Posted over 3 years ago

How To Reduce your Taxes for Business and Real Estate Owners

Tax Deduction for Real Estate Investors

Here are some more deductions you could apply to your income tax return as a real estate investor.

Security Deposit

Initially, when your tenants moved in the most likely paid a security deposit. This money is not taxable because it is not actually part of your income as it is given with the intent to be received back after the end of the lease. However, it doesn’t always work this way. In fact, in most cases, tenants do not receive their deposit in full or at all because they have either breached the contract or damaged in some way the property and the furniture/appliances inside. In such cases, the landlord can deduct the cost of any repairs they had to carry out and claim those as deductible expenses on their tax return.

Repairs and Improvements

All the repairs and general improvements to the property you carry out, not only after a tenant has moved out, but also throughout their stay on your property, are considered deductible expenses. This can include the fresh painting of the walls, replacing a boiler, fixing a broken fridge or buying more furniture requested by the tenants. Also, in cases where an emergency repair is needed and you as an owner are not around to do it, your tenants can pay for it with their own money and ask for the cost to be deducted from the rent due to you that month. At a glance, it may look like a loss, but actually, you can still deduct the repair cost from your tax return at the end of the financial year.

Common Deductions

If you are still paying the mortgage on the property you are renting out, we have good news for you.
Your mortgage interests are deductible as well.
Along with that, any insurance you pay on the property and taxes can also be claimed back.
If you travel to the estate to carry out maintenance or to take the due rent, you can deduct the travel expenses. These could be public transport fares or mileage at the standard mileage rate, approved by the IRS.
It is even possible to claim long distance expenses if you live in another state or country.
Other common deductions include services you pay for, for example, regular weekly cleaning, mowing the lawn, lift maintenance and wages of the building manager if you have one.
In the unfortunate case of property damage by a natural disaster or criminal activity, you are also eligible to deduct some or all of the cost.
Last but not least, tax deductions for real estate go as far as claiming the accountant fees for preparing your annual tax return. Isn’t that great?

As a real estate investor, you may find yourself on the winning side much easier than many other entrepreneurs. While some businesses are very profitable, they don’t give you the opportunity to apply as many tax deductions as real estate investment does. The more profit you make and the fewer costs you incur, the more money you have to give the IRS, and of course who wouldn’t want to keep as much as possible for themselves. When you are a property owner you can do that easily and completely legally.

DepreciationThe value of a property often depreciates with time and other economic changes. This means that as a landlord, you can get some of the money you paid as rental income tax back. Usually, this does not happen in the same financial year, but over a period of a few years. Nonetheless, it’s still a check of extra money you could put towards new investments, savings or just treating yourself with something you love.

Insurance

Wouldn’t it be fantastic if you could also deduct your landlord liability insurance premium? Well, guess what, you can. Not only that but any other insurance related to your rental activity, such as theft and loss, fire or flood damages and so on.

Independent Contractors and Employees

If you’ve made arrangements for various services to be carried out in the property during the rental period, for example, regular cleaning, you can write your contractor’s wages off as rental business expenses. The same also applies to employees’ salary, for instance, if you have a building manager in residence. The end result of applying this will be less tax you owe on your income as a landlord.

Travel Expenses

This is a very little known benefit of the real estate tax, but you can deduct your travel expenses, which relate to any activity of managing or servicing your property. For example, you can deduct travel to the place when you go there to resolve an issue, your tenant has complained about or to the store if you need to buy a specific part, needed for the repair of an appliance. Your travel expenses are deductible not only on local travel but also on long distance. Therefore, in some cases, you could also be able to deduct airfares if you live abroad or in a different state.

Damages and Theft Losses

This is never something you hope for, but it is useful to know that if your property suffers flood, fire or an earthquake, you can deduct part of the damage costs. Unfortunately, you would be able to deduct the sum in full only in extremely rare case. Generally, the amount of the deduction will depend on the size of the damage and whether you had appropriate insurance. If something valuable has been stolen from the property such as furniture, electric appliances or electronics that belong to you, their value can also be deducted from your real estate tax.

Legal Expenses

As unfortunate as it is, landlords often have to use legal services to deal with irresponsible tenants or just to get their property back. The experience on its own is very stressful and not cheap by all means. In many cases, the tenants do not pay the legal expenses even if they’ve been evicted by a court order and all costs end up on the landlord’s bill. That being said, we bring some fresh air into a situation like this by letting you know as a real estate owner you can deduct your property manager, accountant or lawyer fees from your due tax.

Interest

If you are still paying off a mortgage for the property you are renting out, it comes in handy to be aware that you can deduct your interest rate from your real estate income tax. Other interests, such as those on credit cards used for purchasing goods and services for the property or loans taken for repairs, are also fully deductible.

How Real Estate Investors Can Claim 20% Qualified Business Income (QBI) Deduction

What is at Stake?

The IRS does not give a clear answer to the question whether a ‘rental real estate operation’-enterprise is a “trade or business” for purposes of Section 199A of the Internal Revenue Code. Enterprises that are considered a “trade or business” in terms of the same qualify for the 20% deduction provided for, so the stakes are high.
To be considered as a “trade or business” by the IRS the real estate enterprise in question is now provided with a revenue procedure that can result in it being deemed a “trade or business” for Section 199A if the requirements for it are met.
However, in typical IRS style, the fine print here is a bit confusing: Even if the enterprise does not meet the requirements set out in the new revenue procedure, it will still be considered a trade or business insofar as it conforms to the definition of a trade or business as set out in the Act in § 1.199A-1(b) (14).
Put differently, for those enterprises that missed the mark in terms of the above mentioned Act and could not strictly speaking be considered a “trade or business” a second chance is now available. Despite not qualifying strictly according to the Act, the enterprise might now enter the proposed ‘Safe Harbor” and be deemed a “trade or business” by the IRS if they fulfill the requirements of the proposed revenue procedure.

I Need More Background to Understand What All of This Means

What 20% deduction?

On December 22nd, 2017 Section 199A was enacted to provide up to a 20% deduction to non-corporate taxpayer’s qualified business income. The deduction is available for all the taxpayer’s qualified trades or businesses, even those operated through a partnership, S corporation, sole proprietorship and also for real estate investment trust (REIT) dividends and (qualified) publicly traded partnership income.

So what is a qualified trade or business?

Section 199(d) specified service trade or business (SSTB) and trade or business of performing services as an employee, are expressly excluded from a qualified trade or business for purposes of the deduction.
In Section 1.199A-1(b) (14) a trade or business is defined as a trade or business under section 162 other than the trade or business of performing services as an employee.
Both Treasury and the IRS admitted that it is tough to figure out whether a rental real estate enterprise is a trade or business.
To solve this problem, the proposed revenue procedure we will discuss below will provide a Safe Harbor for rental real estate enterprises to achieve the status of a trade or business for Section 199A alone.

When will this apply?

The revenue procedure will apply to taxpayers for taxable years ending after December 31st,
The good news is that taxpayers do not have to wait for the final publication of the revenue procedure before they can start using the Safe Harbor as set out in the proposal, for purposes of determining whether their rental real estate enterprise can be treated as a trade or business in respect of Section 199A.

The Rules Proposed

Introduction

The Safe Harbor in the proposed revenue procedure is available for taxpayers who want to claim the deduction available under section 199A for rental real estate enterprises.
If the taxpayer meets the requirements, it will be treated as a trade or business exclusively to apply the regulations under section 199A.
It is worthwhile to repeat that failure to meet the Safe Harbor requirements does not automatically preclude the taxpayer from qualifying as a trade or business as defined in section 199(d).

Defining a Rental Real Estate Enterprise

A rental real estate enterprise holds an interest in one or more real properties to produce rental income.
The person or a Relevant Pass thru Entity (RPE) who wish to rely on the revenue procedure must hold this interest directly or through another entity disregarded as one separate from its owner in respect of § 301.7701-3.
The taxpayer has to make a choice. It can either treat each of the above-mentioned properties separately as distinct enterprises or as a single enterprise as long as commercial and residential real estate are never part of the same enterprise.
Taxpayers cannot vary this treatment from year-to-year unless substantial changes require the same.

Safe Harbor Requirements for Rental Real estate Enterprise

Every rental real estate enterprise kept separate books to reflect income and expenses.
For tax years beginning before January 1st, 2023, 250 hours or more of rental services are performed per year by the rental enterprise.

1. - Rental Services
    - Rental services include
      - Advertising to rent or lease real estate
      - Negotiating and executing leases
      - Verifying prospective tenant application information
      - Collecting rent
      - The operation, repair, and maintenance of the real estate
      - Management of real estate
      - Purchase of materials
      - Supervision of employees and independent contractors
    - Rental services exclude
      - Financial or investment management activities (arranging financing; procuring property; studying financial statements; planning, managing or construction of long-term capital improvements or hours spent traveling to and from real estate.

For tax years beginning after December 31st, 2022, in any three of the five consecutive taxable years that end with the taxable year ( or in each year for an enterprise held for less than five years), 250 or more hours of rental services are performed for the rental real estate enterprise.
The taxpayer maintains time reports, logs and other documents to record:
1. The hours the services were performed.
2. Description of the services performed
3. Dates
4. Identity of those who completed the same.

These records must be available for inspection by the IRS. The requirement that the records be kept contemporaneously will not apply to taxable years beginning before January 1st, 2019.

Rental Real Estate That is Excluded From the Safe Harbor Proposal

Any real estate that had been used by the taxpayer (includes the owner or beneficiary of an RPE relying on the Safe Harbor) as a residence is not eligible.
A triple net lease for the procedure includes a lease agreement that requires the tenant or lessee to pay taxes, fees, insurance and maintenance over and above the payment for rent and utilities or a portion thereof.

Procedural Requirements

The taxpayer (or RPE) has to include a statement attached to its return claiming the section 199A deduction or passes through section 199A information that the requirements in section 3.03 of the revenue procedure have been satisfied.
The statement has to be signed by the taxpayer, his authorized representative or RPE.
The undersigned statement has to state:

“Under penalties of perjury, I (we) declare that I (we) have examined the statement, and, to the best of my (our) knowledge and belief, the statement contains all the relevant facts relating to the revenue procedure, and such facts are true, correct, and complete.”

Whoever undersigns the statement must have personal knowledge of the facts and circumstances related to the statement.

Filing Deadlines

Before the IRS provided their most recent final guidance, most practitioners ignored final deadlines for the 199A deduction, but now, taxpayers have to pay heed to filing deadlines for early 2020 in respect of the current tax year.

Profit or Loss

The 199A deductions are of no use for landlords who have net losses from their property investments. Those who have net losses, it might be more beneficial for the owner to register as a real estate professional to become eligible to deduct their losses against other income – including capital gains and wages. This option, however, is only available for those who spent more than 750 hours – and – half of your total working hours – on real estate business.

Trade or Business

The taxpayer can only claim the 199A deduction if, in terms of tax law, they derive their income from a trade or business. After eighty years of tax law, the determination of whether someone is engaged in a trade or business is still not trite law despite the safe harbor guidance issued by the IRS a month ago during September 2019.

The safe harbor guidance describes when the IRS will automatically accept a landlord’s status as “engaged in a trade or business,” although the benchmark is out of reach of many. For starters, it is almost impossible for a landlord who owns only one or two buildings, to make it into the ‘safe harbor.’

Forms 1099

For those who plan to use 1099A deductions, 1099 forms will be their currency. Owners of rental properties must issue 1099 forms to every non-corporation service provider who charged them more than $600 for a task or for separate jobs totaling $750 or more per year, and they must send off a copy to the IRS as well.

Landlords who plan to use the 1099A deduction for 2019 must send off their 1099s by January 31st 2020. Stiff penalties are charged for non-compliance: up to $50 for every form not sent to the IRS before the required date, and the fines go up – reaching $270 per form for forms not yet sent by August 1st 2020.

Record Keeping

For those landlords who use the trade or business safe harbor stringent record keeping rules exist. For any other landlords who plan to use the 199A deduction, record keeping needs to be meticulous, and many rules apply, i.e. no commingling of funds are allowed.

Personal Use

For properties like a vacation home that is rented out for parts of the year, no 199A deduction is available. For these landlords the consolation prize is that they can retain any income from renting out personal properties for less than 14 days per year, tax free.