Have you been making huge profits in your real estate but you don’t get to enjoy them? You have no idea where all your money goes when it’s tax time? Think. Have you been planning and preparing for your tax liabilities? If the answer to this crucial question is ‘no’, then my friend, you need enlightenment regarding tax deductions and benefits! Don’t freak out, it’s nothing too complicated; just a few tips and tricks suggested by our experts at MVW Services in Artesia, California to help you invest your money smartly.
The first thing you need to know about are your tax deductions. You can deduct all expenses which are for the management of your rental property. It can be equipment, like a printer for your office or it might be house repairs; such as fixing toilets, which you have to make for your tenant. But the bonus question is: how do the deductions benefit you: the investor? The key is to think smart. Even the cost of the trip you make to keep a check on your property is deductible. What you can do is to make a stop anywhere along the way to cater to your needs; such as picking up your kids from school. These expenses are quite small as compared to what you spend on your property, but collectively they can make a sizable deduction at tax time. But you have to make sure not to include such expenses which do not contribute to the maintenance of your property such as renovation (it actually adds value to your property!). You can do this by finding a tax preparer for your business. They can help you with what you can and cannot deduct from your taxes.
You might have heard this term somewhere, but put simply, it is the deduction in the value of materials that wear out over the course of their usable life. For example, let’s say that you have bought a fax machine for your office. You can deduct its cost, sure, but not all at once: it has to be over the lifetime of the machine. The depreciable life is standardized by IRS. For buildings it is 27.5 years. So, if you buy a house worth $120,000 and the cost of land is $15,000, then you can depreciate your house at $105,000: at a rate of about $3818 annually (you just divide the cost by 27.5). Did you notice that land is not depreciable? Because it does not wear out over time! And, there is a thing called depreciation recapture. It is the IRS’s way of saying, Gotcha! It is the tax that you are liable to pay to IRS when you sell your property; currently 25%.However, it is applicable to the extent of your gain. Everyone’s situation is different so your tax is also calculated differently. Because of such complications, it is best to seek help from a tax professional for real estate at MVW Services in Artesia, California, so you can avoid all sorts of loopholes.
Did you know you can refinance your property if you have equity? With the new loan, you can pay off the cost of your property completely and you can do whatever you like with the remaining sum of money. Why? Because… wait for it: it is not taxed!
The profit you earn through your property is taxed in two types of ways:
Short term capital gains
Long term capital gains
Short term capital gain refers to the profit when the property was owned by you for a year or less. While long term refers to properties held for more than a year. It is always the best tactic to hold onto your property for more than a year, because of: a) the value of a property almost always appreciates with time and b) to reap the benefits of long term capital gains. What are the benefits, you ask? Short term gains can reach out to a maximum of 35% as they are taxed at ordinary rates while long term gains reach to 15% at the maximum, in most cases.
The tax on your real estate profit can be delayed by exchanging it with another property. The only limitation with the 1031 Section exchange is: the acquired property has to engage in producing income. Developed and undeveloped land can be exchanged with each other and a residential property can be exchanged with a commercial one. But remember, this exchange only delays your taxes. You will eventually have to pay them in the future. But it is a good option if you are looking for some time to get your affairs in order.
The income generated from rental properties is not taxed as earned income. FICA (Federal Insurance Contributors Act) is 15.3% tax which is normally split in half between the employer and the employee. Self employed people are responsible to pay the whole 15.3% (self-employment tax). It is a good thing for the investors that the US Government does not consider real estate a job or a self employed business! However, you should be careful about how you manage your holdings. Paying yourself a salary or any sort of fees for holding properties or management services may make you liable for FICA. So, consult with a seasoned accountant at MVW Services in Artesia, California before making any such decisions.
Monique van Wijngaerde is a QuickBooks Specialist (QS) and a Professional Bookkeeper (PB) at MVW Services with a fifteen year experience in accounting. She recommends maintaining proficient financial records. One of the many reasons that the IRS disallows deductions related to property is that investors do not maintain good records.
