Sherman L. Doll, CPA, PFS

With real estate prices so low, I'm thinking about buying a single-family home as a rental property. Is it true that I can deduct the tax loss from this type of investment against the salary from my practice?

The problem with rental activities is that they generally fall into the category of "passive" activities. Thus, rental losses you incur can only be deducted against passive income. However, if you "actively participate" in the residential-rental activity, you may be able to deduct a loss of up to $25,000 against ordinary, or "non-passive," income, such as your salary or investments. You actively participate in the rental activity if you make key management decisions such as whom to rent to, the rental terms, approving capital expenditures, etc. You also can show active participation if you arrange for others to provide services. (Active participation does not require regular, continuous, or substantial involvement with the property.)

If you meet the above tests, you can claim up to $25,000 in losses against non-passive income ($12,500 if you're married, file separately, and live apart from your spouse for the entire year-but you're not eligible for this break at all if you're married, file separately, and 

 live apart from your spouse for the entire year). If your adjusted gross income is above $100,000, the $25,000 allowance is reduced by one-half the excess above $100,000. Under this rule, if your adjusted gross income is $150,000 or more, the allowance is reduced to zero.

 (please include your regular postal address). Answers to our readers' questions were provided by Sherman L. Doll, CPA, Thomas, Wirig, Doll & Co., Walnut Creek, California.

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Q&A: Deducting losses from real estate investment

I hear radio ads and see things on the internet that say there are advantages to incorporating in states that don't levy income taxes. Is that true?

For a physician, unless you're practicing in that state, the answer is no. You must incorporate as a professional corporation, not a regular corporation, in order to practice medicine. That must be done in the state in which you practice. You're also taxed in the state in which you practice, not the state where you're incorporated.

Q&A: Incorporating in other states

Most of my investments are in mutual funds. A friend of mine told me that I should pay attention to a fund's expense ratio and seek funds with low expenses. What does this expense ratio include?

All mutual funds, including no-load funds, have expenses that are passed along to investors. These expenses typically average about 1.3 percent per year in stock mutual funds, but the range of actual expenses can vary dramatically. Some index funds have annual expenses as low as 0.09 percent; other funds may have annual expenses of 2 to 3 percent. The level of expenses can depend upon the fund's investment objective. Large cap funds have-or should have-the lowest expenses; small cap and international funds typically carry higher expenses. Management style can also have an impact on expenses: Index and passive-asset-class funds generally have lower expenses than actively managed funds.

The annual expense ratio usually includes the following types of fees: accounting, administrator, adviser, auditor, board of directors, custodial, distribution, legal, organizational, professional, registration, shareholder reporting, sub-adviser, and transfer agency. The expense ratio does not reflect the fund's brokerage costs or any investor sales charges. This point is important because the fund's brokerage costs can be significant. In addition to noting a fund's expense ratio, you should determine a fund's turnover rate. This figure is disclosed in the fund's prospectus and on various investment websites. A turnover rate represents the percentage of a fund's holdings that have changed during the past year. For example, a turnover ratio of 50 percent means the fund holds a stock in its portfolio for about two years on average. A higher turnover ratio translates into higher expenses to the investor. A fund with a 50 percent turnover ratio is probably passing on an additional 0.5 percent of expenses to investors. This fee is in addition to those included in the annual expense ratio.

Author | Sherman L. Doll, CPA, PFS

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Q&A: Deducting losses from real estate investment

Q&A: Incorporating in other states

Q&A: Behind mutual funds' expense ratios