Taxation of Real Estate Net Income
Real estate activity is taxed as a business on its net income. The income statement from the activity is prepared and federal and state tax is computed from the profits.
- gross income comes from rents and any other receipts (coin operated laundry...)
- operating expenses corresponds to insurance, fees, repairs, management fees, home office costs
- interest from mortgage and credit card are also deductible
- depreciation from improvements and property that have a life above 12 month are also deductible.
- taxable income is net income = gross income - expenses - interest and depreciation
If spending is categorised as operational expense, it is fully deductible, if it is categorised as a capital expenditure (if it is an improvement rather than a repair) it can be categorised as a capital expenditure, in which case is needs to be depreciated. There are many IRS rules dealing this categorisation.
The deductions allowed are substantial. There are rules intended to limit how much deductions can be applied on a return in a given year. Those are the Passive Activity (PAL) and At Risk Rules.
Non Resident Aliens need to elect for their activity to be taxed as ECI (Effectively Connected Income) to choose this regime. The alternative treatment of property income is FDAP withdrawal of 30% of all monies distributed.