how much to deduct? 100k income a year, 100k house?

Question

I had a question, lets say someone makes around 100k a year.  They would end up paying 17-20k in taxes... whats the best way to file it?

If you buy a 100k house and paid it off what happens then? you dont pay that much tax?

any advice? this is my first year buying real estate and filing taxes together need some ideas! thanks

Steven Hamilton II · Answer

Shaneel Lalani,

You need to find an accountant as Jon Holdman said.

We know nothing about what you do or want to do.  You need to determine how you want to invest.

-Steven

Jon Holdman · Answer

I'm still confused, but I'll try.

I'll repeat the advice that you need a CPA.  Taxes with real estate investment are complicated.

I think you're saying you're going to buy an investment property.  Rental or Fix and Flip?

If its a fix and flip, its fairly simple.  When you sell it the gain on the sale is ordinary income, just like from a job.  The gain is only the net profit.  So, that would be the selling price, less all these items:

- The purchase price
- Any costs on the purchase
- Any money you spend on the rehab
- Any costs associated with the sale
- Any money you spend getting the deal done

Now, that's very simplified.  But basically you just keep track of every penny you spend, give it all to your CPA and he or she will figure out the details.

Rentals are more complex.  You usually buy a property, fix it up and rent it.  The price you pay, plus any costs to do the purchase, plus all the money you spend fixing it up aren't deductible at all.  Rather, those go into the "basis" for the property.  Once its rent ready, you start "depreciating" it.  Depreciation is based on the value of the improvements.  Your "basis" includes both improvements and land, so you have to split those apart.  A common way to do it is to look at the tax assessors information.  That will list a value for the each.  Use those to figure a ratio, and apply that to your basis to get your value of the improvements.  Then each year you can take 1/27.5 of that amount as your "depreciation".  In the first year, you only take part of a year's depreciation, based on when it is rent ready (not when you bought it.)   If you make capital improvements (e.g., a new furnace) you can depreciation that separately.  And all that stuff you put into the rehab may be able to be depreciated more quickly.  Floor covering, for example, can be depreciated over five years rather than 27.5. (Though, good luck getting five years use out of carpets in rentals.)

Depreciation is the only deduction you take that doesn't represent actual money you spend.   All other deduction are actual cash that's going out of your pocket.

Tax is based on net rental income.  That's:

taxable rental income = rent collected - actual expenses - depreciation.

Actual expenses include most of what you routinely spend:  taxes, insurance, maintenance, cleaning, tenant screening, snow removal, yard care, etc., etc., etc.  It doesn't, however, include capital items.  Those are big ticket items like furnaces and roofs.  You spend that money all at once.  But the item you bought must be depreciated over some number of years.  How many years depends on the item.  The IRS has lists.  And, all the money spent before its rent ready must be capitalized and depreciated, too.  All capital items increase your basis.  Depreciation decreases it.  When you sell, your gain is the price you sell it for, less your selling costs, less your basis.  So, if you hold a rental a long time, and its fully depreciated, you will have a lot of gain if you sell.

Notice I've not really mentioned loans.  They don't really matter, except for the interest.  The interest is deductible from the rental income.

Here's another hint:  good rentals make money.  People who promote crummy rentals often show you how the depreciation creates a passive loss.  And then they claim you can deduct that against your other income.  Maybe.  You can only do that if your AGI is under $100K.  But the bottom line is this is just lipstick on a pig.  Good rentals make money.

This is very simplified.  Books have been written about this subject.

Have I convinced you about the need for a CPA?

Shaneel L. · Answer

Right now I live in a house that's owned by a different family member. I will own my first investment property next month. But I wanted to know how can I use the maximum deductions.

Jon Holdman · Answer

First, I STRONGLY recommend getting a real estate savvy CPA.

What do you mean "what's the best way to file it?"  You mean paper vs. electronic?  Is paper still even a choice?  I must be misunderstanding something.

Is the house one you live in?  Rental?  Fix and flip?  Did you sell it?  Have you had a loan and you've recently paid that loan off?

Interest on a house you live in is deductible.  Interest on investment properties is also deductible.  When you sell there is tax on the capital gains and on unrecaptured depreciation.