Year-End Strategies for Real Estate Investors
It’s no secret, taxes can get confusing. But with the fast approaching financial year-end, it is vital to exhaust whatever legitimate tax deductions for your investment property. Note that I am not a tax expert, so please consult with a tax lawyer, CPA, and enrolled IRS agent who understands real estate.
Here are some steps you should take before December 31 to maximize tax advantages.
Let’s get to it.
TAX TIPS FOR FLIPPERS
In the real estate business, anything you spend on capital improvements to a property that can deliver value over a period of greater than one year – doesn’t get deducted against income in the current year. Instead, you have to pay taxes, however, the government gives you credit for this investment by adding it to your tax basis in your property. This will reduce your eventual capital gains tax when you sell the property or you can gradually depreciate the property over a number of years. But a repair that simply keeps a rental property in its fully-functional operating condition is a business expense, not a capital appreciation.
The IRS allows house flippers to write off certain expenses that pertain to purchasing, renovating and selling properties. Writing off these expenses help reduce your taxable income.
Here is a very partial list of possible deductions a typical flipper can claim, each year, whether in a startup phase or not:
- Interest in business loans.
- Advertising and marketing costs.
- Costs of an assistant or laborer (but not while they’re renovating a property, in which case labor costs are added to your basis).
- The home office deduction (technically, “business use of your home”).
- The mileage you drive checking on properties, scouting new neighborhoods, or meeting with buyers, sellers, vendors, agents, and advisors. You can take 55.5 cents per mile you drive for business purposes. Keep a log and an appointment book in case the IRS audits you.
- Business legal expenses (not personal expenses).
- Tax preparation fees.
- A salary for yourself as an owner/employee of a corporation (if you have a corporation).
- Local and state taxes.
- Office supplies. But not capital equipment such as printers and computers, unless you can get it in under Section 179. Remember, you must depreciate computers over five years.
- Maintenance costs.
- Consulting fees.
- Health insurance for yourself as the owner/employee and your staff, if any.
- Bookkeeping fees.
- Exterminator fees.
- Lawn maintenance charges on business property (but not landscaping fees, which are probably a capital investment).
- Office space, if you lease an office other than your home.
Further, if the buyer insists to be in possession of the property on January 1 to qualify for a homestead exemption for tax purposes, it might be worth your while to pay the amount your buyer would save by paying some of his or her closing costs. If you’re rehabbing a property, note that you should buy materials now rather than in the New Year, so that the expenses are tax deductible for the current year and have the contractor perform the repairs now. Also, if you have the property inspections on your flip done before December 31, you may be able to take the deduction for the current year.
TAX TIPS FOR LANDLORDS
The following are common tax deductions according to Erin Eberlin on his article entitled “12 Things Landlords Can Deduct on Their Taxes”. However, you should always consult the IRS or a certified accountant to decide what deductions apply to your specific situation.
For something to be considered depreciable, it has to meet three rules:
- Be expected to last for more than a year.
- Be valuable to your business in some way.
- Lose its value or wear out over time.
Some examples of depreciable assets are:
- The purchase price of the property (minus the value of the land).
- Improvements to the property such as new kitchen cabinets or a brand new roof.
- Shrubbery or fences.
- Furniture or appliances.
- Automobile for business use.
The way you depreciate an asset will differ depending on what the asset is. Different assets, such as a refrigerator or a building, will have different useful lives and will need to use different types of depreciation, such as straight line depreciation or accelerated depreciation. Consult the IRS or your accountant to determine the type of depreciation to use and the useful life of each asset you are trying to depreciate.
2. Passive Activity Losses
Owning rental property is considered a passive activity. There are complex rules which apply to passive activities, but in short, they limit your ability to claim losses incurred in passive activity against other types of income.
There are certain exceptions:
- Real Estate Professionals-f you are considered a real estate professional (certain rules apply such as working at least 750 hours a year on real estate related activities), any rental real estate activities you participate in are not considered passive activities.
- Actively Involved- If you are considered actively involved in your rental activity, you can:
- Deduct up to $25,000 in passive rental losses if you make under $100,000.
- Actively involved means you must have participated in making management decisions, such as:
- Finding tenants
- Deciding on the terms of your rentals
- Your interest in the rental activity has never been less than 10% for the year.
- The amount you can deduct will decrease for every dollar your income is above $100,000.
- You will not be able to deduct any passive activity loss once your income reaches $150,000.
You may deduct the expense of repairs that have occurred in a given tax year. Repairs are considered work that is necessary to keep your property “in good working condition”. They do not add significant value to a property.
Repairs include things such as painting. It is important to understand that all maintenance you do on your property is not considered repairs. The IRS makes a distinction between improvement and repairs.
Improvements are seen as adding value to the property. Improvements cannot be deducted in full in the year they incurred. Rather they must be capitalized and depreciated over their useful life.
4. Travel Expenses
Landlords are allowed to deduct certain local and long distance travel expenses that are business related. This does not include commuting expenses, meaning traveling from your home to your everyday office or place of business.
If you have your own automobile for local travel, you can take your deduction using either the standard mileage rate or using the actual expenses incurred, such as the cost of gasoline and maintenance on the vehicle. You can also deduct:
- parking fees and tolls
- interest on a car loan
- Any applicable registration or license fees and taxes.
If you do not have your own vehicle, you can deduct your public transportation expenses for business purposes.
You can deduct the interest you have paid on business-related expenses such as:
- The interest you have paid on mortgage payments or other business loans.
- Interest on car loan payments (but only the part used for business purposes).
- Interest paid on credit cards used solely for business purposes.
6. Home Office
You can take the home office deduction if you use a part of your home exclusively as an office for your business. You must conduct the majority of your business here to claim the deduction. The amount you can deduct depends on the percentage of your home that your home office takes up.
7. Entertainment Costs
Unfortunately, entertainment costs do not refer to costs used to entertain yourself. Entertainment costs mean those incurred during business dealings. For example, taking a client to your country club or giving a potential investor two tickets to the theater are entertainment expenses.
8. Legal and Professional Fees
If you hire a professional to do work for you, the fee you pay to them is deductible. This includes:
- Attorney fees
- Accountant fees
- Real estate agent fees
- Fees paid to other professional advisers.
9. Employee Compensation
If you hire someone to do work for you, you can deduct the wages you pay to them as business expenses. This includes the wages of both full-time employees, such as a property manager or a live-in superintendent and part-time employees, such as a contractor you hire once to fix a roof leak.
You can deduct your property taxes, real estate taxes, and sales tax on business-related items that are not considered depreciable for the year. You can deduct fees for tax advice and the preparation of tax forms related to your rental real estate property. You cannot, however, deduct legal fees from defending the title of the property, to recover property or to develop or improve a property. You must add these types of fees to your property’s basis.
You can deduct the premiums you paid on most types of insurance including health, accident, causality, theft, flood, fire, liability, vehicle, and health insurance for your employees.
12. Casualty Losses
If your property was damaged by a catastrophic event like a fire, you may be able to deduct some or all of the loss. The amount you can deduct will depend on your insurance and the amount of damage to the property.
Other Common Tax Deductions Include:
- Advertising costs.
- Rent you paid to others.
- Telephone calls related to your rental property activities. However, you cannot deduct the first line for local service coming into your home. That is considered a personal line.
- You can credit or deduct expenses paid to make your property accessible to individuals with disabilities or the elderly.
- If your property is considered a commercial building, you can deduct costs to make it energy efficient.
If you’re serious about saving on your taxes through real estate, a good place to start is Publication 925 from the IRS. But given the complexities of tax laws governing real estate transactions, seeking expert tax advice will guarantee maximum tax benefits and minimum payouts for your business.
Are you already well underway? Just starting out? We would love to hear your thoughts or opinions!