The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate because just about every tax rule applying to real estate is different for the AMT than it is for the Regular Tax.  This second part of our four-part series on Real Estate and the AMT will address the most common form of real estate ownership – the taxpayer’s personal residence.  Typically this is a taxpayer’s largest purchase, and the differences in tax treatment between the Regular Tax and the AMT can be significant.

Following the order of the issues described in our previous overview article, here is a look at how they apply to a personal residence:

Interest expense

Interest paid on a loan secured by a taxpayer’s home, referred to in the tax law as “qualified residence interest,” is deductible for purposes of the Regular Tax, subject to a few limitations.  Interest on home acquisition debt is deductible in full to the extent the mortgage does not exceed $1 million, as is interest on home equity debt to the extent the debt does not exceed $100,000.  Home equity debt, typically a second mortgage or a home equity line of credit, can be used for any purpose – a car loan or a child’s education are examples.

Under the AMT, a taxpayer is allow a full deduction for home acquisition debt.  For home equity debt, however, it is AMT-deductible only if it is used to improve the residence, i.e., if it used for other purposes, such as the car loan or student loan mentioned above, it is not deductible for the AMT.

Planning idea – look to alternative means of financing instead of home equity debt when financing automobile purchases, college tuition, or other personal purposes.  A special-offer automobile loan at 1.9%, for example, certainly would be less expensive financing than a home equity loan for an AMT payer.

Property taxes

Property taxes are allowed in full for Regular Tax purposes, but, along with all other state and local taxes, are not allowed at all as a deduction for the Alternative Minimum Tax.

Planning idea – if you have an opportunity to pay your property tax bill either this year or next, pay it in a year that you are not in the AMT.  Depending on levels of income, itemized deductions and other factors, taxpayers may find themselves in the AMT one year but not the next.

Example – in Florida, property tax bills are mailed in October, and are payable under the following discount schedule: November – 4%, December – 3%, January – 2%, February – 1%.  If you are in the AMT in 2010 but expect not to be in the AMT again in 2011, do not pay your bill in November or December  - forgoing that small discount could save a taxpayer up to 39.6% of the amount of the property taxes on his Federal income tax bill next year.

Depreciation

Depreciation does not apply to a personal residence, except perhaps for a taxpayer claiming a portion of his residence as a “home office” or other business use.  This topic will be discussed in some detail under the topics of rental/investment property and business property in the next two articles in this series.

Active/passive investment rules and the “at-risk” rules

Similar to Depreciation, these rules will be discussed in the next articles in this series; they do not apply to property held as a personal residence.

Sale of the property

A sale of a personal residence is not taxable to the extent the gain does not exceed $500,000, for a married couple filing jointly, or $250,000 for a single taxpayer.  Any gains over these amounts are taxable, as long-term capital gains.  Capital gains in and of themselves are not an AMT item, but they nonetheless can result in AMT being paid.  This is because the AMT exemption amount is phased out for taxpayers at certain income levels, so this additional income can have the result of reducing the exemption which, in turn, increases taxable income for purposes of the Alternative Minimum Tax.

This issue is discussed in some detail in an article posted on amtblog.com on December 13, 2009.  This article also can be found by doing an internet search for “alternative minimum tax planning – investments – capital gains.”

Next in this series on Real Estate and the AMT – property owned as rental/investment property.

The Alternative Minimum Tax is a very important consideration for taxpayers who own real estate, because many of the rules that apply to real estate are different for the AMT than they are for the Regular Tax.  This article is the first of a four-part series on Real Estate and the AMT.  We’ll start with an overview of the differences in the rules, and then will drill down into the details in the three different situations taxpayers find themselves when they own real estate: 1) the taxpayer’s residence; 2) a rental/investment property; or 3) property used in the taxpayer’s trade or business.  These articles will be updated periodically to reflect future changes in the tax law that affect the Regular Tax and AMT treatment of real estate.

Here are the things we will be looking at:

Interest expense

Except for anyone who travels in the Buffet/Gates social circles, every purchase of real estate will be financed.  Financing, in turn, means that interest will be paid.  In general, the tax law allows a deduction for this interest for Regular Tax purposes, although a number of different limitations can apply.  These limitations vary, depending on whether the property is a residence, or is rental/investment or business property.  The separate AMT limitations that apply to real estate also vary among these categories.

Property taxes

Property ownership brings with it the obligation to pay property taxes.  In general, for Regular Tax purposes real estate taxes are deductible regardless of the reason for holding the property.  This is not the case for Alternative Minimum Tax payers, however, for whom the deduction may be totally disallowed in some situations, yet allowed in others, depending on which of the three classifications applies.

Depreciation

Depreciation is a deduction that allows a taxpayer to recover the cost of an investment in property, depending again on the taxpayer’s purpose for holding the property.  If depreciation deductions are allowable, the AMT has a set of rules different from the ones that apply for purposes of the Regular Tax.

Active/passive investment rules and the “at-risk” rules

In some cases the tax law’s active vs. passive investment rules, and/or the at-risk rules, will apply to individuals owning real estate.  These are overarching rules that supersede the other individual tax law limitations.  Even if they do apply, however, an AMT payer still must keep track of the separate AMT calculations required by the other limitations.

Sale of the property

Very few taxpayers hold on to property for life; at some point in the future it can be expected that the property will be sold.  A number of special Regular Tax rules apply to the sale of real estate, and, in most cases, an AMT payer will have a different set of calculations to make.

Conclusion

Real estate is one of the biggest purchases most taxpayers make, and it is likely there will be a number of real estate purchases and sales throughout the taxpayer’s lifetime.  The Regular Tax rules are complicated enough, but additional wrinkles exist in the calculations for Alternative Minimum Tax payers.  With a little knowledge, however, these complications and wrinkles can present some real tax planning opportunities for AMT payers.

The next article in this series will address the specific tax issues for real estate owned as a personal residence – certainly the most common form of property ownership.