Residential Rental Pros and Cons

January 23, 2017

We regularly have clients ask us about the pros and cons of purchasing rental properties as ways to supplement their income and create long-term investments. Stagnant interest rates on investments and the current real-estate market has pushed many of our clients into this activity.

No matter what your reason for considering rental activities you will encounter a laundry list of potential pros and cons related to your taxes at the end of the year.   This is by no means a complete list of the benefits and drawbacks of venturing into rental activities; being a CPA firm, we will focus only on the potential tax impact.  Having a discussion with a Financial Advisor of alternative investments may help you identify if rentals are right for you.

If you aren’t a real estate professional there are some pitfalls to be aware of, rental activity is passive and has some loss deduction restrictions. Here are some high points regarding rentals.

Pros:

  • Positive cash flow with the potential to offset ordinary income. For most taxpayers, rental properties result in a taxable loss due to the depreciation deduction allowable.
    • If your adjusted gross income (AGI) is lower than 100,000 per year up to 25,000 of losses can offset other ordinary income. Phasing out by AGI of $150,000
    • Types of Deductions: Depreciation, operating expenses, property taxes, repairs and maintenance, utilities, professional fees, and others.
  • Good long term investment opportunity
  • Potential appreciation of property at date of sale.
  • Passive losses accumulate and can offset gain on eventual sale of the property.

Cons:

  • Upon sale of the property any depreciation expense taken in prior year will convert a portion of your gain to a 25% capital gain rate.
    • You can attempt to manage your tax liability by selling the property in years with lower income.
  • Additional administrative responsibilities.
    • You will need to maintain accurate records of income and expenses related to your rental property
    • Based on preference, you may need to engage a property manager to perform rent collection, repairs, and reference checks for potential tenants.

We can help identify how your personal taxes would be impacted by investing in a rental property.   Proper planning can mitigate year end surprises and potentially undesirable tax consequences.

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