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Essential Tax Guide For Landlords And Real Estate Investors

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Real estate is one of the best places to park your money. Rental real estate can provide a steady source of revenue, and the people who own rental units can take advantage of tax breaks to reduce the income tax on their profits. If you want to make the most of your tax return, you need to know which expenses are deductible.

However, the tax code can be confusing to newcomers. There are a lot of factors at play, and several requirements you must meet to qualify for the tax breaks afforded to landlords.

To help you take advantage of the deductions and save on your taxes, we’ve rounded up some of the best tax tips for landlords.

Reporting rental income

Real estate investors are required to report all rental income as taxable income. Rental income includes all payments received as rent from the occupancy of residential properties, including:

  • Normal rent payments
  • Advance rent payments
  • Security deposits
  • Tenant-paid expenses
  • Non-monetary rent payments

Security deposits are not automatically counted as rental income. Only report the deposit as income if you keep part or all of it according to the terms of the lease.

Fees for parking spaces, pets, late rent payments, or early lease cancellations are considered rental income as well.

Passive investor vs. Real estate professional

Not all owners of rental property are the same in the eyes of the Internal Revenue Service (IRS). Knowing the classifications can help you maximize your tax breaks and save more on taxes.

Passive real estate investing.

You’re considered a passive investor if you’ve invested money in rental real estate, but you’re not involved in the management or operation of the property.

IRS passive activity loss rules limit this category’s ability to deduct losses from income. Passive investors can only deduct up to $25,000 in rental losses every year. Losses that exceed the threshold can be carried over to the following tax year. However, the deduction phases out if your modified adjusted gross income exceeds $100,000.

Real estate professional.

If you primarily work in the rental business, you might be considered a real estate professional. This means that your rental losses are fully deductible against all income.

To be classified as a real estate professional, you need to spend more than 50% of your working hours in the acquisition, construction, development, or management of rental real estate. You must also work in the rental business for more than 750 hours per year to qualify for this classification.

Repairs vs. Improvements

Not all property-related expenses are deductible. To determine if a certain expense can be deducted, you need to determine if it’s a repair or an improvement.

A repair is defined as anything that restores the rental property to its original condition. Repairs include fixing a broken window, changing door locks, or painting the walls. Expenses that fall under this category are deductible in the year it occurred.

Meanwhile, improvements increase the longevity or the original value of the property. For instance, installing solar panels or adding a new patio add value and are considered improvements. Improvement-related expenses are not deductible, but you may recover the cost through depreciation.

Mortgage interest vs. Principal payments

Landlords and real estate investors may deduct the interest on money borrowed to finance the rental business. Some deductible interest payments include:

  • Mortgage interest payments on a loan used to acquire a rental property
  • Mortgage interest payments on and improvement loan
  • Credit card interest for business-related expenses

Only the interest on business-related loans is deductible. Principal payments (i.e. payments on the amount borrowed from the lender) are not deductible.

Any expenses incurred to obtain a mortgage are not deductible. Instead, these expenses are added to your capital investment in the property for tax purposes. Non-deductible mortgage expenses include:

  • Commissions
  • Appraisals and surveys
  • Recording fees
  • Utility installation fees
  • Legal fees
  • Transfer taxes

Tax-deductible real estate expenses

Landlords can claim a variety of business-related deductions to minimize their tax liability. Make sure to keep all receipts and maintain accurate records of all your expenses to justify all your deductions.

For a business-related expense to be deductible, it must be considered both “ordinary and necessary.” The IRS defines an ordinary expense as one that is common and accepted in real estate. Meanwhile, a necessary expense is one that is helpful and appropriate.

It’s important to note that business expenses are separate from capital expenses.

Some tax-deductible business real estate expenses include:

  • Utilities: The cost of electricity, water, gas, trash collection, and recycling can be deducted.
  • Taxes: In many cases, the landlord can claim property-related taxes as a deduction. Some examples include property taxes, payroll taxes, inspection or permit fees, and local (state, county, or city) taxes.
  • Insurance: Insurance premiums related to your rental business may also be deductible.

How to file a landlord tax return

Taxes pose a burden to landlords and real estate investors. Your tax rates remain the same, even in the face of erratic market conditions. We advise you to contact a tax professional to maximize your deductions and put more money in your pocket.

You can trust the experts TFX to give you the advice you need. Our experienced team can help you determine which tax benefits you qualify for and save you thousands of dollars.