Lordo, MBA, graduated from the Pepperdine University Grazia- dio School of Business and Management in August 2008 with a concentra- tion in finance. He has held positions in investment real estate and corpo- rate banking and currently works in the leverage finance and syndications division of a financial institution. Alphonse is also a partner at Blue Point Capital & Consulting, a firm that provides consulting services and capital
A sophisticated entrepreneur can utilize real estate as a specialized vehicle to provide asset diversification, reduce tax liability, offset taxes from other investment sources, and provide the opportunity to leverage and acquire other assets.
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