An Investor’s Guide to Real Estate Tax Planning

Congratulations! If you’re reading this, we’re assuming that you’ve started venturing into the world of real estate or have at least thought about venturing into the world of real estate. If so, you’ve come to the right place.

No matter how much of an expert you may think that you are, real estate taxes are hard. It can be difficult to understand all of the tax rules and know when and how much to pay.

Luckily, we’re here to break everything down for you.

To learn more about real estate tax planning, keep reading. We’re going to let you in on everything you need to know when it comes to taxes on real estate.

How Is Real Estate Income Taxed?

Generally, real estate income is taxed as passive income. This is unless you’re considered a real estate professional who is actively participating.

Taxes for passive income are great because that means that you don’t need to pay FICA, or self-employment, tax.

Usually, the employer and the employee must split this tax which is made up of payments for Medicare and Social Security. If you are truly self-employed, you have to pay both halves by yourself. This totals a tax of 15.3%!

What Separates a Real Estate Investor From a Business Owner?

The distinction between a real estate investor and a business owner matters. It makes a difference in the deductions you can take. It also affects how passive losses in real estate may affect you.

The government determines whether you’re a real estate investor or a business owner by looking at how active you are with your real estate investments.

If you are not actively participating in management decisions, you’re considered a real estate investor. This is because investors are usually silent when it comes to making decisions about the property. They rarely vote or make management decisions, so the government sees them as limited partners.

If you are actively participating in management decisions, you’re considered a business owner. However, this can get a little fuzzy. You don’t technically have to do the work yourself.

In fact, someone who hires a property manager to do the work for them can still qualify as a business owner.

The difference tax-wise comes when you consider deductions. Business owners can deduct business expenses. However, investors cannot.

If you’re looking to maximize your tax deductions, you need to be active in your real estate ventures.

What Is the Difference Between Short-Term and Long-Term Rentals?

When it comes to taxes, there are small differences between short-term and long-term rentals.

First, we should clarify our definitions. We define a short-term rental as those properties with an average rental period of fewer than 30 days. A long-term rental encompasses those properties with an average rental period of more than 30 days.

Generally, you’ll be reporting your rentals on a Schedule E. This is unless you’re providing substantial services like the average hotel would do.

This means that most of you will be reporting your rentals on a Schedule E, no matter how long your average rental period is.

However, you should report your short-term rentals on a Schedule C if you are providing hotel-like amenities. To be clear, these may include the following:

• Changing linens
• Providing fresh towels
• Providing amenities like a coffee maker and coffee
• Providing transportation

Keep in mind that any one of these must happen while the renter is staying there. Providing fresh sheets before the renter moves in does not count as a substantial service in this case.

Overall, long-term rentals are simpler than short-term rentals. All you have to do is report your rentals on a Schedule E form, report depreciation information on Form 4562, and send it off to the IRS.

What Is Considered a Deduction for Real Estate?

If you do qualify as a business owner rather than just an investor, you’ll be able to claim deductions on your taxes. However, many people are lost as to what qualifies as a deduction.

To start, we’ll go over some basic criteria that every deduction you make should meet:

1. The deduction must be considered necessary and ordinary.
2. The deduction must be recent.
3. The deduction must be directly related to your real estate ventures.
4. The deduction must be reasonable.

If you’re at a loss as to whether or not your deductions meet these criteria, we would consider putting yourself in an IRS agent’s shoes. If you saw the deduction on a tax form, would you count it?

Also, you could ask an accountant or financial advisor what their thoughts are.

What Are Some Examples of Real Estate Deductions?

If you’re having trouble thinking of some deductions you can make on your taxes, we’ve made a list of a few that you may want to take into account. However, we should mention that this is not a complete list.

It’s hard to make a full list of the deductions that people have taken on their taxes. Nonetheless, we tried to highlight some of the most common deductions:

• Automotive expenses
• Travel expenses
• Fees for professional work
• Depreciation
• Amortization
• Utilities
• Supplies
• Repairs
• Interest
• Property Taxes
• Insurance
• Management fees
• Commissions
• Advertising
• Cleaning
• Maintenance

After that long list, there is still more to think about.

The best way to come up with deductions is by looking at what you use to run your business. What things do you have to pay for to keep your business running smoothly? Write everything out and – when in doubt – ask an accountant.

Who Can I Ask About Real Estate Tax Planning?

Taxes are hard. Figuring out what to owe the government is stressful, especially if you’re not the best with the tax code. However, that’s what accountants are for.

If you’re having trouble with your real estate tax planning, you can always ask our team here at Freedom Tax Accounting your questions. We’d be happy to help you with your real estate tax planning or any other tax issues that you’re having.

Our tax services are among the best. We’re experts. Give us a call today!