10 Tax Tips for Real Estate Investors

As real estate developers and investors do business, they may face complex tax issues that can strain resources and drain profits. They should keep in mind these tax tips, which can possibly help them save money in the long run.

1. Understand your partnership or LLC agreement. Do you truly understand your partnership or LLC operating agreement? Do you know if the allocations among members have “substantial economic effect”? Do you know what a qualified income offset provision is? Do you understand minimum gain? In real estate matters, operating agreements typically address these and other important tax issues. Chances are your agreement is written with such issues in mind, and it is important that you understand them completely.

2. Consider the tax consequences of distributing appreciated property out of a partnership. Property held for sale that has substantially appreciated in value is a so-called “hot asset.” Ordinary gain can be triggered on the distribution of a hot asset, and careful tax planning is recommended prior to such a distribution.

3. Maintain three sets of partnership books. If your entity is a partnership, are you maintaining three sets of books? If not, you may not be following the required tax rules and your allocations among partners may not be valid.

4. Determine if you are a dealer or an investor. Do you know your status as either a dealer or an investor for tax purposes? Proper planning upfront will ensure the desired treatment upon disposition of the property.

5. Allocate land cost to your benefit. To defer income upon the sale of parcels from a tract of land purchased, proper allocation of the cost among the various parcels must be done. The IRS requires that the cost be “equitably apportioned.” But how? There are several methods available that should be considered when allocating cost.

6. Evaluate your capitalization methods for preconstruction costs. Are you capitalizing direct and indirect costs on property that is held for future development? Are you capitalizing property taxes incurred if it is reasonably likely that the property will be developed? If not, you may not be following the required tax rules and the deductions you are taking could be disallowed.

7. Exchange real estate for a “bond.” Would you like to cash out of real estate but defer your gain? Generally the only way to defer gain in the long term is to exchange into more real estate. However, you may be able to affect the tax consequences by exchanging into real estate that has the attributes of a bond.

8. Take full advantage of depreciation. Has your company recently undertaken new construction projects, expansions or renovations? Substantial long-term savings could result from a cost segregation study which categorizes your assets into the appropriate and most tax-advantaged depreciable lives.

9. Consider yourself a manufacturer. As a real estate owner, do you also consider yourself a manufacturer? Perhaps you should. The final regulations for the I.R.C. Section 199–Domestic Production Activities Deduction may apply to some activities for companies within the real estate industry, including construction companies, homebuilders and engineering and architectural firms. There may be an unexpected tax benefit for you.

10. Reward key executives. Do you have key executives that you would like to give a piece of “the action” as a member of your real estate partnership? If structured properly, this may be accomplished without immediate income recognition by these executives.

Bridgett Earnhardt is manager of Grant Thornton’s real estate industry practice group. For more information, visit

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