Enrolled Agents to Real Estate Moguls: Don’t Overlook These Rental Tax Tips

Every tax season, enrolled agents offer up sage advice gleaned from long hours of study for the enrolled agent examination, or from the EA continuing education courses required for certification, making them the to-go-to registered tax return preparer. One notable beneficiary of this group’s professional assistance are individuals who make a portion of their living from rental income. But every year enrolled agents find that these taxpayers-from the landlord-next-door to thriving real estate moguls-sometimes overlook some important tips that could be saving them money.

RENTAL INCOME The basic logic behind rental income is that this yearly income is, the less a taxpayer will owe in taxes. By minimizing rental income, the taxpayer is able to reduce his or her taxable liability.

Of course, clients in this situation should not construe this as a suggestion to stop collecting rent. Rather the point is that they may be able to avoid classifying all the collected rental income as taxable rental income. Below are three key points to remember in this respect:

(1) Taxpayers are not required to report rental income if the property was rented out for 14 days or less.

(2) Rental income is taxable in the year it is collected. Meaning, if a taxpayer failed to collect December’s rent before the end of the current year, this portion of the rental income does not have to reported until next year’s return.

(3) Taxpayers are able to exclude security deposits from rental income if the intent is to return the deposits once the lease is ip.

MINIMIZING TAXABLE GAIN WITH SALE EXPENSES

Some real estate investors tend to overlook the value of a number of deductions when selling property. When rental properties are sold for a profit, taxes on these sales can be successfully minimized by accounting for various sale expenses, most notably closing costs conveniently located on the settlement statement.

Other often-overlooked items that should also be deducted include:

Real Estate Commissions

Title Work Expenses

Recording and Transfer Charges

Additional Settlement Costs from the Contract Sales Price

By claiming these expenses taxpayers are able to minimize gain and thus lower the tax liability on sold properties.

SCOUT OUT PROPERTIES DURING VACATION

These days an enrolled agent is as much a financial advisor as they are tax preparers. In this vein, real estate investors should be reminded to deduct the cost of expenses incurred while looking for new properties to purchase. All travel expenses associated with managing these investments are tax deductible provided they are considered ordinary and necessary.

Several other rules apply as well. Most notably, at least half of the time spent away on travel must have been devoted to transacting real estate business, and, likewise, the primary cause for travel must be business. Common deductible business expenses include fees for travel, lodging and other real estate-related services.

ADVERTISING EXPENSES

Taxpayers with rental properties should be sure to deduct any advertising expenses that are considered “ordinary and necessary” for finding tenants

Common expenses in this regard include ads featured on the radio, newspaper advertisements and advertisements in various classified lists and phone books. Other expenses may include the cost of signage, banners, postage for mailers and web sites where rental prosperities are featured.

DEDUCTING TENANT UTILITIES PAID BY LANDLORD

In today’s competitive rental marketplace, many property owners are throwing in the cost of utilities to entice new tenants. Fortunately, these expenses are fully deductible, but must be noted in the rental agreement.

Other deductible expenses sometimes incurred by landlords, but not claimed, include lighting common areas, installing and maintaining security systems and providing water, gas, cable and Internet.

However, as enrolled agents well know, deducting large expenses during periods of vacancy can send up a red flag to the IRS.

DEDUCTING LEGITIMATE START-UP EXPENSES

Most costs associating with starting a business are considered capital expenditures by the IRS. Nonetheless, taxpayers can elect to deduct up to $5,000 of business start-up costs incurred in 2010. The $5,000 deduction is reduced by the amount that the total start-up costs exceed $50,000, and the remaining cost is required to be amortized.

Start-up expenses are costs associated with either creating an active trade or investigating the starting of a particular business.

Common start-up expenses may include:

Accounting fees

Analysis of potential markets

Products

Labor supply

Transportation facilities

Advertisements

Office equipment and furniture

Setup costs

Salaries and wages for employees (including executives and consultants)

Training costs

Travel and other costs for locating possible distributors, suppliers, or customers.

Enrolled agents should remind taxpayers that all legal expenses, and the cost for establishing the actual business structure, must be amortized over 5 years.

FOR SALE BY OWNER

One viable option for real estate investors is to sell a property that they’ve recently vacated to their own S-Corporation. This method will permit them to legally exclude capital gain of up to $250k (or $500k if married filing jointly) since requirements for the two-year rule have been fulfilled. The other advantage to this strategy is that taxpayers can have a new basis for depreciation on their appreciated properties.

PAYING CHILDREN BY OPENING IRAS

Some rental owners with substantial taxable liabilities may want to consider hiring their kids to help with the management or maintenance of these properties

Real estate investors are able to hire their children to do work on rental properties provided this money is placed in IRA accounts for them. This is a particularly smart idea for taxpayers who have already maxed out their own IRA contribution for the year. Under this scenario taxpayers will fair better by avoiding the taxes on their extra income.

IRS Circular 230 Disclosure

Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.