Financing April 30, 2022

Tax Deductions on Rental Properties

The 2018 Tax Cuts and Job Act introduced various adjustments for rental property owners that indicate that the business will be more profitable than it was previously. Since the details of how the federal tax changes affect individual property owners can vary, it is important to consult with a tax advisor who specializes in real estate. However, here are some of the new tax rules that would most likely effect rental property owners.

Landlords can deduct a big ‘bonus’ the first year

To the IRS, rental properties depreciate over time simply due to the wear and tear. This is a tax advantage for landlords, which can carry out over several years. Landlords can obtain a “bonus” depreciation deduction for the first year they buy a rental property. Previously, the deduction was limited to 50% of the property’s value. However, under the new tax law, that deduction was increased to a maximum of 100%, which could cover the whole cost of the property. This bonus deduction would be deducted from revenue, resulting in a loss in rental income in many situations.

However, it’s important to note that your property must meet certain criteria: 1) It must be available for rent between September 27, 2017 and January 1, 2023, and 2) the property must have a “class life” of less than 20 years for all or part of it. To take advantage of the additional depreciation, the property would need to be reclassified as a five-, seven-, or 15-year property, as most properties have a class life of 27.5 years. (A CPA can assist you with this).

Up to 20% of rental revenue can be tax-free

While rental revenue is subject to taxation, the tax act may provide landlords with a tax break of up to 20% of their rental income. Section 199A of the Internal Revenue Code allows some taxpayers to deduct qualified business income. There was some debate in the past about whether this applied to landlords, but the IRS clarified the situation, allowing a “rental real estate enterprise” to be recognized as a business.

Landlords can deduct more home improvements immediately

Landlords used to be able to deduct repairs to a rental property right away, but home improvements were depreciated over time. Despite the confusion about this, the tax bill eased the rules and the immediate deduction threshold for home improvements were increased to $2,500 per item under section 179.  So rather than going through the lengthy depreciation procedure, money spent on renovations under $2,500 can be deducted right away.

One negative: Some landlord losses are now capped

When a property’s expenses exceed its rental income, it results in a loss. Owners of renting real estate could formerly take infinite losses on their properties. Now the new tax law restricts these losses to $250,000 for a single person and $500,000 for married couples. The good news is that because these limits are so high, most of the individual rental-property owners will be unaffected.

How to make the tax act work for you

For real estate investors, the new tax bill has provided great opportunities. It is very important for rental owners to maintain records of sales closing disclosures, purchase closing disclosures, refinancing documents, and any receipts related to the residence for at least three years.

Lastly, as mentioned above, if you are a rental owner, it is strongly recommended that you consult with a tax advisor who specializes in real estate to ensure you are making the most of these tax deductions.