Allowable tax deductions

12 Replies

I'm an active investor, but I don't qualify as a professional REI. I'm trying to understand what types of business related expenses I can deduct. I have created an LLC that I will be using to buy my investment properties in.

If I take a trip somewhere to view investment properties, can I deduct those expenses from my earned income when I file? What if I bought a new computer and software to manage my investments?  Or are these expenses deductible only if I'm a real estate professional? 

Thanks. 

Any legitimate expense to find, purchase, manage RE investments allows tax benefits. Travel expenses are deductible that same year. A computer probably must be depreciated. Your tax professional should be able to educate you on that. One thing I have found is some "tax professionals" seem to differ on how items can be expensed. A competent CPA is your best bet. It does not matter if you are a RE professional or a stay home dad. Either way, as long as they are legitimate expenses related to your locating, purchase, maintaining your investment properties you can write them off.

John Thedford, Real Estate Agent in FL (#BK3098153)

I guess I'm trying to understand what tax advantages the real estate professional has over the active investor if the active investor is allowed to deduct legitimate investment/ business related expenses.  Thanks 

This is from reading the Nolo book for Landlords and taxes and a CPA might have different information, but you really don't want to use the term investor if you are a buy and hold landlord.  You want your real estate to be a business not an investment or you limit the deductions you can take. being a RE Professional has some other implications I need to read about since I am getting my license this winter.  I will also be going from self filing to using a CPA because I am expanding from two houses to five this year and plan to get at least three to six more next year and want to make sure I am doing everything correctly and the most anvantagous to me.

@Paul Ewing  Simply calling yourself a business owner vs. investor will not allow you to qualify as a real estate professional. The IRS has stringent guidelines that must be met to be considered a RE Pro.

@Fred Stevenson  Being an "Active" investor vs. a "Real Estate Professional" does not affect the treatment of your real estate expenses. If you replace a roof, both an active investor and real estate professional capitalize and depreciate that roof. For your examples, both an active investor and real estate professional would expense travel expenses and capitalize and depreciate the cost of the computer (generally). 

The difference between an active investor and real estate professional is the amount of tax losses you can deduct against your ordinary income. An active investor may deduct up to $25,000 of tax losses against ordinary income (assuming you meet Modified Adjusted Gross Income thresholds). A real estate professional will be able to deduct the full amount of tax losses against ordinary income since it is essentially that person's business.

Example: You own a apartment building and you have a tax loss of $30,000. The active investor will only be able to deduct $25,000 and will have to carry over the $5,000 tax loss into the future. The RE Pro may deduct the full $30,000. In this case, it will be more beneficial tax wise to be classified as an RE Pro.

Being an RE Pro becomes very helpful when you are married filing jointly because you can deduct your tax losses against your spouse's income. 

@Brandon Hall thanks for your reply.  Are you using the terms tax losses and tax deductions interchangeably?  Thanks again

When I say "tax losses" I mean "loss for tax purposes." Think of it as a tax loss creates the ability to take a tax deduction. They are not necessarily interchangeable since a tax loss will not always create a tax deduction. 

Referring to my example above, if you are an active investor and report a $30,000 loss for tax purposes, you will only be able to deduct $25,000 of the loss in that year and you will have to carry forward the remaining $5,000. 

So they can be used interchangeably, but they do not always mean the same thing. Let me know if you have any more questions. And feel free to PM me.

@Brandon Hall. I got it now. Just like when I have a capital loss inn the stock market except there I'm limited to. 3000.00 annual deduction.  Hopefully, I won't have any real estate capital losses that need to be deducted, (knock on wood).

Anyway, thanks again for all your help. 

@Brandon Hall  

Great info Brandon.  Two additional tax questions.  

1. Regarding the mileage depreciation for when you drive to look at a property or an REIA. Are you only allowed deduct the 55 cents a mile, or can you itemize additional vehicle expenses? For example, if you get in an accident on the way to a property, can you deduct the insurance deductible or is that included in the 55 cents a mile rate?

2. Any advice on an itemized tax deduction list?  Something that gives the items that can be deducted as well as the amortization period. 

Thanks again for the info.

Are you only allowed deduct the 55 cents a mile, or can you itemize additional vehicle expenses?

Either one or the other.  You can either take the mileage deduction or take actual expenses.

Are you using the terms tax losses and tax deductions interchangeably?

Not at all.  Say you collect $12,000 in rent and pay out $1000 in insurance, $1500 in taxes, and $500 in repairs.  Say you also have $5000 in interest payments and $2000 in depreciation.  You have $10,000 in deductions from your rents of $12,000 giving you taxable income of $2000.  Alternatively, say you only collected $9,000 in rent and have the same deductions.  In this case you have a net loss of $1,000 for this property.  This is a rental, so this is a "passive loss".  You could also have a loss on sale of stock or a fix and flip, but that's a different animal.

You may be able to use that $1,000 passive loss to offset some of your other income.   If AGI is under $100K you can use up to $25K if you're not an RE pro.  That $25K special allowance phases out by $1 for every $2 of AGI over $100K, so there is no offsetting if your AGI is over $150K.  But if you're a RE pro you're not limited by the "special allowance" nor by the $100K/$150K AGI limits.

@Darren Smith  Jon is right by stating that you can either take the cents per mile (it may be 56 cents for 2014 but not sure off the top of my head) or you can keep really good receipts and expense items related to business use. Typically, it is much less of a hassle to just use the standard cents per mile. 

I'd like to note that you have a standard deduction of $6,200 ($12,400 if married filing jointly) and if your itemized expenses do not exceed $6,200, then you will just use the standard deduction for the year. A lot of people talk about itemizing expenses yet they don't realize that unless their itemized expenses exceed the standard deduction, they will simply be taking the standard deduction for the year.

Here is a good link regarding what you can itemize: http://www.irs.gov/taxtopics/tc500.html

I also want to say IRS Pub 505 goes into more detail. 

@Jon Holdman  not to be a stickler (and I appreciate your posts) - but the $25,000 special allowance is based off of one's Modified Adjusted Gross Income (MAGI), not Adjusted Gross Income (AGI). AGI represents taxable income while MAGI better represents one's ability to pay by adding back certain (rare) deductions. It is applicable to BP users because while a passive loss can reduce AGI, it must be added back to determine your MAGI, which is then used to determine the special allowance deduction. 

Thanks for that clarification for AGI vs. MAGI, @Brandon Hall    I wasn't aware of that.

@Brandon Hall  

Thanks for the clarification on the mileage and the itemized deduction list.  I was aware of the standard deduction, but "unfortunately" I spend quite a bit on real estate and mortgage interest so it adds up quickly.