Receiving that monthly rental income feels excellent. You worked hard to get where you are today and now own properties and collect the monthly income.
Taxes come into the picture wherever there’s income generated by something you own, and a proper strategy to deal with them is essential. Rental income has quite a few nuances to the tax treatment that are unlike any other business or investment income. That tax treatment can vary depending on the business form in which you organize your rental company.
So what is the most beneficial way to handle your rental income on your taxes? Let’s jump in and find out!
Consider the Rental Company’s Legal Structure
Do you own the rental property(s), or are you a partner with someone else? Under current tax laws, the difference can be pretty stark.
If the rentals are owned by you alone, they will most likely be structured as a sole proprietorship or sole owner LLC. In either case, they both use the 1040 Schedule E for rental properties and have the same deductions and tax treatment.
A sole owner can form an S corporation which requires more work to maintain the legal structure but can result in lower taxes because the US tax code lets owners deduct the first 20% of income from “pass-through entities.”
Rentals with multiple owners will either be a partnership (LLC) or an S-Corp with multiple owners. In both cases, the legal structure is a pass-through entity, and each owner’s first 20% of income is tax deductible.
How is the Taxable Amount Calculated?
Before all else, it’s essential to understand what constitutes the taxable income from your rental property(s).
Add up all of the rent you’ve received and deduct all of your expenses. Expenses include everything that has contributed to the maintenance of the properties, rent collection, communication with tenants, vacancy listings, depreciation, and any other expenses incurred managing your properties. You might even deduct a percentage of your mortgage if you manage rentals from a home office.
If the amount of the rent you’ve received exceeds the costs, that is your taxable amount.
What About Mortgage Interest?
If you purchased the rental property by taking out a mortgage loan, the interest paid each year is deductible from the income earned by the property. If you spend $10,000 on interest and make $30,000 in rental income, subtract the interest and claim $20,000 in income.
Rental properties have the tax benefit of deducting depreciation on the structure but not the land. If you own a rental where the building is valued at $100,000, you can depreciate that building over 27.5 years. Divide $100,000 by 27.5, and deduct that $2,750 from the rental income yearly.
These are just a few basic nuances of handling taxes on your rental income. A tax professional’s advice will help you structure your rental(s) for optimal tax savings.
Owning rental properties can make for great residual income while the property’s value continues to increase. If you take advantage of all the deductions available, real estate can be one of the best investments you ever make.
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