Posted by Income Taxes and Bookkeeping LLC

The Tax Benefits of Rental Investments

The Tax Benefits of Rental Investments

For those who choose to invest in a rental property, there are tax implications in terms of both your income and your deductions. By understanding how these rules apply to your rental property, you can maximize the tax advantages, while using a specific strategy to address the potential increase in your tax liability. Working with your tax professional, such as Income Taxes and Bookkeeping in Winchester, IN, to determine the best tax strategy for your investment property.

Benefits of an Investment Property

When it comes to owning an investment property, there are several unique tax benefits that come with the property. One of the most important is the depreciation deduction. This deduction can be taken as a percentage of the basis of your rental holdings each year. Keep in mind that when you sell your rental properties, you will have to pay tax on any gains. Those gains would include any depreciation deductions that were taken.

Therefore, it is important to determine the best strategy for selling your rental property. An example would be to sell it during a year when you qualify for a lower tax bracket or when other assets might be sold as a loss to offset any gains.

However, there are also some areas to consider when it comes to rental income, as it is subject to a unique set of rules.

Passive Activity and At-Risk Rules

When it comes to rental income, the IRS typically views it as income from a passive activity. Thus, they have created some special rules to apply to this income. For example, if you have a net rental activity loss, under those rules, you cannot use that loss to offset other taxable income. This would include any salary income.

However, if you actively participate in your rental real estate, you may be able to deduct up to $25,000 of loss due to the activity. This type of loss can be used to offset other non-passive income, including the salary from your full time position.

Here are a few other items to note:

  • If your investment is not “at risk”, you cannot take a tax loss of more than the amount you have at risk.
  • Real estate professional that meet specific requirements may be able to count their rental activity as non-passive.
  • If your modified adjusted gross income (MAGI) is $100,000 or higher, then your maximum allowable loss is reduced.
  • If your MAGI is over $150,000, you cannot take a special allowance for a rental real estate loss.
  • You can carry unused loss forward to a year with a lower adjusted gross income or until the year where you sell the investment property.

Other Deductions

As an investment property, it provides a variety of additional deductions. Here are just a few of the ones possible for an average investor to take:

  • Advertising
  • Auto expenses – either the standard mileage rate or your actual expenses, such as gas, oil and depreciation
  • Non-mortgage interest paid on any credit cards used specifically for the rental property
  • Cleaning
  • Insurance, such as fire, flood, liability and mortgage
  • Legal fees and tax preparation fees, as they relate to your investment properties
  • Supplies
  • Property repairs, including appliances, repainting and fixing leaks
  • Mortgage interest
  • Management fees, if you use a management company to care for your investment property
  • Travel expenses relating to improving the property
  • Utilities

Keep in mind, timing is critical for a majority of these expenses. If your investments are tracked using a typical cash basis accounting system, you will have to pay taxes on income as it is received. Thus, if your tenants pay their rent for January in December, you have to pay taxes on that income with the previous year’s taxes.

When it comes to security deposits, you should not count those as income unless they are going to be non-refundable. If you anticipate returning the deposit to your renter, then you will want to be sure to separate it from your actual income.

As we have seen, there are definitely benefits to owning investment properties, primarily due to the increased monthly income. In addition, there are a variety of deductions that also might be available to you as part of the general running of your properties. By working with your tax professional or accountant, you can determine the best way to reduce your tax liability for your rental income.

Click on the link below to connect with your tax professional at Income Taxes and Bookkeeping in Winchester, IN, to find the strategy that works for your investment property.

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