04 Sep Tax Rules and Deductions for Real Estate Investors
If you are investing in real estate there are some tax rules and deductions for real estate investors that they shouldn’t miss. Yes, you need a qualified tax preparer to maximize deductions, but you also need to know what to take to them for a quality result.
Investing in real estate can be a full time job, a part time passion, a way to collect extra cash to cover expenses or even a retirement plan. The choice is yours, Ask yourself what you want to accomplish and then start planning for your success.
You have heard the old saying, “It takes money to make money”. This is true. You may get into a property using a no money down technique, but then you need to pay the taxes, mortgage, insurance, upkeep and the lot.
If you work with your income tax preparation professional they can help you understand what expenses you can offset many with the judicious use of income tax deductions that are legally available to you on your personal tax return.
This article is focused on individuals who file a personal return 1040 with a Schedule E for rental property income and deductions.
Passive vs. Non Passive Tax Rules and Deductions
To claim your deductions you need to keep decent records and meet the qualifications set forth by the IRS. Does your real estate business fall into the category of passive or non-passive income? Passive losses are limited to passive income. What this means is that if you are determined to be a passive investor you cannot deduct losses in real estate to offset income earned from employment or other investments.
Is your investment at risk? If you cannot lose your investment you cannot take the deduction.
Did you materially participate? Unless you are involved in the operation of the business your deductions are limited. If you performed less than 750 hours of service or trades in real estate you did not materially participate.
If you do not meet either the At Risk Rules or Material Participation rules your deductions are extremely limited.
It is ok to hire a property manager. Be aware that if you cannot prove your involvement in the business your deductions are out the window.
If you did not materially participate you can still take the deductions below. Just remember they cannot be used to offset other income.
Every January or February your lender should issue you a form 1098 to report mortgage interest you paid of $600 or more, that was paid by you during the year preceding calendar year. It will show all the mortgage interest you can legally deduct and if you escrow your real estate taxes and insurance payments as well. All three of these can be deducted against the rental income received for that property.
Although the market value of your property may be increasing or decreasing, all real estate except land is depreciable as an annual expense. Residential properties are depreciated over a 27.5 year time span. Commercial properties are depreciated over 40 years.
Example: The purchase price of a single family home is $100,000.00 and a purchase contract is negotiated. The value of the land at the time of acquisition is $12,500.00 and must be deducted from the purchase price to determine how much of the purchase price can be depreciated over the next 27.5 years. In this instance that would leave $87,500.00 which could be depreciated before any needed renovations are incurred.
Depreciation starts on the day the property is first available for rent. Your tax preparer will call this “Placed in Service” This is not the day the tenant signs the contract. It is the day you make it available for rent.
Other items can be depreciated as well such as computers, vehicles, and other major purchases for business use. Many items can be written off in the year acquired, but it might be to your advantage to consider depreciating them if your losses for the years exceed $25,000.00 by any amount.
Renovations and repairs over $2,500 should be depreciated starting the year they were performed. Depending on the type of renovation or repair it might be depreciable over 5, 7.5, 10, 15 or 27.5 years. Ask you tax professional for clarification.
Utilities you pay for that are either required by the rental agreement or needed to keep the property rented. Dusk to dawn lights, gas, electric, water, sewer, trash to name a few. If you provide it with the rented property it should be deductible.
Exception: Utilities paid for during a time of renovation are part of the cost of renovation are not deductible in the year incurred and should be depreciated.
Cars and trucks can be expensed in one of two ways. Actual mileage incurred or actual expenses incurred. Mileage is the simplest and requires record keeping but not book keeping.
Mileage method: Keep separate track of your business and personal miles. Total up the business miles at the end of the year and multiply that number by the mileage dedication allowed by the IRS for that year. This number floats up and down based upon the cost of gasoline but has been over fifty cents a mile for the last decade or so. So if you drove 25,000 miles and the IRS allows $0.56 per mile that year your deduction is $14,000.00 for the year.
Actual Expense method
Keep track of every receipt for gas, oil changes, tires, mechanical work etc and total them up at the end of the year. Add to that the depreciation of your vehicle and you have the deduction. Keep those receipts in a safe place until you have been out of the business 7 years in case the IRS audits you.
All business travel deductions have to be ordinary and necessary for your business. So a real estate investors educational conference such as the Annual National REIA Education Conference and Cruise https://nationalreiacruise.com/ could be 100% deductible including the transportation to and from. However a conference on an unrelated field such as Day Trading would probably not be.
What this means is that something that is a solid standard deduction in one field will probably not be acceptable in another.
Travel to inspect and maintain your properties would be considered ordinary and necessary. You could deduct travel to and from properties in another state or even country if you show the income on those properties on your income tax return. They rule is that your travel MUST be a vital part of managing them. Your travel expenses are part of the cost of doing business, and your taxes should reflect that.
Repairs and Renovations
Repairs are viewed as ordinary and necessary expenses for real estate investors. You can deduct the cost of repairs and improvements you make to properties of up to $2,500.00 in the year in which they were incurred. Repairs over $2,500.00 may be seen as renovations.
Renovations are improvements to the property in excess of $2,500.00 in any one year, These might be deductible in the year incurred but probably should be amortized and depreciated depending on the type of items involved.
Legal and Professional Fees
Legal and Professional Fees includes attorneys, Tax Preparation, Real Estate Appraisers and much more. If you need to hire a professional to help manage your business they might go here.
You can deduct any legal expenses you incur as part of managing your real estate investments. This includes but is not limited to drafting contracts, eviction costs, boundary disputes, defense costs and even the cost of a pre paid legal plan suck as LegalShield. (go to www.Skidis.Biz for more information).
Have your income tax prepared separate the cost of your tax preparation between personal and business. The business part is deductible on Schedule E. If you itemize the personal part is deductible on Schedule A.
Line 19 Miscellaneous Expenses
One of the most overlooked areas of a tax return is Line 19 on Schedule E. This is the place where smaller misc deductions go. Do you use your cell phone in your business. Deduct a portion of the use here. The same with internet costs.
Tax Rules and Deductions for Real Estate Investors includes everything related to your business. If it is incurred, it can be deducted, if the correct procedure is applied. There are restrictions on deductions based upon being at Risk or Materially participating. One final note is that if your earned income exceeds $150.000.00 in a year your real estate deductions are capped at real estate income and many of the losses will not be claimable in those years. See your tax professional for more information about income limitations.
Good Luck and Good Investing
George N. Skidis, Jr.
President and Founder