Tax Elections Real Estate Investors Need to Know

Real estate investors spend a lot of time thinking about deductions, depreciation, cost segregation, and entity structures. But tax elections can be just as important.

Some elections appear as separate statements on a tax return. Others happen by checking a box, filing a form, or taking certain actions during the year. The problem is that some of these decisions can be difficult or impossible to change later.

In this episode of the Tax Smart REI Podcast, Nate Sosa and Justin Shore discuss several tax elections real estate investors should understand before filing.

Real Estate Professional Status and the Grouping Election

Real estate professional status itself is not an election. You either qualify, or you do not. However, investors who qualify may elect to group multiple long-term rental properties together when determining material participation.

Once the grouping election is made, it generally continues in future years. Nate and Justin also discuss situations where it may be possible to revoke the election after a material change in facts and circumstances.

Electing Out of Bonus Depreciation

One of the biggest issues covered in the episode is electing out of bonus depreciation.

Taxpayers can elect out of bonus depreciation for a particular class of property, but doing so can limit future options. This becomes especially important if an investor later wants to complete a look-back cost segregation study and catch up depreciation through a Section 481(a) adjustment.

A cost segregation study may still provide benefits, but an earlier election out of bonus depreciation can reduce the depreciation available.

Installment Sales

Installment sales can allow taxpayers to recognize gain as payments are received instead of recognizing the entire gain in the year of the sale.

This can help spread a large capital gain over multiple tax years. However, failing to properly report installment sale treatment can effectively result in an election out of it, and changing that decision later may not be possible.

Nate and Justin also discuss how installment sales can interact with capital loss harvesting and why the timing of income and deductions matters.

1031 Exchanges

A 1031 exchange is often viewed as the default choice when selling appreciated real estate, but it may not always produce the best tax result for a particular situation.

Once an investor completes the required steps, including using a qualified intermediary and meeting the identification and closing deadlines, the transaction has been structured as a 1031 exchange.

That is why investors should review the numbers with their tax professional before completing the transaction rather than assuming deferring the gain is always the right approach.

Section 754 and Business Grouping Elections

The episode also covers Section 754 elections for partnerships. These elections can become important when partnership interests change hands or a partner dies. Once made, the election generally continues for the partnership.

Nate and Justin also discuss Section 1.469-4 business grouping rules, which can allow certain business activities to be grouped when they form an appropriate economic unit. The timing of this election matters, making it another area to address with a tax professional before filing.