We have received several emails inquiring about investing in real estate and how it affects taxes.
Therefore, we have devoted today’s tax tip on how much you can deduct if you invest in real estate.
Before we cover this topic, I would like to take this opportunity to remind you that our knowledge about real estate and how it impacts your taxes are based on experience. Through our affiliate company, Innovative Real Estate Investing, we provide an assortment of services which include rentals, property management, repair services, and more… Visit us online!
Investing in real estate offers ways to offset your earned income on your tax return.
Rental Property and Your Tax Return
If you own a rental property, all expenses directly associated with it (such as mortgage interest, property taxes, maintenance and repairs, and travel to and from the rental) are tax deductible. You report these expenses on Schedule E.Plus, even though a rental property is an asset that typically appreciates over the long term, the tax code allows you to depreciate it. This creates an additional expense that may also be deducted on your tax return.
Residential rental property is depreciated over 27.5 years or roughly 3.6% per year. Only the value of the building and other improvements can be depreciated. The land cannot be depreciated because it doesn’t wear out. Let’s take an example of a house that cost $200,000. If 80% of the value is the structure and 20% is the land, the value of the structure would be $160,000. The amount you could deduct for depreciation would be $160,000/27.5 years, or a little over $5800.
Passive Loss Deductions
In many cases, the depreciation will create a passive “loss” on your tax return. Real estate is considered a passive investment and generally speaking, passive losses may only be deducted against passive income.But the tax code allows an exception: You can deduct up to $25,000 in passive losses against your active income (that is, your income from working or from dividends), if you meet the requirements for “active participation”. Ok, so what does that mean? Active participation means you must own at least 10% of the rental property and be responsible for significant decisions affecting it. Even if you use a property manager to manage your rental, you’ll meet the requirement for active participation if you make key management decisions (such as approving tenants and expenses for repairs).
Here’s an example of how the passive loss deduction works: Let’s say you’re single and your modified adjusted gross income is $50,000. And let’s say you have a $10,000 passive loss from a duplex you own and actively participate in. In this example, you could deduct the full $10,000 loss from your $50,000 earnings, reducing your taxable income significantly for that year.
Deducting Real Estate Losses
As long as your modified adjusted gross income is $100,000 or less, you can deduct rental real estate losses of up to $25,000 per year from your earned income, whether you’re single or married and file jointly.
Offsetting your active income with up to $25,000 in real estate investment losses is just one of the ways real estate can help you shelter your income from taxes.
