How to cash in by buying a rental property!
This is quite a bit of information….and it’s information that you might first consider to be boring stuff. BUT…reading it could change your life, literally. There are HUGE benefits to owning vacation rental properties that many, if not most people do not know! My first investment was literally forced on me by my CPA because buying it SAVED ME MONEY!! I didn’t believe it either…but it’s very true. My $140,000.00 initial investment is now valued just under $400,000.00, and it continues to appreciate. You REALLY need to read this entire article. Your life could be just as much affected as mine was way back in 1988!! READ ON….
A Presentation by Randy Williams
Land and Sea Realty
Tax benefits of owning rental properties
When it comes to owning rental properties, taxes drive a lot of decisions. And while I’ve always kept in mind that when it comes to taxes and real estate investment, you shouldn’t let the tail wag the dog, it’s sometimes very difficult to follow the plan.
Let’s start off by stating the obvious: The tax system is stacked heavily in the landlord’s favor. Tenants get virtually no tax benefit from renting, while landlords benefit more than virtually any other taxpayer, because they have feet planted in two tax-favored worlds — business and real estate. As a result, over many years of renting, I have paid little if any additional income taxes for my Dupont Circle apartment. When it comes to owning rental properties, the tax system is stacked heavily in the landlord’s favor.
As one reader of my first column astutely observed, making a taxable gain is the last thing a landlord wants to do, and the series of deductions available to landlords frankly makes attaining a taxable income from your property pretty hard to accomplish. For instance, every dime spent ostensibly on the apartment is deductible, from larger ticket items such as property taxes and management fees, down to the smallest such as the paper clip attaching the check to the lease. I even had one friend, who also is a landlord, tell me that I could fly to Washington, dine with friends and tour the Phillips Collection, and, as long as I visited my apartment or stopped in to see my property manager, I could deduct the cost of the trip as a rental expense. (I would not recommend following this “advice.”)
The gift that keeps on giving is the mortgage interest deduction. Like homeowners, landlords can deduct the part of their mortgage payment that reflects the amount of interest paid on their apartments. In addition, if you cash-out refinance the mortgage, the increased interest payments and even part of the loan origination fees and points can be deducted as long as the money taken out was reinvested back in the property. This, of course, distorts the landlord’s incentives; and just as economists predict, landlords overcompensate by borrowing to the hilt to maximize the interest deduction.
Some have talked about eliminating the mortgage interest deduction as a way to simplify the tax system, reduce the deficit and raise revenue. Whether this effort succeeds in Congress or not, landlords are unlikely to be nicked by this tax reform. Landlords receive the interest deduction because it is a business expense, not because it is a home mortgage.
This is not the only advantage landlords have over regular homeowners. Landlords get to deduct items such as insurance, maintenance and utilities from income, which homeowners do not. And the most scandalous and least understood deduction that landlords get is the deduction for depreciation. This deduction assumes that your business asset — the apartment — is like a piece of business equipment with a finite life and, therefore, you are allowed to write off that “loss” over time. This can amount to several thousands of dollars per year in deductible losses. In other words, my appreciating, income-producing asset which has increased in value several times over since I bought it, is treated by the tax code as though it is wasting away and slowly turning to dust.
The obvious retort is that I should just not take the deduction and pay my equitable share of taxes. But they don’t make it easy to be altruistic. The tax program that I use to file my taxes was so hostile to my not claiming depreciation as a deduction, it continually overrode my decision and left me no choice but to manually delete that line item from my tax return. This, in turn, messed up all the calculations; and my return failed the final error check that the program performs prior to filing. I submitted my taxes with the “error” anyway; I figured that if I am audited by the IRS, they could hardly fault me for giving more than what was due to the Treasury.
The Treasury’s largesse to landlords does have its limits. After all the deductions the IRS gives you, the losses remain paper, “passive losses” and those that exceed the rent you received cannot be used to offset ordinary income, such as your salary. (At lower incomes, the loss can be deducted from ordinary income and thereby entitle you to a tax refund, but this phases out for higher incomes unless you qualify as a real estate professional.) So landlords like me are left with a lot of paper losses that can only be used in future years if I make a profit or if I have other passive gains to offset (e.g., income from other real estate investment).
The paper gains and losses are all supposed to wash out in the end, when you sell the property. But even then, the taxman can be cheated–by dying. A person who dies owning a highly appreciated property gets to pass on the property to an heir on a “stepped up basis,” i.e., with the current market value. That means that capital gains on the property’s appreciation evaporated for tax purposes. For the landlord, death may be a certainty, but taxes? Not so much.
My very first property that I purchased in 1988 was “forced on me” by my CPA. I thought she was crazy. She was. Crazy like a fox!! The property has cost me zero over the years, and is now worth 3 times what I paid for it. Keep reading.
Top Ten Tax Deductions for Landlords
Learn about the many tax deductions available to rental property owners.
No landlord would pay more than necessary for utilities or other operating expenses for a rental property. Yet millions of landlords pay more taxes on their rental income than they have to. Why? Rental real estate provides more tax benefits than almost any other investment.
Every year, millions of landlords pay more taxes on their rental income than they have to. Why? Because they fail to take advantage of all the tax deductions available for owners of rental property. Rental real estate provides more tax benefits than almost any other investment. Often, these benefits make the difference between losing money and earning a profit on a rental property. Here are the top ten tax deductions for owners of small residential rental property.
Interest is often a landlord’s single biggest deductible expense. Common examples of interest that landlords can deduct include mortgage interest payments on loans used to acquire or improve rental property and interest on credit cards for goods or services used in a rental activity.
The actual cost of a house, apartment building, or other rental property is not fully deductible in the year in which you pay for it. Instead, landlords get back the cost of real estate through depreciation. This involves deducting a portion of the cost of the property over several years.
The cost of repairs to rental property (provided the repairs are ordinary, necessary, and reasonable in amount) are fully deductible in the year in which they are incurred. Good examples of deductible repairs include repainting, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows.
Read Tips for Maximizing Repair Deductions to ensure your expense will constitute as a repair, not an improvement.
4. Local Travel
Landlords are entitled to a tax deduction whenever they drive anywhere for their rental activity. For example, when you drive to your rental building to deal with a tenant complaint or go to the hardware store to purchase a part for a repair, you can deduct your travel expenses.
If you drive a car, SUV, van, pickup, or panel truck for your rental activity (as most landlords do), you have two options for deducting your vehicle expenses. You can:
deduct your actual expenses (gasoline, upkeep, repairs), or
use the standard mileage rate (56 cents per mile for 2014; 56.5 cents per mile for 2013). To qualify for the standard mileage rate, you must use the standard mileage method the first year you use a car for your business activity. Moreover, you can’t use the standard mileage rate if you have claimed accelerated depreciation deductions in prior years, or have taken a Section 179 deduction for the vehicle.
Learn more about deducting landlord car expenses.
5. Long Distance Travel
If you travel overnight for your rental activity, you can deduct your airfare, hotel bills, meals, and other expenses. If you plan your trip carefully, you can even mix landlord business with pleasure and still take a deduction.
However, IRS auditors closely scrutinize deductions for overnight travel — and many taxpayers get caught claiming these deductions without proper records to back them up. To stay within the law (and avoid unwanted attention from the IRS), you need to properly document your long distance travel expenses.
6. Home Office
Provided they meet certain minimal requirements, landlords may deduct their home office expenses from their taxable income. This deduction applies not only to space devoted to office work, but also to a workshop or any other home workspace you use for your rental business. This is true whether you own your home or apartment or are a renter.
7. Employees and Independent Contractors
Whenever you hire anyone to perform services for your rental activity, you can deduct their wages as a rental business expense. This is so whether the worker is an employee (for example, a resident manager) or an independent contractor (for example, a repair person).
Find out tax rules that apply to landlords who hire independent contractors to help them with their rental business, see Hiring Independent Contractors for Your Rental Activity.
8. Casualty and Theft Losses
If your rental property is damaged or destroyed from a sudden event like a fire or flood, you may be able to obtain a tax deduction for all or part of your loss. These types of losses are called casualty losses. You usually won’t be able to deduct the entire cost of property damaged or destroyed by a casualty. How much you may deduct depends on how much of your property was destroyed and whether the loss was covered by insurance.
You can deduct the premiums you pay for almost any insurance for your rental activity. This includes fire, theft, and flood insurance for rental property, as well as landlord liability insurance. And if you have employees, you can deduct the cost of their health and workers’ compensation insurance.
10. Legal and Professional Services
Finally, you can deduct fees that you pay to attorneys, accountants, property management companies, real estate investment advisors, and other professionals. You can deduct these fees as operating expenses as long as the fees are paid for work related to your rental activity.
Did You Know?
Did you know that:
Landlords can greatly increase the depreciation deductions they receive the first few years they own rental property by using segmented depreciation.
Careful planning can permit you to deduct, in a single year, the cost of improvements to rental property that you would otherwise have to deduct over 27.5 years.
You can rent out a vacation home tax-free, in some cases.
Most small landlords can deduct up to $25,000 in rental property losses each year.
A special tax rule permits some landlords to deduct 100% of their rental property losses every year, no matter how much.
People who rent property to their family or friends can lose virtually all of their tax deductions.
If you didn’t know one or more of these facts, you could be paying far more tax than you need to.
FIVE REASONS WHY YOU SHOULD OWN INVESTMENT PROPERTY
Here are five reasons why an income property can be such a lucrative investment.
1. You Are the Boss of the Income Property
When you decide to invest in an income property, you become your own boss. You choose what property to invest in, what tenant you will rent to, how much you will charge in rentand how you will manage and maintain the property as a whole.
In the average 9 to 5 job, you are subject to the wishes of your boss and the company infrastructure in general, such as adhering to a dress code. As your own boss, you can wake up at 11 a.m. and wear your Kermit the Frog tie if you so choose.
2. Potential Appreciation of a Highly Leveraged Asset
Leverage, in layman’s terms, means you invest a relatively small amount of your own money, and borrow the rest, often four to twenty times more, from a lender. If you purchase a property using significantly more debt than equity, the investment is said to be “highly leveraged.”
Let’s look at an example of how leveraging an asset can increase your potential return:
If you have $10,000 to invest in a property, you can then use leverage and borrow $90,000 from a bank. By combining your money with the bank loaned money, you are now able to buy a $100,000 asset.
We will assume that each year, for 10 years, your investment property will appreciate by 5%. Here is where the ability to leverage benefits you. The appreciation is on the entire $100,000 asset, not only the $10,000 of your own money.
Year 0: $100,000
Year 1: $105,000
Year 2: $110,250
…Year 10: $162,889
So, after 10 years, your property value would have increased by almost $63,000 dollars. Thus, you would have turned your $10,000 investment into over a $60,000 appreciation profit simply by utilizing leverage.
3. Rental Income Is Money in Your Pocket
Assuming that you are investing in an income property to occupy it with tenants, you will be able to receive rental income.
Suppose you have one tenant. You charge that tenant $1,100 a month in rent. Your PITImortgage payment is $700 a month. Thus, subtracting $700 from $1100 will leave you with $400 to go into your pocket each month, right? Not exactly.
From this $1,100, you will want to assume about 5% in monthly maintenance costs and 5% in vacancy costs. Therefore, you will put $110 into a designated bank account each month to deal with maintenance issues and potential vacancy costs. When all is said and done, you will have about $290 each month going directly into your pocket!
$1,100 (monthly rent)
-$700 (monthly Principle Interest Tax and Insurance mortgage payment) =$400
-$110 (for maintenance and vacancy issues
=$290 (your monthly passive income from the rental property)
The most popular type of loan is a 30-year fixed rate mortgage. It has an interest rate that will remain the same for the entire 30 year term of the loan. In the beginning of the loan, significantly more money is paid to interest than to principal, but by year 15, it is close to a 50/50 split. Therefore, the longer you hold the property, the more of the loan principal your tenants are paying down and the more wealth you are creating for yourself.
Say you have a $90,000 bank loan with a monthly mortgage payment of $500. In year one, approximately $385 of this payment will go towards paying the interest, while $115 will go towards paying down the principal on the loan.
$115 (monthly principal payment) * 12 (months) = $1,380 (principal reduction for the year)
$90,000 (original loan)
– $1,380 (principal payments after 1 year)
= $88,620 (loan balance after 1 year)
By year 15, approximately $270 of the monthly mortgage payment will go towards interest, while the remaining $230 towards the principal.
$230 (monthly principal payment) *12 (months) = $2,760 (principal reduction for the year)
Every year that you own this property, you are using the tenant’s money to pay off your debt. By reducing the amount of your loan, you will be building wealth, as you will eventually be able to access this money either by refinancing your loan or by selling the property.
5. Huge Tax Write-Offs for Income Property
As a rental property owner, you are entitled to huge tax deductions. You can write-off interest on your mortgage or on any credit cards used to make purchases for the property. You can write-off your insurance, maintenance repairs, travel expenses, any legal and professional fees, and even your property taxes. You can see a more extensive list at Nolo.com
On top of all of these deductions, the government also allows you to depreciate the purchase price of your property based on a set depreciation schedule, even if your property is actually appreciating in value.
Using our above example, you receive $3,480 in rental income for the year ($290 each month * 12 months). If you made this money at a regular job or in the stock market, you would lose a significant portion of it to pay income taxes. However, by owning a rental property, you can offset the $3,480 income with the depreciation expense for your property, thus being able to reduce or completely eliminate the amount of taxes you have to pay on this rental income.
Speak to an accountant to determine all of your specific tax write-offs.
Being an income property owner is a huge commitment, but, if handled properly, that huge commitment can bring equally large financial rewards.
This is a special compilation of articles that I have taken from the web. I have reviewed this information, and believe it to be totally correct. However, I am a REALTOR. I am not a Certified Public Accountant, and I cannot speak as one. Please apply this information to your own situation, verify that this can work for you via your CPA, and let me know when you want to start saving money and enjoying life more.
Owner, Land and Sea Realty
On the “SELL Phone” at 252-202-4365