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.