As a real estate investor, there is the possibility of ending up with passive activity losses. Unused passive activity losses are suspended until they can be offset against passive activity income. However, of you actively participate in passive rental real estate activity, there is a special exception that allows you to deduct up to $25,000 to offset nonpassive income.

Mortgage interest deduction

If you take a home equity loan from your residence to purchase real estate, you are allowed an interest deduction on qualified property with mortgage of up to $1,000,000 ($500,000 MFS) and $100,000 ($50,000 MFS) of home equity loan. This is only helpful to taxpayers who itemize their deductions. If you do not itemize, you lose the potential of deducting the interest expense. This does not sound fair to real estate investors who use personal property to finance real estate transactions.

Fortunately, the tax provision provides a tax relief for real estate investors who mortgage their home for real estate purposes. Regulation section 1.163-8T provides that interest may be traced according to the actual use of the loan proceeds. In other words, if interest is used for investment purposes, the interest may be deducted as an investment expenses.

In the case of using home equity loan to finance real estate, taxpayers can make a 10-T election. A 10-T election allows the taxpayer to deduct interest on personal residence as if it was taken on the investment property. Once you make the election, it is effective for the tax year in which it is made and for all subsequent tax years unless revoked with consent from the IRS consent. A person who uses this election must keep good documentation in order to trace the portion allocable to the investment property.

Who should make the 10-T ELECTION?

A 10-T election is not beneficial for all taxpayers and should be decided on a case by case basis. In general real estate investors with the following tax situations will gain the most advantage:

• A real estate investor who has maximized schedule A interest deduction
• A real estate investor susceptible to AMT taxes
• A real estate investor with passive activity income or loss less than $25,000

How to make the election

An election statement should be attached with the tax return in the year the debt is acquired. The tax code does not specify any specific format so simply attaching a note that states the intention will be sufficient. Here is an example for Sally Cook:

Election Pursuant to Regulation 1.163-10T (o) (5) to Treat Debt as Not Secured by a Qualified Residence

2014 Form 1040

Sally Cook with SSN 123-45-9868 elects to treat $100,000 of home equity indebtedness, the proceeds of which were used to purchase a rental 2 bedroom town home, as rental activity indebtedness.

The interest on this indebtedness for the tax year was $2, 000 and is being claimed on line 12 of the Schedule E.

As always, contact your CPA for more personable advice