Tax Tips for Landlords

Renting out residential property can be a great investment considering real estate market trends and favorable tax rules. Being able to take advantage of many tax deductions, which are not available for other types of investments, could make it even more lucrative.  However, it can be stressful, challenging and involves additional financial obligations. Furthermore, there are a lot of tax rules that must be followed in order to report rental activity properly, and there are many deductions that can be overlooked.

So, what can you deduct?

Most know about deducting mortgage interest, insurance, property taxes, repairs and maintenance, association fees, utilities and so forth, but there is much more to be taken into account.

Interest

Besides mortgage interest, a landlord can deduct interest paid on other business related expenses, such as business loans taken to improve a rental property, car loan payments (but only the part used for business purposes), and the interest paid on credit cards used solely for business purposes.

Claim your home office

Sometimes we do not think about rental property as a regular business, but it is. If you have a room specifically dedicated for rental activities, you can deduct a portion of house expenses against rental income. A portion of deductible expenses can be calculated either by multiplying business percentage (the office’s square footage divided by the square footage of the entire house) by actual total expenses or using a standard rate allowed by the IRS: $5 per square foot with a maximum of 300 square feet.

Track your mileage and travel expenses

If you use personal vehicle for such rental activities as buying supplies, picking up rent or showing the property to potential renters, a portion of vehicle expenses is deductible. You can either deduct actual expenses based on business use percentage or apply standard mileage rate to total business miles driven during the year (there are some limitations on using standard mileage rate).

If you travel overnight for your rental activity, you can deduct airfare, hotel bills and meals. Remember to keep detailed and accurate records and supporting documentation to substantiate both automobile and travel expenses.

Improvement vs. repairs

Beware that the IRS makes a distinction between improvement and repairs. Repairs and maintenance expenses are considered work that is necessary to keep your property “in good working condition” and can be fully deducted in the year they are incurred. On the other hand, improvements to the rental property should be capitalized and depreciated over its useful life. However, depreciation of the cost of residential building can be a nice benefit sheltering some of your cash flow from taxes. Generally, for something to be considered depreciable, it has to make your property either bigger, add significant value to a property or increase its useful life.

To maximize repair deduction, you can try to fix and restore, if possible, instead of replacing. A replacement is almost always an improvement for tax deduction purposes. For example, if the roof is damaged, do not replace the whole roof, repair or replace only the damaged part. Repairs are usually much cheaper than replacements, however, consider the fact that sometimes it makes more economic sense to replace and you may be able to charge more rent for a unit with new appliances, carpets, etc.

Passive loss rules

Generally, owning rental property is considered a passive activity. In short, it means that losses incurred are limited against other types of income. Passive losses in excess of passive income are suspended until you either have more passive income or you sell the property that produced the losses. This means that rental property loss deductions can be postponed, sometimes for many years. There are certain exceptions to this rule. First, if you are considered a real estate professional, rental real estate activities are not considered passive. Second, if you are considered actively involved in your rental activity, you can deduct up to $25,000 in passive rental losses if you make under $100,000.

Self-Employment Tax and High Income Medicare Surtax

More good news; rental income is not subject to self-employment tax, which applies to most other unincorporated profit-making ventures. However, according to a provision in the health care legislation, rental income and gain from the sale of investment real estate can be subject to new 3.8% Medicare surtax on net investment income.

When you sell

When you sell a property you have owned for more than one year, the profit is generally treated as a long-term capital gain. As such, it will be taxed at favorable rates. However, part of the gain—an amount equal to the cumulative depreciation deductions claimed for the property—may be subject to recapture rules and higher tax rates. Remember that you may also owe state income tax on real estate gains.

You also have the option of selling appreciated real estate on the installment plan. Then, your taxable gain can be spread over several years. Further, suspended passive losses can be used to shelter gains from selling appreciated properties.

On the other hand, it is important to remember that rental property appreciation is not taxed until you actually sell. Good properties can generate the kind of tax-deferred growth that investors dream about. Finally, so-called “like-kind exchanges,” also known as “Section 1031 exchanges,” allow real estate owners to unload appreciated properties while deferring the federal income tax. In short, you exchange the property you want to dispose of for another property. If you adhere to the like-kind exchange rules, you are allowed to defer paying taxes until you sell the replacement property.

As you can see, tax rules for landlords can be very favorable, even though they can become somewhat complicated depending on an individual situation. Call BiggsKofford at (719) 579-9090 to decide what deductions are applicable to your specific situation.

Unfortunately, the tax credit for buying a hybrid car is gone. However, if you are ready to switch to a plug-in hybrid or electric car, you might be eligible for up to $7,500 in Federal and $6,000 in Colorado tax credits. This combination can reduce the cost of such models; however, there are several things to keep in mind.

Both credits can be confusing to understand, have recently changed and are very different in terms of the types of vehicles that qualify for the credit and other requirements. We will focus on qualified plug-in hybrids and electric cars only.

Not all electric vehicles and plug-ins qualify.

In order to qualify for the Federal credit, the vehicle must be a qualified vehicle (a buyer can generally rely on the manufacturer’s representation that the vehicle is eligible), comply with the legal definition of a motor vehicle as per the Clean Air Act, title II and have gross vehicle weight of less than 14,000 pounds. Moreover, the federal credit begins to phase out for a manufacturer’s vehicles when at least 200,000 qualifying vehicles have been sold for use in the United States. Be sure to check IRS website for qualified vehicles, credit amount and quarterly sales by manufacturer:

https://www.irs.gov/Businesses/Plug-In-Electric-Vehicle-Credit-IRC-30-and-IRC-30D.

In order to qualify for the Colorado credit, the vehicle must meet multiple criteria as well, including gross vehicle weight rating of 8,500 pounds or less, Colorado title and registration, maximum speed, etc. Be sure the vehicle meets all the criteria and check a list of makes and models that the department has already evaluated for credit eligibility: https://www.colorado.gov/pacific/sites/default/files/Income67.pdf. While Colorado does not cap the number of credits it awards, the credit is set to expire on January 1, 2022.

Credit amount varies.

The Federal credit depends on the size of the battery in the car. To qualify a vehicle must have a battery pack with a capacity of at least 4 kilowatt hours (kWh) and be capable of being recharged from external. Provided it meets all the other qualifications, the federal government allows a credit of $2,500, plus $417 for a vehicle that has a battery with at least 5 kWh of capacity, and then an additional $417 for each additional kWh up to $7,500.

The Colorado credit is calculated based upon the vehicle’s manufacturer’s suggested retail price or the cost of the used vehicle or the leased value of the vehicle and battery capacity or the conversion cost and an applicable percentage.

Use it or lose it?

The Federal incentive is a nonrefundable credit. While it reduces your tax liability dollar-for-dollar, it cannot reduce your tax balance beyond zero. No refunds or carry forwards are allowed. The Colorado credit is more generous and if the credit exceeds the tax due, it will be refunded.

Should you buy it new?

For the Federal credit, the vehicles must be acquired for use or lease to others and not for resale. Additionally, the original use of the vehicle must begin with you and the vehicle must be used predominantly in the United States. Therefore, you must buy a new vehicle and if you lease a vehicle, you cannot claim the credit. Do not forget that you must place the vehicle in service during the tax year to claim the credit.

On the other hand, the vehicle does not have to be new to qualify for the Colorado credit; leased vehicles may qualify as well. Used vehicles are eligible if they have never been registered in Colorado before.

As one can see, there are a lot of moving pieces. Further, special rules may apply to vehicles bought for business use, alternative fuel vehicle, etc. If you have questions regarding Federal and Colorado tax credits for plug-in hybrids and electric cars, we can run your numbers to estimate the benefit you might receive. Call us at 719-579-9090 or send us an email to info@biggskofford.com.

Pension Subtraction

While warmer weather or more sunshine may be a big factor in picking a place to retire, considering state taxes on retirement benefits and other financial factors are significant steps in making such a major decision. Tax treatment of retirement benefits varies widely from state to state. For example, some states exempt all pension or Social Security income, others provide only partial exemption or credits and some tax all retirement income.

Colorado is one of the states that allows a pension/annuity subtraction for taxpayers who are at least 55 years of age and beneficiaries of any age who are receiving a pension or annuity because of the death of the person who earned the pension.

Amount of Subtraction

Qualified taxpayers who are under age 65 can subtract up to $20,000 of the taxable pension income. And taxpayers who are 65 years of age or older can subtract up to $24,000 of the taxable pension income.

If each spouse receives income from a pension or annuity, then each spouse must qualify by age to claim the pension subtraction for their own pension or annuity. Each spouse’s subtraction is computed separately and no part of one spouse’s subtraction may be claimed by the other. However, when a married couple receives Social Security benefits and they file a joint income tax return, Colorado law requires that they prorate the benefits between them.

Qualifying Income

To qualify for the subtraction, a payment must be:

  • pension or annuity income that is not considered a premature distribution, and
  • reported on the federal return as taxable IRA distributions, pension and annuities, or Social Security benefits , or reported as a lump sum distribution on the Colorado Form 104.

This includes the following:

  • a retirement benefit;
  • a lump sum distribution from a pension or profit sharing plan to the extent such distribution qualifies for the federal tax averaging computation;
  • a distribution from an individual retirement arrangement or a self-employed retirement account;
  • amounts received from a privately purchased annuity;
  • Social Security benefits.

It is important to remember that premature distributions, regardless of the source, do not qualify for the subtraction. And only the portion of the taxable pension or annuity income that is included in federal taxable income qualifies for the subtraction.

Special rules may apply to 457 plan benefits, disability retirement, nonqualified deferred compensation, PERA and DPS benefits, IRA rollovers and trusts/estates. If you have questions regarding Colorado pension subtraction, BiggsKofford, your Colorado Springs CPA Firm, is here to help.

For more information call BiggsKofford at 719-579-9090 or send us an email at info@biggskofford.com.