Should you buy rental property for the tax benefits?

A client “Bob” is looking at buying a summer home in Michigan to get away from the summer heat in Arizona. Bob was born in Michigan and has fond memories of his growing up and enjoying the Michigan summers.

Bob: Jeff, my wife “Sally” told me that the reason some people with a lot of money will rent out a home must have some taxation benefit or they would not do it.

Jeff:  Bob, the reason people buy rentals is because they do not have to put in all of their own money. Instead they can leverage their investment by borrowing over 50%.  They are betting that the house will appreciate in value and that renting the house will offset some of their monthly costs.  Wealthy people may have passive income from a business investment of a closely held S corporation or partnership.   This passive income is reduced by the rental property losses.

Bob: Jeff If I invest in the stock market and make money can I offset my rental property loss against my stock market gains?

Jeff:  Bob, the stock market since stock market income cannot be used to offset the rental property losses because stock market income is classified as ” portfolio” income. Only “passive income” can offset the rental property “passive loss”.
For example, I invested in a successful privately owned restaurant chain. Since I did not spend the 500 per year hours required to make me non-passive in the business, I was passive. I was able to use the passive income from the investment in the restaurants against rental property losses.  However, if I had a passive loss from the restaurants, I would have not been able to deduct the losses because my wife and my income were too high and we did not have any passive income.

The rule is the full passive losses cannot offset non-passive (active income) unless the adjusted gross income is under $100,000 and the losses are from  rental estate which you are involved with.

Bob, the key is to always know where you are tax wise by running a tax plan through 9-30th of each year.

Bob: Jeff. Can we deduct all the repairs and upgrades to the Michigan property?
Jeff: Bob, only if your adjusted gross income is less than $150,000.  We expect your adjusted gross income to exceed $150,000 so the loss will be “suspended” into the future.
Example 1:  Joe and Jill Blow have rental income of $10,000 for 2014 and have the following expenses including utilities, insurance, repairs, maintenance, management fee commissions, mortgage interest, real estate taxes, homeowners association fees, depreciation on the building of $25,000.  The Blows’ adjusted gross income is $100,000 before the rental loss.  The Blows’ get to write off the entire $15,000 loss.

Example 2: Same $15,000 loss as Example 1 but if the Blows’ adjusted gross income was $125,000, they would only be allowed to write off one half of the $15,000 loss or $7,500.

Example 3: Same $15,000 loss as Example 1 but if the Blows’ adjusted gross income was $150,000, they would not  be allowed to write off any of the loss and the loss is carried forward to a future year when either they have A. adjusted gross income below $100,000 B. Sell the property or dispose of the property  C. They have other passive type income that can be used to offset the suspended $15,000 loss.

If the Blows’ rental loses money each year and the Blows’ continue to have adjusted gross income of $150,000 or higher, do not dispose of the property and do not have another rental or other passive activity with income, the losses remain suspended and are increased by each year’s loss until A. B. or C. in Example 3 occurs.

Bob:  Jeff, is there a mininum number of days it has to be rented out?
Jeff:  Bob, if under 14 days, you do not need to pick up any of the income.  So, 14 days would be the minimum number of days that it will need to be rented out.

Bob: Is it sufficient that it be “available and advertised for rent”, or does one’s success in renting play a factor?

Jeff:  Bob, advertising and available for rental make the property a rental. The good news is if you rent for less than 14 days, you do not have to pick up any income. Of course, you could show the rental income and the expenses if you wanted to do because you want to generate a loss.   Bob, the key is that we look at the tax plan and work on trying to move income to the next year so the adjusted gross income is lower and we can deduct the rental loss.    You also cannot deduct expenses for the summer months because you are occupying and not renting out the Michigan property.

Summary:  Before investing in rental real estate, you need to make sure that you understand that losses may not be deductible. This article is based on a client’s questions and the client’s specific tax situation.

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About Jeffrey Brooks

Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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JBrooks Wealth Advisors, PC.

Certified Public Accountant
Address: 4647 N 32nd Street, Suite B245
Phoenix, Arizona 85018
Phone: 602-292-2009