As you enter into the rental property game, taxes get a lot more complicated. Knowing the ins and outs of the tax system can offer some big financial benefits. So here are some tips for your rental properties.
Keep good records. (We help!)
Knowing how much you make in rental income per year and how much you spend on repairs, property tax, operating expenses, etc. is essential come tax time. It’s easier to keep track of things as they come along throughout the year than to try and gather it all when your accountant asks for it. Papers and receipts get lost; people forget. Try to keep a note in your phone, or snap a picture of a receipt so you have it on file for when you need it.
PMI will help you track your rental income and the cost of repairs that we contract out for your property. Our company will send you a statement at the end of the year with all that information. It will be up to you to track what you do, such as the property taxes you pay and the work you contract out independently.
If you need an idea of what you can and cannot deduct, the IRS has great guidance.
What is capital gains tax and why do I care?
To put it simply, capital gain is the amount of money you made off the sale of your investment property less the amount that it cost you. For example, if you bought a condo for $50,000 and sold it for $100,000 (all unthinkable here in Southern California, but you get the idea) you would have made $50,000 in capital gains. That’s money that’s going to be taxed like income. It’s a painful hit when you consider the amount you have to pay under California and federal tax laws.
Often, you can mitigate this hit by considering a couple of strategies.
First, offset your gain with a loss. A common way of doing this is selling in the same year that you take a big loss in stock sales. So if you lost $35,000 in stock sales this year, you can use that $35,000 lost to offset the $50,000 you gained from selling your condo. Then you only net $15,000 in capital gains for the year.
You can also consider what’s called a “like-kind” exchange. For example, you sell your condo so you can buy a duplex. You have reinvested your money and therefore it’s not subject to the capital gains tax.
There are two things you need to watch out for when you do this. You need to make sure your new purchase costs the same or more than the investment property you just sold. You also need to make sure that you reinvest quickly.
As Investopeida explains, “You have 45 days from the date of the sale to identity potential replacement properties and you must close on the replacement property within 180 days. If your tax return is due before that 180-day period, you must close sooner.”
Investopedia has an in-depth breakdown of both. Of course, it’s always good to check with your accountant as well to see what rules apply to your particular situation before you take action.
Your property is a long-term asset or what the IRS calls a “capital asset.” Like all capital assets, the IRS provides a way to deduct a portion of what you paid for that asset over a series of years. This is called depreciation and if you’re not doing it for all your investment properties, you should be.
Depreciation works like this. If you pay $100,000 for a property and the IRS says you can depreciate it over a 10-year period, then you would deduct $10,000 from your taxes every year until the 10 year period is up or you sell the property, whichever comes first.
For rental properties, you may also have the ability to depreciate items such as appliances and new carpet.
There are rules and restrictions for depreciating capital assets. You can find out more details on the website, NOLO.
The PMI deduction
You’re also allowed to deduct the work that contractors (like a property management company) do for you. PMI manages your property. Our work is deductible because we are considered an independent contractor working for you.
There are some hoops that you need to jump through to make this a legitimate deduction. You’ll need to have us fill out a W-9 which is a form for independent contractors (we have some already filled out that we would be happy to send you). Then you’ll need to file a 1099-MISC with the IRS. Once you’ve done that, you can deduct the fees you pay us for managing your properties.
Take a look at NOLO for a better idea of how the contractor deduction works.
All four of these are important things for you to consider as you look at your rental property and taxes, but don’t take our word as law. Every situation is different and it requires a professional to determine what tax breaks work best for your situation.
We here at PMI are property management professionals. We’re very good at what we do and we have a good idea of what does and does not benefit our clients at tax time. However, we’re not tax professionals. That’s a gig for Certified Public Accountants (CPAs) and if you don’t have one, give our office a call and we can recommend a few.