Any Other Deductions?

Question

I keep hearing/reading about people that are not paying taxes on their rental income because they can offset it with deductions. I can't come up with enough to cover the income. What am I missing. I am deducting: -mileage from visits to the property -operating expenses -depreciation The property is a 3/2 townhome I bought for 160k and rent for 2,200/month. There is no debt against the property and it is my first and only rental at this time. I pay HOA and property taxes in TX. Anyone have other ideas on how to offset the income? Also, to confirm, if there is debt against the property, the monthly payment would not be categorized as an operating expense correct?

Brandon Hall · Answer

NA Beard this is correct, and I don't believe anyone was disputing that passive losses cannot apply to your active income unless you meet the active participation thresholds. I believe the argument was that hiring a property manager does not, in and of itself, make you a passive investor. I could have misinterpreted though!Per the IRS Pub 527:"Active participation. You actively participated in a rental real estate activity if you (and your spouse) owned at least 10% of the rental property and you made management decisions or arranged for others to provide services (such as repairs) in a significant and bona fidesense. Management decisions that may count as active participation include approving new tenants, deciding on rental terms, approving expenditures, and other similar decisions."

Dave Toelkes · Answer

NA BeardThe net passive loss allowance is available to residential rental property owners who actively participate in the rental activity. I think you are oversimplifying the active/passive determination. Having a professional property manager does not automatically make your participation passive. I have professional property managers taking care of the day to day operation for all my properties I reserve to myself the key management decisions on rent amount, rent increases, major repairs, and acceptance of a tenant. For major repairs, I may approve or reject proposals/estimates. i may even direct my property managers to get a quote from a particular vendor. Even though my active participation is minimal throughout the year, because I have the final say on the major management decisions, my participation is still active and still qualifies for the net passive loss allowance.I would also amend your comment concerning the principal component of debt service. The principal portion of a loan payment is never deductible. Yes, it reduces net cash flow (not profit) but does not reduce net taxable income. You only get profit when the property is sold. Net rental income received during your holding period is cash flow.

Michael Boyer · Answer

Matt, the tax questions can be tough in forums because you have lots of complicated rules and your own facts and circumstances to apply. And one never knows how much background to add ( eg, should we start with what is an ordinary and necessary business expense or get into expenses versus capital improvements) so to add to the above, I would take a look at the irs forms and instructions and docs on their website, and I hear some on this site recommend fishman's tax guide for landlords, an accountant is often worth it, or close to Houston, there may be a half dozens places to take an income tax course. Best of luck.

Brandon Hall · Answer

@Russell Brazil the 15% tax rate is on long term capital gains and I believe that is what you were referring to. Net income from rental activities will be taxed at your marginal tax rate. NA Beard Considering year end is right around the corner, it's probably a good idea to seek out a competent, real estate savvy CPA and go through some tax planning.

Jeff B. · Answer

Fine and good, but losses do not flow to cover W2 income unless your are actively participating in the management - - look it up.

Jeff B. · Answer

1) No debt? You are overly invested in the asset, imo refi to pull equity UNLESS your cashflow goes into the toilet.2) HOA, property taxes, fire and liability insurance are deductible3) "the monthly payment would not be categorized as an operating expense correct?" Correct, but principle & interest can be shown as Other Expenses and reduces net profits.2) Be aware that purely passive income PnL does not carry back to the 1040: it is self contained on the Sch E form. Yea, they tag you for profits, but not losses. You are passive as soon as you have a property manager for the property.The only way to carry PnL against your W2 income is to be an "Active Manager", where you the owner make the decisions on who, how, where, when whatever gets done. This entitles you to carry back/forward losses as offsets to your W2 earned income.

Russell Brazil · Answer

Also keep in mind that rental income is passive income which is being taxed at 15% for most people (I think). So it has a lower amount of taxes to offset than earned income.One of my properties for instance is valued at $415,000 and rents for $2600. Im not sure what the land/building split is for depreciation off hand, but say it is a 75%/25% split.so $2600 in rent-$943 a month in depreciation-$400 a month in taxes-$75 a month in insurance-$1002 in interest a month. That is leaving me with $180 a month in taxable income before I even get to repairs. So im sure my taxable income on this property will end up be close to zero a year, but I will have free cash flow of about $8400 a year before repairs.Also before everyone on BP harps on the numbers of this being an awful investment, this property was purchased for appreciation and debt pay down as opposed to cash flow.

Ned Carey · Answer

It is easy to confuse financing as an "expense" or not. For the purpose of evaluating cash flow it is not considered an "Operating Expense" For tax purposes, interest paid is absolutely a deductible expense. The principal part of your mortgage payment is not deductible but in the beginning years most of your payment is interest. Properties that cash flow strongly still have taxable income but are taxed on less than they bring in because of depreciation.

Wayne Brooks · Answer

Any decent rental, especially not financed, should end up with taxable income, otherwise it would be a lousy investment. Yes, if you have a mortgage the Interest portion of your payment is deductible, but you're spending $1.00 to "save" .30 in taxes.