“Why buy real estate in a flat market?” That is the essence of a question my airline seatmate asked me after he learned I invest in and write about real estate. But rather than answer his question directly, I asked him, “Do you own your home?”

“Of course,” he replied. Then I followed up by asking him the benefits of owning his home. As I recall, he listed security, pride of ownership, tax savings, market-value appreciation, building equity, investment safety, no rent increases, and perhaps a few I forgot.

My seatmate then asked me if I thought he and his wife should sell a rental house they own in Arizona. They seem to be having problems keeping it occupied by reliable renters since it is about 1,000 miles from their primary residence. But then he quickly added, “Our problem, if we sell, is we would owe tax on at least $75,000 of profit.”

Although I pointed out the current low federal long-term capital gain tax is a maximum of only 15 percent, my new friend seemed highly adverse to paying taxes. So I suggested he make a tax-deferred exchange for a rental house close to his residence so he can better manage it.

MAJOR TAX SAVINGS FROM REALTY INVESTMENT PROPERTY. Although the high, runaway-market-value appreciation rates of the last few years for residential properties has shifted to a “plateau” in most cities, long-term realty investing still provides major tax benefits for owners who “materially participate” in operating their properties.

Although federal tax law requires “material participation” by investors who want maximum tax savings from their realty investments, they can still delegate day-to-day operating details to a property manager. Owners who make the major decisions, such as setting rents, establishing rental rules and authorizing major expenditures, easily quality.

However, an investor who owns less than 10 percent of a property partnership does not qualify, nor do owners of REIT (real estate investment trust) stock and owners of vacation homes who have their properties in “rental pools” managed by others.

Investors who meet the ownership and material participation tests can deduct up to $25,000 of their “passive activity” investment property tax losses from their ordinary taxable income up to $100,000 annual adjusted gross income (AGI). For realty investors with AGI between $100,000 and $150,000, the deduction gradually phases out to zero above $150,000 AGI.

Fortunately, most of these so-called tax losses are not actual cash losses. Instead, they are “paper losses,” usually from the depreciation tax deduction for estimated “wear, tear and obsolescence” of the building.

Residential real estate is currently depreciated over 27.5 years, and other realty is depreciated over 39 years. Personal property used by tenants, such as appliances and furniture, has a much shorter depreciable useful life. But land value is not depreciable.

Investors who find they can’t offset their rental property tax losses against their AGI must “suspend” those unused losses. IRS Notice 88-94 says these unused suspended losses can be used in future tax years on an aggregate basis, rather than property-by-property, when selling.

HOW TO CLAIM UNLIMITED INVESTMENT PROPERTY LOSSES. There is a little-known, perfectly legal way to claim unlimited investment property losses against your AGI regardless how much you or your spouse earns. The solution is to become a “real estate professional.”

Real estate brokers, realty sales agents, property managers, builders, contractors and leasing agents clearly qualify if they work at least 750 hours per year (about 14 hours a week) on their real estate activities.

However, realty investors also can qualify as “professionals” entitled to the unlimited investment property deductions against their ordinary income if they spend at least 750 hours per year on their investment activities. Either spouse can qualify. A real estate sales license is not required.

For example, suppose a married physician’s AGI is $500,000. Normally, he would not be entitled to any property loss deductions because his AGI exceeds $150,000. However, if his wife manages their real estate properties from their home and she spends more than 750 hours annually supervising the properties, making management decisions, inspecting properties for possible purchase, and supervising property sales and exchanges, they qualify. The result is the physician and his wife can claim unlimited property loss deductions from their properties because the wife qualifies as a “real estate professional.”

HOW TO AVOID TAX WHEN SELLING INVESTMENT PROPERTY. Although most investment real estate offers many benefits already listed, when the property is sold Uncle Sam (and most states) are waiting to collect capital gains tax. In addition, Uncle Sam imposes a special 25 percent “depreciation recapture” tax for the portion of capital gain attributable to depreciation deductions enjoyed by the owner.

However, there are several ways to avoid these taxes. The “ultimate tax shelter” is to die while still owning a depreciable property. Uncle Sam will be so distraught upon learning of your death he will waive any capital gains and depreciation recapture tax that would have been due if you sold the property before you died.

But a more acceptable way to avoid capital gains and depreciation recapture tax is to make a tax-deferred Internal Revenue Code 1031 exchange for another investment or business property of equal or greater cost and equity. Personal residences are not eligible. But cash or “boot” such as net mortgage relief taken out of such an exchange is taxable.

However, savvy investors can make a tax-deferred IRC 1031 trade of their rental property for another qualifying rental property, perhaps an ultimate “dream home,” and later convert it into their personal residence. Most tax advisers recommend renting the acquired property at least 12 months to show rental intent before converting it to the investor’s home.

After owning the acquired rental property at least 60 months, 24 months of which it is occupied as the owner’s principal residence, then the owner can sell it and claim up to $250,000 tax-free profits (up to $500,000 for a qualified married couple filing a joint tax return in the year of home sale), thanks to Internal Revenue Code 121.

SUMMARY: Owning real estate investment property provides many tax benefits, both during ownership and at the time of sale or tax-deferred exchange. Most rental properties appreciate in market value over the long term and offer many additional tax benefits. Full details are available from your tax adviser.

If you are among the millions of homeowners and renters who operate a profitable part-time or full-time business from your home, don’t forget to claim your home-business tax deductions to reduce your income taxes. It doesn’t matter if you are self-employed or you are an employee expected to work from home, such as an outside salesperson or a telemarketer.

However, if your employer provides suitable workspace, but you prefer working at home, then you don’t qualify for Uncle Sam’s generous work-at-home tax deductions. For example, if you are a computer programmer who prefers to work from home so you can supervise your pre-school child, you don’t qualify for home-business deductions if your employer provides suitable office workspace.

SELF-EMPLOYEDS MUST PASS THE PRIMARY BUSINESS LOCATION TEST. If you are self-employed, such as an independent contractor real estate sales broker, to qualify for the Internal Revenue Code 280A home-business tax deductions, your residence must be used either (1) to meet with clients, customers or patients or (2) as your primary business location for administrative activity if you have no other fixed business location.

In 1999, Congress changed the tax law to allow self-employeds working from home to deduct business expenses if their residence is their “primary business location.” Examples include a self-employed bookkeeper who travels to offices of her clients, a handyman who works at various job sites, and a computer repairman who works at many business offices during the week.

This tax law change was the result of the 1993 U.S. Supreme Court decision denying anesthesiologist Dr. Nader Soliman (113 Sup.Ct. 701) any home-business tax deductions although he worked many hours at his condominium reading professional medical journals and handling administrative details. Because he spent most of his work time at different hospitals, the court denied his home-business deductions. Today, however, he is entitled to deduct his home office expenses because his condo is his primary business location.

WORK-AT-HOME EMPLOYEES HAVE A SPECIAL TEST. If you are a salaried employee working at home, the IRS imposes a special rule called “the convenience of the employer test.” You probably meet this test if your employer doesn’t provide suitable workspace, or expects you to work from home. Examples include outside salespeople, computer entry clerks and telephone order takers.

PART-TIME BUSINESSES CAN QUALIFY. If you operate a part-time business from your residence and you can meet the “primary business location” or “convenience of the employer” tests above, then part of your home operating costs are tax-deductible.

To illustrate, suppose you operate a profitable part-time home business selling books on the Internet about your passion, horse training. Or perhaps you sell Avon, Amway or Mary Kay products from your home where you have an office and store inventory and supplies. Then you can qualify for the home-business tax deduction.

But your home use must be a business, not a hobby or investment. For example, in the famous tax case of Joseph Moller (553 Fed.2d 1071), he earned 98 percent of his income from his investment business. He was a passive stock and bond investor operating from his living room. But the U.S. Court of Appeals denied Moller’s home-business deduction for investing which, the court said, was not a business.

However, the opposite result occurred in the U.S. Tax Court decision involving Dr. Edwin Curphey (73 T.C. 61). Dr. Curphey was a full-time dermatologist at a hospital. But he managed his rental properties on a part-time basis from his home office. The Tax Court ruled he was entitled to applicable home-business deductions for his part-time property management business.

THE “EXCLUSIVE BUSINESS AREA” RULE. If your full-time or part-time home business meets the rules explained above, the next test requires an “exclusive business area,” which is not also used for personal or family purposes. But the exclusive business area need not be a separate room.

Part of a room can qualify, but it cannot be shared use. To illustrate, if you have your desk, filing cabinet and business supplies in one part of the family room, that area can qualify. However, using your kitchen table to operate your part-time bookkeeping business, or occasionally entertaining business clients in the living room clearly doesn’t qualify.

SQUARE FOOTAGE IS THE BASIS FOR HOME-BUSINESS DEDUCTIONS. Your home-business tax deductions are determined by the percentage of your home’s square footage that is used for the exclusive business area.

For example, suppose you own or rent a 1,500-square-foot house or condo. One-third, or 500 square feet, is the “business area” where you keep your business supplies and have your office.

The result is 33 percent of applicable household expenses qualify as business tax deductions. If you are a renter, one-third of your rent is deductible on your business tax return. If you are a homeowner, one-third of applicable home expenses such as utilities, repairs, insurance, mortgage interest and property taxes will be deductible on your business tax return, in this example.

However, 100 percent of some expenses are fully deductible, such as your business telephone line (if you also have a personal telephone line), business computer broadband fees, and painting or improvement costs for the business area.

REMEMBER TO DEDUCT 100 PERCENT OF BUSINESS EQUIPMENT. If you purchased business equipment and placed it in service in 2006, such as a new business computer and software, 100 percent of that equipment cost is deductible up to a maximum $108,000 deduction, with a maximum $25,000 deduction for an SUV vehicle used in your business.

Higher equipment expense limits apply in an “enterprise zone” such as $208,000 in the Gulf Opportunity Zone. However, no deduction is available for personal assets converted to business use, such as a home computer bought in 2004 but converted to business use in 2006.

DEPRECIATE YOUR HOME-BUSINESS AREA. If you own your house or condo, the exclusive business area is depreciable. Using the example above, if your home-business area occupies 33 percent of your home’s square footage, then you can depreciate one-third of your residence’s cost basis (excluding nondepreciable land value) on a 39-year, commercial property, straight-line basis.

IRS Regulation 2002-142 says business use of your home won’t affect using the Internal Revenue Code 121 principal-residence-sale exclusion up to $250,000 ($500,000 for a married couple filing jointly). However, the total “business area” depreciation deducted must be “recaptured” and taxed when the home is sold using the special 25 percent federal recapture tax rate.

HOME-BUSINESS USERS GET SPECIAL AUTO EXPENSE TAX BREAK. If you qualify for the home-business-use tax deduction, and you start your work day from your home office, when you use your automobile or truck to visit customers or work locations, your business mileage becomes tax deductible the minute you drive away from home.

For 2006, the business deduction is 44.5 cents per mile. But you must keep a daily log of business miles.

HOME-BUSINESS DEDUCTIONS CANNOT CREATE A TAX LOSS. However, home-business-expense deductions cannot create a tax loss.

That means your home-business deductions, when subtracted from your home-business profit, cannot create a tax loss against your other ordinary taxable income. But unused home-business losses can be carried forward to future tax years.

To illustrate, if your business operating from your home produced a $2,500 profit in 2006, but your tax deductions for your home-business area are $3,200, only $2,500 can be deducted and the remaining $700 is carried over to a future tax year.

CONCLUSION: Whether you operate a full-time or part-time business from your residence, and whether you are a homeowner or a renter, you can deduct applicable expenses to reduce your income taxes. Both self-employeds and employees can qualify. For full details, please consult your tax adviser.

Have you ever forgotten to claim a real estate tax deduction? I did. Years ago, after I filed my income tax returns I remembered a mortgage interest deduction of about $4,500, which I totally overlooked. To claim my tax refund, I had to file IRS Form 1040X to amend my tax return.

As a result, I then learned the IRS hates to part with tax dollars already collected. I had to provide details of my additional deduction.

Fortunately, that was easy because it was a mortgage interest deduction for a recently acquired rental property. I photocopied the lender’s IRS Form 1098, mailed it to the IRS, and about a month later received my tax refund.

Just so you never make a tax-deduction mistake like that, here are the “top 10″ most often forgotten real estate tax deductions:

1. DEDUCT LOAN FEE “POINTS” PAID TO OBTAIN A “HOME-ACQUISITION MORTGAGE.” If you bought a house or condo in 2006 as your principal residence, you probably paid the mortgage lender loan-fee “points.” One point equals 1 percent of the amount borrowed.

When the purpose of the loan was to acquire your residence, the loan fee is tax-deductible as itemized interest. However, many mortgage lenders “forget” to include this loan fee, which can be several thousand dollars, on the borrower’s year-end IRS Form 1098 mortgage interest report.

For example, suppose you obtained a $300,000 mortgage to buy your house or condo (not a rental property). You paid a one-point loan fee of $3,000 to the lender. Because it was a primary-residence, home-acquisition mortgage, that $3,000 fee qualifies as a Schedule A itemized interest deduction on your tax returns.

Doublecheck the lender’s 1098 interest report to be certain it includes loan-fee points. If not, add them to your itemized deduction. The best proof is your closing settlement statement.

2. DEDUCT AMORTIZED MORTGAGE REFINANCE FEES PAID TO THE LENDER. If you refinanced your home loan in 2006 (probably to get rid of an adjustable-rate mortgage or reduce your interest rate), or obtained a new or refinanced mortgage on a rental investment property and paid the lender a loan fee, usually called points, that fee is deductible over the life of the mortgage.

The reason many borrowers pay a loan fee on a refinanced mortgage is paying points slightly lowers interest rate. The general rule is for each one point (1 percent) loan fee paid, the interest rate should drop at least one-eighth to one-fourth percent.

But it is very easy to forget this deduction because it is often a small annual amount. Suppose you refinanced your home loan (or the mortgage on your vacation second home). Because it was not a home-acquisition mortgage, the loan fee must be amortized (deducted) over the life of the mortgage.

To illustrate, if you paid a $2,000 loan fee to obtain a new 30-year refinanced mortgage, you can deduct $66.66 each year for the next 30 years. Because it’s not much of an annual deduction, which is easy to forget, it’s often wiser to obtain a “no fee” mortgage rather than pay a loan fee for other than a home-acquisition mortgage.

3. DEDUCT MORTGAGE PREPAYMENT PENALTY YOU PAID. If you had to pay your mortgage lender a prepayment penalty, either to refinance or sell your property and pay off the old mortgage, that prepayment penalty is tax-deductible as mortgage interest. Some home loans have these prepayment penalties during just the first few years, but investment property mortgages often have them for many more years.

4. DEDUCT PRIOR HOME-LOAN REFINANCE FEES. If you have not fully deducted mortgage refinance loan fees from a previous refinance, or you paid in full a mortgage on any property with undeducted loan fees, remember to deduct those fees in the year the mortgage was paid in full.

To illustrate, if you refinanced or sold a property in 2006 with $3,000 of remaining undeducted mortgage loan fees, that $3,000 became fully deductible in the year the mortgage was paid in full (either by refinancing or by sale of the property).

5. REMEMBER TO DEDUCT MOVING COSTS IF YOU CHANGED JOB LOCATION AND YOUR RESIDENCE IN 2006. Whether you are a renter or a homeowner, if you changed both your job site and your residence location in 2006, you might be eligible for the often-overlooked moving-expense deduction.

To qualify for this sometimes-huge tax deduction of several thousand dollars, your new job location must be at least 50 miles further away from your old home than was your old job site. The residence change must occur within 12 months before or after the job location change. It doesn’t matter if you change employers or become self-employed.

For example, suppose it was three miles from your old home to your old job location. But your employer moved to a new location, which is 60 miles from your old home. If you also changed your residence location within 12 months, your moving costs qualify in this example as tax deductions because the new job was more than 53 miles away.

Use IRS Form 3903 to calculate and claim your moving-cost deductions. However, as this form explains, you must work at least 39 weeks during the next 52 weeks in the vicinity of the new work site. If you are self-employed you must work at least 78 weeks during the next 104 weeks in the area of your new job location. Either spouse can qualify, but part-time work doesn’t count.

6. DEDUCT ANY UNINSURED CASUALTY LOSS. Another often-forgotten tax deduction has the misleading name of a casualty-loss deduction.

If you suffered a fully or partially uninsured “sudden, unusual or unexpected loss” in 2006, you qualify. Examples include losses from fire, flood, hurricane, tornado, earthquake, mudslide, theft, accident, water damage, riot, vandalism, embezzlement, snow, rain and ice.

However, slow losses do not qualify, such as termite damage, rust, erosion, mold, corrosion, dry well, moth damage, dry rot, beetles and Dutch elm tree disease.

The casualty-loss tax deduction must exceed 10 percent of your 2006 adjusted gross income, plus a $100 “floor” per casualty event. To illustrate, suppose your uninsured casualty loss was $5,000 and your 2006 adjusted gross income was $30,000. That means you qualify for a deduction of $5,000 minus $3,000 minus $100, or $1,900.

7. DEDUCT PRO-RATED PROPERTY TAX IN YEAR OF HOME SALE OR PURCHASE. Many home sellers and buyers forget to deduct their share of the pro-rated property taxes in the year of sale or purchase. Your best proof of payment is the closing settlement statement, even if the other party to the sale actually paid the tax collector.

8. DEDUCT PRO-RATED MORTGAGE INTEREST FOR HOME SALE OR PURCHASE. If you bought or sold your home in 2006, and you assumed an existing mortgage, bought “subject to” or relinquished a mortgage, remember to deduct your share of the pro-rated mortgage interest for the month of the home sale or purchase. Again, the closing settlement statement is the best proof.

9. DEDUCT PREPAID PROPERTY TAXES AND MORTGAGE INTEREST. My personal favorite, often-overlooked deduction is prepaid property taxes and mortgage interest.

For example, in December 2006 I prepaid my January 2007 mortgage payment, thus entitling me to deduct the substantial amount of prepaid mortgage interest. In addition, I prepaid my 2007 property taxes in 2006, entitling me to another large 2006 tax deduction. However, not all local tax collectors will accept property tax prepayments.

10. IF YOUR HOME IS ON LEASED LAND, DEDUCT GROUND RENT. Thousands of homeowners are not aware of this little-known tax deduction if they pay ground rent.

To qualify, Internal Revenue Code 163(c) permits homeowners living on leased land to deduct their ground rent payments if (a) the ground lease is for at least 15 years, including renewal periods; (b) the land lease is freely assignable to the buyer of the home; (c) the land owner’s interest is primarily a security interest (similar to a mortgage); and (d) you have a current or future option to buy the land beneath your home.

If your situation meets all four of these tests, your ground rent payment to the landowner is tax-deductible as itemized interest. However, if you rent a “lot” or “pad” in a mobile home park, your monthly rent paid to the park owner is not deductible unless you have a 15-year or longer lease with a land purchase option.

HOMEOWNER NONDEDUCTIBLE PAYMENTS. Nondeductible payments into a mortgage escrow impound account held by your mortgage lender are not immediately deductible. However, when the mortgage lender remits money from your escrow account to the local property tax collector, then the property taxes paid become deductible. But personal-residence insurance payments are not tax-deductible.

Of course, if you pay your property taxes direct to the local tax collector, as millions of homeowners do, your property tax payment becomes deductible when paid.

If you bought or sold a home in 2006, you probably paid closing costs such as a transfer tax, recording fees, escrow, title or attorney fees, sales commission and other nondeductible charges. Home buyers should add these nondeductible fees to their purchase price cost basis. But home sellers should subtract these nondeductible costs from their gross sales price. Full details on these and other homeowner and real estate tax deductions are available from your tax adviser.