Taxes and Deductions for Rental Owners

Three Phases of real estate ownership

  1. The initial purchase and set up for tax purposes
    1. Allocate purchase between building and land. Separate land and building. Depreciate the building only.
    2. Methods of allocation
    3. Pick up purchase costs and points. Repair is happened after the property is rented out. Depreciation is happened before the property is rented out, any renovation.
  2. Bookkeeping and taxation of your ongoing operation
  3. Tax issues involved with disposing of your property

No tax due on purchase

Depreciation

  1. You are required by tax law to take depreciation your building
  2. When you sell you are required to pay tax at 25% on depreciation taken or required to be taken
  3. Depreciation on a building is like a loan. You get a tax break in rental years and pay it back when you sell. (27.5 years)

Cost Segregation Studies – Factory, small apartment building

  1. What is usually considered “building” can be broken into sub-systems such as plumbing, electrical, etc. That may qualify for a shorter depreciation life.
  2. To take advantage of this you need to work with an expert in this to document the separation of the building into these sub systems and help with the IRS form required
  3. This allows faster depreciation and may avoid depreciation recapture when the building is sold per the prior slide.

Ongoing Operations

  1. Need to decide how to keep track of your income and expenses

Rental Income and Expense

  1. Income
  2. Cash expenses
  3. Mortgage payments
  4. Depreciation
  5. Reported on Schedule E of your personal tax return

New Repair Regulations

  1. Generally, costs that result in an improvement must be capitalized. Betterment, restoration, adoption to new user or relatively large are capitalized.
  2. Materials and supplies costing less than $200 with a life of one year or less can be expensed
  3. The de minims rule – If you have a written accounting procedure you can expense up to $500 in purchases, up to $5000 if you have audited financial statements.
  4. Safe harbor for small tax payers with average gross receipts of less than $10,000,000 for the past 3 years
  5. For Building with an unadjusted basis of $1,000,000 or less
  6. A qualifying taxpayer may elect to expense costs related to certain rental property if the total amount paid during the taxable year for repairs, maintenance, improvements, etc. does not exceed the less of:
    1. 2% of the unadjusted basis of the building property or $10,000
    2. Must attach as election statement to a timely filed tax return, including an extended return. Can elect building by building

Deductibility of Losses

  1. Rental profit taxable as ordinary income
  2. Losses are deductible up to $25,000 per year from rental activity
  3. Ability to deduct losses phases out with income. Starts to phase out at $100,000 and Phases out completely at $150,000/

Real Estate Professional

A real estate professional can deduct more than $25,000 in losses regardless of income level. Must meet the following tests:

    1. More than 50% of your personal time spent working at real estate property or trades you materially participate in
    2. Spend more than 750 hours per year at real estate activities
    3. Must elect to consolidate your activities

Net Investment Income Tax

  1. MFJ taxpayers with adjusted income over $250,000 owe 3.8% tax on lesser of net investment income or the amount of income over the $250,000 limit
  2. Rental net income and sale of your rental property count as net investment income
  3. A real estate professional may qualify to exclude their income from this tax if they meet the material participation requirements for their rental properties. That means at least 500 hours spent on the rental, not on related real estate activities such as sales or constructions, etc.
  4. Again, you need to consolidate your rental activities or else you need 500 hours for each property.

1099 Reporting

  1. Individual property owners not required to issue 1099s to gardeners, etc.
  2. Businesses must issue 1099s
  3. Be aware of Washington State tax issues in terms of employment taxes, etc. regarding casual laborers who may be considered employees by the State of Washington.

Disposing of your Property

  1. Sell the property
  2. Gift the property
  3. Do an exchange for another property – 1031 exchange
  4. Abandon the property
  5. Die and leave it for your heirs – the best for the tax purpose

 

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