You’re undoubtedly aware that owning rental property has a variety of tax advantages. But what exactly are these rental property tax advantages? This article will tell you.
The truth is that real estate investors may deduct a significant portion of their monthly tax expenses. This is one of the reasons why the average landlord’s income is 44.8 percent more than the median family income in the United States.
Many landlords fail to take advantage of the tax advantages of owning rental property, and as a result, they lose a considerable portion of their income to taxes each year. In this post, we will discuss how owning real estate may help you save money during tax season. You’ll also learn about the rental property write-off restrictions so you know what to shoot for.
Rental investors and property owners can take advantage of a number of tax breaks and deductions. Among them are the following:
#1 – Deductible Operating Expenses
The recurrent expenditures of running a firm are known as operating expenses. They are the expenses related to the operation and general upkeep of a rental property.
Expenses for managing and maintaining a rental property are deductible. These costs are deemed usual and necessary for conserving and maintaining the property by the Internal Revenue Service. Broker fees, utilities, advertising charges, maintenance expenditures, property management fees, lawn care, service fees, and taxes are some of these costs.
#2 – Depreciation Deduction
Depreciation is the gradual decrease in the value of property caused by wear and tear. Depreciation is an annual income tax deduction that allows you to recoup the cost basis of a property over time, according to the IRS.
This depreciation expenditure is deducted over time rather than all at once. This time is 39 years in the case of commercial real estate and 27.5 years in the case of residential rental properties.
Because land does not depreciate, the depreciation expenditure only comprises the cost of the house and improvements that are susceptible to wear and tear. Roofing, fences, home extensions, HVAC systems, and other comparable items are included. For example, if you buy a house for $500,000 and the lot is worth $80,000, the cost basis of the house after depreciation is $420,000. Assume you spent $30,000 to add a garage and $15,000 to install a brand-new roof. The cost basis of your property would be modified for those upgrades and would total $465,000. This would result in an annual depreciation charge of around $16,900. (over 27.5 years).
According to IRS standards for rental property, the cost of a replacement roof depreciates for the same amount of time as the property, whereas appliances depreciate over a five-year period. Depreciation begins on a property when it is either put into operation or ready to be rented out.
#3 – Mortgage Interest Deduction
This is most likely the greatest property tax credit available to homeowners. According to the Tax Cuts and Jobs Act of 2017, homeowners can now deduct mortgage interest paid on loans up to $750,000 (formerly $1 million).
The interest on home equity loans is deductible if the funds are utilized to purchase or enhance your house. Landlords can also deduct the interest on credit cards used to purchase products or services for their business since this is considered “business credit.” As a result, investors should have their own corporate credit cards.
When a property owner refinances a property for more than its current value, the interest can be deducted. This is true if the updated terms are meant to improve or maintain the property.
#4 – Deductible Travel Fees
Travel expenditures are another tax break available to real estate investors. Most travel expenditures, including automobile expenses, flights, hotel, and meals, are deductible. They must, however, follow the criteria outlined in IRS Publication 463:
- Travel expenses, according to the IRS, are charges spent while you are away from your tax residence. Your tax home is your normal office where you work most of the time.
- The journey must be for professional purposes. It may have a secondary personal objective, but it should be primarily for commercial purposes.
- Meals that aren’t considered extravagant are considered deductible travel costs.
- A business cost must be judged usual and necessary in order to qualify for the deduction (O & NE)
Instead of the real cost of the daily meals, you can deduct a standard meal allowance. This allotment varies from state to state. The regular rates are available on the IRS website.
You may also be entitled to deduct vehicle expenditures incurred while going to the property. Driving to the rental property to collect rent or fix an item, for example, is a deductible travel cost.
You can deduct travel expenditures in two ways. You can deduct real expenditures if you kept track of them, or the usual mileage rate plus parking and tolls. The normal mileage rate for 2022 is 58.5 cents per mile.
If you use fewer than five automobiles for business purposes, you can utilize the normal mileage rate. You use it throughout your first year of driving a car for your real estate firm.
#5 – 20% Pass-Through Income Deduction
Pass-through business owners with positive taxable income are eligible for a 20% pass-through deduction (qualified business deduction) on their tax returns.
In this context, pass-through indicates that the earnings and losses experienced in the operation of the firm are allocated to the individual owners, who subsequently pay taxes at individual tax rates. Sole proprietorships, partnerships, LLCs, and S Corporations are examples of pass-through enterprises.
For example, consider an investor who owns numerous condominiums in a corporation he manages on his own. If he earns $100,000 per year, he may deduct 20% of that amount, or $20,000, on his tax return as a pass-through deduction.
The Tax Cuts and Jobs Act (TCJA), which went into effect in 2018, allows owners of pass-through enterprises who qualify to deduct up to 20% of their entire company revenue from their income taxes. To qualify for the deduction, investors must own a pass-through business and have qualifying business income (QBI).
The net profit made by a pass-through firm is represented by QBI. QBI, on the other hand, excludes capital gains, dividends, and interest.
#6 – No FICA Taxes
FICA taxes, often known as payroll taxes, are a United States payroll tax taken from both employees’ and employers’ paychecks to finance the Social Security and Medicare systems. Self-employed individuals are often obligated to pay both the employer and employee halves of the FICA tax – a total of 15.3 percent (for 2021). Social Security taxes are deducted from your total income up to $147,000, while Medicare taxes are deducted from your total earnings.
Rental income, on the other hand, is not subject to FICA tax since it is not legally classed as earned income. For example, if Jane operates a freelancing company and earns $120,000 per year, she must pay 15.3 percent of her earnings, or $18,360. However, if she obtained same money from a rental company, she would not be subject to payroll tax.
#7 – Deductible Legal Fees
Legal expenditures, such as payments to real estate attorneys and court fees, might also be deducted in the case of evictions or legal disputes. These fees are considered operational expenditures and can be deducted as long as they are relevant to your real estate firm.
These are either facilitative expenses (amounts spent to assist the purchase of real estate or a business) or investigative costs (paid in the process of performing due diligence on the property). As long as they are directly tied to your real estate company activities, these charges can also include appraisal fees, title fees, and the cost of getting regulatory permission.
#8 – Home Office Deduction
If you conduct your business from home, you may be eligible for a deduction because of what the IRS refers to as “business use of your home.” Furthermore, the IRS defines “home” as a house, boat, apartment, condo, or similar property that offers basic living facilities.
Before you may be eligible for a home office deduction, you must fulfill three requirements:
- Continual Use: To do business, you must have a specific location in your house.
- Commercial or business use: Your operations in this sector should be associated with a well-established trade or business.
- The main place of business: To do business-related tasks, your home must be your principal workplace.
If you qualify for this deduction, you should be able to deduct the majority of your home expenditures, including rent, maintenance, utilities, phone bills, mortgage interest, and real estate taxes. You have the option of using the Simplified Method or actual expenditures. This deduction is available regardless of whether you own or rent your office.
#9 – Defer Capital Gains Tax
By completing a Section 1031 exchange, real estate innovators can postpone paying capital gains tax and depreciation recapture on the sale of a rental property.
Normally, when you sell a property, the amount of profit you made owing to depreciation is taxed as depreciation recapture. Depreciation recapture is subject to a maximum tax rate of 25%.
In addition, you must pay a long-term capital gains tax (often 15-20% of the profit from the sale). If you own the property for less than a year, you are taxed at the regular income tax rate (up to 37 percent ).
As a result, investors frequently choose a 1031 exchange to defer taxes until a later date. A 1031 exchange includes the exchange of one investment property for another in order to defer capital gains taxes. A 1031 exchange might be tricky, so you should employ a specialist to guide you through it. More information about 1031 exchanges may be found here.
The attributes must be of “like-kind,” that is, they must be of a comparable kind and designed for the same purpose.
There is no limit to the number of 1031 exchanges that can be performed. As a result, capital gains and depreciation taxes can be postponed forever.
However, taxes must be paid at some time, unless inheritance is used, in which case a stepped up tax base is employed.
#10 – Medical Home Improvement Deductions
Homeowners can also deduct house modifications performed for medical reasons. Medical costs are deductible for home renovations intended to provide medical care for house inhabitants. Fire alarm and warning system changes, entrance and exit ramps, handrail installation in restrooms, and stairway modifications are examples of these enhancements.
To be eligible for this deduction, you must be able to demonstrate that the modifications are required by a resident. You must itemize and guarantee that you only deduct medical costs that exceed 7.5 percent of your adjusted gross income (for 2022). In addition, you must deduct the rise in the value of your house from your deductible.
As an example, suppose you pay $5,000 to install porch lifts in your home to offer accessibility. If it enhances the value of your property by $2000, you may only deduct $3000.
Claiming this deduction might be a little complex, so working with someone who is certified and skilled may be beneficial.
It should be noted that homeowner’s insurance and private mortgage insurance are not currently tax deductible.
HOW MUCH CAN YOU WRITE OFF ON A RENTAL PROPERTY?
Homeowners have long been able to deduct the annual property taxes they pay on their homes. The 2018 TCJA set the maximum amount anybody can deduct on itemized deductions for state and local income, sales, and property taxes at $10,000. Married couples filing separately have a $5,000 limit each. To claim tax deductions for rental property, you must be the property’s owner.
Investors may want to take the standard deduction rather than itemized deductions. The standard deduction for single taxpayers is $12,550 in 2021, $18,800 for heads of households, and $25,100 for married couples filing jointly. Singles will pay $12,950, heads of families will pay $19,400, and married couples will pay $25,900 in 2022. If you choose the standard deduction, you will be unable to take itemized deductions for the remainder of the year. Compare both deductions to find which one reduces your tax burden the most. The rental property tax deduction calculator includes a section for standard vs. itemized deductions so you may evaluate which is more advantageous to you.
CONCLUSION
You should now understand the rental property tax benefits you are eligible for and how to deduct them to boost your bottom line. Landlords who do not take advantage of these tax breaks wind up paying more and earning less than they could. However, working with a licensed tax expert can help you acquire the knowledge and advice you need.
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