Rental Income & The IRS: A Summary Of Tax Advantages

If you own rental properties or real estate investments, you should be well informed about the tax consequences.

In fact, real estate owners have a lot of tax benefits that people who earn W-2 wages from their job do now.

To start, there are three types of income for IRS purposes:

• · Earned income (like from a business or your job)
• · Passive income (like rental properties)
• · Portfolio income (stocks, bonds, etc.)

Since real estate investments like rental properties are considered passive income (unless you’re established as a real estate professional, which you can read about here). The good news is that rental income is not subject to FICA tax, which is self-employment tax that includes Medicare tax and Social Security tax, adding up to 15.3%. For W-2 wage earners, half of that FICA tax is paid by the employee or wage earner, and the second half by their employer.

So, that’s a significant savings for landlords and those who collect rents.

Additionally, real estate rentals may be able to bring in positive cash flow while STILL showing a net loss for tax purposes. That allows you to improve your tax position by lowering your effective tax rate, significantly decreasing the amount that’s actually owed to the IRS every year.

Landlords and property owners also benefit from rental property depreciation, which is one of the chief tax benefits from real estate. Depreciation is sometimes referred to as a “non out-pocket expense” since it reduces your taxable income but NOT your actual cash flow.

Basically, just about every component of building a structure is assigned a “useful life,” which stretches over 27.5 years for residential property and 39 years for commercial property. So, you can incrementally deduct the cost of those components over that period of 27.5 years or 39 years (but not the cost of the land itself.)

In fact, claiming depreciation is mandated by the IRS, but we want to be cognizant of the depreciation recapture tax once the property is sold.

If you wanted to accelerate that schedule of depreciation (to take larger deductions sooner), cost segregation studies may allow you to do just that.

The bottom line is that there are a host of tax deductions, benefits, and advantages for real estate investors and landlords, but you must be aware of the tax pitfalls and snares, too.

So, you own rental property or are just thinking of investing in real estate, please schedule an appointment with my office using this link so we can design a smart tax strategy for you.