Tax season is around the corner. Real estate investors have many taxable assets to consider, from rental income to the property itself. However, there are tax deductions for rental properties. Investors have laws at their disposal that serve to save them money during tax season. But those laws can only be put to good use if investors know they exist. In this post, we're going to cover the 5 powerful tips and tax benefits for rental properties that work to save single-family investors money during tax season. Disclaimer: The information provided in this blog does not, and is not intended to, constitute tax advice; instead, all information, content, and materials available in this blog are for general informational purposes only.
Depreciation
While your property is in service (which starts as soon as your property is ready to be rented out), it may qualify for depreciation. Over time, your property experiences wear and tear, thus losing value. But, over time, you put money back into the home, first by buying the property and then through repairs as it ages. Depreciation allows you to deduct the taxes on the amount that you’ve put back into your property as it wears down. Then, you can subtract that number from your rental income earnings. This process takes place over a set amount of years and is calculated by dividing the cost of the building by the number of years you can legally claim that it will depreciate. For residential properties, the years that the property is counted as useful is set at 27.5. Each year, you can divide the cost of the property by the number of years it will depreciate over and subtract that amount from your rental income. Say you paid $200,000 for the building alone (land cannot be depreciated, so the cost of the land is excluded). If it was a residential property, for the first year, you could calculate it like this: 200,000 / 27.5 = 7,272.73 This number is added to the expenses portion on the 1040 form of your Section E, and is subtracted from your total rental income. Figuring out how to correctly calculate depreciation can be tricky, as you can only depreciate the property itself, not the land it was built on, so you must separate those costs. However, this can offer relief on your tax bill and keep money in your pocket each year. Keep in mind, if you use this strategy and then go to sell the property later, you’ll owe a depreciation recapture tax.
Skip the FICA Tax
While income that’s gathered from rental properties is still taxed by the Federal tax bracket, it usually does not qualify as earned income, which means you can skip the FICA tax! What is the FICA tax? Self-employed individuals normally have to pay the FICA tax, which is the U.S. federal payroll tax. This tax includes Medicare and Social Security fees, which total 15.3% of earned income since you’re on the hook for both employee and employer fees. If you had a business generating $50,000 in income, then you’d have to pay $7,650 in FICA taxes. If your rental income qualifies as passive income instead of earned income, then you don’t have to pay the extra 15.3% FICA tax.
Business Tax Deductions
As an investor, you may technically be a business, which means you could get business tax deductions! These can include expenses such as:
- Mileage. This includes gas going to and from your property, and also travel expenses.
- Office space. You may be able to write off an office, or even a part of your home.
- Property Manager
- Lawyer
- Accountant
- Property taxes
- Repair and maintenance costs
- Utility bills
- Insurance premiums
- Section 179 deductions
- Mortgage loan interest.
A good tip is to save all of the receipts for anything you buy that relates to your property. If you have to buy a new appliance, hire a landscaper, or take on a property manager to care for your resident, you’ll want to keep a detailed record of the purchases to see if they can be written off at the end of the year.
1031 Exchange
While there are many rules to follow under the 1031 Exchange of the Internal Revenue Code (IRC), it may allow you to defer all of your capital gains when acquiring a new property. Essentially, a property investor can sell their property and then, within a set number of days, invest the profits of the sale into a like-kind classified property. The investor can hold off on paying the tax on the capital gains of the sale, which they would normally have to pay, and instead invest those funds into a newly-acquired property. If you’re looking to build up your portfolio and upgrade properties, this is a tax law to be aware of. If you’ve deprecated your property, this could potentially save you from having to pay a depreciation recapture tax. Of course, there are many rules to follow and the sale and purchase have to be completed on a set timeline as well. Luckily, we have an entire article dedicated to the 1031 exchange that you can view here>>.
Tax Benefits for Properties Owned for Over a Year
Capital Gains
This tip only applies to investors who have sold a property within the last year or are planning to sell a property. Capital gains are the amount you make after selling an asset. For example, if you bought a property for $300,000 and sold it for $400,000, then your capital gains are $100,000. However, if you buy a property and sell it before you’ve held it for a year, you may be subject to a 10-37% tax on whatever gains you make, depending on your filing status and total gains. So, if you’re a single filer and you fall into the 32% tax bracket, you’ve got to fork over $32,000. However, after holding property for over 365 days, if you decide to sell, then the tax brackets on those capital gains is 0-20% versus 10-37%. In our make-believe scenario, instead of $32,000, you could pay only $15,000. That’s $17,000 back into your pocket. If you’d like to learn more about both short-term and long-term capital gains, then I recommend you check out this post here>>.
Final Thoughts
During tax season, there are many different elements for single-family investors to consider. However, there are tax deductions for rental properties that investors can use to their advantage. Overall, there are many different tax benefits for rental properties available and the important part is to be aware of them so that you can be prepared for tax season. Of course, this post is no substitute for a CPA, and we recommend that you consult with one so that they can advise you on your specific situation and expenses. If you'd like to learn more about single-family investing, then check out our guide to investing in single-family properties.
