Among tax shelters, real estate is the oldest and most widely recognized - and the one that yields the richest benefits, according to tax experts. In its commonest form, this shelter involves one or more investors who buy a rental property. It is no longer limited to the rich; Inflation has pushed many people into higher income-tax brackets, and real estate shelters are now attractive investments for people even with moderate incomes.
In a smaller way, an ordinary taxpayer's home is a tax shelter, in that the homeowner can deduct interest paid on the mortgage from taxable income.
But in a typical real estate tax shelter, a syndicator sells interests in a partnership that will construct or buy apartment houses, shopping centers, theaters, mobile home parks, or other income-producing real estate. As a partner in a syndicate, an investor is entitled to the same benefits he would receive if he owned the property, plus additional write-offs that come from investing in income-producing property.
The shelter aspect is depreciation, which can be deducted from income even though it does not represent a cash payment by the investor. Under present law, all real property, new or used, is eligible for accelerated depreciation.
A big advantage enacted in the Economic Recovery Tax Act of 1981 is that real estate can be depreciated over 15 years under the Accelerated Cost Recovery System (ACRS), even if its useful life is much longer. Because depreciation permits a property owner to deduct the cost of the building or structure from taxable income (land cannot be depreciated), the new schedule provides bigger deductions over shorter periods.
The allowed percentages are either calculated over 15 years on an accelerated basis or are calculated on a straight line basis over 15, 35, or 45 years.
Under straight line depreciation, for example, a $300,000 property can reduce taxable income by $20,000 a year ($300,000 divided by 15) instead of by $10,000 a year ($300,000 divided by 30 years).
''This is one of the most significant pieces of tax legislation in years,'' maintains Stephen Puleo, a tax partner in the Boston office of Coopers & Lybrand , an accounting firm. ''It has probably stimulated more real estate action than any other piece of legislation in recent years.''
Suppose there are five investors. On a $1 million deal on a building that will have a lifetime of 40 years, where the investors put up the first 5 percent in cash - $50,000, or $10,000 apiece - and borrow the rest, the deductions would amount to a total of $66,667 a year ($1 million divided by 15, or 6.67 percent) to be divided among the partners in the shelter. Each would deduct $13,333 per year for the early years of the investment.
Using accelerated depreciation, the early deductions can be 1.75 times the base straight line amount, although deductions decline in later years.
As the building is rented out the investors would receive income to use in paying off the mortgage principle and interest and meeting operating expenses. Although the principal payments on the mortgage would not be deductible, the depreciation deductions would exceed the principal payments at first.
But before you rush into a real estate deal you ought to consider the tax risks. A tax shelter may be the last thing you need.
For instance, if you will have substantial capital gains from other investments, say stocks, during the past year, or if you've already invested in tax shelters that throw off what are known as ''tax preference items'' (like accelerated depreciation or intangible drilling costs), you might be subject to an ''alternative minimum tax.''
Although a minimum tax has been around for a number of years, the version in effect on your taxes after 1983 is new and requires your active consideration before you file your return.
An easy way to estimate the alternative minimum tax is to first determine what your taxable income is in the traditional way. Then, add back the applicable preference items and deductions that are allowed under the tax.
Subtract $40,000 if you're filing a joint return, and $30,000 if it's a single return. Take 20 percent of that sum. It is this figure that is your alternative minimum tax. Remember, you pay it if it is greater than your traditionally computed tax; otherwise, you owe the amount arrived at in the traditional manner.
To guard against paying increased taxes, the best thing you can do is be aware of the 1982 changes in tax preference items and deductions for 1983 income and consult your tax adviser, accountant, or lawyer to see how the new standards apply in your particular case.
Despite the tempting aspects of real estate investments, there are dangers that promoters sometimes don't bring to the attention of would-be investors. ''They often tell them, but it's tucked away somewhere in the middle of a 100 -page prospectus,'' says Peter L. Faber, a tax attorney with the Wall Street law firm of Winthrop, Stimson, Putnam & Roberts.
In the early years of a venture involving a new building, accelerated deductions for depreciation and interest on the mortgage greatly exceed the rental income from the property and ''shelter'' some of the investor's other income from tax. But the deductions get smaller each year, and about halfway through the property's useful life the annual income from the property will start to exceed the deductions.
Unfortunately, this taxable income must be used to make nondeductible principal payments on the mortgage. The tax on it must be paid from the investor's other income.
Tax experts warn prospective real estate investors to look at the investment as though the Internal Revenue Code didn't exist. If the investment doesn't produce enough income to pay expenses without the tax deductions, the bank will foreclose and you will have taxable income. Also, the flood of investment money pouring into real estate is raising the problem of ''too much money chasing too little product,'' says the Real Estate Research Corporation.
Indeed, last year (1983) public syndicators are expected to have attracted close to $4.5 billion in new investment funds, up from $2.7 billion in 1982. And private syndicators are pulling in as much as $20 billion - also largely from individuals, says Business Week magazine.
As many inexperienced investors and syndicators alike enter the field, the basics of real estate investment management are more critical than ever.
The locality of the property which the investor is buying as a shelter, especially locations outside an investor's home community, should be checked.
Attorney Faber tells of one deal involving an apartment building in a small town in Oklahoma that was miles from the nearest city.
Still, excellent deals exist in most parts of the country. The key is choosing the right one. Apartment buildings are particularly attractive in most areas, since vacancy rates have dropped to very low levels in many locations and rent increases are starting to outdistance the escalations of the consumer price index. Be sure that tenants pay all utilities, that the neighborhood is stable or improving, and that rent control isn't a problem.
Office buildings are another matter. They're hot in New York but not in Houston, for example, where there is a surplus.
Qualifications of promoters and lawyers also should be investigated, Faber said. And prospectuses should be gone over with care to see whether assumptions are accurate and whether lawyers or promoters are getting larger fees than the venture warrants.