Hello fellow taxpayers,
This week I am going to provide some information regarding rental property or rentals. The subject has recently come up with a few of my new clients whose multi-year returns I just completed.
One has to do with renting out their one-time principal residence, and the other is related to not being able to deduct any losses related to the rental property.
Firstly, let’s talk about rental property in general.
As long as you rent it out for more time than you use it personally, you can deduct all of your expenses.
What does this mean
Rentals fall into three categories:
- Full rental – You have the property out for the whole year.
- Split use – You can only deduct a percentage of the expenses for the time rented. The period you use it or rent it for less than the fair rent is personal use.
- Personal – Very occasional rental (i.e., rent it less than 15 days) and you cannot deduct the expenses. However, you don’t claim the income no matter how much.
In any case, most expense categories related to a rental are deductible (again too many examples and exceptions to go over here).
- The largest deduction is depreciation. You may rent real estate, and you have a positive cash flow, but your tax return will show a loss because of depreciation. Depreciation is the systematic write-down of the cost of the asset. This area is where many taxpayers get in trouble.
- Say you buy a single-family house to rent out (you do not use it for personal purposes, strictly a rental) for $375,000 on June 1st, 2019. Many begin the depreciation calculation with the $375,000 as the cost. However, that is so wrong. Why, because the single-family house sits on land that you own. Land is not depreciable. So, we need to remove the land cost. How?
- An appraisal would do the trick. When you have the appraisal done before the purchase, request that the appraiser for the breakdown. The courts have ruled that we cannot use the county records.
Now, what happens if you lived in the house and then decide you want to move, but not sell the family home? Your depreciable base is the lower of the fair market value OR cost (plus improvements) on the date you converted the property. Again, you must get an appraisal to ascertain the fair market value and to split it between the land and building. The same rules apply to commercial property.
Once all of the above is completed, you may have a tax loss.
Can you deduct this loss?
- Firstly, you have to materially participate in the rental activity (even if you have a management company). If you do, you can deduct up to $25,000 in losses against your other income. As is typical in taxes, there is a however.
- This, however, has to do with your overall income. If you are single or filing jointly (married filing separately would be half), and your adjusted gross income is under $100,000, you can deduct the total loss. If your income is over $150,000, your loss is suspended (more on that later). Anywhere in between, you get some. For every dollar over $100,000 of income, you lose 50 cents off the $25,000 loss, which the rest is suspended.
What does suspended mean?
You can take the loss in a future year in three ways:
- Your income goes below $100,000;
- You have net rental income;
- You sell the property.
Then you have the real estate professional. That comes with its own set of rules and exceptions and is a post for another day.
And do not forget the rules regarding the like-kind exchange (§1031) before you sell and want to buy another.
So, if you are thinking of renting or converting, buying, or selling (investment or rental property), let’s chat BEFORE you do.
Until next time,
Jeffrey “I am also a landlord” Schneider