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Figuring Tax May Take a Little Longer : Several Code Changes Will Affect Returns of Real Estate Owners

February 07, 1988|DAVID W. MYERS | David W. Myers is a Times real estate writer. and

It's tax season again, and millions of homeowners and real estate investors are trying to figure out how to cope with several changes in the nation's tax laws.

The changes limit write-offs some homeowners can take for mortgage-interest payments, and hurt investors who relied on tax breaks to make their deals feasible.

But even though filing your taxes is going to take more of your time, "most homeowners and small investors will probably be O. K.," said Phil Kavesh, partner in the Torrance-based financial planning and accounting firm of Kavesh & Gau.

Regardless of when you bought your house, you can deduct all the interest paid on your mortgage if all the funds were used to purchase a first or second home, or to improve the property.

Available Deductions

If the funds were used for other purposes, you can still deduct all interest if the mortgage was taken out on or before Aug. 16, 1986, and you didn't borrow more after that date.

Even if you borrowed against the property after that date, you may still be able to deduct all the interest. However, you'll have to do some figuring (see related story on Page 5).

The most important change for investors concerns losses from "passive" investments, such as limited partnerships and, in some cases, rental property that you own by yourself. Such losses can only be used to offset income from passive investments: If you don't have any "passive income," you can't write off any "passive losses."

Most small investors don't have to worry about the new rules because they manage their property themselves and thus qualify for an important break provided "active" investors, said Jeff DeBoer, a tax expert with the National Assn. of Realtors.

Active Investors

"Even if someone manages the property for you, you'll probably be considered active if you make recommendations on what rent should be charged, and if you approve the tenants and expenditures," he said. Active investors can deduct losses of up to $25,000 on rental property from their other sources of income as long as their adjusted gross income doesn't exceed $100,000.

If you can't write off all the losses, here's something that may soften the sting: If the property was placed into service before Oct. 22, 1986, the passive-loss restrictions will be phased in gradually. On your 1987 return, 65% of those losses are deductible.

Unused passive losses can be carried forward to offset passive income in future years or subtracted from profits when you sell.

Equally complicated rules apply to vacation homes.

Rental, Personal Use

If you use the property for 14 or fewer days--or less than 10% of the time it is rented out, whichever is greater--it qualifies as a rental. To determine deductions, expenses must first be allocated between rental and personal use.

Rental losses are considered passive losses unless you're considered an "active" investor. You can't deduct any mortgage interest for time allotted for personal use.

If you use your vacation home more than 14 days a year--or more than 10% of the time it is rented out--it's considered a personal residence. You can deduct all interest on the property, subject to the conditions mentioned earlier. However, deductions for rental expenses can't exceed the rental income the property generates.

Owners of vacation homes who will lose write-offs because of these new rules should consider two options. First, it may pay to refinance the primary residence and use the proceeds to pay off the mortgage on the vacation property. Doing so may provide more interest deductions and virtually assures that the vacation home will generate positive cash flow.

Other Tax Steps

As an alternative, Kavesh said it may pay to use the property long enough so it qualifies as a residence, so all interest payments will be deductible.

Here are some other steps experts say could reduce your taxes for 1987 or in '88: --If you own rental property, try to include fees for accounting, safe-deposit boxes and the like as rental-property expenses instead of miscellaneous expenses. Deductions for miscellaneous items have been limited, but rental expenses can be subtracted directly from rental income.

--Consider the benefits of tax-deferred exchanges and installment sales.

--If you sold your home last year--or are thinking of selling this year--remember that you can defer taxation of the profits as long as you buy a home of equal or greater value within 24 months.

--If you have passive losses that you can't write off, talk to an accountant to see what can be done. If there's no way to begin writing off the losses as they're accrued, consider selling the investment and deduct unused losses from the resale price.

--If you're 55 or older, you can still sell your home and keep the first $125,000 in profits tax-free, even if you don't reinvest the funds.

--Recent legislation has limited deductions for interest payments on expensive homes and home-equity loans. Although the rules don't affect your '87 return, they may affect your filing for '88. Check out these rules if they might affect you.

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