1031 exchanges, depreciation, tax benefits, entity taxation, deductions, and tax planning strategies.
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Foundation terms you need to know first (24 terms)
Accrual basis accounting records revenues when they are earned and expenses when they are incurred, regardless of when cash actually changes hands. This method provides a more accurate picture of a business's financial performance over time.
A tax refund is a reimbursement to taxpayers of excess tax paid to the government. For real estate investors, it represents a potential source of capital for new investments or property improvements.
The marginal tax rate is the tax rate applied to your very last dollar of taxable income. It's crucial for real estate investors to understand how additional income or deductions will impact their tax bill.
A tax credit is a direct reduction in the amount of tax owed, dollar-for-dollar, providing a significant financial benefit to real estate investors by lowering their overall tax liability.
An Employer Identification Number (EIN) is a unique nine-digit number assigned by the IRS to identify a business entity for tax purposes, often required for real estate investment structures like LLCs and partnerships.
Complex strategies and professional concepts (46 terms)
The accounting process of recognizing the estimated cost of an Asset Retirement Obligation (ARO) as a liability and capitalizing a corresponding asset, which is then depreciated over its useful life, reflecting the future costs associated with retiring a long-lived asset.
Unrelated Business Income Tax (UBIT) is a tax levied on the net income of a tax-exempt organization, including certain real estate investment vehicles, derived from a trade or business regularly carried on and not substantially related to its exempt purpose.
Tax-exempt debt refers to bonds or other debt instruments issued by governmental entities or qualified private entities, where the interest earned by the bondholder is exempt from federal, and often state and local, income taxes.
Premium financing is a sophisticated financial strategy where an investor borrows funds from a third-party lender to pay the premiums on a large insurance policy, typically a life insurance policy or substantial commercial property insurance, using the policy itself or other assets as collateral.
A Self-Directed IRA (SDIRA) is a specialized retirement account allowing investors to hold alternative assets like real estate, private equity, and precious metals, offering enhanced control but requiring strict adherence to complex IRS regulations to avoid prohibited transactions and Unrelated Business Income Tax (UBIT).
Paper losses, also known as unrealized losses, represent a decrease in the market value of an asset below its purchase price, but the asset has not yet been sold. These losses exist only on paper until the asset is actually sold.
A business structure, such as an LLC or S-Corp, where income, losses, deductions, and credits are passed directly to the owners' personal income tax returns, avoiding corporate-level taxation.
Passive Activity Loss (PAL) rules limit the deduction of losses from passive activities, such as most rental real estate, against non-passive income like wages or portfolio earnings. These losses are typically suspended and carried forward until passive income is generated or the activity is disposed of.
Passive income refers to earnings from an enterprise in which an individual is not actively involved, typically generated from real estate investments like rental properties, REITs, or syndications, requiring minimal ongoing effort after initial setup.
Penalty abatement is the process by which the Internal Revenue Service (IRS) or state tax authorities remove or reduce a tax penalty, typically due to reasonable cause, administrative error, or a first-time penalty waiver. It allows real estate investors to avoid financial penalties for certain tax compliance issues.
Penalty-free withdrawals refer to specific distributions from tax-advantaged retirement accounts, such as IRAs and 401(k)s, made before age 59½ without incurring the standard 10% early withdrawal penalty, provided they meet strict IRS criteria.
Phantom income refers to taxable income that an investor is required to report to the IRS, even though they have not received the corresponding cash or economic benefit.
Pre-tax funds are investment capital contributed before income taxes are calculated, allowing for tax-deferred growth or immediate tax deductions, commonly used in retirement accounts for real estate investing.
Premium financing is a sophisticated financial strategy where an investor borrows funds from a third-party lender to pay the premiums on a large insurance policy, typically a life insurance policy or substantial commercial property insurance, using the policy itself or other assets as collateral.
Private lending with life insurance policy loans involves borrowing against the cash value of a permanent life insurance policy to fund real estate investments, offering a flexible and often tax-advantaged financing method.
The Pro-Rata Rule dictates that allocations, distributions, or liabilities are divided proportionally among parties based on their respective ownership percentages, contributions, or claims, commonly applied in 1031 exchanges and partnership agreements.
Prohibited transactions are IRS-forbidden dealings between a tax-advantaged retirement plan (like an SDIRA) and a "disqualified person," designed to prevent self-dealing and misuse of funds.
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