While real estate activity has slowed down in recent months the current market climate has caused some people to examine the prospect of buying rental properties. If the "buyer's market" trend continues we can expect more clients to ask about the tax benefits of renting real estate. Here are a few rules you should be aware of.
- If you use the property for personal purposes more than 14 days or 10% of the total days rented you will be required to pro rate all expenses between personal use and rental use. This can result in a significant reduction in tax deductible expenses, including depreciation. However, days you spend at the property performing maintenance or other tasks required for its rental are not counted as personal days.
- Residential rental property obtains a depreciation period of 27.5 years but in order to qualify the property must meet the IRS definition of residential rental. "This class includes any real property that is a rental building or
structure (including a mobile home) for which 80% or more of the gross
rental income for the tax year is from dwelling units. It does not
include a unit in a hotel, motel, inn, or other establishment where
more than half of the units are used on a transient basis," IRS Publication 527 (2005). If you don't meet this definition the property is commercial real estate and must be depreciated over 39 years.
- Losses from rental property up to $25,000 can be used to offset other income. This is a great tax planning strategy but if adjusted gross income is too high ($150,000 for married couples) the losses are suspended.
- Favorable tax treatment requires active participation. Even if your AGI is low enough to qualify for the above deduction of losses you may not be able to take them if you just place the rental with a property manager and do not actively participate in its management. IRS has definitions and guidelines for active participation that you should take the time to understand with your CPA.
- Check with the locals. Much of our focus here has been on the federal tax treatment of rental properties. The local county, municipalities, even the neighborhood homeowners' association may impose additional fees, taxes, reporting requirements or restrictions that could affect your decision to buy. Make sure you ask the real estate agent for information regarding these issues before you get to closing.
With interest rates rising, more restrictive lending policies and a softening housing market the residential rental arena may become more and more attractive in coming months. For investors looking to add properties to their portfolio or jump into their first rental house it makes sense to take some time to understand both the before and after tax economics of a potential investment.
Joey Brannon is the founder of Axiom Professional Group, a tax, consulting and accounting firm in Bradenton, Florida. Mr. Brannon is both a CPA and an EA. You can find out more about Axiom by visiting www.axiomcpa.com.
Monday, June 12, 2006 at 11:37PM