How Investment Homes
Could Affect Your Taxes

Question: I currently rent a home, but would like to purchase a property to use as an investment. I make more than $100,000 a year and would like the tax benefits. Do I have to live in the property to take the maximum deduction? Also, if my spouse obtains a real-estate license and manages the property, will this provide additional tax benefits?

-- Ayr, Madison, Wis.

Ayr: You raise an interesting question: From a tax perspective, is it better to own property as a personal residence or as a producer of income?

Generally speaking, if you make more than $150,000 a year, you can't write off the "loss" (presumably caused in the main by depreciation) on investment property in the year it was received. If you earn between $100,000 and $150,000, you can deduct 50 cents on the dollar -- up to $25,000. Depending on your actual income, you might be able to claim a sizeable deduction.

On the other hand, if you convert the property to a personal residence, you can write off both mortgage interest (up to very high limits) and real-estate taxes. In addition, with a personal residence, provided you meet the requirements, you can exclude up to $250,000 ($500,000 for a married couple) of your capital gains when you sell. Of course, you must live in the property for a set period of time and can't rent it out for more than two weeks per year; some special rules apply.

Regarding adding a real-estate license to the mix, I have found that this is only a hindrance -- not a help when investing. To get the write-off of as much as $25,000 on investment property, you must actively participate in its management. But I have never heard that having a real-estate license is a necessary ingredient for this. On the other hand, real-estate agents who frequently buy and sell properties can find themselves declared "dealers in real estate" by the Internal Revenue Service, making them unable to claim the advantages of capital gains, and forcing them to pay taxes on property profit as ordinary income.

One thing should be clear: This is a confusing and complex subject. Before taking any action, consult with a professional tax adviser.

-- Mr. Irwin has more than 25 years' experience as a Los Angeles-area real-estate broker. He is the author of more than two dozen books about real estate and is recognized as one of the most knowledgeable writers in the real-estate field. Mr. Irwin's most recent book is "Tips and Traps When Renovating Your Home," (McGraw-Hill, 2000).

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