Net Operating Losses

For many investors, buying income-generating real estate isn’t too different from buying corporate bonds or stocks. But there is one major advantage: losses on rental properties can be deducted from taxable income.

Getting that provision into the tax code was a rocky road. In 1986, Congress passed a law that treated virtually all investments in rental real estate properties as passive investments (much like stocks or bonds).

This meant property owners could no longer deduct any operating losses on their properties from their taxable income. In the following years, property prices went into a tailspin. Legislators blamed the 1986 law in part for causing the Savings & Loan crisis by discouraging investment in real estate, according to a 1994 Chicago Tribune report. So they changed the rules again.

Since 1993, rental property owners can deduct operating losses on their properties from their taxable income, provided they spend at least half their working hours and at least 750 hours a year as a “real estate professional.”

Other Mechanisms of Tax Reduction

Depreciation is the most famous — and counterintuitive — way real estate investors can shrink their tax bill. The IRS treats real properties as assets that lose value over time, along with cars, desks and refrigerators.

Property owners can deduct a certain portion of a property’s value every year until that value reaches zero. For residential rental properties, the typical depreciation period is 27.5 years, according to the IRS website.

As useful as depreciation is to property owners, it is a gradual process and rarely generates a sudden sizeable loss.

Another way developers can lower their tax exposure is through cancellation of debt, or outstanding debt that has been forgiven after negotiations. Typically, this kind of debt forgiveness is treated as income on a tax bill, but current laws allow taxpayers to deduct this debt if it is tied to Chapter 11 bankruptcy or if the taxpayer is insolvent — meaning their debt is greater than the total market value of all assets

Developers have long used these strategies. After a recent article in The New York Times about Donald Trumps reported losses — $915,729,293 — on his tax forms in 1995, tax services firms sought to seize the moment by sending out email blasts advertising their tax reduction services.

One email from South Florida-based Property Tax Appeal Group, titled “Donald Trump Knows How to Avoid Taxes in Real Estate,” urged investors to file property tax appeals and “take advantage of what the law allows.”

“This is truly a win-win situation,” the email read.

Last January, the Detroit Free Press reported that home prices across Southeast Michigan have risen back to 2007 levels. However, for many homeowners, the prices they sold their homes for may still not be as great as what the purchase price was.

Because of that fact, in December 2015 Michigan Governor Rick Snyder signed into law legislation that people who sold their homes on or after June 24, 2011 may be entitled to a refund of the transfer tax that they paid to the State of Michigan — if the state equalized value (SEV) of the home at the time of sale was less than the SEV at the time of purchase. The legislation was in response to a Michigan Supreme Court ruling that expanded refund eligibility in these circumstances.

In other words, if you sold your home for less than what you purchased it for, and it was your principal residence, you likely are now eligible for a refund of the transfer tax you paid to the state.

Of course, there are some catches …

In order to claim the exemption, three conditions must be met at the time of sale:

1. The property must be claimed as the seller’s principal residence.
2. The tax-assessed value of the property (or, state equalized value “SEV”) must be lower in the year of the sale than the year in which the property was purchased.
3. The property must have been sold for a price in which a willing buyer and a willing seller would arrive through arm’s length transactions.

And according to the Michigan Department of Treasury Form 2796 (Application for State Real Estate Transfer Tax [SRETT] Refund), transfer tax refunds can be applied for up to four years and 15 days from the date of sale.

The SRETT can be a significant amount of money, so it shouldn’t be ignored. As an example, if the sales price of your house was $200,000, you could be eligible for a $1,500 refund.

In early July of 2015, the Michigan Supreme Court issued an expansive opinion providing many more Michigan homeowners the right to claim an exemption from the SRETT assessment of $7.50 for every $1,000 in value that was sold.

While the exemption has been available to Michigan homeowners for a number of years, the Supreme Court’s opinion and the subsequent legislation greatly expanded who is eligible for it.

For more information on whether you may entitled to a refund of your transfer tax or other real estate matters, call Resnick Law at 248.642.5400 or click here.

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