What is the GO Zone?
The GO Zone (short for Gulf Opportunity Zone) benefits for residential real estate investors apply to investments made in the regions heavily damaged by the hurricanes that hit the U.S. Gulf coast in the summer of 2005 (areas defined by the GO Zone Act). This page is intended as a high level overview of what those benefits are and how they can be used by the average investor. Nothing contained herein should be construed as legal or financial advice. We strongly recommend that should you be interested in GO Zone investments that you obtain independent financial and/or tax advice.
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GO Zone = Depreciation. For the residential real estate investor the GO Zone is all about depreciation. As most of us know, under "normal" circumstances it is quite possible to have an annual positive cash flow on a residential rental property and yet report a tax loss. For instance, let's use a fictional $240,000 rental property as an example. If we determine that the lot is worth $40,000 and the improvements (the house, driveway, landscaping, etc.) are worth $200,000 then every year for 27.5 years (excepting the first and last which are partial years) we would have an approximate $7200 depreciation deduction to deduct from that property's income.
What the GO Zone does to this "normal" house is provide for an extremely accelerated depreciation schedule whereby half of the total available depreciation can be taken the first year as bonus depreciation. The remaining half is treated normally. Using the example above our first year depreciation deduction would now be greater than $100,000!
For this bonus depreciation to apply the property in question must fit some guidelines as spelled out in the legislation. First it must be located in one of the areas of destruction as defined in the GO Zone Act. Additionally there are requirements related to when the property was built (after the hurricanes), what it is being used for (a rental), and original ownership, etc.
Other Tutorials
For purposes of this primer we are more concerned with that example $100,000 depreciation deduction and what the average investor can use it for. We'll use three broad examples. In all the examples let's say that the property broke even from an operating expense point of view (income minus its expenses) and the $100,000 bonus depreciation represents our passive loss on this property.
Example 1 - Other passive income. Residential rental property losses are passive losses. In general you can deduct passive losses only from passive income (and NOT from other active income (your job) or portfolio income (stocks, etc)). In this example if you owned other rental properties that are producing passive income you could deduct this $100,000 passive loss against that other income up to the full amount of passive income you had that year. There are no limits. If you had $60,000 in passive income from other rentals (after their own depreciation deductions) you could offset that $60,000 in income with $60,000 of your passive loss from your GO Zone property and still have $40,000 left over to use next year! This is the easiest method to understand but for most people is an unlikely scenario unless they've owned rental properties for a number of years.
Example 2 - The $25,000 offset. After deducting from any available passive income the next step would be to check into the $25,000 offset Congress set up for small investors. This $25,000 offset allows for a limited deduction against "Active" income (i.e. W-2 income, etc) and applies to people who "actively participate" in their properties and who meet certain income limits.
First, "active participation". Active Participation and Material Participation (covered later) represent two different levels of involvement in your personal rental properties. For the $25,000 offset you must actively participate in the management of the property. Since a GO Zone investment is very likely to be "long distance" you'll almost certainly have a property manager (as with any other long distance property). You can still actively participate if it is clear that you are the one in charge of the property. You'll want to be the one setting the rental amounts, having final approval on tenants and so forth. The manager is just there to do your bidding. Contrast this to a more "non-active" approach where you simply get rental statements and have no general idea as to what is going on with your property. It should be noted here that active participation is a fairly simple test to meet, even on longer distance properties.
Assuming you "actively participate" the next test of the $25,000 offset is the income test. If as a single person or a married couple filing jointly you earn $100,000 or less in adjusted gross income in the tax year you acquired your GO Zone property then you are allowed to offset up to $25,000 of that income with passive losses from your rental real estate including losses derived from that bonus depreciation on your GO Zone property. As your adjusted gross income (AGI) increases over $100,000 your offset diminishes by 50 cents on each dollar until finally at $150,000 there is no offset. For example if your AGI for the year is $110,000 then your allowed offset is $20,000.
As before, what doesn't get used up this year rolls forward to the next. Using our example $240,000 house a person could end up deducting $25,000 from their W-2 income for the next four years!
For those who are married filing separately the rules are slightly different. See your tax professional.
Example 3 - The Tough one! The last example we'll talk about is the one most often mentioned when speaking of the GO Zone. Unfortunately this example, while certainly the most attractive tax-wise, is also the toughest to qualify for. In fact, the vast majority of people who THINK they qualify for this actually don't.
This exemption is called the Real Estate Professional Exemption and comes in two parts. There is no way in a short paper like this to fully explain this exemption but the idea is that IF you are classified as a real estate professional AND you "Materially Participate" in your properties' management (vs. the lesser active participation mentioned in the previous example) then there are no limits as to how much of this year's passive losses can be deducted from your other active income. For our example home the entire $100,000 passive loss could be deducted in one year!
Before anyone gets too excited about this it should be mentioned that if a property is long distance from you and/or if you have a property manager it is going to be VERY difficult to claim that you materially participate in that property. The second part of this exemption is that you must be deemed a real estate professional. Many licensed real estate agents think they meet this test. There are other ways to be a "real estate professional" but using the licensed agent as an example we can explore how this works. First you must spend at least 751 hours during the year at your real estate business. If you work 50 weekends out of the year both Saturday and Sunday for eight hours each you would cover this test (16 hours x 50 weeks = 800 hours). If, however, you had another full time job on top of this you would fail because this 751+ hours did not represent greater than 50% of what you do for a living. If you worked 2,000 hours at "something" and 800 hours at real estate then you don't pass the real estate professional test and even if you manage your properties yourself the exemption fails. You can still use the $25,000 offset above (if you qualify) but this more aggressive professional exemption is out of reach.
Please note that this last exemption is very complicated. If you feel you qualify (or may qualify) be sure and talk to your tax professional. A good tax accountant can certainly help you with this.
What else should you know about the GO Zone? One thing that comes to mind is that there are time limits. Benefits are expiring. If, however, you purchase a GO Zone qualified investment in time your benefits are cast then regardless of when you're able to fully use them. In other words if you were able to use the $25,000 offset and $40,000 in unused bonus depreciation is still out there waiting to be used it doesn't go away. The benefit was received when you purchased the property and put it up for rent. All the rules above about who can use what are not GO Zone specific. They're simply normal tax rules that apply, GO Zone or not. If you PURCHASE the property after the deadline, however, the benefits are lost.
Likely many readers of this paper will have heard of other methods of taking these deductions or differing time periods as to when deductions can be taken. A common theme is that these "paper" losses can be taken back years as well as forward. Please note that for the vast majority of investors examples 1 and 2 are your most likely scenarios. There is a lot of misinformation out there. If you're thinking other methods apply please talk to your tax professional.
Lastly, if all this simply sounds too complicated to bother with then maybe you need to reconsider real estate as an investment altogether. 99% of what's written above applies to EVERY PROPERTY YOU PURCHASE, GO ZONE OR NOT! The only thing that stands out from a GO Zone perspective is the amount of the first year depreciation allowed. The rules on what you do with that depreciation are the same as any other property you own.
