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INDUSTRY NEWS & MARKET TRENDS

Rental Properties Yield the Best Tax Benefits

By Michelle Gamble

Owning any kind of business offers a number of tax benefits, however, renting properties can produce some of the best tax benefits than any other investment. Just the business ownership alone allows property owners to leverage the usual tax deductions and more. If you failed to realize these benefits in 2021, you’re in luck. You can start tracking all of your deductions and prepare for a more fruitful 2022 tax year or you can file an extension on your 2021 taxes and backtrack the required information for filing.

If you’ve owned a business before or you’re starting a new rental property business, look to your profit and loss (P&L) spreadsheet and the categories to understand what you can write off. Also, make sure you keep careful records, including receipts (electronic or print), invoices, W-9 forms for contractors, and anything else that might be applicable. You want to stay organized and on top of everything so if any questions arise, you can easily pull the information.

In the state of California, the top property deductions include: interest, depreciation renting real property, repairs and maintenance, personal property, pass-through tax deductions, travel, home office space and supplies, employee and independent property contractors, insurance, and legal and professional services.

DEDUCTIONS

Let’s start with interest. If you still owe mortgages on the property(ies) you own, then the interest you’re paying on those properties is fully deductible. According to the article by San Francisco-based Bungalow, “This is often one of the biggest tax breaks [a rental property owner] gets to take on their rental properties. Typically your lender will send you a Form 1098 at the beginning of the year detailing the amount of interest you paid in the past tax year.”

Another area is depreciation renting real property, which according to the IRS, rental properties have a productive lifespan of 27.5 years. According to “California’s Top 10 Property Deductions” by Marina del Rey-based company Home Rental, “[Housing provider] can get back the cost of real estate through depreciation. This involves deducting a portion of the cost of the property over several years. • To calculate your depreciation expense, here’s the formula: Depreciation expense = Actual value of the property divided by 27.5 years. • For example: If you own a $200,000 rental property, your depreciation expense would be: Annual depreciation expense = $200,000 / 27.5 = $7,273 • Under these conditions, you’ll be allowed to deduct $7,273 depreciation expense from your gross taxable rental income each year.”

The other areas such as maintenance and repairs, outside services (e.g., hiring a marketing firm to market your rentals), employees and contractors are pretty straightforward. Every maintenance activity and anything that involves travel either directly related to going to a site or doing professional development activities are all write-offs straight across.

Starting in 2021 and 2022, you can now write off 100 percent of entertainment costs whereas in the past you could only take a percentage. These entertainment costs can even include meals delivered to your home office, concert tickets to entertain clients, or any recreational activities. Of course, any travel related to business or working with clients can also be 100 percent written off.

The outside office is a 100 percent write-off, meanwhile the rules regarding the home office are different. An article titled “The Home Office Tax Deduction for Small Business Owners” that appeared on the NerdWallet blog said, “Although your home office doesn’t have to be the only place you meet your clients or customers, it must be your principal place of business. That means you use the space exclusively and regularly for administrative or management activities, such as billing customers, setting up appointments, and keeping books and records, according to the IRS.”

The home office deduction is based on the square footage of your office that is specifically being used for business and nothing personal, which means if you have personal items stored in the office, you can’t write off that space. For example, let’s say you have a daybed in your office, you can’t write off the space that the bed occupies – it must all be office-related. So, if your home office is 2,000 square feet then you could write off 300 square feet of it.

A different write-off is called Section 1031 of the IRS tax code. “As per Section 1031 of the Internal Revenue Code, you can swap your rental property for another with little to no tax obligations. The 1031 exchange allows property investors to pass on their capital gains from one property to another without having to worry about taxes. You have to meet a few conditions in order to qualify for this tax benefit,” according to “California’s Top 10 Property Deductions.”

The best way to ensure you take advantage of all of your tax benefits is to consult with a tax professional. Make sure you work with someone who specializes in property management and land ownership.

Michelle Gamble is the editor of Rental Housing magazine.

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TIPS & HOW-TOS

Time to Get Your 2022 “Tax House” in Order

You’re probably thinking, “What! I just filed my 2021 taxes, do I really have to think about 2022 already?” Yes, “death and taxes” come to us all – and in the case of taxes, it’s an annual thing. Now for those of you who have filed extensions for 2021, the following preparation advice also applies.

A great place to start when getting your taxes organized is to begin with the IRS. The IRS provides a useful list of how to get organized to prepare for your taxes. You will find this excellent information on the IRS website at www.irs.gov.

“Some key tips to file a complete and accurate 2021 (it applies to 2022 as well) tax return include: • Gather all necessary records, such as W-2s, 1099s, receipts, canceled checks and other documents that support an item of income, or a deduction or credit, appearing on a tax return • Develop a system that keeps all important information together, including a software program for electronic records or a file cabinet for paper documents in labeled folders. Having all records readily at hand makes preparing a tax return easier • Compile all year-end income documents, such as Form 1099-MISC, Miscellaneous Income; Form 1099-INT,

Interest Income; Form 1099-NEC, Nonemployee

Compensation; Form 1099-G, Certain Government

Payments, like unemployment compensation or state tax refund; and Form 1095-A, Health Insurance Marketplace Statements • Taxpayers should wait to have all 2021 tax information before filing to avoid a processing delay that could slow down a tax refund.”

As property providers, you might consider keeping extensive and separate records for each property site, which is especially true since property and sales taxes vary from county to county. So, if your property is outside of the East Bay Area and the included counties, make sure you know the individual rules. One recommendation is to keep completely separate electronic and paper files labeled for each property that can be easily pulled one at a time to create your profit and loss (P&L) sheet for your tax preparer.

Tip: To avoid being flagged for an audit, always use a professional tax preparer. You are less likely to end up with heaps of time spent with an auditor. However, those accurate files will make it easy to pull information should you end up in front of the auditor.

Basic housekeeping to stay organized requires you do completed cycles of action. This means, for example, if you’re working with contractors and invoicing, keep track of related activities in a single folder and ensure you include contracts, invoices, W-9, and receipts in the same file. Create a checklist for each relationship you have with outside contractors and vendors, then check off each activity to ensure all loops are closed.

If you pay quarterly taxes, use some kind of calendar alert system to remind you when payments are due. You want to avoid late payments to avoid penalties. Your alerts much like any “alarm clock” let you know it’s time to pay. After all, as a property provider you probably have a lot of things on your mind other than taxes. An alert prevents missed payments and reduces your personal stress.

Create a single checking account for all expenses. Try not to mix your personal and professional accounts. When it comes time to figure it all out, you will have far less work to do. If you use any kind of credit card, keep company expenses on just one. Again, it creates more efficiency so you’re not having to sort through multiple bank and credit statements.

Also, to save money avoid using your tax preparer to create your P&L statement. If you’re short on time and have an assistant (or better yet, a bookkeeper), try to have this person do a monthly P&L. When it comes time to organize your taxes, you can easily pull the month’s statements and put together your annual P&L. So, when you sit down with your tax preparer you can just hand over the P&L, or better yet send it to them electronically so all it requires is your signature. It’s more efficient and much easier than having to scramble around to put something together at the last minute, which many Americans do anyway. You won’t though, you’ll be ready.

Following these kinds of tips and tricks will make you groan a lot less when next year’s tax season rolls around. Good luck!

Michelle Gamble is the editor of Rental Housing and owns a business.