The marginal tax rate has long been an important tool for real estate investors. Your marginal tax rate is, of course, the percentage of tax that will reduce your next dollar of income. In other words, if you’re in the 38.6 percent tax bracket and earn an extra dollar, you will pay 38.6 percent of that dollar to the IRS.

Truth be told, a surprising number of taxpayers have an effective marginal tax rate that’s different from any of the official tax brackets. They are paying “stealth taxes” – a higher tax-rate than they originally qualified for.

If you thought you were in one tax bracket and ended up in a higher one, you probably wonder how this happened. The answer lies deep in the Internal Revenue Code, where the stealth taxes lay in wait in the form of phase-outs and limitations that inhibit you from claiming certain deductions, credits and other tax benefits. And as a real estate investor, you’re particularly vulnerable. Let’s take a look at some ways to avoid these tricky tax-boosting tools.

Passive Losses

The phase-out of allowances for certain real estate losses under the passive investing regulations require special attention. In a nutshell, losses from passive activities are generally deductible only to the extent of income received from other passive activities during the year. Remember, when most people sell or otherwise dispose of a rental activity, they can carry forward only excess losses to offset passive income in future years and deduct whatever is left.

As long as you qualify as a real estate professional, you can get around these rules and offset all passive real estate losses against ordinary income. To qualify, more than half of your working hours during the year, 750 at minimum, must be spent in a trade or business connected with real estate ventures.

Investors with less than $100,000 of adjusted gross income who don’t qualify under the real estate professional rule may still deduct up to $25,000 in rental real estate losses, if they are actively involved in managing the property. However, this exception also phases out as adjusted gross income rises above $100,000.

A word to the wise: If you don’t qualify as a real estate professional and your adjusted gross income rises above $100,000, your ability to take the $25,000 real estate loss deduction begins to phase out.

Limits and Exemption Phase-Outs

Instead of increasing your taxes directly, Congress figured out how to indirectly raise them by reducing your itemized deductions. Either way, the net result is the same: more taxes for higher-income real estate investors.

Miscellaneous expenses are one example where deduction limits apply. They aren’t tax-deductible unless they exceed 2 percent of your adjusted gross income. That means that if your adjusted gross income is $100,000, the first $2,000 of miscellaneous itemized expenses aren’t allowed as deductions. All of these floors on deductions are meant to increase how much you have to pay as your income increases. Deductions such as business expenses, job-related education, legal advice and investment expenses are all deductible and subject to the 2 percent floor.

Other phase-outs kick in when your adjusted gross income is too high. In 2002, most itemized deductions are reduced by 3 percent of the amount by which your adjusted gross income exceeds $137,300. This limitation can reduce up to 80 percent of your itemized deductions.

The net effect of these phase-outs and minimums is to increase your marginal tax rate. In other words, if you attend three real estate seminars in one year, but your deduction for job-related business expenses is phased out because of your high adjusted gross-income, you have a higher marginal tax-rate than someone with the same income who wasn’t subject to a phase-out of itemized deductions.

Instead of increasing your taxes directly, Congress figured out how to indirectly raise them by reducing your itemized deductions.

In addition to reductions in itemized deductions, higher-income real estate investors can lose some or all of their personal exemptions. Tax savings may also be decreased and marginal tax rate increased, by phase-outs: the dependent credit, child credit and adoption credit; IRA contributions; Hope and Lifetime Learning education credits; education savings bonds; and elderly and disabled tax credits.

Ultimate Stealth Tax

No discussion of stealth taxes would be complete without mentioning the alternative minimum tax – designed for those who plan too well. More and more taxpayers, including real estate investors, are falling into its net. The alternative minimum tax’s sole purpose is to ensure that you don’t take an inordinate amount of tax breaks. Investors most likely to trigger the tax are those who have: high state or local taxes; large itemized deductions in relation to their income; high employee business-expense deductions; or qualified stock option exercises.

When calculating the alternative minimum tax, you add back certain adjustments and preferences that you took when calculating the regular income tax. For example, you can’t take the standard deduction under the alternative minimum tax. Taxpayers who itemize must add back such adjustments as personal and dependent exemptions, state and local taxes, property taxes, investment interest expense, child care credits, some home equity loan interest, and that portion of home refinancing that’s higher than the refinanced debt. Charitable deductions and home mortgage interest remain deductible for the alternative minimum tax, subject to the regular deduction rules.

Although the alternative minimum tax rates of 26 percent and 28 percent are lower than the top regular tax rates, the alternative minimum tax makes up for this by assessing tax on a much broader income base. The result could be a larger tax bill than most people expected.

You have many strategies available to reduce your risk of paying these so-called stealth taxes. Think of tax planning – early on and throughout each year – as a safe path to savings. The earlier you plan, the more tax-saving options you’ll have.