Do your research before buying. Consider market conditions, the local unemployment rate, the proximity to schools, transportation options and whether the neighborhood is considered desirable. Consider hiring a management company. These firms screen potential tenants and arrange for routine maintenance on the property. It's a good way to protect yourself from unforeseen problems. Fee: 10% to 15% of the gross rental income. Be very picky about tenants. Bad tenants pay late or not at all, and may damage the premises. It can take six months or more to evict a tenant. Make sure to check credit and business references. Don't expand too quickly. Unexpected vacancies can make it very difficult to meet carrying costs. Update your rental application to reduce legal and other problems.
Unless rent is collected at 80% of fair rental value or higher, deductions may be limited. If you are renting to a related party and they are paying less than 80% of fair rental value, deductions are limited to income. If you are renting one of your rental properties to a related party or relative for less than fair market rent, please let us know when you submit your tax documents for tax return preparation.
The like-kind exchange (IRC Code Sec 1031 exchange) provisions provide rules that allow a gain on a transaction to be deferred to a future time. In a typical like-kind exchange, real estate is exchanged for other real estate. These rules are complex and have specific requirements for the exchange to be valid, so make sure you consult us prior to selling the real estate. For additional information, please give us a call.
Special rules apply when renting a portion of your primary residence or second home. Expenses relating to common areas that are shared by you (or your dependent) and other tenants are not deductible. If you have a property with mixed personal and rental use, please let us know on your tax organizer, so we may properly report the income and deductions relating to the rental portion. We will need the square footage of spaces rented to unrelated parties at fair market rent, the square footage of spaces rented to related parties (if any), and the square footage of common areas, which should total to the total square footage of the rental property. If renting to related parties (such as a dependent or other relative), unless fair rental value is collected, there may be additional limitations on deductions. See comment below regarding renting to related parties.
In general, losses on rental properties are only deductible to the extent you have passive income. However, if you are able to classify yourself as a real estate professional, the losses are deductible regardless of passive income. These rules are somewhat complex and include very specific record keeping requirements. If you feel you may be able to qualify as a real estate professional, please contact our office so we can analyze and document your qualifications.
Insurance, even if it includes replacement costs, will only pay up to the limit of insurance. This can result in financial problems if the value of your building is greater than your insurance limit. Therefore, you should compare the amount of coverage with the current value of your building. Contact your insurance agent to make any necessary changes to your policy.
Consider forming a Single-Member LLC and transferring your rental properties to it. Benefit: Owning rentals creates the potential for legal liability. By transferring them to an LLC, you create a legal entity that will potentially offer you protection against lawsuits that could take your other assets, such as your home, savings, etc. Note: You can never escape liability for acts of personal negligence or willful intent. Also, you should not transfer property and debt to an LLC if the debt exceeds your depreciated cost in the asset. However, you can transfer just the property and retain the debt in your name, if your lender will permit this. You should contact your attorney regarding any legal questions related to formation or liability protection provided by an LLC.
If you sell a property this year to a credit worthy buyer, and you don't need all of the sales proceeds immediately, consider an installment sale. When using the installment method of accounting, gain is reported as payments are received. This method can be used by taxpayers under certain circumstances. The rules for installment sales are complex. However, if usable, the installment method can significantly postpone the payment of taxes. Generally, the smart course of action is to collect your sales price up-front and pay the income taxes currently. If you are considering an installment sale, contact us to determine if the method is available for your transaction.
Vacation rentals are subject to many restrictive rules. Income and deductions can be reduced based on personal usage and losses can be limited. One of the most restrictive rules you must comply with is the "7 day rule". If a vacation rental is rented on average for 7 days or less, your deductible losses are normally limited to zero. To avoid limitation, you should rent your property for an average period of MORE THAN 7 days. To do this, you should avoid renting the property for weekends since this will make it difficult to achieve the required more than 7 day average period. If you can prove you "materially participate" in the activity, losses will be deductible, regardless of failing the 7 day rule, as business losses (i.e. not as rental losses). However, "material participation" is a high standard requiring many hours of work each year. For more information or assistance, please contact us.
The IRS is looking closely at the accuracy of amounts reported for rental activities. The IRS estimates over half of taxpayers with rental activities under report revenues and/or overstate expenses.
New rules define and establish thresholds for materials and supplies, clarify when amounts should be capitalized versus being classified as a repair or maintenance, and allow small taxpayers to make elections and expense items previously capitalizable. Additional information regarding these regulations can be found on the FAQs page in the Tangible Property Regulations section on our website.
In prior years the IRS's position was that significant amounts spent on tangible property should be capitalized rather than treated as a repair and expensed. The theory was that as a property deteriorated, even through normal wear and tear, costs to bring the property back to its ordinarily efficient operating condition were to be capitalized as an improvement to the property. The new regulations allow taxpayers to expense amounts that are considered costs for repairs and maintenance. Only costs that result in a "Betterment", "Adaption" for a new use, or a "Restoration" are required to be capitalized. Additional information regarding the tangible property regulations can be found on the FAQs page in the Tangible Property Regulations section on our website.