The Money Mustache Community
Learning, Sharing, and Teaching => Taxes => Topic started by: HAULIN3 on July 24, 2015, 01:51:54 PM
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So I'm keeping track of everything like closing costs, painting, etc. I do have a small mortgage on it. So I'll be able to depreciate this house, deduct the mortgage interest and all expenses, and also claim the rent as income, correct? So if the expenses are more than the rent, what happens?
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I recommend some books by Nolo about being a landlord, running a small business, landlord taxes, etc. They have some good advice about how to avoid breaking the law and how to make sure you get all the deductions.
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If monthly expenses are more than rent income, you will have experienced what the IRS calls a "passive loss."
The IRS places restrictions on passive losses to keep people from abusing the tax code using extreme, manufactured situations (think "tax shelter"). In the heyday of tax shelters, many accountants were experts in crafting tax shelters involving rental activities that would show losses for tax purposes even though the holder was realizing economic income. In fact, its the very nonsensical notion of depreciating a home that everyone expects to APPRECIATE in value that creates this situation but, I digress.
You yourself are in a situation that is a microcosm of this: surely you're not investing in your rental to lose money! Passive losses are non-deductible (you can't net these types of losses against your normal income to reduce your taxes) EXCEPT in a few situations designed for non-abusive taxpayers:
1. You may deduct $25,000 of these "passive losses" each year if you own at least 10% of the property, do your own property management, and make less than $100,000 per year from all income sources (including your day job). If you make between $100,000 and $150,000 per year, you must reduce the $25,000 of allowed passive losses by 50% of the amount exceeding $100,000.
EXAMPLE: You have $30,000 of passive losses and your income is $120,000. You can deduct a maximum of 25,000 - ((120,000-100,000) x 50%), or $15,000. Your remaining $15,000 that isn't deductible can be carried forward and used in future tax years or when you sell the property.
(see http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG-Chapter-2-Rental-Losses)
2. If you're a realtor/real estate professional, you can deduct all rental passive losses. You must work in real estate over 50% of your working time and more than 750 hours per year.
(see http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Passive-Activity-Loss-ATG-Exhibit-2-4-Real-Estate-Professionals)
Also, be mindful of what is an "expense" and what is a "capital improvement." If you're making any major repairs to your home (replacing the roof), they should be "capitalized" and depreciated over their useful life, just like your home. Several exceptions exist to this general rule.
(see http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Tangible-Property-Final-Regulations#Ademinimis)
Congratulations on your foray into rental real estate. It is a fantastic way to build wealth, and you're already on to the tax advantages of this type of income!
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Keep in mind that any prepwork such as painting accomplished before the rental is "put into service" (IE: rented) must be depriciated over 27.5 years. It is possible to post a passive loss when starting out; but it is much more difficult than I thought after purchasing my first rental 2 months ago and learning A LOT about depriciation. Keep in mind closing costs must be depriciated across the life of the loan too!