1st time filing taxes with real estate...What should I know?

Question

Hi, I want to thank you for taking the time to read this.

Call me insane but I wanted to take a stab at doing my own taxes and see if I can make my way through. However my biggest fear is that I leave a significant chunk of money on the table (or worse, I over look something that causes me to have to OWE taxes). So I wanted to understand a couple things to help me get started.

First, I own a couple properties under my name and a couple under a sole-prop LLC. My question is generally what are the tax forms that spit out from these. Schedule E of course..would there be one for for personal and one for LLC? What other forms maybe worthwhile

Second, I understand that you should keep ALL of your receipts and itemize your expenses. Also that you can take depreciation over the 27.5 years. There is also a deduction for a home office and mortgage interest, what other deductions are there that I should be considering? Anything I should consider itemizing over taking the standard deductions?

Third, I purchased 5 properties THIS year. What specific deductions would be applicable. Is there a very easy to read document that outlines line by line what items from the HUD-1 are deductible vs depreciated vs ????

I'm being told that especially for the 1st year of owning a rental I should be getting a good chunk of money back but I'm not seeing that so I'm 2nd guessing myself so far, hence the post.

Anyone know of a good example of a real estate rental tax filing?

Thanks in advance

Alan Rohrer · Answer

@Dave Saveri

I won't call you insane! The thought of paying an accountant somewhere around $800-$1,000 for your tax return sucks. Especially if it seems like the only thing an accountant would save you is the time it takes to do the return.

It's a compliance service, and doesn't really add value. It only reflects the value created over the year. (what I mean by this is that the tax return only reflects the tax planning done during/the end of the year- which is a true value-add).

That being said, you want to make sure it's prepared correctly (because a mistake can cost you lots of money- either in lost tax savings, or penalties).

If you sincerely believe you can do it, you understand the risks, your situation isn't too complicated, and you are willing to put in all the time, then go for it.

What you SHOULD be happy to pay an accountant for is tax planning and strategies. These aren't just compliance services. These add value and get a return on investment. A CPA specializing in real estate can help you FIRST AND FOREMOST  structure the purchase and SECOND, reflect it on your return.

For instance:

• Why are you depreciating everything for 27.5 years? A proper tax strategy session can accelerate a lot of that and lower your income in the early years. Search the forum for recommendations on how to allocate the purchase price.
• What costs can you flat out expense, and what have to be added to the property and depreciated? Depends on when you placed the property into service. Costs before are generally capitalized, and costs after can generally be expensed... and on the note- what is considered "placed into service". May need to have a convo with someone who knows RE tax who can help you in your particular situation.

What I would recommend:

• Hire a CPA specializing in RE that will do more than file your tax return (but will also do your return). One that will walk through strategies with you before you do more deals so you can structure them the best way. They'll also then be able to reflect these strategies on your return.
• If you are going to be doing lots of deals, consider a CPA that understands setting up systems within your business that can help you make better decisions and make more money (weekly profitability reports by property, weekly project reports on rehabs, etc.)
• And finally- if you are planning on doing your own taxes, don't do it the first year. Get someone who knows how to maximize deductions and breakout the purchase price. Then when you see how it's done, take it over in year 2.

Hope this helps!

Mike McDevitt · Answer

Hey Dave - - There's no other way to say this.

You need to have a CPA do your taxes and give you advice.

Your questions (i.e. "Anything I should consider itemizing over taking the standard deductions") suggest you're not able to prepare your own return (correctly and to your benefit).

Your CPA will keep up with the latest rules. Mine did, and saved me (easily) the cost of tax prep; and I'd been self-preparing for over 30 years - - - during which time I now realize I paid some "stupid tax".

Best to you - whatever you decide.

-mm

Dave Toelkes · Answer

@Dave Saveri

1.  All your rental income and expenses for all your rental properties are reported on Schedule E (1040) as if the LLC did not exist and all properties are titled in your own name.

2.  Yes, by all means keep receipts and paid invoices for at least seven years.  As mentioned previously, all expenses directly related to a specific property to include mortgage interest and depreciation are taken on Schedule E for that property.  Residential rental property has a class life of 27.5 years, but depreciation does not start until the property is placed in service.   To take a home office deduction, you have to have a separate room or area of the house which is used exclusively for your real estate activity.  If you have an office but play games on your office computer, then you are not using the office exclusively for your rental business.  I a a room in my house set up as an office, but I also use that office for my personal stuff (such as paying the household bill), for homework (I am in college), and for answering posts such as yours.  So my office is not reserved exclusively for my rental activity and thus I don't even try to take a home office deduction.

You should download a copy of the IRS Pubs that include instructions for Schedule E, depreciation, and business expenses.  These publications will give you a clearer picture of what is deductible on Schedule E.

3.  The HUD-1 has been obsolete since Oct 2016.  It has been replaced by a Closing Disclosure (CD).  A quick search of the IRS website should help you identify which closing costs can be expensed, which must be amortized, and which are added to your cost basis and recovered through depreciation.  A search of these forums might also yield the same result.

4.  You may have been told correctly that your first year of rental property ownership will most likely give you the greatest income tax refund, but only if your other ordinary income is less than $100K.  Typically, the first year of mortgage interest expense is greatest for a property with an amortizing loan.  Over time, as the mortgage interest declines, your net taxable income increases.  Whether that equates to a "good chunk" or not is relative and subjective.

However, if you consider the actual cash flow from a rental property, cash flow tends to decrease over time unless you are agressive about rent increases.  If you have a fixed rate amortizing loan, your mortgage payment stays the same from year to year, but property taxes and property insurance premiums tend to increase.  As your property ages, maintenance and upkeep also tend to get more expensive.  These costs tend to reduce your annual cash flow, so I would venture to say that your first years of ownership will most likely produce your best cashflows.

If the metric you use to determine a "good chunk" is a return on equity metric, then a financed property will give you best return on equity in the early years of ownership.  In later years, as your loan balance is paid down and your equity position increases, then return on equity tends to decrease.  Some investors say this happens to them somewhere around the fifth year of ownership and sell their property only to replace it with a newly constructed rental property.  You have to decide for yourself what metrics you want to use to measure acceptable investment return and to determine when you want to stop acquiring properties, and begin just reducing the debt on what you own with your eventual goal free and clear ownership.

Jon Holdman · Answer

Number one thing to know:  phone number of an accountant experienced with real estate.  Probably challenging to find anyone this late in the cycle, though.  You don't want H&R Block.  You want someone who has clients that are real estate investors.

Whether you get a tax refund is dependent on the tax you owe and the tax you've had withheld.  There's nothing magic that buying properties gives you a big deduction.

LLC is irrelevant for taxes.  All properties show up on your personal return.

If you've bought five properties, fixed them up, and rented then, you have a complex tax situation.  Money spent before the properties are "rent ready" becomes part of your basis and gets depreciated.  Those expenses, including pretty much everything on that HUD-1, are not deductible right away, but must be depreciated.  If you've done fixup, though, some items can be depreciated faster than 27.5 years.

I won't say you're insane for trying to do your own taxes, but I will say you're almost certain to get it wrong.  Not only do are your taxes complicated right now, you have a bunch of carry forward items you'll need to track from year to year.  The trick is not filling out the forms, as painful as that is.  Its knowing what to do with all your income and expenses and where it goes on the forms.

If you've really wholesaled any properties, that's ordinary income.  So you pay federal and state income tax as well as self employment tax on that income.

1st time filing taxes with real estate...What should I know?

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