There are a lot of different types of rental real estate. There are people renting out their personal residence or vacation property, people purchasing property for residential rentals and others who are doing commercial rental. All these have their own differences. Today I want to talk about residential rentals.
What do you like about residential rental real estate properties?
- These can be a good way to shelter taxes, offset some of your other income and the potential to defer the gain when the property is sold.
Let’s start with the sheltering of taxes?
- Real estate tends to be one of those investments that go up in value, especially if an owner keeps up the property or makes improvements.
- Like other investments, the IRS does not tax the owner of the property on unrealized gains. So the property has to be sold in order to pay any tax on the appreciation.
- If someone holds the property for a long time, they may never have to pay tax on the appreciation.
And the losses can be used to offset other income?
- In many cases, yes. Now if you have losses and your other income is greater than $100k, some of the ability to take losses will be limited. They are not lost, just deferred until your income goes down or you sell the property.
What kind of expense can be used to create that loss?
- In most cases, if you have an expense that you would not have had if not for the rental property, then it is probably deductible.
- The main ones are interest, taxes, repairs, utilities and insurance.
- But there are also expenses like auto miles, advertising and legal and accounting.
And what about depreciation?
- Glad you brought that up. For those that do not know when you buy an asset that is expected to last a year or less, you can just expense that when it is purchased.
- But if the asset is expected to last for greater than a year, you would deduct that over its useful life, whether it be 5, 7, 15 or 27.5 years. Now there are ways to depreciate it faster, but that is a whole another show.
You also mentioned ways to not pay taxes when the property is sold?
- Unlike most other investments, when an owner wants to sell a property, they can defer the gain.
- This is done by trading it or exchanging it for another piece of similar property. This is called a deferred exchange or like kind exchange.
- It allows an owner to roll the gain on this property into the next property and not pay the tax until that property is sold.
- Or if the owner passes away, the heirs may not need to pay tax on the gain at all!
Anything else we should know before we go?
- Yes, the Biden plan is looking at limiting how much gain can be deferred on these like kind exchanges. I think the current proposal is to limit the deferred gain to $500k for individuals and $1 million for married couples, so I don’t think it will impact too many residential real estate owners.
Be sure to talk to a tax professional if you have any questions about the benefits of your rental real estate or would like further assistance.