Repairing rental property? Here are some tax benefitsRental property is a good investment vehicle (but first consult your investment advisor) and provides tax relief from the income tax liability.
By: Dean Alexander, for Blueprint
Rental property is a good investment vehicle (but first consult your investment advisor) and provides tax relief from the income tax liability. Preparing the tax return properly should protect you from future tax problems and enhance your chance for a favorable tax resolution if you are one of the unlucky ones that have to go through an IRS tax audit.
Rental property is one of the basic tax reduction investments. Many people prefer rental properties as an investment compared to alternative investments such as the stock market; it's tangible (you can kick the tire sort of thing) and it may provide an average of 8 percent return over the years, which is not much different from the average stock market return over fifty years horizon.
You usually incorporate your real estate investment with your personal return by filing schedule E. The most glaring error we have seen is filing rental property on schedule C. You file rental property on schedule C only if your rental property is a business activity such as property management and real estate companies. As an investor who owns a house or two, you must report those on schedule E.
An erroneous assumption some taxpayers have involves rental property assets such as appliances, AC, installing carpet or a new roof. These items cannot be deducted all at once. They should be capitalized and depreciated over their useful life. Repairs are one of those areas that may trigger an IRS audit, whether on a schedule C or schedule E. Inflating repairs and maintenance may cause you a tax audit and hence a tax problem.
Remember that repairs are deductible for rental property only. You cannot deduct repairs for your homestead. If you have major remodeling for your home you can capitalize it. Capitalizing means that you add the remodeling to the purchase price. Then it increases the cost of your home which will help you when you sell your home (reduces your taxable gain)
Another error is missing the depreciation of the house itself. Many taxpayers overlook depreciation of the house altogether. Others depreciate the full cost of the house which is also erroneous. You must subtract the cost of the land from the total cost of the house, then depreciate the remainder.
When people convert their own personal residence into a rental property a contention may arise between the CPA, or your tax attorney who represents you in a tax audit. The IRS may argue (at least in the short run) that the property is not a rental property instead it is a vacant house and thus disallows the expenses. To provide evidence in this regard, you may keep evidence of listing or advertising to rent the property or summary of property showing.
One of the missed opportunities is failing to depreciate appliance and house equipment such as AC systems separately from the structure. This is important because the structure may be depreciated over 27 ½ years while the equipment may be depreciated over lesser years. This will accelerate your write off and minimize your tax debt, if any.
Dean Alexander has 30 years experience as a CPA and tax consultant. He is the managing director of National Financial Advisors Tax Help, a national firm headquartered in Houston. Contact him at firstname.lastname@example.org.