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2	Real Estate Taxation Real estate and taxes are inherently intertwined. Taxes affect real estate and real estate values in at least three ways. From the standpoint of tax savings against other active income. (Depreciation) From the standpoint of real property taxes, an expense, that is normally deductible from active income. From the standpoint of taxable gain upon the sale of the real estate.
3	Classifications for Taxation Real estate has different tax preferences depending on the way the real estate is used, and whether or not there are improvements on the property. The personal residence is entitled to some tax benefits. Income or Business property is entitled to most of the tax benefits of personal residence property, and is privileged to other tax advantages as well.
4	Personal Residence. The personal residence has two periods in time when taxes come into play; 1. During the ownership. a. Property taxes are deductible b. Interest on loans are deductible c. Gains from the sale may be taxable d. Method of holding title can be critical. 2. Upon the sale of the property. a. During certain time periods. b. Amount of gain.
5	Personal Residence Page 2 During the ownership we have property taxes. Property taxes in California are based on 1% of the purchase price of the property. They are allowed to increase 2% annually. Let’s look at an example of property taxes. A couple purchases a home for $400,000. The property taxes on the home will be $4,000 the first year that they own the property. Mathematically this would look like this; Purchase Price X Tax Rate = Year one Taxes $400,000 X 1% = $4,000
6	Personal Residence Page 3 Each year that this couple owns the home the taxes will increase 2%. Look at this year by year; Year of purchase = $4,000.00 Year 2 = $4,000.00 X 1.02 = $4,080.00 Year 3 = $4,080.00 X 1.02 = $4,161.60 Year 4 = $4,151.60 X 1.02 = $4,244.83 Year 5 = $4,244.83 X 1.02 = $4,329.73 Year 6 = $4,329.73 X 1.02 = $4,416.32
7	Personal Residence Page 4 Each year that the owner owns the property they are entitled to deduct this tax from their adjusted income. They then benefit from the savings that this tax deduction generates. Often we speak in terms of Marginal Tax Brackets. A Marginal Tax Bracket is stated as a percentage. The next dollar earned, or the next dollar in deduction will earn or cost an amount equal to this Marginal Tax Bracket.
8	Personal Residence Page 5 Let’s say that our couple is in a 40% combined marginal tax bracket, State and Federal. Their savings would look similar to this; Marginal Tax Year Taxes Bracket Savings 1. $4,000.00 40% $1,600 2. $4,080.00 40% $1,632 3. $4,161.60 40% $1,665 4. $4,244.83 40% $1,698 5. $4,329.73 40% $1,732 6. $4,416.32 40% $1,767
9	Personal Residence Page 6 The second area that we would encounter is the gain from the sale of a property. When our couple purchased the property for $400,000 that was their tax basis or book value. This book value sets a benchmark for any gain that might be realized, over time, upon the disposition of the property. As an example let’s say that this $400,000 property increases in value 5% annually for 6 years, what would be the gain from this property?
10	Personal Residence Page 6 Year Value Appreciation Year End Value 1. $400,000 5% $420,000 2. $420,000 5% $441,000 3. $441,000 5% $463,050 4. $463,050 5% $486,202 5. $486,202 5% $510,513 6. $510,513 5% $536,038
11	Personal Residence Page 7 The home has increased $136,038 over the five year period. If the couple would sell right now they would have two situations to consider. 1. The gain from the sale 2. The basis of the new property 3. Possible taxes 4. What you do with any gain
12	Personal Residence Page 8 Net Proceeds From The Sale Of The Property; There are costs in the sale of a property, the loan is usually being paid down, equity build-up, and the property will increase in value over a period of time. Sales Price of Home $536,000 Less Expenses of Sale 8 ½% ($ 45,560) Less Loans of Record ($292,474)* Net Cash Close of Escrow $197,966 * The loan was estimated to be $320,000 at 6% interest, amortized for 30 years, and payable in equal monthly installments of $1,918.56
13	Personal Residence Page The Tax Picture Is Different From The Cash At Close of Escrow: The tax obligation, or picture is calculated differently from the COE. Sales Price of Property $536,038 Less Expenses of Sale ($ 45,563) Less Adjusted Tax Basis ($400,000) Net Tax Loss or Gain $ 90,475 If this home was sold, and it was subject to a taxable gain, then this sale would have generated a taxable $90,475 gain.
14	Income Property Income property is a different issue. Income property is privileged to more deductions. Income property has the same deductions as a persons personal residence, but there is more. Owners of income property can deduct expenses of operation, taxes, utilities, repairs, insurance, and additionally income property qualifies for a thing called depreciation.
15	Income Property - Depreciation When property produces income, the improvements, buildings, are entitled to an annual deduction from value called depreciation. Depreciation can only be taken against the improvements, never the land. Let’s look at an example of a building, it’s write off, it’s income and depreciation, and the losses that the property will generate. First against its own income and then whatever is leftover against the owners active income.
16	Income Property - Depreciation
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