Tax Implications of Owning a Rental Property Out of State

[Arjen Mercado]

Hello everyone!

My wife and I are very new to real estate investing. We are both full time software engineers and are very motivated to start our real estate investing journey -- rental properties in particular. We live in Reno where home prices have gone up drastically in recent years and so we are looking to start purchasing small multi-family homes in surrounding states such as the Fresno/Merced, California or Phoenix, Arizona. With that, we are wondering what the tax implications of doing this would be. For example, if we bought a duplex in California -- would we have to pay California taxes on only the rental income from the duplex or are our income from our full time jobs also subject to California income tax?

[Nicholas Aiola]

@Arjen Mercado

@Will Dixon is correct in saying that your home state will not tax you on an out of state investment but I want to clarify - that is because you live in Nevada, which has no state income tax.

If the situation was reversed (live in CA, invest in NV), CA would tax all net rental income, regardless of where it was earned. Nonresident states tax the income that is sourced to that state; your resident state taxes all income, regardless of where its earned, but you get a credit on your resident state tax return for taxes paid to other states.
So, if you live in a state with higher income tax rates than the state you invest, you can expect to pay tax to the state in which you invest and possibly some tax to your home state if the credit paid to other states is not enough to cover your home state's tax liability from the investment. 

Keep in mind, when dealing with rentals, tax losses are very common (no income tax), so you may not run into this issue.