This email may be the most important one that I send out this year as it has to do with maximizing 1 of the 5 ways your rental property pays you a return and that is tax savings. If you are not approaching tax savings as a big part of the investment, then I would say you could be leaving a big part of the return on the table and unnecessarily paying the IRS more then you are required to pay, which at a current debt of 28 trillion, the IRS thanks you. However, we do not want the IRS to thank us.
As we approach tax time, here are a few tips to consider. For the record, I only took 2 semesters in college in Accounting–consult your CPA on the items below. However, these are the deductions I take every year.
- Business Expenses: You own property, you own a business. Such deductions as your cell phone, internet, industry related publication subscriptions, real estate education and allowable space in your home for a home office should be taken.
- Meals: Did you go out to lunch with a colleague or your spouse and discuss real estate? Those meals are eligible for deduction and in the 2020 tax year, 100% of those expenses were allowed to incentivize going out to the struggling restaurant business during COVID-19. Ironic huh? I would do this within reason as it may be hard to justify to the IRS writing off $5,000 a year in meals for 4 rental properties.
- Travel: Did you travel to other markets to look at real estate? All of those expenses would be written off. Actually that is another good reason to buy in markets that make sense as you can travel there as much as you want and write off the trip–again, all within reason. Whenever I travel, I try to spend some time looking at real estate, talking to a real estate professional and making an offer, even if it is ridiculous. By doing so, I can write off a portion of that trip and if that ridiculous offer is accepted, then as Charlie Sheen would say, “winning!”. Make sure you want that property just in case that offer is accepted.
- Self-Directed IRA’s / Health Savings Accounts: Max these out’s.
- Capital Gains: If you are selling a property that you have owned less than a year, if you can, try to punt that sell to year 2 as long term capital gains have a lower tax liability then short term gains. When calculating capital gains, make sure you are considering all the expenses related to the acquisition and sell. Such things as legal fees, commissions, closing cost, strategy session meals, buying lunch for contractors, etc.
- Property Expenses: Insurance, mortgage interest, property taxes, management fees, utilities, property maintenance, legal fees and closing cost are all expenses to deduct. Basically any realistic expense directly effecting your bottom line
- Deprecation: my favorite part of real estate. This is one of the few (maybe the only, I do not know) investments where you can make money, but on paper show a loss. Deprecation is the ability to deduct the cost of your property over 27.5 years. Thus a $100,000 property is a loss of $3,636 a year. Own 10 properties and you are taking a loss of $36,360 a year regardless of the money you made on the cash flow. This is where a good CPA comes in strong as there are ways to maximize this by cost segregation, accelerated and bonus deprecation. The downside with deprecation is you do have to recoup those deductions upon the sale, but doing a 1031 exchange will roll those deductions and profits into the next property. Below is an example of our CPA using his expertise in the field of real estate investing tax preparation turning the profit of $7,980 on 1 property into a loss of $6,062.
The pool scene out of National Lampoons Vacation always comes to mind when taking deductions on my tax return. Clark W. Griswold is explaining to his son, Rusty, that the clothless woman in the pool was taking his order, to which Rusty responds, “she took your order? Do you think mom will buy it?” Remember, when reporting deductions, they have to be documented, supported and realistic within the tax law and be able to explained in the rare case of an audit by the IRS. Always ask yourself, “will the IRS buy it?” If that answer is no, then I would not take the deduction. Just because your CPA advises it, doesn’t mean you have to take it as some CPA’s are more aggressive then others. I advise using an CPA who specializes either in rental property or has a large portfolio of business owners.