Becoming a landlord is one way that many East Bay property owners secure a stream of passive income. However, there’s a lot more to owning and renting out property than just collecting those monthly checks. Hire an attorney and an accountant with experience in this area before deciding to move forward. And be aware of applicable tax laws before buying, selling or changing the use of your property. This is fundamental to your success as an investor in rental property.

 

Here are a few important items to remember:

 

The rent paid by tenants is generally taxed as regular income for the property owner. This includes advance rent payments and any portion of security deposits retained to cover damages. Deposits used as a final rent payment are regarded as advance rent, and any expenses paid by a tenant on behalf of the landlord and/or services provided in exchange for rent are considered income.

 

It pays to know which deductions you qualify for as an active landlord. The IRS allows you to deduct the expenses incurred to maintain, manage and repair the rental, as well as those that relate to the eventual sale of the property. You can claim expenses for property management services, cleaning, general maintenance, HOA dues, insurance, mortgage interest and property taxes. These deductions are generally taken in the same year you spend the money.

 

You can also deduct the costs of purchasing and improving your rental property, but that works differently. These costs are recovered over time through depreciation. Most residential rental property is depreciated at a rate of 3.636% per year for 27.5 years. This is what the IRS considers the property's "useful life." Only the value of, and improvements to the building can be depreciated. (You can't depreciate the land the building is on since it never gets "used up.")

 

State and local taxes (or a portion thereof) may also be deducted. Previously unlimited, in 2017, a $10,000 ceiling for this deduction was enacted and made applicable for tax years beginning in 2018 and continuing through 2025. For more detailed guidance concerning deductions, we can help you find a qualified tax professional.

 

When the time comes to sell your rental property, you may be looking for ways to avoid paying capital gains taxes. Your primary residence is treated differently from a rental property. If you have lived in your home for at least two of the last five years, you are exempt from capital gains taxes on the first $250,000 if single and $500,000 if married filing jointly.

 

Careful planning may allow you to benefit from this exemption if you have lived in the home as required. This strategy also works for owner-occupied properties with more than one unit.

 

One effective method for deferring capital gains is the 1031 tax deferred exchange. This occurs when you sell one investment property in order to purchase another. The main requirements for this are:

 

• You must purchase another “like-kind” investment property. This is defined by the IRS as “the same nature or character, even if they differ in grade or quality.”
• The replacement property must be of equal or greater value.
• You must invest all of the proceeds from the sale (and cannot receive any "boot").
• The title holder and taxpayer must be the same as for the relinquished property.
• You must use a qualified intermediary. This is a company that facilitates the exchange by holding the funds involved in the transaction until they can be transferred to the seller of the replacement property.
• You must identify the replacement property within 45 days.
• You must close escrow on the replacement property within 180 days.

There’s an industry phrase, “swap ‘til you drop” which means some people continue to do 1031 exchanges on any subsequent investment property sales. Eventually, the demise of the owner (or either spouse) triggers a stepped-up basis with the associated tax savings.

 

You may want to shift the focus of your investments, transitioning from a high-maintenance property to one that’s more self-sustaining. Or you may want to move your investments from one state to another, without a negative impact on your bottom line. At Red Oak, we are proud to be a part of the exceptional referral network, Leading Real Estate Companies of the World. We can assist you with property investments anywhere in the world.

 

If you’re looking to sell your investment property or if you are interested in becoming a local housing provider, reach out, and we will happily share our expertise.

 

Note this article does not constitute tax advice; reader should check with their CPA before taking any steps.