https://www.rentalutions.com/education/articles/new-tax-laws-can-save-landlords-3500-annually/
In September, the IRS released the final version of regulations that may save you up to $3,500 in taxes every year, beginning with the 2014 tax year. If you follow Inman News like I do, then you may have read the article last month by Stephen Fishman that the IRS released its final guidance on tax laws that could allow a do-it-yourself landlord, like you, to save thousands in taxes next year.
But it requires that you or your accountant know about the guidance and specifically elect to not apply a long-standing rule. In fact, Fishman, a regular contributor at Inman on Real Estate Taxes suggests this is one of the most significant tax law changes for rental property owners since 1986 (when passive loss rules limited the use of rental properties as tax shelters).
What’s this all about?
Historically, it has always been unclear whether certain expenses to restore or improve a property are considered capital expenditures (unfavorable for landlords like us) ordeductible ordinary and necessary repair and maintenance expenses (favorable).
Why does this matter? As investors, we want to shrink our current year’s taxable income by offsetting that income with expenses (rather than spreading the cost over several years). For example, if a $1,000 expense can be classified as an ordinary, currently deductible expense, your taxable income decreases by $1,000, therefore reducing your tax liability by $300 and essentially putting that amount back into your pocket(assuming a 30% marginal tax rate). If the same expense is classified as a capital expenditure, then instead reducing your tax liability by $300 this year, you’d only reduce the liability by $10 this year and again for each year over about 30 years (the math here has been simplified for illustration).
Capital expenditures don’t sound as good, do they? We prefer lowering our taxes now as well. The issue has always been about how to determine whether something is deductible this year or over its useful life – which can be up to 30 years.
Specifically, the lack of clarity comes from two sections in the Internal Revenue Code that to an everyday person seems to contradict each other.
[one_half padding=”0 10px 0 10px”]IRC section 263(a) says that any expenses used to buy or improve the property must be capitalized over its useful life rather than be deducted in a single year.[/one_half][one_half padding=”0 10px 0 20px”]IRC section 162(a) says taxpayers may deduct ordinary and necessary expenses incurred during the tax year that are part of carrying on the business, including repairs and maintenance.[/one_half]
How do the new regulations save me $3,500?
The new rule allows a qualified taxpayer to elect to use a simplified version of the code, called the Repair Allowance Method, where all improvement, repair and maintenance expenses can be treated as currently deductible so long as the total for the year does not exceed a specified limit. Any expenses over the limit would then be capitalized regardless of its nature. For us, and most landlords who own just one or only a few units, it is unlikely that you will reach the limit, therefore making this election quite favorable for us.
This means that as a small landlord, you can elect to not apply the complex rules mentioned above and instead opt for the simplified Repair Allowance Method. Any amount under your expense limit will be deducted in the current tax year rather than having to be capitalized over up to 30 years. With this election, you won’t have to worry about whether an expense should be considered currently deductible or must be capitalized.
What’s the limit? Although the limit may seem a bit complex to calculate, it’s roughly the lessor of $10,000 or 2% of the unadjusted cost of the property. For more information or the complete tax guidance, please refer directly to the Office of the Federal Register.
Talk to Your Accountant
If you typically work with an accountant to do your property taxes, be sure to mentionthat you want to discuss the Repair Allowance Method this coming year. Otherwise, bookmark this article and come back to it when doing your tax planning for next year.
You can also visit our complete Landlord Tax Guide to make sure you’re in the know on other tax deductions.
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