Owning real estate rental property can be a profitable business but it also comes with a lot of work. In addition to maintaining the property, managing repairs, advertising, and more, rental property owners must prepare all year for the tax return filing. Having a tax plan in place throughout the year will help to make the end of the year filing less stressful and more accurate.
What Do I Need To Keep Track Of?
The best tactic for keeping track of income and expenses is to use a spreadsheet or software specifically geared towards rental property ownership. If you are using a CPA to help you with your taxes, you may be able to obtain a template or advice on software to use. Regardless of the medium you choose, here are the main items you will need to keep a record of:
- Keep any paperwork handy on the purchase of the property you are renting
- Depreciation worksheets from previous years
- Income received as rent, security deposits, trade agreements between you and the tenant where work is done in lieu of rent
- Normal and necessary expenses such as the mortgage interest, insurance premiums, advertising costs, repairs, maintenance, cleaning, lawn and pest control services, property management fees, utilities, taxes paid for the property and HOA/condo fees
Keeping a monthly record will help you avoid leaving off something that could make a big difference in your tax liability.
Passive Income Activity
Renting property is considered passive income. As passive activity, there are limitations to the deductions that can only be applied to lower a profit from the rental property. However, there are some exceptions. For instance, if you own at least 10% of the property, make decisions such as approving tenants and arranging improvements, this would allow you to deduct up to $25,000 of rental loss. Even so, the limitations continue because as your income increases, this deduction phases out. This phase out begins at a modified gross income of $100,000 and is completely eliminated after the $150,000 mark.
Tax Planning Tips For Landlords
Wise tax planning can make all the difference for real estate investors and landlords. In the current climate, tax planning for real estate investors has never been more vital. Below are some important tax planning tips:
1. Distinguish between Repairs and Capital Improvements
Repairs are counted as simple expenses and are deductible in the year in which they occur. Capital improvements, on the other hand, are depreciated over their useful lives. The IRS rules on what constitutes a capital improvement are quite extensive and detailed. Advanced tax planning that distinguishes and plans for this distinction can help maximize the potential of your real estate investments.
2. Use Depreciation to your Benefit
Depreciation is one of the very few major expenses that does not require a cash outlay. It can help you offset income and even show losses on rental property. Residential property usually has a depreciable life of 27.5 years, while added capital improvements might be depreciated 27.5 years, 15 years, 7 years, or 5 years. Depreciation is according to property class and the rules are set by the IRS. The IRS also offers the taxpayer the ability to use accelerated depreciation on some of these properties with lesser useful lives.
While depreciation is a great option for lowering your taxable rental income, there are some important factors to remember. Keeping track of depreciation can be a little confusing so hiring a professional to help with this may be a good idea.
3. Take Advantage of 1031 Exchanges
Additionally, depreciation will need to be recaptured if you sell the property. As real estate doesn't actually depreciate, the IRS says if you sell and make a profit, your depreciation on the property must be recaptured. This means that the depreciation you originally claimed would need to be listed as taxable income. You can avoid this by doing a 1031 exchange. In short, you would use the proceeds from the sale of one property to turn around and purchase another property. This would allow you to defer the capital gains and the depreciation until you sell the new property.
4. Purchase and Inhabit a Property for Two Years
Purchase and inhabit a residence for two years. Upon the sale, capital gains up to $250,000 for a single filer, or $500,000 for those filing jointly, can be tax free.
Refinancing can sometimes be an attractive alternative to selling an appreciated property. If the terms are favorable, as they often are now, you may be able to realize funds for other investments, while keeping the property and letting the tenants pay off your loan.
6. Take the 20% Pass-through Deduction
You may very well be able to take the 20% pass-through deduction. Some fairly complex specific conditions involving business income and hours of service apply for real estate investors and must be met. Planning is important here as well.
7. Explore Investment in Opportunity Zones
Opportunity Funds permit deferral of proceeds by investing them in Opportunity Zones. These are zones specifically designated to be economically distressed areas, created by the 2017 Tax Cuts and Jobs Act to increase investment in areas of economic hardship. These areas are very specific, and legally designated. Also, the opportunities are restricted as to types of use, with certain types of businesses, such as country clubs, golf courses, racetracks, and liquor stores not qualifying.
8. Seek Professional Advice
Tax laws are filled with complex regulations and/or requirements. It's especially important currently to investigate thoroughly all applicable tax ramifications. The best and wisest tax planning tip is often consultation with a reputable and knowledgeable tax planning professional, such as Chandler & Knowles CPAs. Contact Chandler & Knowles CPAs today