Reducing Your Taxes as Landlord
Our topic suggests deductions related to rentals. These particulars will be discussed, however, we begin with helpful suggestions for organizing one’s rental affairs so that tax-saving information is available and timely.
Organizing Rentals in a Way That Saves Time and Taxes
What records are the property owner’s responsibility? What records need to stay with the tax professional? Review your files periodically but ask these questions at least once a year.
Consider more formal organizing-type worksheets with due dates, and ID numbers of people and entities. Worksheets don’t work themselves, so include who-does-what-and-when notes.
Note the timing of communicated assignments.
Keep in mind taxes go on all year. What realty figures enter into your quarterly estimated taxes?
While income tax is normally the main concern, do you have control of property tax due dates?
Getting the accounting and tax administration details in the best order can yield savings in the long run.
Do you regularly review developments with your adviser? Developments may be your telling the adviser about value changes, family needs, plans for sales or property exchanges. Developments may be tax law changes your adviser would understand.
How often should you be meeting with your tax advisor about your rental affairs? Is the usual once a year enough?
Are you at an age where estate planning is a high priority?
Should you be considering different modes of ownership, such as a family limited partnership?
In getting better organized, keep in mind the big picture and the details.
Organizing Focuses on the Details
Following are helpful suggestions for organizing realty operations:
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Lists of properties and their owners;
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Location of acquisition documents;
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History of like-kind realty exchanges;
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Due dates for all types of taxes;
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Tax returns filed in all jurisdictions;
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Tax elections affecting basis, e.g. partnership elections under Sections 734, 743, 754;
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Cost segregation studies;
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Agreements with taxing authorities to extend the statute of limitations;
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Locations of accounting records;
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Other investor information.
Others will often need to be kept informed of such administrative details.
It Helps to Understand Your Tax Return
Rental realty income is usually reported on Schedule E of Form 1040.
The IRS has issued a draft of the 2021 Schedule E, though not its instructions. The instructions with the 2020 Schedule E ran twelve pages. See About Schedule E (Form 1040), Supplemental Income and Loss. See also IRS Publication 527, “Residential Real Property (Including Rental of Vacation Homes).”
Rental real estate income or loss may be reported in Part I of Schedule E, dealing with rental real estate. It may also reach Part II of your Schedule E by way of Form 8825 required of partnerships and S corporations.
It is also possible that the level of services, such as maid service, will cause rentals to rise to the level of a trade or business to be reported on Schedule C of the Form 1040. In that case, there will usually be self-employment tax, as well as income tax.
Your rental realty may need to be reported on Form 8960, “Net Investment Income Tax – Individuals, Estates, and Trusts.” This form can at times trigger a 3.8% tax. Your understanding the details can also help your tax professional.
Maximizing Your Rental Tax Deductions
We review some of the many rental income tax deduction details that may affect your return.
Depreciation
New acquisitions are usually the most problematic. The tax professional usually needs to analyze the closing statement to distinguish what is capital in nature. Important details here include allocating total basis between depreciable building and non-depreciable land. This allocation is sometimes resolved by appraisal, but it is also often handled by looking at the values on the property tax statement.
20% Business Income Deduction
Rental realty can at times qualify for the 20% of business income deduction. See important realty announcement Notice 2019-07.
The IRS discussion of this topic includes such details as accounting records necessary to qualify under safe harbor guidelines. See Rev. Proc. 2019-38.
Normal Operating Deductions
These include such items as mortgage interest, property tax, advertising, utilities and insurance.
Legal and professional fees are generally deductible assuming they relate to operations.
Repairs generally qualify. Distinguishing repairs and capital items is a common area of dispute with the IRS. The IRS says that
“You can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep your property in good operating condition.”
See Tips on Rental Real Estate Income, Deductions & Recordkeeping.
Deductible repairs are not an improvement, generally considered a betterment or new use.
Most small landlords will qualify to deduct up to $25,000 in rental losses each year.
Planning for Change
Many of the Biden tax proposals may significantly impact real estate investors and professionals, particularly those with larger operations.