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Real Estate Taxes 101: What You Need to Know Before Year-End (+ 2 Steps to Complete ASAP)

Nathan Miller
5 min read
Real Estate Taxes 101: What You Need to Know Before Year-End (+ 2 Steps to Complete ASAP)

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.

Filing taxes can be a complex process, and when you add real estate investments into the mix, the whole undertaking may suddenly seem overwhelming. There are many benefits to investing in real estate—tax deductions and credits included—but first, it’s important to understand how you can prepare to most efficiently file your taxes. 

A close friend of mine is a property manager. He has an ex-pat client who still owns a rental property in the United States. The client lives in Spain, where she is considered a full-time resident. Let’s call her Sarah. 

Sarah has a U.S. tax identification number. Last year, she reported her income under a single-member, U.S.-licensed LLC. Considering she’s the property manager, my friend had to do significant research to find out which form was correct for Sarah to fill out.

The conclusion? Form 1042-S would be the best option to report rental income subject to withholding for a client who lives in a foreign country.

Related: The Ultimate Guide to Real Estate Taxes & Deductions

My friend came to find out that, for tax purposes, the IRS disregards LLCs that are designated “single-member.” This meant rental income in these scenarios is taxed on the individual’s personal tax return. Sarah should have filled out Form W-8ECI (W-9 for U.S. citizens), which is appropriate for U.S. property owners with a foreign address.

The moral of the story is that investing in real estate can easily complicate your tax-filing process—especially if you work as a property manager or help others manage their investment properties. Issues may arise of which you weren’t previously aware. So, here are some of the main considerations you should keep in mind when planning ahead for tax time in order to reduce your taxes and minimize your risk of audit. 

Real Estate Taxes: Do This Right Away When Starting Out as an Investor

Verify vendor and contractor information

Touch base with each vendor or contractor you’ve worked with throughout the year. Make sure you have the correct federal tax I.D. number and mailing address.

If you are a property manager, this includes reaching out to each of your property owners. 

Issue and file 1099-MISC forms

Typically, 1099-MISC forms must be sent to recipients by January 31 and to the IRS by January 31 if there is a nonemployee compensation amount in Box 7. If there is no information in Box 7 (this is rare), the deadline is extended slightly.

As a property manager or landlord, you are required to issue 1099s to any service provider who received compensation higher than $600 for work related to your investment property. It might seem easy to not issue 1099s as you hire handymen or other laborers throughout the year, but penalties from the IRS can be quite steep and are not worth the risk. 

Related: How to (Legally!) Avoid Capital Gains Taxes on Real Estate

closeup of hand using scissors to cut paper that reads taxes

Tax Deductions for Real Estate Investors

Deducting expenses related to managing a rental property is one of the main benefits of investing in real estate. Make sure to keep excellent records and do some research (or hire a professional) to look into all of the deductions and credits you may be eligible for.

A few examples of real estate investment-related tax deductions include:

  • Property repairs and maintenance
  • Property tax
  • Insurance
  • Travel costs
  • Mortgage interest
  • Depreciation
  • Operating expenses

Business-related deductions often catch the eye of the IRS, so be sure you can provide proper receipts and can justify the business necessity of each claim in the off-chance that you are audited. 

How to Fund Your Retirement Accounts as a Real Estate Investor

Most of the time, the deadline to fund retirement accounts for the previous year is April 15, but some specific accounts have a December 31 deadline in order to be deducted. It is crucial to plan ahead and know your tax deadline to ensure your accounts are in place by the correct deadline. 

If your investment grows substantially over the course of a year, you may want to consider a Roth IRA to keep your profits tax-free. If your investment has modest growth or loses money over the course of a year, you may consider converting your Roth IRA to a traditional IRA without facing any taxes or penalties. Understanding your options and what will work best for your portfolio can have some significant tax advantages. 

Related: 7 Common Myths About Rental Property Taxation—Dispelled

How to Save Money on Taxes by Spending Money on Your Property

No one likes the idea of handing over money sooner than necessary, but in some cases, it makes the most sense. For example, if your investment property is generating substantial profit, it might be worthwhile to pre-pay recurring bills that aren’t likely to change—think insurance, disposal, landscaping—to bring your income level down for the year. On the other hand, if your investment is going to be negative, you may be able to write off your losses and expenses to show no income. 

Another option to consider before tax season to reduce your taxable income is to purchase items or make other pending repairs. Replacing worn-out appliances, repainting, mending broken fences, and other similar activities can turn out to be a wise investment. 

calculator with less tax and more tax buttons

How to Prevent a Tax Hit When Selling Real Estate

Selling an investment property is not a decision to be taken lightly. The tax pros and cons should be carefully considered before pulling the trigger. Selling your property at a gain in a year during which you have many tax breaks (and therefore less taxable income) can be a strategic move.

Related: Yes, You CAN Write Off Your Depreciation: Here’s How

Every situation is unique and depends on your local market. Be sure to consult with a tax advisor or financial planner before you make the official decision to sell. 

How to Protect Your Data During Tax Season

Each and every day, data theft puts our personal and financial information at risk. Besides the holiday shopping season, tax season is one of the most popular periods of the year for cybersecurity issues. Of course, we want to keep our personal information safe, but you are at an increased risk if you act as a property manager and are also responsible for the information of your clients and tenants.

There are steps you can take to prevent theft and keep your data safe during tax season:

  • Use strong, unique passwords for each of your online accounts.
  • Take advantage of two-factor authentication whenever possible on financial, email, and social media accounts.
  • Avoid conducting business or personal transactions on unsecured wifi in public locations.
  • Use caution when opening emails or answering phone calls. The IRS will not initiate contact with taxpayers by email or phone to request personal or financial information.  
  • Check credit monitoring services for any activity you don’t recognize.

Filing taxes as a real estate investor will probably always be a bit complicated, but you can make the process easier on yourself by keeping detailed records and documentation, as well as planning ahead as much as possible. If you have any questions or are unclear about any part of the tax filing process, you should always consult a tax professional, CPA, or attorney familiar with rental properties in your state.

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.

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Questions? Advice for other investors?

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.