While tax returns aren’t due until April, to minimize your tax burden the strategy of accelerating rental property expenses should be considered now, according to Larry Nelson, CPA and partner at Kerkock Katter & Nelson LLP. With twenty years of experience assisting rental property owners, Nelson suggests that deducting these expenses this year could be more important than ever, especially if you’re affected by the new Affordable Healthcare Act tax.
Under the Act, if your modified adjusted income exceeds $250,000 (filing jointly) then you’ll pay an additional 3.8% tax on any rental income or other passive income above that amount. Rental property expenses are deductible only in the year they are paid, so December is your last chance to pay for any rental property-related expenses that you want to deduct this year. Additionally, you can pay your expenses in advance, so consider paying in December some expenses due next year (such as a mortgage payment, property taxes, or utility bills) to offset this year’s income.
As far as rental income is concerned, don’t be tempted to defer rental income for December rents to next year. The Internal Revenue Service matches 1099s for commercial leases, and they want to see rental income match up with 1099s. While residential rental owners don’t receive 1099s from their tenants, Nelson says he has been involved in audits where the IRS examined residential lease agreements and had issues with the rental owner declaring less than a full twelve months of income if the unit was occupied for the entire year. But what if you were on vacation for all of December and didn’t check your mailbox until mid-January? Nelson says that’s income for December.
Nelson also says it’s important to not make assumptions about rental income losses — he’s seen several clients get burned because they thought they could deduct these losses. The problem is that rental income losses fall under the “passive income rule” which can be a complicated beast. Rental income is considered passive income, and under the rule, passive income losses can only be offset against passive income, which means you need to have another rental property that makes money or some other passive income source. The rule is different if your adjusted gross income is less than $150,000. Nelson emphasizes that passive income rules are very complex and everyone has a different situation, so it’s critical that you consult with your tax adviser before you act on any assumptions.
Checklist: End of Year Taxes:
- Meet with your accountant to discuss end of year tax strategies.
- Consider paying now expenses due next year to offset this year’s income.
- Let your accountant know if you anticipate any rental losses next year, or if you’re planning on refinancing, buying, or selling rental property as these activities may have tax consequences that might be partially mitigated with informed planning.
- If you formed an LLC or S-Corporation to hold your rental property, order 1099s now to send to your unincorporated vendors (to whom you paid more than $600) by January 31st — it can sneak up quickly.