As a bankruptcy attorney I have seen plenty of individuals, who have lost money on rental real estate investments in the last few years. This can prove quite a letdown after people buy a house or an apartment building with the hope of building a nest egg for their future. Fortunately though compared to people, who have lost money on their principal residences, the tax law is more generous with people who invest in rental property.
A building owned for rental purposes is covered by Section 1231 of the Internal Revenue Code. Section 1231 assets include most property which is held for more than one year and used in a trade or business or for the production of income. Such an asset receives special tax treatment when it is sold.
When a Section 1231 asset is sold, any gain is treated as capital gain, which means the tax rate on the gain will be considerably lower than the tax rate on ordinary income. For most property which is entitled to capital gains treatment there is a potential downside in that, if the property sells for a loss it will be treated as a capital loss, and capital losses create a number of hurdles for claiming the benefit on your tax return. For example you can only deduct a net capital loss of $3,000.00 or less against ordinary income on any year’s tax return.
When a Section 1231 asset is sold at a loss though the taxpayer may treat it as a loss deductible against ordinary income. This can produce a considerable break for someone, who has made an unlucky real estate investment in the last few years .
The Section may not produce as much of a benefit though for a large landowner who has bought and sold a number of rental properties. This is because, when you have net 1231 gains in any tax year, you will have to reduce the amount that can be treated as capital gain income by the amount of Section 1231 losses which you incurred in the prior five tax years.
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