Jeff Lazerson: Columnist at Orange County Register and other Southern California News Group; Owner Mortgage Grader, Aliso Viejo; MLO Student
You can deduct 20 percent of your real estate rental profits right off the top before calculating your taxes.
Starting with your 2018 federal tax return filing, and so long as you meet certain criteria, you can deduct 20 percent of your real estate rental profits right off the top before calculating your taxes.
So if you made, for example, a $10,000 profit, taxes owed would be calculated on an $8,000 profit.
Last week, the Internal Revenue Service clarified section 199A of the 2017 Trump tax overhaul that offers a plethora of taxpayer benefits to landlords.
- The deduction generally is limited to individuals earning less than $157,500 and married couples earning less than $315,000.
- You must perform 250 hours of service each taxable year. Examples of some of these services are property maintenance, repairs, collection of rent and efforts to rent the property. This includes services performed by owners, employees and independent contractors.
- You must keep books, records, and separate bank accounts for each real estate enterprise.
Clearly, this is not all-inclusive. Consult your tax advisor for your specific situation.
Even with this new guidance, you first need to deduct what you previously have been entitled to deduct.
A Few Caveats
There are a few caveats: You are adding up your total annual rents and subtracting your payments and expenses to determine your profits. For example, the interest portion of your mortgage payment is deductible but the principle you pay down is not deductible.
The IRS allows you to depreciate the structure of your rental over 27.5 years on a residential property and over 39 years for a commercial property, according to CPA Warren Hennagin, partner at Marcum LLP. This could boost your deductions.
Typically, your property appraisal will itemize the structure value. A rental in a high-density area on a small lot will have more structural value. Conversely, land value is much higher when it comes to beach-area properties, for example.
Hennagin points out that you also can accelerate depreciation through “cost segregation” studies, which breaks down a property’s value by component.
“Online cost segregation studies are available for as little as $300 for single-family residences,” said Hennagin. “You can accelerate the total depreciation as much 20 percent in the first five years.”
Purchase financing provides for as little as 15 percent down should you be thinking about buying a rental or two. You can even do a 15 percent down interest-only loan to increase your cash-flow and bottom line profit. (Remember principle is not deductible).
In my mortgage originator experience, higher priced Southern California properties typically require 25 or 30 percent down to break-even on newly purchased traditional long-term rentals.
For short-term rentals, a.k.a. Airbnb, if you work it right, you can realize an immediate profit with substantially less down.
As your rentals season over time, profits tend to be much easier to come by. This is because property values and rental rates tend to rise. Your mortgage payment tends to be stable or may decrease as your loan balances decrease on adjustable loans.