Real estate has always been a golden investment opportunity for Americans, and that is still true today. The market for apartment rentals in 2022 was valued at $253.4 billion — and is ripe with individuals transforming keys into cash. Indeed, the rise in demand for rental housing presents a thrilling chance to potentially generate significant income.
But let's hit the brakes for a moment. Before diving headfirst into the world of real estate, it's important to remember that owning and renting property comes with tax complexities. One wrong tax move could dip into your profits and get you into trouble with the IRS.
This article will guide you through the maze of real estate tax liabilities and benefits, helping your rental property investment sail smoothly toward the lucrative potential it promises.
So, if you're ready to maximize your returns, let's dive into the top essential landlord tax tips and benefits.
As a real estate investor, your tax obligations extend beyond just annual income tax filings. Rental income generated from your properties is typically taxable and must be reported as part of your gross income. However, it's not as straightforward as it seems — the IRS allows you to deduct “allowable expenses” from this rental income, reducing your tax burden.
Allowable expenses can include:
Read our blog post for a complete list of real estate tax deductions. Bear in mind that these costs must be ordinary, necessary, and directly tied to the rental property.
Additionally, if you're selling a property, you could be liable for capital gains tax on any profit. However, there are strategic methods to defer or avoid these taxes, which we'll delve into later.
Being well-informed about your basic tax responsibilities as a landlord is imperative, as it sets the foundation for further tax planning and optimization. Now that we've covered these basics, let's move on to our landlord tax tips that can help you maximize your rental property investment returns.
Real estate investing is a smart way to build wealth, but it's not without complexities. A big part of that is understanding and managing your tax obligations. With the right strategies in hand, you can turn tax season into an opportunity, not a chore. Let's dive into some key tax tips every landlord should know to keep more of their hard-earned rental income.
Record keeping is an important part of managing rental properties. Property owners and managers must keep records of their properties at all times, but this can be challenging, especially since the IRS requires separate records for each rental property.
Each time a document is missing from a tax return, it creates significant administrative challenges for property owners and managers. These processes can be time- and resource-intensive, and the consequences are real — incorrectly filing tax returns can result in a higher tax bill or potential legal issues for property owners.
Proof of rental income, maintenance records, tax documents, and legal records are just some of the documents that property owners must keep over the entire course of a lease. Modern real estate accounting tools like Azibo allow rental property owners to manage these documents in a central hub for multiple properties.
Tempe, AZ-based real estate investor Steven Toth recommends using Azibo's accounting solution to simplify tax prep:
"The bookkeeping solution definitely helped with end-of-year taxes... That was the biggest time-saver.”
Rental properties are a business, so owners need to evaluate the expenses required to keep and maintain their most important assets. Investors can use a variety of tax benefits to reduce the impact tax obligations can have on rental profits. As we covered earlier, one primary strategy is to claim all appropriate deductions. For example, landlords can write off rental property expenses like insurance, depreciation, and repairs. But different rental property types may have unique financial situations, so be sure to learn which deductions apply to each property.
The Tax Cuts and Jobs Act (TCJA) was signed into law in December 2017. Under this law, rental property owners can utilize the qualified business income (QBI) deduction to receive a 20% deduction on their tax bill. This significant deduction can help property owners maximize their rental income.
However, the Biden administration has publicly discussed the possibility of eliminating this deduction for certain property owners. Since this change has not yet been formally introduced, rental property owners should make the most of this deduction while the TCJA is still in full effect.
While there are many deductions landlords can use to maximize their rental income, and many property owners apply deductions across multiple categories each year, it is important to justify each one appropriately. Each deduction has specific requirements that property owners must understand and track before they can correctly claim it on their tax returns.
With this in mind, rental property owners should assess each property individually, consider which deductions they might be eligible for, and prepare the receipts and documentation.
Managing tax returns for even a single property can seem daunting for new rental property owners and property managers — and doing so for multiple properties can be challenging for even the most seasoned investors.
To ensure that each document is prepared and submitted with no errors, landlords should refrain from rushing through the tax filing process and start preparing for tax season early. Rental property owners needing more time to prepare documents can apply for deadline extensions that allow them to legally submit all the relevant forms after the April 15 tax deadline.
A 1031 exchange, also known as a "like-kind" exchange named after Section 1031 of the IRS code, offers a strategic advantage to savvy landlords. It's a powerful tool that allows you to defer capital gains taxes that would typically arise from the sale of an investment property. But how does it work?
The mechanism of a 1031 exchange is based on the concept of continuity of investment. When you sell a property, instead of pocketing the proceeds and paying capital gains tax, you reinvest those proceeds into a new, "like-kind" property. "Like-kind" refers to the nature or character of the property, not its grade or quality. Therefore, any type of investment property can be exchanged for another. For instance, you could sell a duplex and purchase a commercial property, or vice versa.
This strategy allows you to defer capital gains taxes, which can be significant, especially if your property has appreciated considerably over the years. Moreover, there's no limit on how many times you can do a 1031 exchange, allowing you to continually defer capital gains taxes while you grow and diversify your real estate portfolio.
The 1031 exchange allows you to defer capital gains taxes, which can be significant, especially if your property has appreciated considerably over the years.
But it's essential to note that the 1031 exchange has strict rules and timelines. For example, you must identify the potential replacement property within 45 days of selling your old property and close on the new property within 180 days. Learn more in our Guide to 1031 Exchanges.
Using payment apps like Venmo, PayPal, Zelle, or Cash App for collecting rent payments may seem convenient, but landlords should be aware of the tax implications involved. The IRS has implemented new requirements for tax reporting, and failure to comply can result in penalties or audits. Here's what landlords need to know:
To minimize tax risks, landlords should consider alternatives that offer dedicated rent collection and management features. Platforms like Azibo provide tools specifically designed for rental property owners, including online rent collection, tenant payment tracking, expense categorization, and automated financial reporting and tax document preparation, including Form 1099-K.
By utilizing a comprehensive rent collection platform, landlords can ensure proper tax compliance, minimize the risk of tax audits, and streamline their overall rental property finances.
Tax laws are subject to regular changes that can significantly impact your tax strategy as a landlord. It's crucial to stay informed about these changes or seek guidance from a tax professional who can help you adjust your strategy accordingly.
Keeping up with tax law changes involves reviewing IRS publications and being aware of legislative updates. Changes can range from modifications in depreciation rules and standard deduction amounts to shifts in income brackets and capital gains tax rates. Awareness of these changes will ensure you are prepared and can make informed decisions regarding your rental property business.
While navigating tax laws can be complex, consulting with a tax professional who stays updated with the latest changes can simplify the process. They can provide valuable insights and help you optimize your tax strategy, saving you time, money, and potential legal issues.
By staying current with tax law changes through independent research or professional assistance, you can confidently adapt your tax strategy to maximize your benefits and comply with the latest regulations.
Property owners need to understand and effectively manage tax obligations to maximize profits and navigate the complexities of real estate investment. This article has provided nine tax tips that can guide landlords through the intricacies of tax laws and regulations.
By implementing these tips and staying informed about changes in tax laws, landlords can confidently fulfill their tax responsibilities, minimize liabilities, and maximize returns on their investments.
Utilizing modern real estate software tools like Azibo can streamline operations by simplifying record-keeping and document management. With Azibo's features, landlords can efficiently organize rental property documents throughout the year, ensuring compliance and ease of tax preparation.
Collaborating with tax professionals is highly beneficial, as they provide valuable insights and ensure adherence to the latest regulations. Their expertise helps landlords navigate tax complexities, make informed decisions, and optimize tax strategies.
By incorporating these tax tips, staying informed, and leveraging the right tools and professional guidance, landlords can proactively manage their taxes, enhance their financial positions, and unlock the full potential of their investments. Embracing these strategies will pave the way for long-term success in the real estate market.
You can reduce your taxable rental income by utilizing all of the allowable deductions, such as mortgage interest, property tax, operating expenses, and depreciation.
Rental property owners can deduct various expenses related to their rental activities, including insurance, repairs, maintenance, property management fees, advertising, and utilities. Get a complete list of real estate tax deductions in our blog post 10 Tax Deductions to Maximize Rental Property Profits.
The IRS expects you to report rental income on your tax return. To ensure compliance, they may cross-reference reported rental income with information from third parties, such as tenants and payment processors.
Disclaimer: The information provided in this post does not, and is not intended to, constitute tax advice; instead, all information, content, and materials are for general informational purposes only. This content may not constitute the most up-to-date tax information. No reader, user, or browser of this article should act or refrain from acting on the basis of information herein without first seeking the advice of a tax professional.