Personal Finance
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RENTAL REAL ESTATE AS AN INVESTMENTA popular form of long-term investment is real estate rentals. Rentals can fall into several varieties, of which real estate rentals is the most common. This material will explain some of the tax ramifications of renting real estate, both residential and commercial. Specifically excluded from this discussion are transient rentals, where the tenants rent for an average of seven days or less, such as motels and equipment (machinery) rentals. Both are considered self-empl...
Active Participation If you “actively participate” in the residential rental activity, you may be able to deduct a loss of up to $25,000 ($12,500 if you’re married, file separately, and live apart from your spouse for the entire year—but if you’re married, file separately and don’t live apart from your spouse for the entire year, you’re not eligible for this break at all) against ordinary (nonpassive) income such as your wages or investment income. You actively participat...
Depreciating Rental Property “Depreciation” is an accounting term for writing off the wear and tear on an asset that has a useful life of more than one year and costs over $100. Generally, rental real estate improvements must be depreciated over a period of 39 years. However, there are exceptions for residential rental real estate, which is depreciated over 27.5 years and most personal property such as furniture, equipment, etc., which is depreciable over 5 or 7 years. There are additional special rules apply...
First, Last and Security Deposits Generally, landlords require a new tenant to pay the first and last month’s rent in advance along with a security deposit. A frequent question is whether to treat these payments as current-year income or income to a future year. The IRS says that advance rent payments are income in the year received. However, security deposits you plan to return to your tenant at the end of the lease are not income. But if you keep part or all of the security deposit during any year because your tenant ...
Operating Expenses For tax purposes, you will figure your profit or loss each year from operating the rental property. Generally, you can virtually deduct all expenses incurred to operate the rental. The following is a list of potential operating expenses that are deductible:
Advertising
Cleaning & maintenance
Bank charges – if a separate account is maintained.
Insurance – fire, casualty and liability
Utilities – gas, electricity, water, cable, etc.
Services (1) – yard c...
Outright Sale When a rental property is sold outright, the entire gain will be taxable in the year of sale. Let’s assume (without considering property improvements or buying or selling costs) that you purchase a rental for $50,000 and then several years later sell it for $300,000. Over the period of time that it was a rental, you took $10,000 in depreciation deductions. Your tax basis in the property at the time of sale would be $40,000 (your cost of $50,000 less the $10,000 taken in depreciation). T...
Real Estate Professional If you qualify as a “real estate professional” (which requires the performance of substantial services in real property trades or businesses), your rental real estate activities are not automatically treated as passive, and so losses from those activities can be deducted against earned income, interest, dividends, etc., if you materially participate in the activities. Please call this office for additional details associated with this limited exception.
Renting Part of Property If you rent part of your property, such as a room or a portion of the house, you must divide certain expenses between the part of the property used for rental purposes and the part of the property used for personal purposes, as though you actually had two separate pieces of property. You can deduct the expenses related to the part of the property used for rental purposes, such as home mortgage interest and real estate taxes, as rental expenses. You can also deduct as a rental expense a part o...
Renting to a Relative Special rules may apply when renting a home or apartment to a relative. If you rent a home to a relative who: (1) uses it as his or her principal residence (that is, not just as a second or vacation home) for the year, and (2) it is rented at a fair rental (not at a discount), then no limitations apply. You simply treat it like any other rental property. However, if it is rented to a relative at below fair rental value, all of the expenses, except mortgage interest and property taxes, are con...
Repairs vs. Improvements When you figure your profit or loss from operating the rental property each year, you can deduct the cost of repairs to the rental property. However, any improvements that were made must be depreciated over the improvement’s useful life. How do you distinguish a repair from an improvement?
Repairs - A repair keeps your property in good operating condition and does not materially add to the value of your property or substantially prolong its life. Repainting your property inside or...
Separating Improvements from Land Not all of the cost of acquiring real estate is depreciable. Specifically, the cost of the land is not depreciable and must be separated from the improvements. Thus, you should identify and document at the time that you acquire real estate, the part of your overall acquisition cost allocable to improvements. One way to accomplish this is to retain a qualified real estate appraiser to make an allocation between land and improvements, or if the real property tax bill for the property includes a...
Tax-Deferred Exchange A tax-deferred exchange (otherwise known as a “1031 exchange” referring to the tax code section pertaining to exchanges of property or “tax-free exchange” and a misleading title since the tax is actually deferred and not free“) can be used as a means of avoiding immediate taxation on the gain from a rental property by deferring the gain into a replacement property.Reasons to Exchange: Structuring a transaction so that it meets the requirements of Section 1031 can...
Vacation Home Rental There are special tax consequences when you rent out your vacation home for part of the year. The tax treatment depends on how many days it is rented and your level of personal use. Personal use includes vacation use by your relatives (even if you charge them market rate rent) and use by non-relatives if a market rate rent is not charged.Rented less than 15 days - If you rent the property out for less than 15 days during the year, the property is not treated as a rental. Any rents received ar...