anbody know what percent tax you are charged for rental income? does this just get added onto your current salary and then taxed according to what bracket you fall in? … or is there some other method?
thanks,
ryan
The profit or loss from your rental activities is calculated on Scedule E gets added (or subtracted) on Form 1040, line 17 and is taxed as ordinary income…
This year my number was negative so I had a passive loss – on paper anyway… (woo hoo!)…
Keith
negative loss? was this a bad thing? was this some creative investing in which you fanaggled (sp?) something? please elaborate, i’m all ears ;]
If you have a rental property whose expenses (See schedule E for ALL expenses) including maintenance, repairs, advertising, taxes, insurance, interest, depreciation, etc. is more than the income, you may have a pssive loss. If your Adjusted Gross Income is less than $100K, you can take up to $25K in passive losses off of your income. No, this is not a bad thing…it is a GREAT thing! You just need to accurately and honestly take all of your deductions. With several properties on the books, my loss was about $5K this year. That’s $5K that I did not have to pay taxes on.
Keith
thanks for the input keith. that’s an area thats new to me which i plan on doing some reading. any recommended links which a newbie can understand the whole process in very basic terms?
i’ll google it, just figured i’d check if you had any helpful links handy. thanks again ;]
I used TurboTax (whatever the good one is…“Gold”…?) this year for the first time. It made it very easy. The depreciation on various assets can be a bear if you do it ‘stubby pencil’…
This is my opinion: If you are going to be in the REI business, you have to understand the tax implications/benfits/complications to effectively manage your properties. You can get into serious trouble if you mismanage/ignore this piece of the REI puzzle. Some of the tax legislation can be very lucrative for Real Estate Investors if you play the game right (i.e., capital gains exclusions for personal properties, Schedule E, 1031 exchanges, etc.).
Do you taxes legally, but take all of your entitlements fully! It’s YOUR money, not the Government’s! (They’re just gonna pi$$ it away anyway! And, I’m a Federal employee!)
Keith
tax avoidance – avoiding any taxes you are not legally required to pay – is your right.
tax evasion – attempting to evade taxes that you are legally required to pay – is not.
I’ve been doing some brainstorming and took a quick glance over Schedule E
Some questions:
- What repairs are considering tax deductable? For example, I’m putting a new walkway and redoing the landscape after tenants move in.
- Since I’m doing a complete rehab, what other repairs can I take into account that can be considered a loss, repair, etc.?
- This may sound weird, but I’d almost like to plan ahead and take into account all the expenses, repairs etc. that at the end of the year it’s likely I would be showing a loss as well. Any good ways to go about this? Is this a bad idea?
- What if I’m doing the repairs to save money, could I techincally “bill myself” as if it were being done by someone else?
- Do you have any other helpful hints in which are legal and can help take advantage of the tax benefits I’m entitled too?
ryan
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- EVERYTHING you spend on the property is deductible somewhere. keep EVERY receipt. keep a mileage log for EVERY trip to the property or the hardware store.
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- your own time is not billable.
- the question is where to deduct it. major rehab should probably be capitalized and depreciated. “repairs” (that do not extend the life or improve the value of the property) can be deducted on the sch E.
1. What repairs are considering tax deductable? For example, I'm putting a new walkway and redoing the landscape after tenants move in.
A repair fixes something that is broken. All repairs for your rental property are deductible expenses on Schedule E. A new walkway is not a repair, it is a major replacement. Depending upon the extent of the work to be done, you might say the same with landscaping. Major replacements are capital improvements, not repairs.
2. Since I'm doing a complete rehab, what other repairs can I take into account that can be considered a loss, repair, etc.?
A major rehab is not fixing something that is broken, it is a capital improvement that extends the life of the asset or increases its value. When a lot of “repairs” comprise a large project, all the repairs are considered one renovation project – a capital improvement. Capital improvement costs are recovered through depreciation. Since you have already characterized your project as a major rehab, you are no longer doing repairs, you are completing a capital improvement.
3. This may sound weird, but I'd almost like to plan ahead and take into account all the expenses, repairs etc. that at the end of the year it's likely I would be showing a loss as well. Any good ways to go about this? Is this a bad idea?
Great idea. I don’t know who said it first, but the quote “Failing to plan is planning to fail” seems applicable here. However, remember that repairs fix something that is broken. Repairs are “unplanned”. This is different from maintenance which is scheduled, such as preventive maintenance service on your HVAC, annual battery replacement for your smoke detectors, fire extinguisher inspections, even the complete interior or exterior painting that you do every five to seven years.
This site has a free cash flow analysis spreadsheet available to download that may give you some ideas. Just click here
Cash Flow Analysis Spreadsheet
4. What if I'm doing the repairs to save money, could I techincally "bill myself" as if it were being done by someone else?
Technically, no. Your own labor is contributed free of charge – that’s why they call it “sweat equity”. Even if you did pay yourself a labor charge which you expense on Schedule E, you would have to report that income on Schedule C and pay self-employment income taxes on that income in addition to ordinary income taxes. Better to just contribute your labor without charge, you come out ahead.
5. Do you have any other helpful hints in which are legal and can help take advantage of the tax benefits I'm entitled too?
Keith already gave you a good reminder “If your Adjusted Gross Income is less than $100K, you can take up to $25K in passive losses off of your income.” that warrants more discussion.
If your other ordinary income is less than $100K, then your net passive losses up to $25K can be used to offset your other ordinary income. For incomes between $100K and $150K, this net passive loss allowance is reduced by $1 for every $2 that your other income exceeds $100K – and is phased out completely for incomes at $150K and higher.
Take your depreciation expense even if you can’t use the net passive loss allowance. The depreciation expense does reduce your taxable rental income, and net passive losses that can not be used this year can be carried forward to the next tax year.
When the property is sold, unrecaptured depreciation will be taxed. If you did not take a depreciation expense, the allowable depreciation that you should have taken will still be recaptured (taxed).
Overlooking a tax deduction is not nearly as costly as a lawsuit. Conduct your rental property activity in a professional manner, keep your property in good repair, don’t discriminate, and scrupulously comply with your landlord-tenant law. Purchase liability insurance with your landord dwelling insurance, and perhaps consider an umbrella policy if you have a lot of assets to protect. Do everything you can to minimize the opportunity to be sued. Conducting your rental activity ethically, professionally, and above board minimizes your risk of being sued.
I am not saying that you should disregard other asset protection measures such as holding your rental property in a limited liability company. An LLC helps limit your liability in the event you are sued.
great replies!
If your other ordinary income is less than $100K, then your net passive losses up to $25K can be used to offset your other ordinary income
yes my ordinary income is less than 100k. even with rent, it will fall under 100k. i’m just trying to see how this would all add up to be a passive loss. how does depreciation come into play? how can i figure out what number this would be (any forumula?).
It seems the total rent I’d be collecting would be around $12k per year. So I take it if I could justify 12k+ in repairs etc. that I won’t be taxed on this rent income correct?
Some more questoins…
-Landlord tenant laws…do I need to file anything with the town to let them know im renting?
-Liability: I was told that I could raise the Homeowners insureance to 1m (currently 500k I believe) to give me a nice buffer zone instead of forming an LLC/S Corp. that is until I get more rentals he added.
-Are there any sites where I can read up from the ground on up to find out more info on landlording and which covers all legal aspects. I’m new to this area and have some time constraints so I’m “under the gun” right now.
thanks again. i love this site ;]
ryan
that million dollar liability policy won’t even begin to touch the judgement mama is going to get when little Billy slips and falls and breaks his neck on that loose board you didn’t fix. And all of your personal assets are at risk.
no one should own investment property in their own name.
LLC’s are cheap asset protection.
mcwagner,
i will be living there with two other roomates (of similar age 25). however point well taken.
i was told by my tax advisor that LLC’s do not prevent people from being those doing the suing from attacking them personally. he said hte first line of defense is the HO insurance and uping it to 1mil shoudl be fine.
the funny thing about REI is that everyone has their own perspective on how to do things…for us new guys it’s tough to choose which path to take.
ryan
neither will insurance protect you from being sued. and while insurance will pay small (ha!) claims, it won’t protect your assets from a significant judgement. anybody can sue anybody anytime they can find an atty. and what happens when your smoke detector doesn’t work and roomie #1 gets horribly burned and disabled for life? there are no friendships in such situations.
nothing will make you bullet proof, but both entity protection and insurance are valuable; as are anonymity where possible, liens and encumberances and just plain ole’ not bein’ stupid.
man, I hate being a cynic, but I sure hate to see people lose everything. I have a client who’s being sued in a slip & fall. I tried for years to get him to silo his properties in entities. Now he’s probably going to lose 5 rental properties (he owns free and clear) plus a used car lot. in LLC’s the most he would have lost would have been one. The rest may have been hobbled with charging orders, but at least he’d have had a chance to leverage and rebuild.
Depreciation is an allowed expense that does not cost you any money out of pocket. Download Schedule E (1040) from the IRS website. Look at all the expense categories that reduce your taxable rental income. Mortgage interest will probably be a large component of your operating expenses. For me, my big three are property management, home owners association fees, and mortgage interest, with repairs, advertising, and leasing fees rounding out the top six operating expense items. Finally, at the bottom of the form, about line 20, there is a line where you enter your depreciation expense.
Vacancy, while not a deductible expense, is a “cost” – actually a reduction in operating income – to be considered, too, when you are doing your cash flow projections.
Rental dwellings (buildings, not land) are depreciated over 27.5 years. This means that if you paid $37500 for your rental property, and $10000 of that purchase price is the value of the land, then $27500 would be allocated to the value of the rental structure. You would take an annual depreciation expense of about $1000 each year until the full value of the rental structure is depreciated. IRS Publication 946, How To Depreciate Property will give you all the rules and the depreciation schedules that apply to your rental property.
Rental property owners often find that the total of all their actual rental expenses and the depreciation expense is greater than the rental income received. When this happens, you have a net rental loss on Schedule E. You “lost” money on paper, even though you still had a positive cash flow because the depreciation expense did not take any money out of your pocket. Net rental losses can be carried over to line 17 of your 1040 to offset your other ordinary income and reduce your total tax bill.
If you are operating your rental property at near breakeven or small positive cash flow, you will likely have a net rental loss for the year when you do your tax return, too.
More details are available in IRS Publication 527, Residential Rental Property
-Landlord tenant laws...do I need to file anything with the town to let them know im renting?
Depends upon your local jurisdiction. Some municipal authorities require a rental unit license for each rental property you operate, others don’t. Some county taxing authorities require you to file a personal property tax notice each year for the personal property you supply for your tenant’s use (range, refrigerator, microwave, washer, dryer, and furniture). You just have to call your county tax assessor and your city/county housing authority to ask what filings are required for your rental property.
As far as landlord-tenant laws are concerned, you might find your local laws by clicking the “State Property Codes” hotlink on the left side of this page.
If you operate your rentals from within a business entity, some local jurisdictions may require a business license. You just have to call the appropriate licensing authority to see if you are required to have one, and how many rental properties you must have in operation before a business license is required.
Rent controls exist in certain areas of the country, though, most often these apply to landlords with several rentals in operation. You just have to make phone calls to your local government offices to see what applies to your situation.
-Liability: I was told that I could raise the Homeowners insureance to 1m (currently 500k I believe) to give me a nice buffer zone instead of forming an LLC/S Corp. that is until I get more rentals he added.
For your rentals, you want a separate rental dwelling policy for each rental property you own and operate. Each rental dwelling policy should have its own liability coverage limit. As Mark already said, it does not really matter how much liability coverage you have on your rental property, when you are sued you will be sued for mega-millions. The insurance policy will only pay any judgements you lose up to the limit of coverage. The rest is your responsibility. You limit your personal liability by using a business entity to conduct your rental property operations.
There are a lot of rental property owners who conduct their rentals as a sole proprietor without any problems, whatsoever. Furthermore, these landlords will tell you that they have done it that way for many, many years and have never been sued (yet).
There is some merit to what the tax advisor told you, if your personal net worth is less than the liability insurance coverage limits on your rental policies, but this only buys you some time. When you have a larger net worth, consider an umbrella insurance policy AND further limit your liability by using an appropriate business entity to conduct your rental activities. Insurance and a business entity are not mutually exclusive, instead they are complementary. A business entity limits your liability – contains the amount you can lose – in the event of a lawsuit. An insurance policy pays the judgement when you lose, and the insurance company will provide the lawyer to defend you.
-Are there any sites where I can read up from the ground on up to find out more info on landlording and which covers all legal aspects.
If you are looking for free resources, try your public library. There are a lot of books on the shelves that address landlording. If you find a book you want to have for a permanent reference, there is always Amazon.com or your local bookstore. Internet search engines will give you more hits than you can handle if you just enter a few search words, such as “landlord” “tenant law”, etc.