At Green Mountain Realty, our commercial real estate brokers occasionally get asked about “phantom income.” Phantom income can sometimes affect commercial real estate investments when the IRS determines that the taxable income exceeds the “actual” income to the investor. Many novice investors don’t realize how this can happen. Our brokers know that phantom income can occur when there is financing in place on a commercial real estate property. The IRS only allows the interest portion of the mortgage payment to be deducted for tax purposes. The principal portion of the mortgage payment is not deductible as an expense. The IRS treats the principal reduction as taxable income or “phantom income.”
Our Commercial Real Estate Brokers Educate Investors to Minimize Losses
Our Asheville NC commercial real estate brokers know that amortization schedules are structured to allow very little principal reduction in the early years of a loan. However, as the loan gets older, more and more principal is paid and less of the mortgage payment goes to the interest. While that may be great to reduce the loan balance more quickly, it can wreck havoc on a commercial real estate investor’s tax return. In the early years of the loan, the phantom income or principal reduction is usually offset by the depreciation that the investor takes on the building. However, at some point, the principal reduction becomes larger than the depreciation. At this point, the investor is paying taxes on money that he did not receive but went to the mortgage holder.
Phantom Income Taxes could destroy a Real Estate Investors Portfolio
Many commercial real estate investors have been bankrupted because they failed to understand this principle. At some point, it becomes necessary for the investor to refinance the mortgage to start the amortization schedule over again. Our commercial real estate brokers recommend that the new remaining term be close to the remaining years on the original loan. Of course, we recommend that investors seek professional tax advice. Call the Asheville commercial real estate professionals at Green Mountain Realty for a free consultation and to talk more about phantom income.