Hans Kasper, MS-CPA, PS

Rental Real Estate
 

Rental real estate can be a money making opportunity if the following principals are adhered to:

• The correct location is purchased;

• You have the emotional tolerance to deal with people;

• The property is purchased at the right price;

• The property is rented at the right price;

• The property is rented to the right people;

• The property is properly maintained;

• You have the ability to manage negative cash flows during certain periods of time; and

• You know when to sell the property at the peak in the economy.

Rental income includes the following items:

• Money received for the rental of the property including advance rents (last month's rent);

• Reimbursements for expenses;

• Rental deposits (security deposit) received less rental deposits refunded at the time of departure from the property; and

• Money received for the early cancellation of a lease.

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Rental expenses include the following items:

• Advertising for new tenants;

• Homeowners association dues;

• Auto transportation expenses (mileage) to and from property for check up visits, repairs, etc;

• Cleaning and maintenance of the property;

• Commissions paid to rent out the property;

• Gardening;

• Homeowner's or renter's insurance;

• Legal and other professional fees related to the property;

• Licensing and permits;

• Management paid to oversee the property;

• Miscellaneous;

• Mortgage interest;

• Credit card and other loan interest on repairs or improvements to property;

• Painting and decorating;

• Pest control;

• Plumbing and electrical;

• Repairs to property (major capital improvements must be depreciated);

• Supplies to clean and maintain the property;

• Real estate taxes;

• Telephone;

• Utilities that you pay on the property--electric, gas, water, garbage, and cable;

• Wages and salaries for staff to run the operation;

• Depreciation on cost of home (excluding land) and capital improvements; and

• All other directly related expenses.

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Depreciation expense must be taken on the original cost of the property that you are renting.  Residential real estate is depreciated over 27 years and commercial real estate at 39 years.

Capital improvements and repairs are closely related.  Capital improvements are major items that are more costly and will last a long time.  Repairs are low cost items that will need to be fixed frequently.

Capital improvements will need to be depreciated over the life of the improvement.

The IRS has standardized life tables for almost all rental assets.

You are also allowed to segregate the costs of a building and depreciate the separately depending on the category of the components that make up the building.  This is very complicated and requires an engineer or, if new construction, the contractor to create a cost breakdown for you.  Click here for a detailed article about cost segregation.

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Since 1986, rental losses can be limited depending on your non-rental income and the total amount of your net rental losses.

If you actively participate in the rental management of the property, then you can deduct losses up to $25,000 per year.  However, even those losses will be limited or reduced to zero if your income exceeds $150,000 (married filing joint).  These limited losses are carried forward to future years when you income is lower or you sell the property at which time a deduction can be taken.

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The sale of rental real estate held more than one year is taxed at capital gain rates and, if less than one year, then the gain will be taxed at regular tax rates.  The gain is calculated as follows:

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Please click here to follow the link.