What are the Tax Advantages of Rental Properties?

Mark Ferguson for InvestFourMore writes:  Rental properties are a great investment thanks to the cash flow they produce.  Not only does a great rental property provide plenty of cash flow, but rental properties have incredible tax advantages.  The IRSs allows most expenses associated with rental properties to be deductible or to be depreciated and you can depreciate the property as well.   It is very common for a rental property to produce a profit, but thanks to depreciation show a loss on your taxes.

For more information on why I think rental properties are such a great investment check out my complete guide to purchasing long-term rentals.

I am not a tax professional!

This article is meant to offer a broad overview of the tax advantages of rental properties, not specific advice.  I am not an accountant or an attorney and if you are looking for tax advice please talk to a tax professional.  This article gets much of its information from the IRS tax code on rental properties.

Can interest on a mortgage be tax deductible on rental properties?

The interest you pay on a rental property can be a deduction on your tax return.  Your entire payment cannot be deducted, because part of your payment is equity pay down which is not deductible.  Paying down equity is not considered a business expense, since the money is not spent on repairs or maintenance, but used to reduce debt.

There is talk of the IRS eliminating the interest on mortgages as a deduction for primary home owners.  However That probably will not affect rental property owners because the interest is thought of as a business expense, not a special deduction.

How does the IRS treat depreciation on rental properties?

The IRS treats rental property as an asset that can be depreciated.  They assume the rental property will slowly degrade over time until it falls down and is worthless.  Most properties are not going to fall into a pile of rubble unless they are not maintained, but the IRS does, which is very good for rental property owners.

The IRS says a house will last 27.5 years, which means an investor can deduct the cost basis of the rental property in equal increments over 27.5 years.  To calculate the amount that can be depreciated; divide the cost basis by 27.5 and that is your deduction for the next 27.5 years.

What does the IRS consider the cost basis on a rental property?

The cost basis is the cost of the rental property and only includes the structure of a rental property, not the land.  If you buy a rental property for $100,000 that is on its own lot, the entire $100,000 is not the cost basis.  You have to deduct the value of the land from the purchase price and then you have the starting point for your cost basis.  You can also add many of the closing costs like abstract, title, recording and other fees to the cost basis.  The entire list can be found on the IRS website.

Depreciation is what allows a rental property to show a loss, even though it may have made you money

If I am bringing $3,000 of rental income on a property after all expenses, I get to use that $3,000 however I want.  However it most likely will not show up as $3,000 in taxable income because of depreciation.  If the cost basis of my rental property is $100,000 then the depreciation would be $3,636 a year for 27.5 years.  The $3,636 would counteract all the income I made, plus show a loss of $636!  Even though I have $3,000 more in my pocket due to my rental property, I pay no taxes on that money and may even be able to counter other income with that loss.

What is the disadvantage of depreciating a Rental property?

If you depreciate a rental property over 20 years and sell the home; you will have a large tax bill from the IRS.  The depreciation on rental properties can be recaptured, which means you have to pay back all those taxes you saved with the depreciation deduction.   The depreciation is only recaptured if you sell the asset and for at least the amount of your cost basis minus the depreciation.

Even though you have to pay back those tax savings it is still better to pay those taxes 20 years down the road instead of now.  With inflation, money is worth less in the future and you can also invest that money for 20 years until you have to give it back to Uncle Sam.  It is like a no interest loan from our government!  There are also many ways to avoid depreciation recapture.

How do you avoid depreciation recapture on rental properties?

• The easiest way to avoid paying back the tax savings is to keep the rental property and never sell it.  After 27.5 years you won’t be able to use the depreciation tax break anymore, but you also won’t have to pay back any of the previous tax savings.
• Another way to avoid the depreciation recapture is to use a 1031 exchange.  If you sell your rental property, the IRS allows you to exchange that property for a similar property without having to recapture any depreciation.  Here is much more information on 1031 exchanges.
• If you happen to pass away while you own your rental properties; the properties will pass on to your heirs.  When your heirs inherit the properties the cost basis becomes the current value of the properties, not what the original owners cost basis was.  That means there will be no depreciation recapture.  Planning to hold your rental properties until you die, is not a bad strategy tax wise.

What other expenses can be deductible on rental properties?

Not every expense on rental properties is deductible, but many are.  Since rental properties are considered a business; travel expenses, accounting fees, management and many more expenses are debatable.

If you make repairs on your rental properties they are deductible as well, but improvements are not.  If you repair a leaky faucet that is deductible, but if you add-on a second story it is considered an improvement and not deductible.

For more information on why I think rental properties are such an awesome investment, check out my book How to Retire Rich and Early with Real Estate.  The book is available as at Amazon or as a PDF here. 

How are improvements calculated on tax returns?

Even though improvements are not deductible, that does not mean you can’t count them on your taxes.  Improvements can be depreciated like the rental property itself.  There are different amounts of time that improvements are depreciated over, ranging from 3 to 20 years.  You won’t have to wait 27.5 years to see the full tax benefit of most improvements.

Are there maximum amounts that can be deducted?

The IRS has different rules for those considered in the real estate business and those that are not.  If you spend more than half your time on rental properties you are considered in the rental property business.  If you are in the business there is no limit to the deduction or losses you can take on your rental properties.

If you are not in the rental property business you can take a maximum $25,000 loss depending on how much money you make.  The more money you make the less of a loss you can count towards your other income.  The deductions and depreciation will still counteract the money you make on the rental properties, but it might not help reduce your regular income taxes.

Conclusion

Rental properties are an awesome investment and a great way to retire thanks to the cash flow they produce.  The tax savings are an amazing benefit that make rental properties an even better investment.  I would always consult a tax professional for any specific tax questions or when trying to figure out what can and cannot be deducted or depreciated.

Xero and TaxJar go Together like Peanut Butter and Jelly

Mark Faggiano for  TaxJar writes: You were tired of always dealing with your small business accounting, so you signed up for Xero. This was an incredibly great idea because you can now focus more on your small business rather than wrestle with numbers all day.

Xero does a great job of showing you how much sales tax you have collected, but our new TaxJar/Xero integration takes that one step farther.  TaxJar helps you slice and dice what you owe to each state and when. We even break this down by tax jurisdiction for those pesky destination-based states that require an extremely granular sales tax return.

While sales tax and accounting may not be “simple” anytime soon, combining these two small business finance management services together gets you as close as possible to automating your small business  accounting and sales tax compliance.

How Xero and TaxJar Work Together for Your Business

Not convinced? Here’s a quick rundown of how it works so you can see how much simpler your business life will be.

When Xero pulls your ecommerce order history, TaxJar will automatically look up the sales tax collected through each state, city, and beyond. In no time flat you’ll know how much you owe to each state. On top of that, you also know when you need to pay these amounts. This is incredibly helpful for sellers with sales tax nexus in multiple states, considering how varied the due dates can be across the nation.

TaxJar will even create “bills” within your Xero account to let you know how much sales tax you have due, and when. No more dealing with calendar alerts, spreadsheets or tax tables to ensure you pay your sales tax on time!

Filing sales tax with a state’s taxing authority isn’t the whole story, though. You also need to keep accurate track of these numbers so you better grow your business. After all, it’s part of the reason you signed up with Xero in the first place. Keeping good records of your finances frees you to make your business truly thrive.

So that’s why we made sure to also focus on improved accuracy of your Xero ledger. Instead of trying to remember the totals or using guesswork, TaxJar now updates Xero with all the latest sales tax totals. Now you really know how well your business has been doing,  and you can adjust accordingly.

Ease of Use

As mentioned, sales tax is never really going to be “simple.” In fact, states are going out of their way to make things tougher and tougher to make what they deem a more fair playing ground in business. Basically states want tax revenues from eCommerce, and they keep trying new and novel ways to collect it.

But this is where companies like Xero and TaxJar shine, especially when they work together. As complicated as online sales tax is, we’re determined to make it that much easier. That’s why we’re glad to be working with partners like Xero who know that running a business takes a lot of work and are just as determined as we are to streamline the process for everyone.

So the next time you think about sales tax and are stressing about the filing frequency or how to figure out all the tons of districts and states and their various sales tax rates, just pull up your Xero account and link your account with TaxJar. We promise to reduce your stress level as much as we can.

Confused about sales tax? Our Sales Tax 101 for Xero Users will answer your questions and get your Xero/TaxJar integration set up as quick as you can enjoy a peanut butter and jelly sandwich!

Acclux accounting: Unleash your creativity with accounting software built for web designers

As a web designer, you are the only player in your business; you are totally responsible for your customers starting from the first meeting all the way to the delivery of your project. As well as you are responsible for your all finances expenses, income and taxes. We all know how tax time can be hard time for you as a web designer.

No one wants to deal with all these challenges, especially when you have the passion of creativity and innovation. You need to find the solution that carries out what’s worrying you and let you focus on your creative work.

Of course the primary demand for web designers is to create invoices, track payment, manage expenses and follow you projects and tasks progress.

So how acclux accounting can be your beloved hero!

Work in the environment you are familiar with
acclux accounting is a cloud solution and its operating in your favorite space “the web”, You will always have the easy access to your data from anywhere using any device.

Project and task management
For each project you will have, you can immediately define it with important information like customer name, project deadline and expected cost.

Create tasks for your projects and arrange those tasks in sections (or milestone) for easy tracking of those tasks.

If you are invoicing your customers by hourly bases, acclux accounting provides you with a creative app to track precisely the time you spent for each task, acclux timer is a free app for acclux accounting users, it’s available in iOS, android and windows phone devices. Once your task is completed, you will be able to invoice it to your customers.

Quick Invoicing
One of the biggest challenges of web designers is to create professional invoices in minimal time and efforts. With acclux accounting smart and easy to use interface you will be able to create your invoice very quickly. You won’t have better fun other than create your invoices with no worries about any financial side everything is carried out for you.

Once your invoice is saved you can email it to your customers directly from your acclux. Your email will include your own message, your contact information you want to show, PDF attachment and also your invoice will be included in your email for fast customer review.  All these options made through a simple form that designed in a smart way to spare your time. Also, you can print your invoice or export it to PDF.

Easy Payment
acclux accounting provides you with a great tool to get paid online faster than ever with PayPal integration. All you have to do is add your PayPal account and send your invoice. Your customer will be able to view your invoice online and pay it right away. Besides that you can get paid directly using your smart phone.

You can still pay your invoices manually using the acclux accounting payment form.

You can easily track your invoices and know how many invoices get paid and how many are overdue with the help of built-in interactive dashboards and reports.

Expenses
acclux accounting is a huge time saver when it comes to your expenses, you can easily record your expenses if you are at work or even on the go. Also acclux accounting comes with various reports and analytics tools that help you to track your expenses and export it to beautifully designed sheets in excel or PDF format.

Also, you can add your expenses to a project so you will be able to track your project actual fees and eventually project revenue.

Managing your expenses can be very helpful to get the best tax benefit and be better prepared at tax time.

Tax returns benefit
acclux accounting helps  you to get ready at tax time and get  the best benefit of your tax returns. acclux accounting provides you with all the documents you will need in your tax submission.

Easy generated financial documents
All the accounting documents that make your nerves will be automatically generated for you with one click. You will be able to export them in beautifully designed sheet to excel or PDF so you can send them to your accountant to check on them and let know how good you are doing this far.

Sign up today and enjoy 14-day free trial of the best in class accounting software for made for web designers. Sign up for acclux accounting for free.