Tax Tips for Rental Real Estate Investors
Rental real estate investing is a business with many unique and complex tax considerations. A savvy real estate investor will seek guidance when filing their year-end taxes to ensure they are taking advantage of the many tax benefits and deductions available when investing in and renting out real estate property.
Implement proper record keeping
As a landlord, you will undoubtedly incur many expenses when investing in, marketing, repairing and maintaining your rental property. According to IRS guidelines, you must maintain a digital or hard copy receipt for any expense over $75. There are many software programs available to help you streamline your record keeping system and maintain organization. Digitizing your records may allow you to cut down on paper clutter and secure your documents in cloud-based storage.
Take advantage of all available deductions
Within the tax code, there are numerous sections that apply to real estate investments. Taking full advantage of available deductions will minimize your overall tax liability at the end of the year and may increase the amount of your tax return. As a rental real estate investor, there are eleven different types of tax deductions that you should be aware and take advantage of.
Rental Property Tax Deductions:
You may deduct the total amount of any repairs to your rental property that are ordinary, necessary, and reasonable in amount, like a leaky roof, plumbing issues, painting, fixing broken windows or damaged floors, in the same year that the expense was incurred.
2. Pass-through income
Under the 2018 Tax Cut and Jobs Act, landlords who rent out a real estate property and earn income as a sole proprietor, LLC, or partnership, may qualify to deduct up to 20% of their rental income. To be eligible for the deduction, your rental activity must qualify as a business. The threshold guideline for determining whether your rental activity qualifies as a business is if you, your employees, or independent contractors spend at least 250 hours per year providing services related to your rental(s).
You may deduct a portion of the total cost of your real estate investment over a period of time. Real estate is considered a long-term asset, as it lasts for more than one year. Only portions of the property that depreciate or wear out may be depreciated for tax purposes. Portions that do not wear out over time, like the land a home is built on, cannot be depreciated. Structures, on the other land, like houses, apartment buildings, parking lots, storage units, or any structure that can wear out may be deducted, whether or not your tenant(s) actually use them.
Insurance premiums for any type of insurance related to your rental property or your business operation of the property can be deducted including flood, fire, and theft, as well as health and workers’ compensation insurance for employees in your business.
5. Employers or contractors
Any money that you pay to employers or contractors for work on your rental property or in relation to your rental activities can be deducted as a business expense. This may include administrative staff, assistants, property managers, bookkeepers, and independent contractors like real estate appraisers, plumbers, landscapers, electricians, construction contractors, and painters.
As a landlord, you can deduct interest on your rental mortgage and even interest from credit cards that you used to purchase products or services for your rental property. You may also deduct interest payments for personal loans used in connection with rental property. Keep in mind that this deduction only applies to interest that you pay on a loan, not payment made on the principal of your loan. Note that there is a limitation on interest deductions that applies to real estate investors earning $25 million or more.
7. Property taxes and related fees
You can also deduct your property taxes on your rental property, occupancy taxes, and licensing fees paid for your rental real estate property. Depending on where your rental property is located, these costs—particularly property taxes—can be very significant and a deduction can result in considerable savings.
8. Expenses for professional services
Running a successful rental real estate investment business will often involve consulting experts in various fields for advice and direction to protect your business financially and legally. Fees paid to professionals like CPAs, lawyers, financial advisors, and other professionals can be deducted as a business expense.
9. Personal property and land improvement depreciation
You can depreciate personal property like washers, dryers, refrigerators, dish washers, furniture, and yard and gardening equipment that wears out, as well as depreciation on land improvements like paving a new driveway, installing a curb, or planting shrubbery.
10. Home office
Whether you are a homeowner or a renter, you may be eligible to deduct a portion of your monthly mortgage or rental payment for space that you use as an office for your rental business. To be eligible, you must regularly and exclusively use that space in your home for business and be able to demonstrate that your home is your principal place of business.
You may also qualify for a simplified home office deduction, if your home office deduction is under $1,500 per year. Under the simplified home office deduction, you may deduct $5 for every square foot of your home office up to $1,500 each year, totaling a limit of up to 300 square feet. If you are a homeowner and elect to use this method, you cannot claim a depreciation deduction on your home office, but you may take itemized deductions for allowable mortgage interest.
Expenses you incur for travel related to the operation of your rental real estate investment are deductible as business expenses. If you are required to visit a rental property to make a repair, check the condition of the property, or any other legitimate business reason related to your rental property, you may deduct vehicle expenses by deducting your actual expenses, including gas costs and repairs, or using the standard mileage rate, which is published by the IRS. If you are required to travel a far distance or overnight, you may deduct the costs of a rental vehicle, airfare, hotel, meals, taxis, and other travel expenses.
Typically, items that can be depreciated in connection with real estate property can be depreciated over a 27.5 year period. Cost segregation is a method that allows rental real estate investors to depreciate items individually rather than all together and take advantage of things that have shorter periods of depreciation like land improvements and personal property. These items can usually be depreciated on an accelerated schedule of 5 to 7 years, rather than together with the building itself over 27.5 years.
Conduct a 1031 tax-deferred exchange
Usually, when you sell real estate property and it sells for more than its depreciated value—the property’s purchase price, plus improvements, and minus depreciation—you are required to “recapture” the depreciation by paying capital gains tax.
If you meet certain criteria, you may be able to defer capital gains tax on real estate property. The 1031 tax-deferred exchange allows real estate investors to sell a property and then reinvest those funds into a like-kind property and defer capital gains tax. This allows you to maintain more capital that can be invested into another property.
Consult a Tax Professional
It is likely that the more experience you gain in rental real estate investment—whether residential or commercial—the deeper your understanding will become of the complexity of our tax code and how it relates to capital investments and deductions potentially available to investors in rental properties. Whether you are a first time rental real estate investor or you already own multiple rental properties, working with a tax professional during tax season—and throughout the year—will help to ensure you are accounting for all relevant expenses and taking advantage of all available deductions.
Working with a tax professional can help you to navigate tax issues relevant to rental real estate development like IRS Final Tangible Property regulations, how to prioritize improvements and repairs for maximum annual deductions, determining when a property is placed “into service”, maximizing tax advantages through your choice in business entity structure, and many other factors that can limit your overall tax liability and maximize your return.
When hiring a tax professional, be sure to ask them about their experience working with real estate investors and landlords, specifically.
Whether you are thinking about starting a rental real estate investment business, already own a rental property, or own several rental properties, the experienced and knowledgeable tax planning experts at Anderson Advisors would be happy to review your portfolio and records to help ensure that you take full advantage of your available tax deductions and receive the most back in your tax return this year.
We provide tax review services, year-end tax planning, small business bookkeeping for your rental business, and preparation of tax forms. Contact us today to schedule your free Tax Plan Strategy Session.
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Mr. Bowman is a Partner with Anderson Law Group in the firm’s Las Vegas office. He received his Bachelor of Science degree in business from Arizona State University. After spending five years in the computer industry, Mr. Bowman received his Juris Doctor from Seattle University School of Law and is licensed to practice in multiple states. His experience includes commercial and civil litigation, construction defect law, complex real estate transactions, and business law.