One of the most common topics I talk and write about are the other ways in which real estate pays you. With April 15th upon us, make sure you are getting your tax benefits. For those who have followed us for years, this topic has been discussed on several blog posts, however I do add new content each time I post on this topic, thus worth reading all the way through, especially given the importance. As always, consult with your CPA.
As a full-time real estate investor, the rules are different for me as I am able to deduct (at my income level) 100% of my paper losses on my rental properties against my income. That is a huge benefit and my favorite part of owning rentals. Each year I figure out how many rentals I need to purchase to keep my tax bill, which BTW, is the largest expense most of us face, to an amount that I only somewhat cringe when I cut the check to the IRS. This blog post is for those who invest in real estate passively, meaning, you spend the majority of your time dedicated to your main source of income.
If real estate is not your main gig, then there are limits to the losses you can take. Basically, your rental property losses can’t exceed your rental property income. By losses, I am referring to paper losses that are generated from taking deprecation on your property. Deprecation is an often misunderstood term in real estate; it has not a thing to do with the value of property. Rather, it is the process used to deduct the costs of buying and improving a rental property. Rather than taking one large deduction in the year you buy (or improve) the property, depreciation distributes the deduction across the useful life of the property. With deprecation taken into consideration, it is possible that you take a paper loss, referred to as a passive loss. If these passive losses exceed your passive income, they are suspended and carried forward indefinitely until future years, when you either have passive income or sell a property at a gain. This is good news because a net loss (for tax purposes) means you aren’t paying taxes on your rental income today, even if you have positive cash flow. Carrying the losses forward is going to be huge in the reduction of taxes you pay on the future sale of your rental. There are exceptions to this rule where you may be able to claim real estate losses against your ordinary income if your modified adjusted gross income is $100,000 or less. This next tip is important. If you are spending money on capex type expenses, break out those expenditures to your CPA as you can offset some of the expenses through deprecation. Such items as roofs, appliances, sewer lines, windows, etc.
If your spouse is not working, then it is possible, even if you have a full-time day job, that you can take the full-time real estate investor designation. Reply to this email if you need clarification here.
Regardless if you are a full-time investor (active investor) or a part-time investor (passive investor) here are some other deductions.
Mortgage interest deductions: Mortgage interest can be deducted as a business expense to lower taxable income by filling out a schedule E on your tax return.
Business Expenses: You own 1 rental, you own a business that is operated out of your home office. A reasonable portion of your home internet, cell phone and sq. ft. in your home.
Travel Expense: If you bought a rental and came to visit us, you can write off travel cost
Expenses to Obtain your Rental: While you can’t write these off expenses, they can be added to your basis in the property and depreciate them, along with the property. These include: legal fees, mortgage commissions, appraisals, title insurance, recording fees, property inspections, transfer taxes, etc.
These are general guidelines. The tax code changes and the IRS tax code is complicated. Income levels and participation in other businesses and investments could modify these basic guidelines. Take these guidelines to your CPA to make sure you are at the bare minimum, capturing these very basic deductions. Even as a passive investor, the tax savings add to your ROI from your rental. The general consensus based on average income and portfolio size says 3 to 5% is added to the ROI of your property in addition to cash flow, tenant paying down the principal, appreciation and hedging against inflation. It is far more for active investors; I have seen it add over 15% to my ROI.