Yajnesh Rai

Investment Property: How Much Can You Write Off on Your Taxes?

Learn how to navigate the tricky tax laws around investment properties, including ways to save.

There are certain things you can do as a real estate investor to help manage your tax bill and maximize your after-tax return on investment. To do so, however, you need to understand the primary ways in which investment real estate portfolios get taxed. You must also have a general grasp of some abstract concepts like calculating your tax basis, as well as the depreciation of capital investments.

Warning: This article is not going to make you an expert. But it will acquaint you with the basic terminology so you can be better prepared for a meeting with your tax adviser.

Taxation of rental income

The IRS taxes the real estate portfolios of living investors in two primary ways: income tax and capital gains tax. (A third way, estate tax, applies only to dead investors.)

Rental income is taxable — as ordinary income tax. That means you must declare it as income on your tax return and pay income tax on it. Unlike wages, rental income is not subject to FICA taxes.

Your income is everything you get from rents and royalties on the property, minus any deductible expenses. You can’t deduct everything though. You can only deduct mortgage interest and repairs you make that restore the property to its original minimally functional condition. You can’t deduct capital investments like new buildings, additions or renovations. More on these later.

Capital gains tax

The second tax bill you need to worry about is capital gains tax. The IRS taxes you on any net profits you get out of a property when you sell it. If you’re flipping the property and you’ve owned it for less than a year, you pay short-term capital gains tax, which is the same rate as your marginal income tax rate. If you’re in the 28% tax bracket, you’ll pay a 28% tax on short-term capital gains.

If you hold the property for 12 months, you’ll qualify for more favorable long-term capital gains. Depending on your marginal income tax bracket, these taxes could range from 0% to 15%. In every bracket, however, the IRS takes a smaller cut out of long-term gains than out of ordinary income or short-term gains.

Calculating capital gains

You pay capital gains tax on the difference between your selling price in the property and your adjusted tax basis. Your adjusted tax basis in a property is the original cost you paid for the property, plus any amount invested in renovations and improvements (including labor costs on these projects) that you have not previously deducted for taxes.

If you have deductions associated with the property, you subtract them from your tax basis. If your adjusted tax basis is higher than your sale, you have a capital loss. You can subtract capital losses from a given year from capital gains to reduce your tax bill. If you have more capital losses than capital gains, you can “carry forward” these capital losses into future years to offset future capital gains. If you have no capital gains, you can deduct $3,000 annually until you have recognized all your capital loss carryforward.

How to defer capital gains taxes: an intro to like-kind exchanges

The IRS provides an important exception to capital gains taxation, made-to-order for real estate investors: If you own an investment property, you can sell your property at a profit and roll your money over into another property within 60 days without having to pay capital gains taxes at all. This transaction is known as a Section 1031 exchange, named for the section of the U.S. Revenue Code that allows it. You cannot swap your rental property for a personal residence, or vice versa. For this reason, these exchanges are called like-kind exchanges, in that the property you replace it with needs to be substantially similar to what you sold.

The 1031 exchange makes it possible for real estate investors to defer paying capital gains tax, which is another advantage over investing in mutual funds, stocks, bonds and other securities or collectibles. Outside of a retirement account, you have to pay tax on gains in these items by April 15 of the year after you sold them.

Depreciation and amortization

This is a broad concept, so we can only cover the very basics here. When you buy investment property — be it a building, a computer or a horse — the IRS knows that the item won’t stay young and new forever. Over time, the property will decrease in value. Depreciation is the process of claiming a deduction to compensate you for the property’s decrease in value during the year.

Note: You can’t depreciate your personal residence. You can only depreciate investment property. For more information on the process of depreciation, see IRS Publication 946, How To Depreciate Property.

Land, of course, doesn’t depreciate. But minerals underneath the land do. If you are extracting oil or other minerals, or timber, for that matter, from the land, you will account for the gradual loss in value through a process called depletion.

Likewise, when you make a purchase of investment real estate or capital equipment with a useful life of longer than a year, the IRS knows you will be using that property to generate income for a long time to come.

Except in certain circumstances, the IRS does not allow you to deduct the full cost of your investment in the first year. Instead, you must amortize your investment over a number of years. For real estate, you must spread the deduction out over 27.5 years.

Passive activity rules

Again, these rules are complex. But in a nutshell, if you are a passive investor — meaning you are not working day to day in the business of managing your real estate investments — you are subject to passive activity rules. Basically, you can only deduct passive losses to the extent that you can cancel out gains from passive activities. These rules restrict your ability to use passive activity losses to offset capital gains elsewhere in your portfolio. Congress implemented these rules in 1986 to eliminate tax loopholes and abusive tax shelters.

Most individual investor landlords can deduct up to $25,000 per year in losses on rental properties, if necessary (subject to income limitation). Hopefully you won’t have to make use of this provision much.

Property taxes

Expect to pay property taxes to local and county governments each year. Your local government will assess the market value of your property at its “highest and best use” and charge you a percentage of that value every year. You can deduct property taxes against your rental income, though, provided the property tax is uniformly assessed throughout the jurisdiction and is not a special assessment.

Other tax deductions

Watch for opportunities to take deductions for these common real estate investment expenses:

• Mortgage interest
• Legal fees related to your investment properties or business
• Mileage
• Business use of your home (the home office deduction)
• Advertising fees

Employees (but if they are working on capital improvements or renovations, you have to amortize their labor costs as part of your capital investment, rather than as a current year expense.)

Carve Out the Perfect Outdoor Space: 3 Tips | Realtor Magazine

The backyard can be a selling point in your listing, no matter the size. Up your listing’s backyard appeal by transforming it into an entertaining space. Houselogic, a home remodeling and design website, offers some key areas to address to achieve the look:

1. Create privacy.

Make the backyard a private sanctuary for homeowners. Precast concrete geometric blocks, for example, can protect privacy without blocking light, Houselogic suggests. They can be used as a vertical element to make smaller yards feel bigger.

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2. Mimic the indoors.

Make the spaces functional by taking a cue from the indoors. Sellers may get much of their money back too: Homeowners tend to recoup 70% of their costs on resale after building a new patio and an outdoor kitchen gets 71%, according to the National Association of REALTORS®’ “Remodeling Impact Report.” Consider adding built-in benches for seating or hanging a chandelier or pendant lights for functional lighting over the dining space, Houselogic recommends.

3. Add some shade.

Extending the roof may be a pricey option, but there are other ways to make the backyard more shielded and inviting from that summer sun. Houselogic recommends a pergola planted with vines or a retractable awning.

Mortgage Rates Barely Budge From 3-Year Lows | Realtor Magazine

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After steady declines since the beginning of the year, mortgage rates appear to be leveling off. But that still bodes well for home buyers.

“While rates have moderated, we’re still at nearly three-year lows, which is good news for buyers looking to purchase a home before school starts,” says Sam Khater, Freddie Mac’s chief economist. “The recent stabilization mortgage rates reflects modestly improving U.S. economic data and a more accommodative tone from the Federal Reserve to respond to the rising downside economic risk from trade tensions and soft global economic data. On the housing front, the latest weekly purchase application data suggests home buyer demand continues to rise, which is consistent with the slowly improving real estate data from the last two months.”

Freddie Mac reports the following national averages with mortgage rates for the week ending July 11:

• 30-year fixed-rate mortgages: averaged 3.75%, with an average 0.5 point, unchanged from last week. Last year at this time, 30-year rates averaged 4.53%.
• 15-year fixed-rate mortgages: averaged 3.22%, with an average 0.5 point, rising from last week’s 3.18% average. A year ago, 15-year rates averaged 4.02%.
• 5-year hybrid adjustable-rate mortgages: averaged 3.46%, with an average 0.4 point, rising from last week’s 3.45% average. A year ago, 5-year ARMs averaged 3.86%.

Where Mortgage Debt Is Highest | Realtor Magazine

For most Americans, a home purchase is the biggest purchase of their life and thus requires taking on a large amount of debt. The average mortgage debt can vary considerably from state to state.

“Cost of living and home prices are a big factor,” says Greg McBride, chief financial analyst at Bankrate. “The cost of living impacts how much you can save for something like a down payment, and home prices impact how much you have to borrow.”

Mortgages Are the Happiest Type of Debt

Wealthier states tend to have the highest amount of mortgage debt. 24/7 Wall St., a personal finance website, pinpointed which states have the highest amount of mortgage debt. Here are the top 10:

1. California

• Avg. mortgage debt: $347,652
• Median home value: $509,400 (2nd highest)
• Median household income: $71,805 (8th highest)
   

2. Hawaii

• Avg. mortgage debt: $342,613
• Median home value: $617,400 (the highest)
• Median household income: $77,765 (3rd highest)
   

3. Maryland

• Avg. mortgage debt: $256,744
• Median home value: $312,500 (9th highest)
• Median household income: $80,776 (the highest)
   

4. Massachusetts

• Avg. mortgage debt: $252,624
• Median home value: $385,400 (3rd highest)
• Median household income: $77,385 (4th highest)

 

5. Washington

• Avg. mortgage debt: $250,467
• Median home value: $339,000 (5th highest)
• Median household income: $70,979 (10th highest)
   

6. New Jersey

• Avg. mortgage debt: $247,868
• Median home value: $334,900 (6th highest)
• Median household income: $80,088 (2nd highest)

7. Virginia

• Avg. mortgage debt: $246,379
• Median home value: $273,400 (11th highest)
• Median household income: $71,535 (9th highest)

8. New York

• Avg. mortgage debt: $243,244
• Median home value: $314,500 (8th highest)
• Median household income: $64,894 (14th highest)
   

9. Colorado

• Avg. mortgage debt: $241,980
• Median home value: $348,900 (4th highest)
• Median household income: $69,117 (11th highest)
   

10. Connecticut

• Avg. mortgage debt: $235,786
• Median home value: $273,100 (12th highest – tied)
• Median household income: $74,168 (5th highest)

Is Inventory Tightening Again? One Forecast Says Yes | Realtor Magazine

In just a few months, home shoppers may begin to see a drop in the number of homes for sale, which could lead to the return of bidding wars and quicker home sales, a new report from realtor.com® predicts.

Realtor.com® researchers predict a major shift to occur in the housing market that will affect buyers’ bargaining power well into 2020. With high demand for the limited number of homes for sale, buyers may need to be braced to pay higher home prices.

The U.S. median listing price in June reached its highest point of the year at $316,000. Properties in June spent an average of 56 days on the market, a two-day increase from a year ago.

“It was only 18 months ago that the number of homes for sale hit its lowest level in recorded history and sparked the fiercest competition among buyers we’ve ever seen,” says Danielle Hale, realtor.com®’s chief economist. “If the trend we’re seeing continues, overall inventory could near record lows by early next year. So far there’s been a lackluster response to low mortgage rates, but if they do spark fresh buyer interest later in the year, U.S. inventory could set new record lows.”

Newly listed homes have either declined or only increased very little in 2019. Why aren’t more homeowners taking advantage of the market and listing their homes for sale? “It’s likely a combination of a rate lock, recently decreased consumer confidence, and older generations choosing to age in place,” Hale says. Consumers are showing slightly more concern over a potential recession and future economic growth that could be making them skittish.

But low mortgage rates also may be keeping many homeowners in place. Seven years ago, the 30-year fixed-rate mortgage reached its lowest average at 3.3%, according to Freddie Mac’s records. That prompted many homeowners to refinance and lock in lower monthly mortgage payments.

Rates today remain low, but they’re still 50 basis points higher than they were in December 2012. That means many homeowners still have mortgages with rates well below today’s averages.

How Much Money Will You Need to Retire – A House?

Most Americans believe they’ll need an average of $1.7 million to retire, according to a new study from Charles Schwab. Researchers analyzed 1,000 401(k) plan participants across the country.

“The bulk of folks do not get there,” Nathan Voris, a managing director at Schwab Retirement Plan Services, told CNBC.

More than half of respondents surveyed say they are contributing 10% or less of their salary to their 401(k), which is the largest source of retirement savings. The average annual contribution is $8,788, according to the Charles Schwab study.

But that likely won’t be nearly enough if you started saving later on life, the study finds. A person in their 20s who saves 10% to 15% of their salary each year likely would have enough to retire comfortably whereas a person who doesn’t start until age 45 or older would need to set aside up to 35% of their salary annually, according to the study.

Yet, two-thirds of U.S. workers surveyed by theEmployee Benefit Research Institutesay they are “very” or “somewhat confident” that they’ll have enough to live comfortably throughout retirement. But only 42% have used retirement calculations to estimate how much they’ll actually need.

4 Maintenance Chores To Keep In Mind Regularly | Realtor Magazine

Homeowners who fail to perform certain maintenance tasks in a timely manner may face hefty repair bills in the future. Professional home inspectors shared with Apartment Therapy some of the most important home maintenance chores that owners should be doing.

1. Clean your gutters. Be sure to check and clean gutters throughout the year to remove any debris. “Once debris is carefully removed, any dirt or grime should be thoroughly cleaned and cleared; any missing caulk replaced; and holes, cracks, or loose areas repaired,” Benjamin Martin, a home inspector and president of Florida Certified Home Inspections, told Apartment Therapy.
2. Check the HVAC system. Change filters out once a month. If any condensation is gathering on the outdoor AC unit, flush the condensate drain with soapy, hot water and vinegar, experts say. Hire an HVAC professional for semi-annual maintenance to keep it operating correctly and potentially stave off an expensive replacement.
3. Flush out any plumbing clogs. Even seemingly small clogs can become more problematic if not taken care of right away. Regularly remove any grime or hair buildup in the shower; remove any gunk that accumulates near a toilet valve; and replace worn flappers (the rubber seal inside the tank), Martin says. Check underneath the sinks and inside the cabinets to make sure there are no water spouts from a leak.
4. Address insect problems. Don’t let bug problems escalate, warns Kathleen Kuhn, CEO and president of HouseMaster Home Inspections. Termites can cause extensive damage; carpenter ants can damage the wood where they nest; and powder post beetles can create hollowed out spaces in your wood. Also, watch out for supersized bee hives. Call in a professional to get the home’s yard sprayed.

Survey: Buyers Rank Commute Time Above Square Footage | Realtor Magazine

Commute time is an important factor to buyers when they’re deciding on a home to purchase. Eighty-five percent of buyers say they would sacrifice other home features, such as lot size, square footage, and home style, in order to shorten their commute to work, according to a survey of more than 600 realtor.com® users. Forty percent say they are looking to reduce their commute time by up to 45 minutes.

 

® realtor.com

® realtor.com

 

In response, realtor.com® announced a new tool that enables buyers to filter their home-search results according to rush-hour and off-peak commute times. “Our commute time filter is different from others in the marketplace because it gives buyers the ability to toggle between rush-hour and off-peak commute times,” says Chung Meng Cheong, chief procurement officer for realtor.com®. “With a more holistic view of their drive to and from work, people are able to make more informed decisions about where to live and, hopefully, reduce some unnecessary stress from their daily lives.”

Home shoppers can enter basic search information, such as number of bedrooms, bathrooms, and location desired. They can then filter listings to match their preferred commute time. Commute times are offered in 10-minute increments up to 60 minutes or more. All of the available homes that match the search parameters and commuting distance will then be displayed.

The Commute Time Filter is available on realtor.com®’s iOS app and will soon be available on Android, as well as mobile and web versions.

Low 30-Year Rates Keep Buyers in Summer Market | Realtor Magazine

® REALTOR® Magazine

 

Mortgage rates barely budged this week, keeping borrowing costs low for summertime home shoppers. Mortgage rates continue to hover near their 2016 averages. “We’re seeing a tug of war happen as the fixed-income market flashes warning signs while the equities market continues to march higher with optimism,” says Sam Khater, Freddie Mac’s chief economist. “The data suggests the economy is weakening but is still on very solid ground, with high consumer confidence and a strong labor market. Closer to home, the housing market continues to slowly improve and gain momentum as we head into the second half of the year, which is good news and should keep the economy growing.”

Freddie Mac reported the following averages for mortgage rates for the week ending July 3:

• 30-year fixed-rate mortgages: averaged 3.75%, with an average 0.6 point, up slightly from last week’s 3.73% average. Last year at this time, 30-year rates averaged 4.52%.
• 15-year fixed-rate mortgages: averaged 3.18%, with an average 0.5 point, rising from last week’s 3.16% average. A year ago, 15-year rates averaged 3.99%.
• 5-year hybrid adjustable-rate mortgages: averaged 3.45%, with an average 0.4 point, rising from last week’s 3.39% average. A year ago, 5-year ARMs averaged 3.74%.

Contingent Offers May Not Hurt You As Much | Realtor Magazine

Compared to a year ago, a contingent offer may be less likely to threaten a sale, according to an analysis from the real estate brokerage Redfin. Fewer buyers waived financing and inspection contingencies in May than they did last year.

In May, 14.6% of successful offers submitted by Redfin agents waived the inspection contingency, which is down from 19.8% a year earlier. Meanwhile, nearly 12% of buyers waived the financing contingency, down from 13.2% a year prior.

Buyers may be tempted to waive contingencies in highly competitive markets in order to make their offer look more attractive and avoid any hangups and negotiations in situations with multiple offers. Inspection contingencies, for example, allow a buyer to cancel the deal if something surfaces during the inspection period; a financing contingency allows buyers to cancel their offer if their financing falls through, like if an appraisal comes in below the purchase price.

“Sellers are more willing to give buyers what they want because sellers don’t have as much negotiating power as they did a year ago,” says Daryl Fairweather, Redfin’s chief economist. “Last year, sellers would often receive multiple offers and had their pick of the litter. Now that they have less control of the market, sellers are taking on more of the risk from the buyer—like the risk that the buyer can’t sell her own home, or the risk that something unnerving is found during the inspection.”

About 74% of transactions had a contract contingency in May, according to the REALTORS® Confidence Index. The most common contingencies involved home inspections, obtaining financing, and getting an acceptable appraisal.

Home-sale contingencies—which are used by buyers who need to sell their own home in order to buy a new one—are also increasing. In May, 8.4% of successful offers submitted by Redfin agents included a home-sale contingency, up from 4.4% a year earlier but down from 8.5% in April.

“Typically, a seller won’t even consider an offer with a home-sale contingency during the first week or two that the home is on the market,” says Glenn Rickel, a Redfin real estate professional in the Chicago area. “If the buyer is not already under contract with the home they have to sell, they’re asking a big favor of the seller to take their home off the market for two months or more and hope that the buyer’s home sale goes through smoothly. Now that more homes are taking longer to sell, it’s become easier for a move-up buyer to find a home that has been on the market for a few weeks or a few months, which makes the seller a lot more likely to accept an offer with a home-sale contingency.”