Category Archives: Advice for Landlords

0 Investment Property Tax Deductions and Implications

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investment property tax deductions

 

In order to better understand the implications of investment property tax deductions, let us briefly discuss the process for determining your tax liability.

 

Tax Preparation Process:

Whoever is preparing your taxes fills out a Form 1040 and submits it to the IRS. This form does two things: 

  1. Calculates your taxable income for the year by taking your earnings minus your tax deductions. Earnings consist of all sources of income received throughout the year. Deductions consist of things such as mortgage interest payments, property depreciation, etc. The IRS offers a standard deduction, which you will use unless your itemized deductions exceed that amount.
  2. After you determine your taxable income, the Form 1040 is used to reconcile the amount you owe based on your taxable income, minus what you have already paid in through the year. If you paid in more than you end up owing, you get a tax refund. If you end up owing more than you paid in, you get a tax bill.

Owning an investment property will affect your tax liability in two main ways:

  1. Rental Income increases your taxable income by the amount received in the tax year.
  2. Investment Property Tax Deductions lower your taxable income by deducting certain expenses associated with owning an investment property.

investment property tax deductions

Investment Property Rental Income

The IRS considers rental income to be “any payment that you receive for the use of occupation of property”. When determining your taxable income, it must be included, along with any other income you receive from your investment property.

Timing is important because even if you are paid rent in advance prior to the time period it covers (say, December 31st for January’s rent), you must report the income in the year it is received. That means when the funds were given to you, not when you cash the check.

Something else to consider is that any expense that the tenant pays for the property, such as repairs or replacement of an appliance, must count as rental income received. You must also report as income any non-refundable deposit. If the deposit is to be returned, you should not report it.

Investment Property Tax Deductions

Deductible expenses are things that you are able to write-off on your taxes in order to lower your taxable income. There are a bunch of investment property tax deductions that are available to the property owner. If you are claiming these investment property tax deductions on your tax return, make sure you keep good records in case of an audit.

These are the most common investment property tax deductions:

  • Depreciation Deductions

    • This investment property tax deduction is based on the percentage that your asset depreciates each year. Depreciation refers to the value of the property that’s lost over time due to wear, tear, and obsolescence. This can give you a nice tax break in some situations. The depreciation of the rental property and its appliances begins as soon as the property is held out for rent, even if you don’t yet have tenants.
    • Remember that when you sell you will pay tax on the gains you receive as well as the depreciation deductions that you took. You can’t avoid this by not taking the depreciation deductions either. When you sell, the IRS requires you to adjust by your depreciation deductions or the amount of depreciation you could have deducted. What’s the lesson here? Use your depreciation deductions because you have to pay the taxes on them later regardless.

  • Interest Deductions

    • Mortgage Interest Deductions: Mortgage interest is another investment property tax deduction that can be very beneficial. This is generally reported to you on a Form 1098.
    • Non-Mortgage Interest Deductions: If you put expenses for your investment property on a credit card that you only use for rental expenses, any interest received is tax deductible.

  • Property Tax Deductions

    • Any taxes that you pay for your investment property, whether personal property or sales tax are eligible as investment property tax deductions.

  • Maintenance and Management Fee Deductions

    • This includes fees associated with maintaining the investment property such as landscaping, lawn care, cleaning, homeowners associations, condo dues, pest control, and even the cost of light bulbs and smoke detector batteries. If you hire a property manager, that expense is also deductible. If you are a property manager, you can write off any commissions paid to rental agents.

  • Repair Deductions

    • This accounts for any property repairs, such as repairing the dishwasher or fixing a leak. You have to tread carefully here and know the difference between repairs and improvements. Repairs are tax deductible, improvements are not tax deductible and they add value to the rental property. Repairs are any fix that is necessary to keep your property in working condition.  

  • Office Operating Expense Deductions

    • You can write off expenses associated with running your business, such as office supplies and office space. If you work from home, you can write off your home office based on its square footage percentage of your home. However, you should only use this space for business purposes.

  • Advertising Deductions

    • You can deduct the cost of advertising to find tenants for the investment property.

  • Traveling Expense Deductions

    • These are expenses associated with traveling to the investment property for maintenance, rent collection, and showings. If you are using your own vehicle you can claim the standard rate per mile as well as any fees associated with tolls or parking.

  • Insurance Deductions

    • Insurance premiums are tax deductible. This includes fire insurance, flood insurance, liability insurance and mortgage insurance.

  • Legal Fee Deductions

    • Some legal fees associated with your investment property are tax deductible. Tax preparation fees are also tax deductible.

  • Utility Deductions

    • You can deduct any investment property utilities that you pay for. However, if the tenant reimburses you later, you must claim that as income

Passive Activity Rules

The IRS’s passive activity rules prevent you from applying net rental losses to offset your other income, such as your salary. In other words, your investment property tax deductions can offset up to the amount of income that comes from your investment property, but no more. You can carry forward disallowed passive losses to the next taxable year.

There are a couple of exceptions to the passive activity rule. If you actively participate in your rental activity, you may qualify to deduct up to $25,000 of loss from the activity to offset nonpassive income. If you are a real estate professional and you meet certain requirements, you may be able to treat it as nonpassive activity and avoid the passive activity rules altogether.

Vacation Home Tax Implications

If you rent out your property for less than 14 days a year, you don’t have to pay taxes on the rental income. This situation normally arises when you have a vacation home that you mostly use personally, but rent out on a very limited basis. The vacation home status also limits the investment property tax deductions that you can claim.

Foreign Investment Property Tax Implications

If your investment property is in another country, you must report the rental income on all of your tax returns. This means that you may be paying the income tax in both countries. However, in the U.S., you can claim the foreign income tax as a deduction against your U.S. tax liability. You report your rental income and deductible expenses at the current exchange rate.

 

Investment property tax implications are complex. It is important to always have a licensed tax professional advise you on your individual tax scenario. Working with a property management company can help ease some of the burden at tax time. At Paradise Care, the property management division of RE/MAX Paradise, we have software to make your 1099 submission easier. Contact us today to get your free property management quote.

0 Property Management Horror Stories

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property management horror storiesManaging an investment property is a huge responsibility. The idea of having a free and clear property or two to generate income every month might sound like a dream come true, but in reality that journey it is full of unexpected hurdles.

There is always some degree of risk involved when renting out a property, but hiring a property management company that you can trust takes a lot of the stress off of your shoulders. There are a hundred reasons to hire a property manager, but in short, you need to protect yourself, your time, and your investment. The property management horror stories shared below shed some light on the many ways things can go wrong when you are renting out a property.

Terrible tenants

George Paiva shares a story about one of his rental properties on Bigger Pockets that reminds us why it is important to check in on tenants.

“There were 3 people living there. Boyfriend, Girlfriend, Girlfriend’s 4 yr old daughter. That place was literally a pig pen. Garbage, car parts, broken windows and doors. I must of spent $5k out of pocket and I did all the work. It took out 3 truck loads including a utility trailer with those loads of Garbage and Broken Furniture. I just couldn’t believe how much stuff was in there. As bad as I thought the clean-up and repair was, I couldn’t stop thinking about the little girl growing up in that. I had a son the same age. To this day I wish I did a site inspection and called child protective services on them.”

Maintenance Nightmare

Jimmy’s property management horror story comes from Lighter Side of Real Estate.  This maintenance nightmare jeopardized the happiness of his tenants and could have been avoided with the access to experienced contractors and repairmen that comes with partnering with a good property management company. Jimmy got the following text from his tenant, Maria one night:

Maria: ‘Hey Jimmy, we’ve got A LOT of rain coming in through the back window. It’s coming through the wall.’

Jimmy goes on to say “of course, by the time I arrived it wasn’t raining so I couldn’t tell what was going on. The next day I return to put some tarps up with my kids, just to buy some more time to call a few contractors and figure it out. It took 2 additional weeks for 2 contractors to finally go over there just to assess what was going on and give me an estimate. Meanwhile, the tarps didn’t work and my house continued to flood every time it rained. And as murphy’s law would have it, it rained pretty much everyday.

Why multiple contractors couldn’t figure out what was going on is beyond me. One of them wanted me to rebuild the whole back wall at a measly price of $12,000! Another said he could rebuild part of the back wall for only $2,000. I chose the latter. Meanwhile the poor tenants had to deal with this for 2 months!”

Property Damage

A landlord wrote into Curbed with a property management horror story that included some of the strangest and grossest property damage imaginable. Leading up to that, this tenant had refused to pay rent for 8 months. He had to go through the entire legal procedure, and once he achieved the eviction things only got worse..

“We quickly had a new resident interested in the unit. We did our final touch ups and the minimal needed repairs prior to them moving in just three days after the sheriff showed up. Within a couple of days the new tenant complained that the apartment had an odd odor. We inspected and did not find anything wrong. The HVAC filters had just been replaced. We had replaced the carpets as part of our standard turn. The walls had a fresh paint of coat. Nearly everything in the apartment was brand new. The source of the odor could not be found.

A few days later, more complaints from the new residents. Again, we inspected and found nothing wrong. As a precaution, we had the apartment repainted, filters replaced, carpets cleaned and even had a deodorizing bomb while the resident was out of town for the weekend.

Almost one month later, the new resident was still complaining about a fowl odor throughout the apartment. We inspected yet again. However, this time we could start to see some slight discoloration in some portions of the walls throughout the apartment. We began to poke holes in the drywall where this discoloration appeared. To our complete surprise, maggots crawled out of the holes. We began to pull back the drywall piece by piece. The evicted tenant had cut multiple holes in the drywall in every room of the apartment and thrown packages raw meat into the wall cavities—steaks, ground beef, chicken breasts, pork chops, etc. Before moving out, he patched the holes so well that they looked as if they had never been touched.

We had to rip every piece of drywall, insulation, etc. out of the apartment and the surrounding units to get rid of the smell. But, I don’t know if I’ll ever be able to get the memory of that smell out of my mind.”

7 Months of Deferred Rent

A member of the National Association of Independent Landlords tells the story of a horrible tenant that he was left with after opting to not run a background check because the tenant flashed some cash up front.

“A nice dressed man came to rent my property. He drove a very nice car and said he had a good job. When I asked him if I could run a background check on him, he said his wife had recently died and he wanted to rent now! He flashed a lot of cash and I agreed. He never paid rent again, after the first month. When I started to evict him, I found out he filed bankruptcy. By law he did not have to pay me rent while he was in bankruptcy court. I was considered a creditor. He lived in my home for seven months without paying a dime. I still had to pay my mortgage. I found out later, he had done this repeatedly.”  

Tenants Not Paying Rent

Melissa W shares her story of dealing with scam artist tenants on Bigger Pockets.

“There was a family who didn’t pay rent and called codes. There was a lengthy list of violations, some of which he had caused himself (holes in walls, excessive trash, etc). Still, it is the landlord’s legal responsibility. They would make appointments with maintenance and not let them in. Since they changed the locks and had dogs there was nothing they could do.”

Knowledgeable property managers know your rights and have seen all the tricks. They can guide you through this kind of situation, or better yet, prevent it through vetted screening processes.

Unexpected Tax Changes

Holly Johnson talks on The Simple Dollar about her regrets over not being informed of the impact that owning a rental property would have on her taxes. 

“One of the first lessons we learned about owning rentals came as a huge, scary surprise and ended with a night of tears and weeks of stress. I’ll never forget the day I opened our property tax bill for our first rental and realized that our property taxes had gone up 300% overnight. property tax caps on rental properties were a full percentage point higher.”

Avoid Your Tenant Horror Story

Vetted screening processes, knowledge of real estate tax laws, and access to a team that handles rent collection and home repairs can protect you from the vast majority of property management horror stories. Don’t underestimate the importance of putting your investment in the hands of trained professionals. Contact the professionals at Paradise Care, the sister company of RE/MAX Paradise to get your property management quote today.