It’s an election year, and there is a lot of “make everybody pay their fair share” talk going around. The problem is in defining “fair share” with our really complex tax code. The thing is that a lot of those tax rules and deductions were devised to encourage certain behaviors. Nowhere do we see more of this than in real estate investing.
Congress and the IRS reward real estate investors in a number of ways in order to encourage the buying of real estate and a sound rental market. Now, it would be easy to think that taking write-offs, even generous ones, wouldn’t take you into a loss situation, but that’s not the case. When you’re speaking of losses for taxes, it’s really quite common in rental property investment.
Deductions
First, as with many investments, there are certain expenses that can be deducted against rental income. They include property taxes, mortgage interest, repairs, maintenance, management, insurance and others. If you make a good buy and your cash flow is nice, those expenses alone may not be enough to offset all of your profits for taxes.
Speak to an accountant
However, there’s one big expense allowed most rental property investors, depreciation. Talk to an accountant instead of taking anyone’s word on financial matters, but this is an allowed deduction against rental income.
Check with the IRS and your accountant, but generally you’re allowed to depreciate a rental property over a life of 27.5 years. This means that you can divide the value of the property by 27.5 and deduct the result every year of ownership. Now, it’s not the total property value, as land doesn’t depreciate. An acceptable calculation must be made to determine the value of the structure without land, as that is what you can depreciate.
Check the numbers
Let’s do a simple example, and we won’t get into a lot of detail. However, let’s say that you’re paying all of the expenses and enjoying a $320/month positive cash flow on a rental home worth $127,000 without land included. Your positive income (simplified) is $320 X 12, or $3,840. Let’s disregard other expenses and just consider depreciation. We divide $127,000 by 27.5 to get $4618.00 +/-.
As you can see, you just moved into negative territory on your investment, expensing more than your income. he awesome beauty of this is that you aren’t spending any of that $4,618 out of pocket. It’s a deduction that isn’t negative cash flow. So, it’s just putting income into your pocket using the legal rules afforded real estate investors. Also, often you can use the excess losses against other investment income (call that accountant again).
This is your “fair share,” even if you have no income tax liability on a specific property in a given year. You’re still contributing to the economy, providing housing for someone, and you’re following all of the rules to the letter. If you have nowhere else to use losses that year, you can carry them forward to use against future income; just follow the rules.