As a landlord, you probably already know that taxes are unavoidable, but that doesn’t mean you can’t minimize them and keep more of your hard-earned cash. The IRS can be your friend who gives you their notes before the test or the bully who takes your lunch money. It’s all about how you utilize the tax code in your favor. Here’s a little guide on how to play the tax game without paying a cent more than necessary.
Tax Advantages Of Rental Properties
First off, depreciation is your best friend. The IRS lets you deduct the wear and tear of your property over 27.5 years. So, while your house may actually be appreciating in value, on paper, it’s “wearing down,” which magically reduces your taxable income. Next, we have deductible operating expenses like insurance, taxes, and more that can significantly lower your tax bill. Finally, there is capital gains tax relief that comes into play when you hold your property longer than one year, which you may qualify for.
Another tip: if you’re planning to sell your rental property, the 1031 exchange is your golden ticket. This lets you reinvest the sale proceeds into another rental property and defer paying capital gains tax. It’s like pressing pause on taxes while you grow your real estate empire.
How is Rental Income Taxed With a Mortgage
Next, if you’ve got a mortgage, you’re in luck. The interest you pay is fully deductible. Think of it like this: every time you make that monthly payment, a chunk of it goes towards lowering your tax bill. And if you use part of your property as your primary residence and rent out the rest, you can even deduct the interest on the rental portion. Sadly, the principal paydown is not tax deductible.
6 Tips To Reduce Your Rental Income Tax
Actively Managing
One of the lesser-known tricks is actively managing your property. According to the IRS, if you spend at least 750 hours a year managing your rentals, they consider it “active” income rather than passive. This classification opens up more deductions, which means more money stays in your pocket. The more involved you are in your property’s upkeep, the bigger the tax benefits. There are several factors to be considered active, so talk with an investor-friendly CPA to learn the ins and outs of qualifying.
Track and Deduct All Expenses
Keep a detailed list of every single expense related to your rental. We’re talking about everything from new appliances to marketing costs and travel expenses. Even the miles you drive to and from the property are deductible. Miss a deduction, and you might as well be tossing money out the window. Even the HOA fees you may pay are deductible. Finally, we can benefit from them telling us our trash cans were out an hour too early.
Depreciate Capital Investments
If you made any big-ticket upgrades like installing a new HVAC system or putting on a fresh roof, you can depreciate those over time. Depreciation accounts for the natural decline in the value of assets over time. Maintaining your property, and will the IRS reward you for it? That’s a rare win-win for both of us.
Make Borrowing Your Friend
When you take out a loan or line of credit for your rental, the interest is deductible, too. It’s another win-win: you get the cash to improve your property, and you get to reduce your tax bill. Just be careful not to overdo it—too much debt might limit your financing options down the road.
Reduce Capital Gains Tax
Now, if you plan to sell the property, brace yourself for capital gains tax, but don’t worry—there are ways to soften the blow. If the property was your primary residence for at least two of the last five years before selling, you can exclude up to $250,000 ($500,000 for married couples) from capital gains. For those thinking long-term, careful estate planning can help defer and even eliminate capital gains taxes when passing properties on to your heirs. Selling your property or gifting it to a family member will trigger a gain tax. Tax rules swing in our favor, though, when it is an estate gift instead.
Review your property tax assessments regularly
Over-assessed properties mean overpaying taxes. Compare your property’s assessed value to similar ones in your area, and if it looks off, appeal the assessment. You’d be surprised how often tax assessments are higher than they should be. The process to appeal property taxes varies by jurisdiction, so make sure to familiarize yourself with the deadlines and procedures needed. There are even companies that will do all of the work for you in return for a percentage of the money they saved you if you are confused by the process or don’t have time.
Managing rental properties is a juggling act, and taxes are just one of the balls in the air. But with these tips, you can minimize your tax bill and keep your investment profitable. If all these deductions and tax strategies sound overwhelming, don’t sweat it. Software like Baselane can help you stay organized. It simplifies bookkeeping and rent collection and even helps you categorize all those deductible expenses, so you’re not scrambling at tax time. Take it from me, the guy who regularly used to not keep up properly and would turn on panic mode each tax season.
These are just a few of the strategies to remember, and you should always consult with a tax professional who works with investors. Every deduction is a step toward paying less and keeping more of your rental income, which is exactly how you want to play the game.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
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