California imposes taxes on any gain accrued during the property’s ownership within the state — even if the property is exchanged for one outside California. This rule effectively ensures that the state captures its share of taxes on California-based investments, no matter where your portfolio grows. Lastly, California’s top marginal income tax rate of 13.3% — the highest in the nation — can significantly impact high-income earners. The state’s aggressive tax policies can increase your financial burden, whether your income is derived from rental properties, a business, or capital gains from real estate sales. Some investors even consider relocating to avoid these rates, but California is known for pursuing taxes aggressively, even after individuals have moved out of state. Contact Dahl Law Group at our offices in Sacramento or San Diego to discuss how we can assist with your real estate and tax planning needs.
Federal Benefits vs. California Limitations Qualifying as a Real Estate Professional
TAX IMPLICATIONS OF CALIFORNIA’S HANDLING OF REPS.
The California real estate market offers magnificent opportunities to create a highly profitable portfolio, but the legal landscape creates unique challenges. FEDERAL LAW VS. CALIFORNIA LAW: HANDLING OF REAL ESTATE PROFESSIONAL STATUS (REPS). Qualifying as a real estate professional at the federal level allows eligible taxpayers to offset passive rental losses against other ordinary income (such as wages). However, California does not follow these federal rules at the state level. Federal law establishes strict criteria to achieve REPS status; a taxpayer must meet the following requirements: • Spend at least 750 hours annually in a real estate trade or business in which they materially participate. • Spend more time on real estate activities than any other occupation. • Meet material participation standards in real estate activities, which generally require actively managing properties rather than hiring a management company. A crucial federal rule affecting REPS classification is the 30-day rule. If a taxpayer leases a property for fewer than 30 days and materially participates in its management, it can qualify as non-passive for federal tax purposes, potentially increasing tax savings. FEDERAL TAX SAVINGS AND EXCEPTIONS FOR REPS. The federal tax benefits of REPS can be significant. Qualifying taxpayers can fully deduct rental losses against their ordinary income by classifying them as non-passive. Without REPS, rental losses are generally limited to $25,000 per year for taxpayers with modified adjusted gross income (MAGI) under $100,000, and this deduction phases out entirely for MAGI over $150,000.
California’s unique tax treatment of real estate extends beyond REPS. For instance, the state does not allow federal bonus depreciation, which lets investors accelerate tax deductions for property purchases. Instead, California requires its depreciation schedules, often resulting in higher compliance costs. Maintaining separate records for state and federal purposes is not just an administrative burden; it can also lead to unexpected tax liabilities. Another significant challenge is California’s “clawback rule” for 1031 exchanges. While 1031 exchanges allow investors to defer federal capital gains taxes by reinvesting proceeds into similar properties,
Classic Fish Fry
Inspired by FoodNetwork.com
We’re in the middle of Lent, so there’s no better time to host your own fish fry for your loved ones!
Ingredients • Vegetable oil • 2 lbs fresh cod • Salt and pepper, to taste • 1/2 cup all-purpose unbleached flour • 2 large eggs
• 2 tbsp water • 2 cups plain bread crumbs • 1/2 tsp mustard powder • 1/4 tsp cayenne pepper • Lemon wedges
Additionally, there are specific exceptions to passive activity loss limitations or special rules under federal law:
• The rental activity may be treated as non-passive if the average stay per tenant is less than seven days or if the taxpayer provides significant personal services. • Taxpayers may group real estate activities with other trades or businesses under certain conditions to meet material participation standards. • Real estate professionals who do not qualify under REPS may still claim deductions for mortgage interest, depreciation, and other expenses that reduce taxable rental income at the federal level.
Directions 1. Pour 2 inches of vegetable oil into a large skillet over medium-high heat. 2. Cut cod into 4 servings and season with salt and pepper. 3. Place flour into a pie tin. Whisk egg and water in a second pie tin. Combine bread crumbs, mustard powder, and cayenne in a third pie tin. 4. Coat your fish in the flour tin, then the egg tin, then the bread crumb tin. 5. Set coated fish in hot oil and fry for 5 minutes on each side. 6. Serve with lemon wedges and enjoy!
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