If you decide to invest in real estate, particularly if for residential or commercial rental use, you have essentially gone into business and there are many tax benefits to owning such a business.
First, it is important to consider all of the possible forms of ownership and the tax benefits of each. You can own a business as any of the following:
- Sole Proprietorship
- Limited Liability Company (LLC)
Your Certified Public Accountant (CPA), in partnership with a good attorney, can properly guide you in forming the entity that is right for you, by considering your own individual needs, goals and circumstances.
When you‘re ready to invest, your CPA will want to meet with you to project possible scenarios of your investment. You will need to know how different investment avenues and the timing of such investments can affect your investment decision. The tax laws are constantly changing. The United States Congress acts on tax matters several times every year, and you can expect that your CPA is keeping up with the ever-changing tax laws.
Recent major tax acts include the American Taxpayer Relief Act of 2012. In addition, congress continues to extend most of the provisions of the 2010 Tax Relief Act and the Act affects tax rates for investors and small businesses in a variety of ways.
Keeping Your Books
One of the most critical aspects of operating your business is keeping good accounting records. Whether your CPA does most of this for you, or you have someone qualified to do the basic day-to-day bookkeeping in-house, this is an area of your business that should never be neglected. If you do get behind, however, rest assured that your CPA will be able to help you reorganize and bring your records up to date.
Your CPA can help you select appropriate bookkeeping software or a more simplified manual system that will best meet your needs while assuring that you are producing records that will assist your CPA in meeting your more complex accounting and tax compliance requirements.
Interim and Annual Reporting
Your CPA should be able to produce, or assist you in producing your own financial statements. A properly prepared financial statement should give you an accurate picture of the current financial state of your business and reflect a historical presentation of the income, expenses and profit or loss of your business for the period reported, whether monthly, quarterly, or annually. The CPA can also prepare forecasted financial statements to help you in planning.
A properly prepared financial statement can be an extremely useful tool in helping you manage your business and its investments. Your CPA should be able to assist you in understanding your financial statements so that you can get the most out of the information presented.
Anyone in business has income tax reporting requirements. Some businesses also have sales tax (transaction privilege tax) and employment tax requirements. Your CPA should have expertise in each of these areas of tax law, and will prepare all of the appropriate reports to keep you in compliance with the various government agencies, including the Internal Revenue Service and each required state and local agency.
When you purchase an asset that has a useful life that spans an extended period of time, you typically must expense it over that useful life. This is referred to as “depreciation.” The IRS has assigned most assets to a specific depreciable life. Here are some examples of assets you may own as a real estate investor and the depreciation life assigned to each.
- Residential Real Property (excluding land value) 27.5 years
- Commercial Real Property (excluding land value) 39 years
- Most Residential Real Property Improvements* 27.5 years
- Most Commercial Real Property Improvements* 39 years
- Qualified Restaurant Building and Improvements 15 years
- Qualified Retail Property Improvements 15 years
- Car Wash Buildings and Service Stations 15 years
- Land Improvements (Sidewalks, Parking Lots, Playground Equipment, etc) 15 years
- Trees or Vines Bearing Fruit or Nuts 10 years
- Office Furniture & Equipment 7 years
- Office Computers 5 years
- Breeding or Dairy Cattle 5 years
- Assets used in Construction by certain Contractors, Builders, and Real Estate Subdividers and Developers 5 years
- Assets found in a Rental Property (Personal Property):
- Furniture 5 years
- Stove & Range Hood 5 years
- Oven 5 years
- Dishwasher 5 years
- Refrigerator 5 years
- Microwave Oven 5 years
- Space Heaters 5 years
- Window Air Conditioning Units 5 years
- Window Treatments 5 years
- Carpeting 5 years
Recent Internal Revenue Procedures have allowed for a “Safe Harbor” election to expense certain otherwise capitalized purchases as expenses if under a specified dollar amount and the proper election is made on the tax return.
From time to time, Congress passes legislation that allows for business assets to receive extra depreciation in the year of purchase. This bonus depreciation in the first year has sometimes been as much as 100% of the cost of the asset. For 2016, the bonus depreciation rate is 50%. Your CPA will know if you are eligible for bonus depreciation.
First-Year Expensing (Section 179 Depreciation)
This special election allows you to depreciate all of the cost of certain assets in the year of purchase. For tax year 2016, the aggregate cost of depreciable property a taxpayer can elect to expense under Code Section 179 cannot exceed $500,000. The limit is reduced on a dollar-for-dollar basis to the extent the total cost of eligible property placed in service during the year by the taxpayer exceeds $2,000,000.
Let’s suppose you live in Seattle, but own rental property in Phoenix, Arizona. You can take a tax deduction against your rental income for your cost to travel to and from Phoenix to check on your property, take care of business, meet with your attorney or CPA. This includes air travel, auto travel, and lodging. For 2016, auto travel can be deducted at the standard mileage rate of 54 cents per mile. Any side trips you take, such as driving to Tucson to visit a relative are not deductible, nor is an extra day’s lodging to do shopping or attend a concert.
There are many other possible deductions you can take against your rental income, and your CPA is available to guide you in getting the greatest tax benefit allowable.