Reserves and Taxes, how does it work?

Question

What's up everyone. I have been lurking around for while and I have a question I can't find the answer to.

Lets say I am renting out a home for $1,000 a month and I am setting aside 25% (lumped CapEx, Maintenance,  Vacancy).

At the end of the year, I have a reserve of $3,000 designated for a certain purpose. Now let's assume I didn't have to spend a dime of this money. If this money is taxed, my reserve has been slightly diminished by the amount of tax paid.  Is it possible to avoid this? Can I itemize/label/categorize this money so the IRS knows this is for a rainy day?

Thanks everyone, these forums have already provided a wealth of information!

Bjorn Ahlblad · Answer

@Royston McKaig Income is income whether you spend it or not. Good try though ;-))

Basit Siddiqi · Answer

an S-corp does not have "tax rates"

Account Closed · Answer

@Basit Siddiqi Just a few quick questions:

1. Is an Assignment Fee "earned income"?

2. Is an Option Fee "earned income"?

3. Is a Consulting Fee "earned income"?

Brian G. · Answer

@Royston McKaig income - expenses (including a depreciation deduction; see a tax pro) = your taxable income. Thankfully there is no FICA (ie Social security/medicare) taxes on rental income, it is however taxed on your federal/state taxes.

Mary M. · Answer

Anyone owning RE needs a CPA to help them with understanding tax law and capital improvements. There are amounts that can be directly written off instead of depreciated.  its normal business accounting and tax prep. The best concept is to meet with your tax advisor and plan out your tax strategies for now and in the future :)

Percy Matsunaga · Answer

@Royston McKaigton

I would definitely get an CPA to take a look at how you can get more tax deductions.

I recently installed a fence in CA and the state law says to deduct a portion for 7 years, but in my case I was able to take the whole deduction all in 1 year.

So there might be a way for your tax guy to help protect some of the $$

Royston McKaig · Answer

@Bjorn Ahlblad, hey man..I have to try right?  @John S. I wish that were the case but it doesn't appear so. @Basit Siddiqi thanks for your input as well.

This was helpful! I know to make sure I account for this in the future.

Thanks again guys!

John S. · Answer

@Basit Siddiqi What's the advantage of taking S-corp taxation then, if you're an LLC? Just the difference in tax rates between corporate/personal?

Basit Siddiqi · Answer

That is incorrect - Shareholders of an S-corp report income as the S-Corp earns the money and not necessarily when dividends/distributions are made.

John S. · Answer

Not a CPA, but my understanding is that it would depend on your corporate structure/tax treatment, if any. If you're doing this in your own name or as an LLC without S-corp election, no. It's taxed as income this year and you can deduct it when you spend it. If you're a corporation, or an LLC taxed as an S-corp, then your business can retain earnings for tax purposes and you would not be taxed until it is distributed.

Reserves and Taxes, how does it work?

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