No one wants to pay more taxes than absolutely necessary! Here are some potential tax strategies to consider and discuss with your tax advisor as you plan for 2017.
REPAIR OR IMPROVEMENT FOR REAL ESTATE?
Why is it important to consider the difference? Repairs are deductible in the year they are paid, while improvement must be capitalized and only a portion is deductible each year. The $150 you spend on a plumber to fix the bathroom sink would be expensed the same year, but the $10,000 you spend on a new roof will likely need to be capitalized.
You may want to have a mix of both, as having deductions “waiting” for you next year, might not be a bad thing.
How do you determine the difference? Some say, if it’s something you would brag about, it’s likely an improvement. If it’s something you don’t want to let people know about, then it’s likely a repair.
IRS rules are a bit more complicated. If you are telling a potential renter that the bathroom is newly remodeled or that the house has a brand-new roof, these are likely improvements. Repairs are generally things such as the burst pipe under the kitchen sink or the termite damage around the roof trim.
The newest IRS rules state if it cost $2,500 or less, it generally is a repair. Over $2,500, then you must determine if it more likely to be considered an improvement.
Discuss expenditures with your tax advisor. With items that could fall into both categories, you can decide which deduction would help you the most.
CAPTURING BUSINESS DEDUCTIONS
Make sure you gather your business expenses. You have more costs than you may realize. Even if you pay a Property Manager for most repairs and deduct the bare bone expenses of Mortgage interest, property tax and insurance, you still have administrative expenses such as postage, office supplies, bank charges, etc. These add up.
If you manage your own rental property, don’t forget to deduct gardening, advertising, business license, etc. Investors who do fix and flip need to remember the miscellaneous expenses in addition to purchase price, sales price and re-hab costs.
Don’t forget Home Office deductions. Many investors do not want to take the time to figure out their expenses, but home office deductions generally provide thousands of dollars of write offs. Your investment is your business and you should get a deduction for your in-home business office. Ask your tax advisor and search on-line for tips on how to maximize this deduction.
The home office deduction is also available to renters, as well as home owners! Although renters do not get a deduction for mortgage interest or property taxes, rent payments can be factored into the home office deduction. It might take a bit more time, but if you are in a 40% bracket between fed and state, then every $1,000 of deductions can save you $400. Saving and sorting those receipts can be worth it!
Accelerated depreciation or a cost segregation study is a way to take more depreciation now by breaking down your depreciable basis into shorter periods of time. A residential rental property typically has a building depreciable life of 27.5 years. With accelerated depreciation, you can break down that building into other types of property that have 5, 7 or 15-year lives.
If this is something you want to do, make sure you start the process now.
Keep in mind that taking more depreciation now also means that you will have less depreciation 5, 7 and 15 years down the road. Your decision may depend on the length of time you plan to keep the property. Be sure to discuss this strategy with your tax advisor in detail before making any decisions!
Flippers, if you have positive active income such as commissions or income from flips, you may be eligible to contribute to retirement accounts. This does not apply to rental real estate, as rentals are considered passive activity. However, flip or wholesale income are types of income that may qualify.
A powerful retirement account is a SEP IRA. If you have positive self-employment income, then you may be able to contribute up to 25% of your net profit. For example, if you made a $50K profit from your flip, then you may be able to set up and contribute $12,500 to a SEP IRA. The contribution can also potentially be a tax deduction against your other income and reduce your taxes due. Remember you must have a net profit to use this strategy. If you have a loss, a SEP may not benefit you.
ESTIMATED TAXES FOR THE FOLLOWING YEAR
If you have an overpayment from one year’s taxes, consider applying it to the next year, if you are generally required to make estimated tax payments. This could help you to minimize or avoid estimated tax penalties. If you missed estimated taxes for the current year, consider increasing you W-2 withholdings. Since W-2 withholdings are considered to be done evenly throughout the year, increasing your withholding amount can help you significantly reduce any underpayment penalties.