Tax Savings for Landlords
It’s spring again and the tax man is knocking at your door. As a property management company accountant, landlord or property investor, you’re undoubtedly wondering how to cut your tax payable.
Tax is a serious issue representing one of your largest business costs. Get your tax losses down and you’ll be singing a happier tune.
To help you cut your rental property taxes and property management taxes, we’ve got your tax savings tips. It’s important to know that tax planning and strategy this year keeps you primed for reduced taxes next year.
Exploring Tax Deductions: The Good, the Bad & the Ugly
Please note that this helpful overview is not meant to replace legal tax advice provided by a qualified tax accountant. Tax laws change fast. It should help you think about and plan your tax strategy that will last for many years. Your tax advisor can help avoid traps and pitfalls.
There was a lot of hype and misunderstanding about what was proposed last fall and what was actually passed in the new Trump tax bill. There were some Good changes such as the standard deduction which was almost doubled. Other, perhaps Bad changes for investors and homeowners however limit the amount of mortgage interest you can claim and how much state and local property tax (SALT) you can deduct.
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As a property investor with significant wealth in play and at risk, you need a good tax strategy to keep your business solvent. Tax planning is critical to building your long term wealth.
Part Time or Full Time Pro?
If you’re a part time real estate person or investor, your losses are passive and only deductible up to $25,000 against your rentals’ income. You may need to incorporate and go Pro in order to access greater revenue and tax savings.
If you spend the majority of your time as property manager, or real estate investor, your rental losses are not passive. This means that your losses are fully deductible against all income, passive and non-passive. This is where it gets good.
A professional real estate person is one who spends half of their time, more than 750 hours working in their real estate properties. How you establish your business determines a lot about its potential revenue and perhaps whether you can access more investment funds and better mortgage rates. Something to consider.
The Tax Cuts and Jobs Act doubled the standard deduction from $6,350 in 2017 to $12,000 now (and for couples is $24,000 now from $12,700 last year).
Tax Changes for Homeowners Too
As a homeowner, the new tax changes may affect your tax situation. The tax checks issued this year will make a lot of people happy.
The Tax Cuts and Jobs Act raises the standard deduction to $12,000 from $6,350 in 2017 ($24,000 from $12,700 for couples). This means homeowners no longer need to itemize mortgage interest and property tax bills that fall below these thresholds.
The new Tax Cuts and Jobs Act unfortunately lower the amount of deductible property taxes and other state and local taxes to a $10,000 ceiling. And further, it cuts back the potential mortgage interest deduction to a new limit of $750,000.
It’s now believed that only 14% of homeowners will use itemized tax returns now, down from 44% last year.
The Ugly might be that the new tax law will discourage those who rent, who have saved for it, from buying a home or a condo. And fewer buyers will buy second homes and thus rent them out. This will likely cause a drop in demand for new and used housing, and lessen rental availability.
After establishing your overall business tax strategy, you’ll need to attend to the items or expenses you can claim, as this will indicate what price of property(s) you might be able to afford. Your numbers for next year’s tax return will look a lot different from 2018.
What are your Allowable Deductions or Writeoffs for 2018?
In short: they will include mortgage interest, property tax, repairs, maintenance, travel expenses, vehicle expenses, advertising, software subscriptions, internet service, cell phone, business use of auto, workspace in your home, home office renovations, heat, electricity, utilities.
Your home improvements may not be tax deductible, since they’re considered a capital gain, however repairs and maintenance are deductible.
It’s When you sell a property, that you need protection from capital gains expenses and from paying the depreciation recapture. To do that, you’ll use a 1031 exchange to carry depreciation forward to the next property. You must buy the like-kind property within 40 days, so you should have that new property already researched and ready to buy.
As part of the Section 1031 of the Internal Revenue Code, the 1031 Exchange is essentially a swap of the tax liability of one real estate investment asset for another.
To create a 1031 exchange, investment properties must meet these criteria:
- The value of the replacement property must be equal to or more than that of the property being sold.
- Properties in the transaction are exchanged for another type of asset, such as a real estate investment trust (REIT).
- The new property must be held for “productive purposes in business or trade.”
Pass Through Entities Advantages
Real estate investors stand to benefit from the changes made to pass-through entities (Partnerships, Sole Proprietorship, LLCs and S corporations). You’ll want to examine the corporate tax rate, obligations and consider the new low tax rate of 29.6% on qualified business income. Rentals and new real estate development investments may both qualify for the 20% deduction for pass-through entities.
Passive Income Tax Benefit
The self-employed / FICA Tax will save you from being taxed like an employee at the Federal 15.3% tax rate.
Tax Free Refinancing & Interest on Mortgages
You can take out a line of credit on your property of refinance the property and use that money to buy another property, or use that money to improve another property you own. However, you can only write off the interest and expenses paid on that property if there are home renovations and improvements.
The mortgage interest deduction was reduced from a limit of $1 million to $750,000.
Consider the term when you claim capital gains when selling properties.
Short term of one year is taxed at a higher rate. The longer term is a lower rate and you could be exempt from paying taxes on profits up to $500,000 on selling a property. If a property investor sees their capital losses exceed their capital gains, they are able to offset upwards of $3,000 of other income.
The New IRS Tax Brackets
|Tax Rate||For Individuals||For Married Couples|
|10%||Up to $9,525||Up to $19,050|
|12%||$9,526 to $38,700||$19,051 to $77,400|
|22%||38,701 to $82,500||$77,401 to $165,000|
|24%||$82,501 to $157,500||$165,001 to $315,000|
|32%||$157,501 to $200,000||$315,001 to $400,000|
|35%||$200,001 to $500,000||$400,001 to $600,000|
|37%||over $500,000||over $600,000|
|Data From Taxfoundation.org|
How to Handle Losses
Property managers and investors can claim losses from one rental property in order to offset taxable income generated by other rental properties. It’s possible to reduce your taxable income earned from other sources.
Building Depreciation That Can be Claimed
Depreciation can claimed on the building of course not the land. Residential property can be deducted over 27.5 year time frame and for commercial properties over 39 years.
House value / 27.5 = deduction each year
Bonus Depreciation under the TCJA
For new or used assets acquired and put in use (not for assets that are normally written off over 20+ years) between 9/28/2017 and 12/31/2022, the TJCA allows you to write off 100% of the cost in your 2018 taxes. That’s up from 50% previously.
100% First Year Writeoff of Heavy Work Vehicles
If you use a heavy 6000 lb + vehicle for 50% for work, you’ll enjoy a generous depreciation bonus of 100% on your vehicle price. For some businesses, this can be very helpful. You’ll have to check to see if your Escalade, Sequoia, Explorer or Tahoe qualifies.
Deductions for Luxury Work Vehicles
For regular vehicles acquired during the period 1/1/2018 and 12/31/2026 above, you can writeoff up to $18000 in the first year and 16,000 for the second. It’s gradually less each year afterward.
Modified Accelerated Cost Recovery System (MACRS).
Can you claim depreciation on improvements? For repairs and improvements, it may be better to itemize the cost for each item, then depreciate or deduct each cost separately.
Claiming Rental Income
Unless you are a fully qualified real estate professional, your rental business is classified as an active business according to the tax code.
The Tax law states that all rental activities are passive activities, even if the landlord is a material participant. Therefore, losses incurred from rentals can only be deducted from other passive income.
Generally, a passive activity is any rental activity OR any business in which the taxpayer does not materially participate. Nonpassive activities are businesses in which the taxpayer works on a regular, continuous, and substantial basis. In addition, passive income does not include salaries, portfolio, or investment income.
As a general rule, the passive activity loss rules are applied at the individual level. — From the IRS
Rental income is any income received for the use of tangible, either real or personal, property, However, if you rent the property out for 122 days of the year and occupied it for 31 days, then only 80% of any deductible expense can be claimed.
If you rent out your primary residence for 15 days or less over the year, then the income you earned will not be taxed.
Flipping the House you Live in?
Flipping a house you live in offers many tax benefits and the capital gains is often very good too. And there’s ways to avoid the tax you must upon selling.
If you’re living in a house and flipping it, you’re considered a self-employed taxpayer. You can claim what are called office and capital expenditures and most of your business expenses and commissions paid to realtors and lawyers related to the property. You can claim office expenses this year, however you can’t claim capital expenditures until you sell the property.
Estate Transfer Taxes
The new tax bill raises the estate transfer tax exemption limit to $11.2 million per person ($22.4 million for a couple) which is double what it was previously.
Property Tax Deductions
If you’re hoping to improve property investment income, there’s plenty you can do. As a property investor you might also consider the weight of the taxes in the locations you could buy properties.
There are federal, state and local taxes that must be paid every year, and they may be significant in the state and city you’re considering. There is even more to consider than the typical property taxes due in each state as you’ll see in this graphic courtesy of Wallethub.
Managing Your Tax Burden
The above is just some ways you can lighten your tax burden. You can discuss your property investment tax strategy with your tax accountant and determine what legal and business entity status you should pursue for the years ahead.
We hope you’ll get every tax break you can and that of course, you’re able to manage your portfolio documentation and financial transactions well. Using a property management software package can make it easy to keep on top of the glut of paperwork. That in itself may help you get all your tax deductions and avoid an audit.
Take a test drive of the simple accounting features of ManageCasa. Our aim is to make property management a breeze for you in 2018.
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