Tax accounting

We're going to talk about that real quick. We talked already about cash or accrual. You have to pick one and go with it. If you file an individual tax return and you own the properties in your individual name, you are most likely going to be filing a Schedule E. That is where you would itemize your income and expenses. Then it would flow through to your normal tax return as either passive income or passive loss, depending on the situation.

If you have an LLC you're going to file a Schedule 8825. Basically it's the same form, but it would be a part of your LLC schedules.

Another thing you've got to remember for tax returns, and that is you are in theory required if you pay a vendor like a maintenance guy over $600 in the course of a year, you send that person a 1099 Schedule by January 31. Keep that in mind.

That's another thing about some of these software packages. At the end of the year you can go back and calculate that. It would have a list of vendors and the amount you paid and you can go back and figure it out. That's one of the advantages of having these software packages.

Depreciation

When you do your tax accounting one of the great things about real estate is you get to use depreciation. It's a pretty large concept and I don't want to go into it in great detail. I will just brush into it that you can take the value of your property, the net book value...

I'm not going to go into the net book value, but basically it's the purchase price plus any additions you've added to the property over the years, less any prior depreciation.

So it's the purchase price, plus what you spent to fix the property, less any depreciation that you've taken prior. You would divide that by 27-1/2 years and then divide that by 12 for each month. That is the amount of depreciation you can take each and every month.

What it should do in most real estate is even if you have a positive cash flow, when you add the depreciation as an expense for tax purposes it should take you to a loss. Most rental real estate should run at a loss. You should lose money in rental real estate on a tax basis.

You might make money on a cash flow basis, because they're different. Obviously depreciation is a non cash issue. Keep that in mind that one of the features of real estate is that you get to show a loss. That loss then goes into your tax returns.

Most people and the way they're going to operate real estate is going to be on a passive income basis. You're not going to qualify to be an active real estate investor. That's most people.

You have to look at the requirements within the federal guidelines to determine passive and active. Passive is you have a full time job and do real estate on the side. That's fine and that is truly a passive activity. There are fairly strict limits about how much of a loss you can carry through to your normal income.

If you are an active real estate investor - meaning traditionally you have probably have 25 hours a week and gather a substantial amount of the activity of the business - there are a number of tests you have to go through. If you are an active real estate investor there are several advantages on a tax basis.

One advantage is you are now allowed to use losses on your real estate business to offset your normal income up to I believe it's $25,000. If you had up to $25,000, you could deduct that from your normal tax return and that's a fairly substantial amount of money.