Monday, February 17, 2014

Property Management, Investment Property Tax Deductions, and Tax Strategies for Real Estate Professionals

The cost of hiring a property management company to handle investment properties is significantly less than most property owners believe.  Investment property owners who manage their own property with the idea that property management costs are too much might be mistaken as to the actual real costs.  Additionally, a large percentage of property owners do not take advantage of all of the tax strategies available to them.  For example, if a property owner manages their investment portfolio out of their home office there may be some business related items they are not expensing.  Interest in all forms including mortgage interest, equity lines of credit interest, and any business loan interest are all expenses which are typically deductible.  Losses like casualties, disasters, and thefts are expenses which properly accounted for are deductible.  The most overlooked deduction is depreciation on investment properties, and for real estate professionals as defined by IRC 179, an investment property owner can supercharge their depreciation deductions.  To maximize one’s return on investment each property owner should educate themselves about tax strategies, and thoroughly evaluate their entire tax planning roadmap with a tax attorney or competent certified public accountant.

Combined Tax Bracket Percentage Determines the True Cost of an Expense in Your Investment Property Business
First of all a property owner must fully understand this basic concept.  If their annual income from all of their activities placed them into the combined, federal, state, and local tax bracket of 50%, then their ordinary and necessary business expenses are in actuality fifty cents ($.50) for every one dollar ($1.00) spent.  It’s simple to think about it this way: If a one dollar ($1.00) is spent on advertising then that one dollar ($1.00) is legally expensed.  If a person is in the 50% combined tax bracket then they have actually only spent fifty cents ($.50).  This is because the one dollar ($1.00) they spent actually reduces their taxable income by one dollar, thus, reducing their tax liability by fifty cents ($.50).  So each ordinary and necessary expense is truly only 50% of the actual cost.

Now that you have your mind around that concept if a property manager is charging you $200/month to manage their single-family residence rental property the actual (end of year) cost to the owner is only $100/month because the property management fees are an ordinary and necessary business expense and fully deductible.  Now consider that 50% reduction in your perceived cost and maybe property management doesn’t seem so expensive anymore.  Add to that the impact on your time, energy, effort you spend managing that property.  Add to that the gasoline expense necessary to drive by that property once or twice a month.  Finally, add to that the comfort of knowing a professional property manager could in fact be taking care of your property and you wouldn’t have to have all of these expenses, time, energy and effort and maybe, just maybe, you would reconsider using a property manager going forward because you now realize that they really aren’t that expensive for the services they provide.

Home Office Deductions are Tricky, but can be Legitimate
If a home office is used 100% for ordinary and necessary business reasons then there is no reason a person shouldn’t be taking advantage of expensing the home office square footage, the equipment, the materials, the supplies and any utilities paid to help operate the office.  The problem lies when the home office is used for personal reasons because it is difficult to prove what percentage of the home office is actually an ordinary and necessary business expense.  There are many Internal Revenue decisions on this vary issue, and each one shows the difficulty in achieving the correct balance between business and personal expense, and more importantly, being able to prove it in an audit.  If you are considering running your property management business out of your home office be careful.  Although there are a lot of legitimate expenses which are clearly available to you, there are several that are not.

Interest Expense is Sometime Overlooked
When you are evaluating your interest expenses do not forget to expense any interest from your home equity line of credit as this can be easily overlooked.  Also, if you have a small business loan that interest is deductible as well. 

Disaster, Theft Losses are Deductible
In the event that a loss occurred during your business cycle those expenses are deductible provided you had a good record of the items that were lost.  There would almost always be an offset as well for any insurance reimbursements, but the point here is that losses must be fully evaluated while you are preparing your tax strategies.

Depreciation and the Real Estate Professional Internal Revenue Code
When planned correctly the “non-cash” expense of depreciating one’s rental property can be the difference in paying taxes or realizing the benefit of a tax-loss.  Most residential investment properties are depreciated over 27.5 year period.  Commercial property is depreciated over 39 years.  However, if a person were to be classified as a “Real Estate Professional” pursuant to Internal Revenue Code 179, then the benefits of owning investment property become much greater.  Without going into great detail a real estate professional’s own personal property portfolio is treated differently than a typical investor.  If this is enticing enough one should investigate the benefits of this little known exception in the IRC and real estate industry.

Contact a Competent Tax Attorney or Certified Public Account to Review All of Your Current Tax Strategies and any Planning Going Forward with Your Investment Properties

The information contained in this article is by no means tax advice, but merely some ideas to contemplate the next time you consider your tax situation.  Every person who owns a rental property business should consider tax planning and tax strategies with a competent professional specializing in tax.  There are numerous legal ways to take full advantage of tax laws and your professional status within the property management context, however these decisions need to be considered carefully with a tax professional.