Being able to take advantage of tax deduction is often what makes owning a rental property worthwhile. These deductions can offset taxable income.
You may only deduct expenses if they are considered ordinary and necessary in the line of business:
POINTS OF CAUTION
COMMON TAX DEDUCTIONS
Depreciation expense is used for those things you have purchased for your business which have a useful life beyond the current tax year. For something to be considered depreciable, it has to meet 3 rules:
Examples of depreciable assest are:
Assets will have different useful lives, such as a refrigerator or a building. There are different types of depreciation, such as straight line depreciation and accelerated depreciation. Consult the IRS or your accountant to determine the type of depreciation to use and the useful life of each asset.
PASSIVE ACTIVITY LOSSES
Owning rental property is considered a passive activity. There are complex rules which apply to passive activities, but in short, they limit your ability to claim losses incurred in passive activity against other types of income.
There are certain exceptions:
You may deduct the expense of repairs. Repairs are considered work that is necessary to keep your property “in good working condition”. They do NOT add significant value to a property. Repairs include things like painting or roof repair. It is important to understand that all maintenance you do on your property is NOT considered repair. The IRS makes a distinction between improvement and repairs.
Improvements are seen as adding value to the property. For example, an entire new roof would probably be considered an improvement. Improvements CANNOT be deducted in full in the year they incurred. They must be capitalized and depreciated over their useful life.
Landlords are allowed to deduct certain local and long distance travel expenses that are business related. This does not include commuting expenses, meaning traveling from your home to your everyday office or place of business.
If you have your own vehicle for local travel, you can take your deduction using either the standard mileage rate or using the actual expenses incurred, such as the cost of gasoline and maintenance on the vehicle. You can also deduct parking fees and tolls, interest on a car loan and any applicable registration or license fees and taxes. If you do not have a vehicle, you can deduct your public transportation expenses for business purposes.
Many rental property owners live in other states from their rental properties and sometimes travel to visit the property. If you travel to visit your property, don’t forget to keep all receipts and take advantage of these deductions.
You can deduct the interest you have paid on business related expenses. For example: You can deduct the interest you have paid on mortgage payments or other business loans, car loan payment (but only the part used for business purposes) and the interest paid on credit cards used solely for business purposes.
You can take the home office deduction if you use a part of your home exclusively as an office for your business. You must conduct the majority of your business here to claim the deduction. The amount you can deduct depends on the percentage of your home that your home office takes up.
Unfortunately, entertainment costs do not refer to costs used to entertain yourself. Entertainment costs mean those incurred during business dealings. For example, taking a client to your country club or giving a potential investor tickets to the theater are entertainment expenses.
LEGAL AND PROFESSIONAL FEES
This includes the fees you pay to an attorney, accountant, real estate agent or fees paid to other professional advisors.
You can deduct the wages you pay to someone who does work for you, such as the wages of both full-time employees, such as a live in Property Manager or Maintenance employee and part time employees, such as a contractor you hire once to fix a roof leak.
You can deduct your property taxes, real estate taxes and sales tax on business related items that are not considered depreciable for the year. You can deduct fees for tax advice and the preparation of tax forms related to your rental real estate property. However, you cannot deduct legal fees from defending title of the property, to recover property or to develop or improve property. You must add these types of fees to your property’s basis.
You can deduct the premiums you paid on most types of insurance including health, accident, causality, theft, flood, fire, liability, vehicle and health insurance for your employees.
If your property was damaged by a catastrophic event like a fire, you may be able to deduct some or all of the loss. The amount you can deduct will depend on your insurance and the amount of damage to the property.
OTHER COMMON TAX DEDUCTIONS INCLUDE:
YOU SHOULD ALWAYS CONSULT THE IRS OR A CPA TO DECIDE WHAT DEDUCTIONS ARE APPLICABLE TO YOUR SPECIFIC SITUATION.
Because of the complex nature of real estate investor taxes, you should keep complete and detailed records of all important documents, income and expenses throughout the year in order to take advantages of the many available tax deductions. Knowing what records to keep for tax purposes can save you money and stress!
Keeping detailed records can help you for many reasons:
WHAT RECORDS SHOULD I KEEP TRACK OF?
The short answer is EVERYTHING! The IRS is notorious for auditing small businesses, especially those that show a loss in consecutive years.
Also, many IRS Agents do not understand the tax nuances that apply to real estate investors, making them more likely to question your filing. You will need to have proof if the IRS questions any of your items or even in the everyday course of business, if someone tries to question a payment.
You need to keep PERMANENT RECORDS and SHORT-TERM RECORDS.
Not just a couple of months, but you will want to keep any documents you deem important enough to claim on your taxes for a minimum of 5 years.
Keep anything that counts as income or an expense for the given tax year, such as:
HOW SHOULD I KEEP TRACK OF MY RECORDS?
You should keep a digital copy (computer) and/or a hard copy (paper) of all your records.
You will want to use a program such as Quicken or just create a spreadsheet with Excel. You should do this as soon as the income comes in or the expense occurs. Include as much detailed information as possible – the date, time, who you paid or who paid you, what the income or expense was for and the amount. Also include method of payment – cash, check number, credit card, money order, etc.
Some software programs will link directly to your bank accounts and will record your income and expenses for you. However, a simple spreadsheet will do the job. You should set up separate records/spreadsheets for each property, for each type of expense and for separate types of income. The point is to record as much information as you can at the time of the transaction, so you can easily create financial reports in the future. It is MUCH easier to keep records as you go than it is to dig them up for recording, at a later date.
You should always back them up on CD or an external hard drive and even with a paper copy. They should be printed out at the end of every month and/or at the end of the year.
You will want to make sure you have a paper copy of your most important documents. If possible, you will want to store them in a fire-retardant filing system or safe deposit box. If you cannot find one large enough for all your files, keep the most important ones, such as titles to the property in this box. Organize everything by year and then alphabetically sort the files so they are easy to find.
Just a bit of organization along the year will save you money and reduce stress at tax time!
Tax day is just around the corner and for many investors, panic can set in. Maybe all your tax documents have not arrived yet, maybe someone made a mistake. Maybe you can’t find the receipt for that large improvement or any number of other hold ups.
Don’t worry, just file a tax return extension! The IRS realizes that not everyone has a quick and easy return and if you are a real estate investor, your return is probably not “quick and easy”. If you feel like you are rushing to get everything together and feel the stress of that rush, it might be a good idea to file an extension.
NOTE: Extension are only for additional time to file. All taxes due are still due on the actual due date. The best way to get the tax paid on time is to estimate what you owe. Contact your CPA and ask them to prepare an extension payment calculation for you using the information you have received so far. If you are not sure what your profit or loss will be from your rental properties, use an estimate along with the rest of your tax documents. If your extension payment ends up being more than you owe, then you can have the excess refunded when you file your returns.
HERE ARE A FEW REASONS WHY IT MAY BE IN YOUR BEST INTEREST TO FILE AN EXTENSION:
If you have a new investment, you may not be sure what documents you are supposed to receive. If you miss a document, the error is fixable, but this will probably be at an additional cost to you.
Then there is increased risk that your CPA or tax preparer will make a mistake in the RUSH of getting the huge volume of tax returns prepared in a short period of time. Most tax preparers are working LONG hours during tax season, so that increases the likelihood of a mistake, as well as added IRS audit risk. So why not extend and make sure you don’t miss anything and give your preparer more time to devote to your taxes?
Extending your returns will give you additional time to ensure your taxes are done correctly and that ALL of your tax deductions are captured and you receive the maximum refund possible!
If your investments didn’t grow as well as you expected, you are able to undo the conversion and put the funds back in a traditional IRA. After your taxes are filed, this perk is gone.
Potential strategies include changing accounting methods, making elections to carry-forward or carry-back certain losses or taking advantage of the bonus depreciation or cost segregation for real estate. With a better idea of how the following year will turn out and what new tax laws might be, you can make better informed decisions.
As always, consult with your CPA or tax advisor for professional advice on your particular situation!
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Turn-Key Properties LLC
Combined 53+ years of real estate and property management experience serving Missouri and Kansas.