It's tax time again and tax planning is a vital component of real estate investing. Every landlord, seasoned or not, has questions. Appropriate tax planning and proper reporting can make or break those rental property profit margins.
Innovative Property Solutions is here to answer the three most popular tax questions posed by landlords near and far:
The short answer: "NO!" The longer answer: by law, a property manager is required to provide both the property owner and the IRS with the amount of income collected by the management company. It is required to be reported on the 1099 MISC form. This is what most people think of and hear about, however these documents are only the beginning. The 1099 MISC reports your income and raises your reported income to the IRS, effectively telling the IRS you owe more money in taxes. Ideally, your property manager will provide you a "Schedule E" which is the tax form you will use on your tax return to report your expenses. Expenses reduce your tax burden. The Schedule E summarizes your expenses into categories. For example, your Schedule E may have the total amount you paid for in cleaning, lawn care and utilities while the property was vacant plus the amount you spent on management fees. Reporting your expenses is vital and can save you hundreds or even thousands of dollars. Don't just report your income from your 1099 and don't let your property manager off the hook! Get a good annual expense report or hire a new property manager.
Your 1099 and the income reported to the IRS is total revenue. It is not the profit from your rental home. In fact, all income that you made from the rental property must be reported on your 1099 and to the IRS. This includes application fees, pet rent, coin laundry revenue, etc. Many property owners think you only have to report profits. Unfortunately, that is not the case and is the reason why your schedule E is so important. You want to make sure you are properly reporting your expenses in order to ensure you are properly offsetting the income your property generates. Leaving off deductible expenses costs you money and profits.
Depreciation is one of the most commonly forgotten tax benefits, yet one of the most important tax benefits of owning rental properties. Depreciation means taking the value of your properties which are building value and dividing it by its useful life, defined as 27.5 years by the IRS. You then take that amount as a deduction every year that you own the property or until the end of its useful life of 27.5 years. For example, if you have a $150,000 property and the land is valued at $50,000, you have a building value of $100,000. Divide $100,000 by 27.5 years and this gives you a yearly deduction of $3,636 for depreciation. That's an automatic $3,636 deduction on your taxes just for owning a rental property. Something to understand is that when you sell an income producing property, you must report Depreciation Recapture. Whether you took the depreciation deduction or not, the IRS assumes you did and will tax you as such. So make sure you take this deduction now! You are going to pay for it later whether you took it or not! Depreciation Recapture can be a bit complicated and is a great topic to discuss and plan for with your CPA or tax professional.
Tax planning and preparation is vital to real estate investing. I am not a tax professional so I encourage all real estate investors and landlords to have a good CPA as part of their team and to consult them and discuss these topic as part of your annual tax preparation and planning.