Questions about tax write off's with a rental property
Rochester, NY · Member since 2014 · 83 posts · 19 votes
We recently closed on our first rental property and I'm trying to keep everything organized for our tax professional next January. Which of the following can be written off?
1. Pre-purchase - Home inspection and appraisal fee?
2. Closing costs - Lender origination charges, credit report, flood cert, interest, escrows, bank attorney fee, title insurance, record deed, record mortgage, mortgage tax, private attorney fee
3. I'm paying for some minor rehab, can the materials, mileage to home depot, and the cost of the laborers/tradesmen be written off?
Thanks,
Greg
Yes, you are off on that. Money put into repairing a purchased property prior to putting on the market for rent is generally added to the Basis of the property (and the depreciation is based on the Basis - excluding land value). You'll get to fully deduct mortgage interest, property taxes, insurance, etc. as expenses and you will also get to claim the depreciation expense. This is (Basis - land value)/27.5 if you are doing straight line depreciation and not breaking out different components for accelerated depreciation. On a 100k property, assuming the land value is ~15k, this means you get a little over 3k in depreciation. There is little or no direct relationship between your rental income/expenses and your W2 income in terms of taxes unless you spend enough time to claim Real Estate Professional status and are not excluded from the benefit by having too much W2 income. But your rental expenses and depreciation likely will offset most or all of your rental income, leaving your overall tax burden unchanged and making your rental cash flows mostly tax-free.
PS - Get a CPA. I am not one and I could well be off on what I just told you, but that is my current level of understanding/ignorance. :-)
1. Home Inspection = Basis; Appraisal Fee = Amortized over life of loan
2. Loan Origination Fee, Credit Report Fee, Recording Mortgage = Amortized over life of loan; Attorney Fee, Title Insurance, Recording Fee = Basis
3. Likely added to basis to get the property "rent ready"
Thank you for the reply. Quick follow up questions:
I just read Publication 527, "Depreciation of Rental Property" and while it makes some sense, I'm not going to kid myself and claim I understand basis and depreciation and how they interact. Put simply, should I keep a 4 column spreadsheet for my tax professional that says Date, Company Paid, Total Cost, Specific items/services and then let her determine what is amortized and what is basis? I'll obviously keep my receipts organized separately.
Lastly, I think I had a horrible misunderstanding of this all. I was under the impression that money I put into the property is eventually directly removed from my taxable gross earned income. So, if I had a gross earned income of $100,000 but spent $2,000 on refinishing hardwood floors then my gross income at tax time would be adjusted to $98,000 and then I'd be refunded the tax I previously paid on the $2,000 (100k-98k). Am I way off on this?
Thanks again!
Yes, you are off on that. Money put into repairing a purchased property prior to putting on the market for rent is generally added to the Basis of the property (and the depreciation is based on the Basis - excluding land value). You'll get to fully deduct mortgage interest, property taxes, insurance, etc. as expenses and you will also get to claim the depreciation expense. This is (Basis - land value)/27.5 if you are doing straight line depreciation and not breaking out different components for accelerated depreciation. On a 100k property, assuming the land value is ~15k, this means you get a little over 3k in depreciation. There is little or no direct relationship between your rental income/expenses and your W2 income in terms of taxes unless you spend enough time to claim Real Estate Professional status and are not excluded from the benefit by having too much W2 income. But your rental expenses and depreciation likely will offset most or all of your rental income, leaving your overall tax burden unchanged and making your rental cash flows mostly tax-free.
PS - Get a CPA. I am not one and I could well be off on what I just told you, but that is my current level of understanding/ignorance. :-)
Thanks, that sounds accurate from the IRS page. Quick follow up, let's say the property is rented and a tenant is in place....
a.) Hypothetically, I've saved some cash flow up and decide to replace/upgrade the counter tops because I know they're beat. I spend $800 in materials and $200 in professional install labor. Can this $1,000 be used to offset cash flow?
b.) Or on a micro scale, let's say a lightbulb goes, the tenant is not responsible for changing light bulbs so I go to home depot, buy a bulb, drive to the rental and replace the bulb. Can the cost of the bulb and mileage be used to offset cash flow?
I do not plan on doing a or b above, but trying to learn and understand.
Side note: I do have a tax professional I plan to use next tax season, she's not a CPA, but she comes recommended from a local investor who said he used her until he ended up with numerous properties and a S-Corp and stepped it up to a CPA. We met for an initial free consultation but I'm technically not paying her for her services until next tax season.
The answer to "a" is yes but it depends on how. If you don't have to capitalize and depreciate the asset, you may be able to deduct it in full in the current year. You can deduct it in full if you are within the rules surrounding the Safe Harbor For Small Taxpayers or the Routine Maintenance Safe Harbor. I wrote a blog post here: http://www.biggerpockets.com/blogs/6032/blog_posts...
After you read the above article, please ask your current tax practitioner the exact same question you asked us - whether you can deduct the countertops and labor or if you need to capitalize and depreciate. If she doesn't mention the safe harbors I discuss in the article, find a new tax practitioner.
In terms of question "b," yes the expense and mileage can be deducted. You need to keep excellent mileage records though, just a fair warning.