The Tax Implications of Owning Rental Property

By Billy Withers | December 13, 2018 | 0

Investing in real estate is a tax shelter, which is why many successful and wealthy people invest in real estate.  If you are reading this blog, you know where to look to find how to minimize your tax burden and keep more of your money in your pocket.  Here at The Real Estate CPA we keep a pulse on all of the taxes that real estate investors pay to work within the laws and minimize tax burdens on your investment.  This post will make you aware of all the taxes you can expect to pay on your real estate investments so that you can work with us to minimize the burdens.

Here are all the taxes that you could be potentially paying on your investment properties:

  • Property taxes
  • Income taxes
  • Transfer taxes
  • Estate and Gift taxes
  • Sales Tax
  • Capital gain tax
  • Occupancy tax
  • Recapture

 

We'll break down when you'll pay each tax so you can be on the lookout for them from when you purchase a property to when you get rid of it.

Taxes you pay when you purchase or acquire a property

If you take a look at a settlement statement from a home purchase, whether your personal residence or your investment property, you will see many of the initial taxes that you pay outlined on the form. The settlement statement shows any property taxes that are paid and the transfer taxes that are paid.  Typically whether the buyer or seller pays these taxes is decided by the locality of the property or the terms of the sale.

For example, the seller may typically pay a certain property or transfer tax in your locality, but if the property was distressed and the seller is a bank, the bank might be able to pass these taxes on to you.  Often times we cannot minimize property taxes or transfer taxes as they are set by law, but there are situations where we can help determine if property taxes are too high and can be appealed or we can discuss looking for properties in other localities that are more reasonable in tax burden but still meet your investment goals.

Taxes you pay as you hold an investment property

As your property generates cash flow, you need to start thinking about income taxes.  While we specialize in minimizing income tax bills, there is generally income tax imposed on rental properties that are generating positive cash flow.  The income tax is reported to the IRS at the end of the year via your tax return, whether it is your individual return or your entity return.

Also, the county or locality the rental property is located in generally imposes property taxes annually or semi-annually.  The timing of these bills depends on the locality that imposes them, but you will generally receive a bill in the mail with instructions to pay property taxes.

If you hold a property out for rent on Airbnb or in any short-term capacity, sometimes localities also impose hospitality and sales tax. Usually, Airbnb will withhold these for you but there are usually registrations you need to go through with your localities to get these taxes remitted.

Taxes you pay when you sell or transfer a property

The taxes you pay when you sell a property are most similar to those that you pay when you buy a property because these taxes are reflected on the settlement statement.  The main difference in taxes on the sale side are the income taxes. To the extent that you made money on the sale of your property, you will likely owe capital gains tax or ordinary rate tax, depending on how you were using the property.  

For property that was held for rent and depreciated, the depreciation benefit you had been receiving every year becomes income through what is called depreciation recapture.

There are also a few other considerations when you transfer a property as well.  First, transferring a property to a person before you pass away will likely have gift tax implications. A gift of greater than $14,000 per year to any one person will need to be reported on a gift tax return. Transferring a property after you pass away will likely need to be reported on your estate tax return.  Depending on the size of your estate, you may be liable for tax when that happens. But of course, there are strategies that can you can use to or avoid or mitigate the estate tax.

How to minimize the tax burden

Ultimately you are the best person to reduce your tax burden.  Understanding the taxes as I have laid them out above is the first step, and then when you see some of the taxes or when you are evaluating your portfolio, that is when you should pick up the phone and call or email us.  We can help you navigate the effects of certain properties and certain localities on your investment portfolio.

The other main driver in reducing your tax burden is good recordkeeping. We advise our clients on several apps and tools that are helpful for tracking every possible deduction and making sure that nothing substantial falls through the cracks.  The most successful clients we have invest in their accounting and recordkeeping systems to make sure the information they provide is relevant and thorough.

Posted in Tax Strategies

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