Taxes and depreciation question

[Matt Lord]

I’m a newbie here. Been listening to tons of the BP podcasts and I read a bunch of books. But my mind is somewhat simple. I’m having some trouble understanding a few things.

My wife works full time, I recently walked away from my job as a teacher. I’d like to do do fix and rents full time. We file jointly and my rentals are getting transferred into an entity in January.

Could somebody explain, in relativity simple terms, the MAIN tax benefits of owning rentals.

Is building depreciation and component depreciation different things? Can you claim them both or do you have to select one or the other?

How is rental income taxed? Is it taxed the same as earned income?

If I’m personally and physically doing the rehab work, management and maintenance, and everything else, will I be considered self-employed and be subject to SS, Medicare and all the other joyful taxes?

What’s the basic formula or strategy to drastically reduce or eliminate paying income taxes on my rental income?

Should I consider forming an LLC that would be my "construction business" which would be payed by my rental LLC for doing all of the rehab work. Or should I just do the purchasing, rehabs and management all through a single entity?

[Natalie Kolodij]

In a Nutshell: 

Main benefits of rentals are: Depreciation. You get to deduct something you did not have a cash outflow for. 

So ideally, at the end of the year- you can have $5k in the bank that a rental earned but after your $7k depreciation deduction- you actually have a loss of $2k on taxes. 

If your income is under $150k or if you're a real estate professional- you can utilize those losses to offset your other earned income. (Flip income and your wife's w2 income)

If you are now full time in REI, and do not have another 9-5 job talk to your tax pro, as you can potentially qualify as RE pro. This means that you can utilize rental losses- with no limit- against other income.

Rentals are ordinary passive income. Taxed at your ordinary tax rate (if they have income not a loss) but NOT subject to self employment taxes (15.3%)

Your flips will be ordinary income, but active. Meaning no limits on losses, but all income is subject to that 15.3% tax. 

I would keep RENTALS AND FLIPS SEPARATE. 

They are taxed differently and we can't maximize either if they're combined for an assortment of reasons. 

Also however, I would NOT bill your rentals for work your construction/flip company does. This is just moving income from a category with no 15.3% tax, to one where it DOES have the 15.3% tax - and costing you more. 

I would recommend finding a Tax pro who specializes in REI and reaching out for a consultation. If you look through the forums on BP there are several who have been here long term, and you can read through lots of their responses and see who you think would be a good fit to work with.