Rental Real Estate Deductions 15 th Edition Stephen Fishman, J.D.
Chapter 1 Tax Deduction Basics for Landlords... 1 Learning Objectives... 1 Introduction... 1 How Landlords Are Taxed... 1 Income Taxes on Rental Income... 1 Income Taxes When You Sell Your Property... 2 Social Security and Medicare Taxes... 2 Net Investment Income Tax... 3 Property Taxes... 3 What Is Rental Income?... 3 Other Rental Income... 3 How Income Tax Deductions Work... 4 What Can You Deduct?... 5 Pass-Through Tax Deduction... 6 How Your Tax Status Affects Your Deductions... 6 How Property Ownership Affects Taxes... 6 Individual Ownership... 7 Ownership Through a Business Entity... 10 Review Questions... 13 Review Answers... 14 Chapter 2 Landlord Tax Classifications... 15 Learning Objectives... 15 Introduction... 15 The Landlord Tax Categories... 15 Business Owner Versus Investor... 15 Are You a Business Owner or an Investor?... 16 The Importance of Good Records... 18 Tax Consequences... 18 Are You Profit Motivated?... 19 What Is a Not-for-Profit Activity?... 19 Tax Consequences of Not-for-Profit Rentals... 20 How to Show Your Profit Motive... 21 Review Questions... 24 Review Answers... 25 Chapter 3 Deducting Your Operating Expenses... 27 Learning Objectives... 27 Introduction... 27 Requirements for Deducting Operating Expenses... 27 Ordinary and Necessary... 27 Current Expense... 29 Business-Related... 29 Reasonable in Amount... 30 Operating Expenses That Are Not Deductible... 31 Review Questions... 32 Review Answers... 33 Chapter 4 Repairs... 35 Learning Objectives... 35 Introduction... 35 IRS Rules: Repair Versus Improvement... 35 Three Safe Harbors... 36 Safe Harbor for Small Taxpayers (SHST)... 36 Routine Maintenance Safe Harbor... 39
De Minimis Safe Harbor... 41 Repair Versus Improvement Analysis Under the Regulations... 42 Defining the Unit of Property (UOP)... 42 What is an Improvement?... 44 Other Issues under the Repair Regulations... 47 How IRS Repair Regulations Affect Prior Years... 49 How to Deduct Repairs and Maintenance... 50 Making Tenants Pay for Repairs... 50 Repairs Paid for or Performed by Tenants... 51 Properly Document Repairs... 51 Do Preventive Maintenance... 52 Delay Big Repair Expenses... 52 Review Questions... 53 Review Answers... 54 Chapter 5 Depreciation Basics... 55 Learning Objectives... 55 Introduction... 55 Depreciation: The Landlord s Best Tax Break... 55 Understanding the Basics... 56 What Property Can Be Depreciated?... 56 How Depreciation Works... 58 Taking Separate Deductions... 59 How to Depreciate Buildings... 60 What Is a Building?... 60 When a Building Is Placed in Service... 60 Determining a Building s Basis... 61 The Depreciation Period... 65 How Much You Depreciate Each Year... 65 Depreciating Additions and Improvements... 66 Building Components That Cost $2,500 or Less... 68 Depreciating Land Improvements... 68 Changes to Land... 69 Structures Other Than Buildings... 69 Depreciation Methods... 69 Determining Cost of Land Improvements... 70 Deducting Personal Property... 70 What Is Personal Property?... 70 How to Deduct or Depreciate Personal Property... 71 Bonus Depreciation... 72 De Minimis Safe Harbor... 74 Materials and Supplies Deduction... 77 Section 179 Expensing... 78 What Property Can Be Deducted... 78 Restrictions on Using Section 179... 78 Regular Depreciation... 79 When Is Personal Property Placed in Service?... 79 Determining the Basis of Personal Property... 80 Depreciation Period... 81 First-Year Depreciation... 81 Depreciation Methods... 82 Listed Property... 82 When You Sell Your Property... 83 Adjusted Basis... 83 Effect of Adjusted Basis When You Sell... 84 Like-Kind Exchanges: Deferring Taxes on Rental Property... 84 The Home Sale Exclusion Avoiding Taxes When You Sell Your Rental... 86 ii
Tax Reporting and Record Keeping for Depreciation... 87 Review Questions... 89 Review Answers... 90 Chapter 6 Maximizing Your Depreciation Deductions... 93 Learning Objectives... 93 Introduction... 93 Determining the Value of Your Land and Buildings... 93 There Is No One Way to Determine Land and Building Values... 94 Figuring Your Improvement Ratio... 94 Property Tax Bill... 95 Replacement Cost... 96 Buyer-Seller Valuation... 97 Comparable Land Sales... 98 Cost Segregation... 98 Problems With Cost Segregation... 99 Time for Cost Segregation... 100 Cost Segregation Studies... 100 Identifying Personal Property and Land Improvements... 101 Cost Segregation Example... 103 Review Questions... 106 Review Answers... 107 Chapter 7 The Pass-Through Tax Deduction... 109 Learning Objectives... 109 Introduction... 109 Your Rental Activity Must Be a Business... 109 You Must Have a Pass-Through Business... 109 You Must Have Qualified Business Income... 109 Rental Losses Reduce or Eliminate the Pass-Through Deduction... 110 Landlords With Multiple Businesses... 110 You Must Have Taxable Income... 111 Calculating Your Pass-Through Deduction... 111 Taxable Income Below $157,500 ($315,000 for Marrieds)... 111 Taxable Income Above $207,500 ($415,000 for Marrieds)... 112 Taxable Income $157,500 to $207,500 ($315,000 to $415,000 Marrieds)... 113 Taking the Pass-Through Deduction... 113 Strategies to Maximize the Pass-Through Deduction... 114 Review Questions... 115 Review Answers... 116 Chapter 8 Interest... 117 Learning Objectives... 117 Introduction... 117 Interest Landlords Can (and Can t) Deduct... 117 Mortgage Interest... 118 Interest, Not Principal, Is Deductible... 118 Expenses to Obtain a Mortgage... 118 Private Mortgage Insurance... 119 Mortgage Refinancing... 119 Mixed-Use Properties... 119 Other Interest Expenses... 119 Credit Cards and Loans... 119 Car Loans... 120 Home Offices... 120 Home Equity Loans... 120 Points and Prepaid Interest... 120 Interest on Construction Loans... 121 iii
Loans With Low or No Interest... 122 Loans on Rental Property Used for Nonrental Purposes... 122 Limitation on Interest Deductions by Landlords Earning $25 Million or More... 122 Review Questions... 124 Review Answers... 125 Chapter 9 Start-Up Expenses... 127 Learning Objectives... 127 Introduction... 127 What Are Start-Up Expenses?... 127 Determining Your Business Start Date... 128 Rental Business Begins When You Offer Property for Rent... 128 Expanding an Existing Rental Business... 128 How to Deduct Start-Up Expenses... 129 Expenses You Can Deduct... 130 Costs That Are Not Start-Up Expenses... 130 If Your Business Doesn t Last 15 Years... 132 If Your Business Never Begins... 132 Review Questions... 133 Review Answers... 134 Chapter 10 The Home Office Deduction... 135 Learning Objectives... 135 Introduction... 135 Qualifying for the Home Office Deduction... 135 Threshold Requirements... 136 Additional Requirements... 136 Calculating the Home Office Deduction... 137 How Much of Your Home Is Used for Your Rental Business?... 138 What Expenses Can You Deduct?... 138 Simplified Home Office Deduction Method... 140 IRS Reporting Requirements... 140 Deducting an Outside Office... 141 Renting an Office... 141 Using an Office in Your Rental Building... 141 Buying a Separate Office Building... 141 Review Questions... 142 Review Answers... 144 Chapter 11 Car and Local Transportation Expenses... 147 Learning Objectives... 147 Introduction... 147 Deductible Local Transportation Expenses... 147 Travel Must Be for Rental Activities... 148 Driving from and to Home... 148 The Standard Mileage Rate... 149 How the Standard Mileage Rate Works... 149 Requirements to Use the Standard Mileage Rate... 150 The Actual Expense Method... 150 How the Actual Expense Method Works... 151 Record-Keeping Requirements... 151 Vehicle Depreciation Deductions... 151 Leasing a Car... 153 Other Local Transportation Expenses... 154 Reporting Transportation Expenses on Your Tax Return... 154 Review Questions... 155 Review Answers... 156 iv
Chapter 12 Travel Expenses... 157 Learning Objectives... 157 Introduction... 157 What Are Travel Expenses?... 157 Where Is Your Tax Home?... 157 Your Trip Must Be for Rental Business... 158 Deductible Travel Expenses... 160 Traveling First Class or Steerage... 160 Taking People With You... 160 How Much You Can Deduct... 161 Calculating Time Spent on Rental Activities... 161 50% Limit on Meal Expenses... 162 Review Questions... 163 Review Answers... 164 Chapter 13 Hiring Help... 165 Learning Objectives... 165 Introduction... 165 Deducting Payments to Workers... 165 Operating Expenses... 165 Start-Up Expenses... 166 Depreciation Expenses... 166 Employees Versus Independent Contractors... 166 Tests to Determine Workers Tax Status... 167 Common Classifications for Workers... 168 Tax Rules When Hiring Independent Contractors... 168 Threshold for IC Income Reporting... 169 Obtaining Taxpayer Identification Numbers... 170 Filing IRS Form 1099-MISC... 170 Reporting Requirements Don t Apply to Corporations... 172 New Hire Reporting Requirements for ICs... 172 Paying Independent Contractors Expenses... 172 Tax Rules for Employees... 172 State Payroll Taxes... 173 Hiring Your Family... 174 Employing Your Children... 174 Employing Your Spouse... 175 Rules to Follow When Employing Your Family... 175 Hiring a Resident Manager... 176 No Payroll Taxes for Free Lodging... 177 Review Questions... 178 Review Answers... 179 Chapter 14 Casualty and Theft Losses... 181 Learning Objectives... 181 Introduction... 181 What Is a Casualty?... 181 External Force Required... 181 Theft or Vandalism... 182 Calculating a Casualty Loss Deduction... 182 Insurance... 182 Property a Total Loss... 183 Property a Partial Loss... 183 Deducting Separate Components... 184 Effect of Casualty Losses on Basis... 184 Disaster Area Losses... 185 Repair and Replacement Costs for Casualty Losses... 185 v
Tax Reporting and Record Keeping for Casualty Losses... 185 Review Questions... 187 Review Answers... 188 Chapter 15 Additional Deductions... 189 Learning Objectives... 189 Introduction... 189 Dues and Subscriptions... 189 Education Expenses... 189 Before You Are in Business... 190 Traveling for Education... 190 Gifts... 190 Insurance for Your Rental Activity... 191 Homeowners Insurance for Your Home Office... 191 Car Insurance... 191 Prepaying Your Insurance Premiums... 191 Legal and Professional Services... 192 Buying Long-Term Property... 192 Management Fees... 192 Starting a Business... 192 Accounting Fees... 192 Meals and Entertainment... 193 Taxes... 193 Real Property Taxes... 193 Employment Taxes... 194 Tax Break for Accessibility Changes... 194 Unpaid Rent... 194 Review Questions... 196 Review Answers... 197 Chapter 16 Deducting Rental Losses... 199 Learning Objectives... 199 Introduction... 199 What Are Rental Losses?... 199 Overview of the Passive Loss Rules... 200 What Are the PAL Rules For?... 200 How the PAL Rules Work... 200 The $25,000 Offset... 202 Requirements... 202 Determining Your Offset Deduction... 204 The Real Estate Professional Exemption... 205 Real Estate Professional Test... 205 Materially Participate in Rental Activity... 210 Applying the Test... 212 What Happens If You Qualify for the Exemption?... 212 The Real Estate Professional Exemption Is Not Optional... 213 Record Keeping for the Real Estate Professional Exemption... 213 Deducting Suspended Passive Losses... 215 You Must Have Passive Income... 215 The $25,000 Offset... 215 The Real Estate Professional Exemption... 215 Profits from Sale of Property... 215 Tax Reporting for Passive Rental Losses... 216 Strategies for Dealing With the Passive Loss Rules... 217 Lower Your Rental Expenses... 217 Generate More Passive Income... 217 $250,000/$500,000 Annual Loss Limit... 218 At-Risk Rules... 219 How to Deduct Rental Losses... 220 vi
Calculating Your Net Operating Loss... 220 Review Questions... 221 Review Answers... 223 Chapter 17 Record Keeping and Accounting... 225 Learning Objectives... 225 Introduction... 225 What Records Do You Need?... 225 Paper Versus Electronic Records... 225 Create Your Own Spreadsheet... 226 Software Programs... 226 A Simple Record-Keeping System... 227 An Easy Filing System... 227 Separate Checkbook and Credit Cards... 227 Dealing With Receipts, Canceled Checks, and Other Supporting Documents... 228 Expense Journal... 230 Rental Income Journal... 232 Asset Records... 233 Records Required for Local Travel... 234 Records Required for Long-Distance Travel, Meals, and Gifts... 235 How Long to Keep Records... 236 Accounting Methods... 237 Review Questions... 238 Review Answers... 239 Chapter 18 All About Schedule E... 241 Learning Objectives... 241 Introduction... 241 Who Must File Schedule E?... 241 Filling Out Schedule E... 242 Filing IRS Forms 1099 (Lines A and B)... 242 Property Description (Line 1)... 242 Dual Use Properties (Line 2)... 245 Qualified Joint Venture (Line 2)... 245 Rental Income (Line 3)... 245 Royalties Received (Line 4)... 245 Expenses (Lines 5-20)... 245 Rental Summary (Lines 21 26)... 247 Review Questions... 249 Review Answers... 250 Chapter 19 The Net Investment Income Tax... 251 Learning Objectives... 251 Introduction... 251 How the NII Tax Works... 251 What Is the NII Tax?... 251 Who Is Subject to the NII Tax?... 251 Amount of the Tax... 252 Real Estate Professional Exemption from the NII Tax... 253 Real Estate Professional... 253 Material Participation in Rental Activity... 254 Rental Activity a Business... 254 Planning to Avoid the NII Tax... 254 Review Questions... 256 Review Answers... 257 Glossary... 259 Index... 263 vii