I recently wrote (So you want to be a real estate mogul) about the “right way” to get involved in real estate investment.  You’ll remember that I suggested that you set up a corporation to hold all these properties; the business of the corporation would be real estate management.

Well, here’s another reason.  If you are not a real estate professional (remember, that means 750 hours a year), you are considered to be a passive investor.  Which means starting in 2013, you are probably subject to a surtax (3.8%) on your rental real estate income. This tax is part of the Affordable Healthcare Act  (Obamacare).  It’s one of the ways America will be able to pay for insurance for those that lack it. And, since the full scenario of this program has not yet come into force, it is possible that my interpretation is not correct- but don’t bank on it. (And, I am writing this before the election- which I am certain will yield no change in the Presidency; moreover, the Republicans will not be able to make such immediate changes in the law, anyway, if at all.)

Now, part of the issue is that many of the wealthier investors still consider rental property income the best way to make money.  Given the paucity of returns in the stock market and the banks, they are probably correct. You see, the tax only applies to married couples with $ 250,000 in taxable income (singles with $ 200K).  (Remember, that probably means your real income is closer to $ 335K, not $ 250K.)

One way to avoid this special tax is to effect a 1031 exchange, instead of an outright sale of property.  This is a special process whereby you sell your property and purchase a similar type property.  You can’t decide to do this after the fact, since a legal intermediary must be involved,  who takes possession of your money (from the sale of the first property) and dispenses it for the purchase of the second property.  And, you pretty much need to know which is to be the second property when you sell the first.

Or, you can participate in an UPREIT, an umbrella partnership real estate investment trust, a concept that has been around for 20 years.  Instead of selling your property, you merge the property into limited partnership with a new REIT (real estate investment trust) that has cash, forming an Operating Partnership (OP). This concept can be troublesome, however, since you can lose control of your property (ies). The REIT is the controlling partner who will now manage the properties, and you (and any other property owners) become a limited partner, with a share in the profits of the partnership based upon the percentage of value contributed at the start of the OP. Of course, you could have formed the new corporation as we suggested and precluded this entire mess…

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