For many of us, it is easy to understand why rental properties are such attractive investments. This is an investment that generates monthly revenue in the form of a rental payment and those payments in turn pay off property mortgages and can put passive income into an owner’s pocket every month. Add in long-term appreciation of the real property and this can be a lucrative investment for your portfolio, which you may leave to your heirs through your estate planning.
Even though it may seem like an attractive option, bear in mind, the truth is there are a number of expenses and risk factors associated with any rental property. Even in the best scenarios, the tax implications can make or break the investment. While some rental property strategies are good, others may be expensive.
It is also an investment that you want to protect both now and in the future. This means that you may want to ensure your future agents and trustees are not only aware of but have the requisite knowledge to manage this investment should you become incapacitated or pass away. Let us share several concerns to think through for yourself and your loved ones here in our blog.
1. Maintenance and repair deductions. Rental properties aren’t paper investments. Unlike stocks and bonds, they may require physical upkeep, in addition to insurance, and property taxes. Is the roof leaking? Does the yard need mowing? Any and all of these items are the owner’s responsibility, and thankfully many of the costs may be tax deductible. The IRS views maintenance and repair expenses separately from property “improvements,” however, which only a portion of costs can be deducted.
2. Deducting depreciation. Physical structures deteriorate over time, even with vigilant upkeep. Age, wear and tear, weather damage, and other related issues can significantly devalue a rental property. While that is certainly not a good thing, the IRS allows for a portion of qualifying losses to be deducted through depreciation.
3. Rental property losses. In many cases, business owners are allowed to deduct their losses against revenues to limit their tax liability. That also applies to rental property owners, but only to a point. In most scenarios, landlords can only deduct losses of $25,000 over their income, and the money they make the less opportunity they have to deduct the full amount. According to the IRS, modified adjusted gross income (MAGI) over $150,000 fully negates the ability to deduct any losses. Of course, any and all of this information should first be discussed and reviewed with your accountant and your estate planning attorney to make sure that you receive all the benefits you are entitled to.
4. Capital gains taxes. While a primary residence is exempt from capital gains taxes, up to $250,000 for single, non-head of household or $500,000 for married couples filing jointly, rental properties are not exempt. In fact, this is where a lot of investors take a big hit and is something to watch out for.
In all of these scenarios, as with all of your questions, one of the best ways to mitigate capital gains taxes and take advantage of various deductions is to work with an experienced estate planning attorney who knows the ins-and-outs of this type of investment. We welcome you to contact our law firm now, or any time throughout the year, to schedule a meeting to discuss this type of planning or any estate planning questions you may have.