Summer is over, and the kids are back at school. The weather is getting colder, and you realize that you still have not filed your taxes. If you are one of the many real estate investors who have put off on filing taxes until the last minute, then you may find this article helpful. Believe it or not, there are still some really powerful last-minute strategies you can use to slash your taxes for October 15th.
This may be the first time that the thought of taxes for last year has crossed your mind. Or your taxes may have been a long and painful process that you started months ago but were never able to finish. In either case, now is the time to make sure that you get last year’s taxes wrapped up if you have not done so already since the penalty for late filing can be pretty hefty. Here are some potential tax strategies to keep in mind as you work with your tax advisor in the next few weeks to get 2015 filed.
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Repairs vs. Improvements for Rental Real Estate
Once you have figured out all of your repairs for the year, next it is time to break them out into repairs versus improvements. One trick that I heard years ago is if it’s something that you would brag about, then it’s likely an improvement, while if it’s something you don’t let people to know about, then it’s likely a repair.
The IRS rules are a little more complicated than that unfortunately. If you’re telling a potential renter that the bathroom is newly remodeled or that the house has a brand new roof, those are likely improvements. The repairs are generally things such as the burst pipe under the kitchen sink or the termite damage around the roof trim.
Why is this distinction important? Well, repairs are deductible in the year they are paid, while improvements must be capitalized, and only a portion is deductible each year. The $150 you spend on a plumber to fix the bathroom sink would be expensed immediately, but the $10,000 that you spent for a new roof will likely need to be capitalized.
Sometimes it is difficult to determine whether something is an improvement or not, so the IRS recently released new rules which state that if a repair or improvement is $2,500 or less, then it may generally be expensed. If it is over $2,500, then you will have to determine whether it is a legitimate repair or if it is more likely to be considered an improvement.
Capturing Business Deductions
Make sure you spend some time to gather your business expenses. Too often I see investors with rentals provide only the bare-bone expenses: mortgage interest, property tax, and insurance. There are no gardening, advertising, or business licenses listed anywhere. Investors who do fix and flips often list only their purchase price, sales price, and rehab costs — without including all of the other small miscellaneous expenses that they had for the project.
Don’t forget to deduct the general and administrative expenses like postage, office supplies, or bank charges, as those can all add up. These wonderful write-offs are often forgotten since they are generally not linked to only one investment property.
Home office deductions are also an expense that many investors choose not to take simply because they do not want to figure out their expenses. However, home office deductions generally provide thousands of dollars of write-offs, and many investors legitimately qualify. To learn more about the home office deduction, check out “3 Reasons You Should Love the Home Office Tax Deduction.”
Another perk of the home office deduction is that it is available to renters, as well as home owners. While renters do not get a deduction for mortgage interest or property taxes, their rent payments can still be factored into the home office deduction.
While it is a pain to look for each and every expense for your investments, it could save you a significant amount of taxes. For example, if you are in a 40% bracket between fed and state, then every $1,000 of deductions saves you $400. So sorting through those receipts might just be worth it.
Accelerated depreciation, also known as a cost segregation study, is a way to take more depreciation now by breaking down your depreciable basis into shorter periods of time. Generally, a residential rental property has a building depreciable life of 27.5 years. With accelerated depreciation, you can break down that building into other types of property that have 5, 7, or 15-year lives. It’s not too late to do this for the 2015 year. Cost segregations can be done up until October 15th.
However, if this is something that you want to do, make sure you start the process now to ensure that you have enough time before filing. Keep in mind, though, that taking more depreciation now also means that you will have less depreciation 5, 7, and 15 years down the road, so be sure to discuss this strategy with your tax advisor in detail.
If you have positive active income such as commissions or income from flips, you may be eligible to contribute to retirement accounts up until October 15th or your filing date (whichever is sooner). This does not apply to rental real estate, as rentals are considered a passive activity. On the other hand, flip or wholesale income are examples of income that may qualify.
Related: Tax-Saving Strategies for Real Estate Investors: How to Pay Less & Keep More This Year
An example of a powerful retirement account is a SEP IRA. If you have positive self-employment income, then you may be able to contribute up to 25% of your net profit. For example, if you made a $50k profit from your fix and flip business, then you may be able to set up and contribute $12,500 to a SEP IRA before October 15th. This $12,500 contribution can also potentially be a tax deduction against your other income and reduce your taxes due. Remember that you must have a net profit to use this strategy since if you have a loss, a SEP may not benefit you.
Estimated Taxes for 2016
If you have an overpayment from 2015 taxes, consider applying it to 2016 if you are generally required to make estimated tax payments. This way, you can reduce your estimated payments for the 2016 year. This little trick could help you to minimize or avoid estimated tax penalties. If you missed estimated taxes thus far for 2016, consider increasing your W-2 withholdings. Since W-2 withholdings are considered to be done evenly throughout the year, increasing your withholding amount now to make up for lost estimated tax payments can help you to significantly reduce any underpayment penalties.
Although chasing down receipts and making last minute phone calls are not favorite pastimes for many investors, the tax benefits hopefully will motivate you to double check that you have captured every expense that you are entitled to under the tax code and have done everything that you can to keep your hard-earned cash. Don’t leave money on the table. Make sure that you do everything that you can now before it’s too late. Mark your calendars, folks, and start preparing if you haven’t already started. October 15th isn’t very far away!
Investors: Which tax strategies will you be using? Any questions about the above ideas?
Let me know your thoughts with a comment!