Rent to Win: Understanding the Income and Tax Benefits of Rental Property
Have you thought about purchasing a rental property? Great! You have the opportunity to generate additional income, save for retirement, and improve your tax posture. To unlock the full income and tax benefits of rental property, it’s critical that you do the following 5 things first:
- Meet with a financial planner. Explore how owning a rental property will fit into your current and future financial needs.
- Carefully choose the right rental property! Do your homework. Research the neighborhood. Compare monthly rental rates for nearby properties.
- Consult with a lawyer. You’ll need an airtight rental contract to reduce your liability.
- Decide if you’ll manage the property or hire a manager. Don’t miss out on the tax benefits of rental property because you’re afraid managing real estate will take up all your spare time. Many owners of apartments and homes for rent will hire a property manager.
- Meet with a CPA who has real estate and rental property experience. Real estate taxes can get complicated…fast. However, here at Robert P Russo CPA, we work with everyone, from couples who own a single rental property to landlords with dozens of apartments and homes for rent. Our goal is to maximize the tax benefits of rental property for our clients. Now, let’s take a closer look at those benefits…
Do I Qualify for Tax Benefits of Rental Property…Even if you Own One or Two Properties?
Before we explore the tax benefits of rental property, there’s one question we always get here at Robert P Russo, CPA. No, you don’t need to quit your day job to get the full tax benefits of rental property. Even owning a single property can generate significant income while delivering thousands of dollars in tax savings for decades to come.
Note: If you think you’d like to make a business out of owning and managing real estate, there are more extensive tax benefits of rental property. However, you’ll need to meet strict requirements, as noted in the link.
Can I Write Off the Entire Purchase of a Rental Property as a Loss?
Not right away (unless you are a real estate professional). To help you understand the tax benefits of rental property, we’ve prepared a case study based off of a real client of ours based in New York City. Let’s dive in…
Olivia decides she wants to invest a portion of her savings into real estate. She finds a condo in Yonkers for $1 million dollars. Olivia puts $100,000 or her own money into the property as a down payment and then takes out a $900,000 mortgage from the bank.
While Olivia can’t deduct the entire $1 million as a loss, she will definitely reap the tax benefits of rental property over time. Olivia will be paying a $30,000-a-year mortgage. She will be able to deduct the entire mortgage interest as an expense. In addition, the IRS allows an annual deduction of $36,000 for depreciation (a non-cash expense) on her residential real estate property over a 27.5 period!
What About Income Generated by the Monthly Rent? Does That Offset the Tax Benefits of Rental Property?
Not at all. You will still benefit from significant tax savings. Let’s examine Olivia’s income from the condo versus her deductible expenses.
Annual Rental Income is $55,000
Annual Expenses are $40,000 ($20,000 in mortgage interest, $15,000 in real estate taxes, and $5,000 in insurance)
=Olivia’s Annual Cash Profit is $15,000 (she gets to keep this money and not pay tax on it)
Olivia’s Annual Tax Loss is $21,000 ($15,000 cash profit minus $36,000 in depreciation)
Basically, Olivia gets to put $15,000 in her pocket every year as cash flow. She is then able to deduct the rest of her losses to lower her total taxable income.
Can I deduct my rental property losses every year? Or, do I have to wait until I sell the property?
It depends on your salary. In Olivia’s case, she makes just about $100,000 per year. Therefore, she will see the tax benefits of rental property every year at tax time. The IRS allows for up to a $25,000 loss against your personal income tax return if you make $100,000 or less. So instead of paying income tax on her salary of $100,000, Olivia can deduct $25,000 in losses and only $75,000 of her salary is taxable!
What if my salary is $200,000?
Don’t worry, you’ll also get to enjoy the tax benefits of rental property…you’ll just have to wait until you sell the property. (And remember, you are getting rental income each year, which is definitely a big benefit of investing in rental properties).
If your salary is over $150,000, you cannot deduct passive loss from real estate each year. But you’re not “losing” those tax savings at all. Here’s an example:
Let’s say Olivia has a salary of $200,000 instead of $100,000. After 10 years of owning her rental property, she decides to sell the condo. That’s when the tax benefits of rental property come into play. Even though Olivia couldn’t deduct that $21,000 in passive losses over the past 10 years, she can now! That means she has $210,000 in losses she can take.
First, the $210,000 loss will “cancel out” her $200,000 salary on her tax return, which translates into roughly $50,000 in savings. She then can apply the remaining $10,000 loss against the capital gains – or her “profits” from selling the condo. If Olivia’s profit from selling the condo was $600,000 (her capital gains), then the $10,000 loss would reduce her taxable profits to $590,000.
Yes, Olivia just saved $65,000 in taxes. It’s proof of the tax benefits of rental property. Add that to the $10,000 in rent income she enjoyed over the last decade. The numbers definitely add up. However, it’s important that you sit down with a qualified CPA to maximize your tax benefits of rental property.
There are many additional deductions you can take such as repairs, marketing and promoting your rental listings, and more. If you are living in a dwelling that you are also renting out, there are still tax benefits of rental property of this type – but it is more limited (and can get complicated, fast).
In addition, under the new Tax Cuts and Jobs Act enacted starting in 2018, if the rental property is generating a profit instead of a loss, there is the potential of a 20% deduction of the profits to reduce your taxable income if you meet certain conditions.
If you are a real estate professional, you can deduct all the losses annually, but the rules for meeting this threshold are very strict. A more detailed conversation is needed.
If you have any questions, you can always reach out to us here at Robert P Russo, CPA. We’re ready to put our real estate tax knowledge to work for you.