[00:00:00] Hi, everyone. This is the how to lower your tax bill 
[00:00:10] podcast. I'm your host, Terrence Hutchins. I'm, a financial and tax advisor in the Dallas Fort worth area. And the goal of this podcast is to help you listeners get 
[00:00:20] educated on different tax strategies. That you can implement to improve your tax situation immediately? Each episode, we'll break down useful tax tips you can use to save 
[00:00:30] money no matter what your personal or business income situation. Because our motto is keep more of what you earn. So let's get into today's [00:00:40] episode.   
Okay, so thank you for tuning in to another episode of How to Lower Your Tax [00:00:50] Bill. I'm your host, Terrance Hutchins, and we have been going through real estate and talking about just some of the tax rules and strategies around that. And 
[00:01:00] so today we're gonna dive into rental property deductions, and we're gonna go through number one, what is considered rental income.How landlords are 
[00:01:10] taxed, what you can and you can't deduct, what are some strategies that you might be overlooking? And we're also gonna look at what's a non-for-profit rental. As I know some 
[00:01:20] people have multiple houses or properties that they own and they maybe have family members living there. So we'll just talk about what that looks like from a tax perspective.
So first, what 
[00:01:30] counts as rental income? Rental income includes any payment you receive for the use or occupancy of the property. So it's a pretty broad definition, 
[00:01:40] but obviously when you're getting your rent every month, if you get advanced rent that counts in the year that you receive it. Security deposits count. Once they become 
[00:01:50] forfeited. Someone puts a $300, 500 security deposit down, they move out. Uh, you keep $400 to their deposit, that $400 becomes rental income at that 
[00:02:00] time. Fees for breaking a lease, that's gonna be considered income. And then if you pay for expenses in exchange for rent, that's gonna be considered 
[00:02:10] income. So for example, if you have a tenant that. Goes and buys something that's $500 for the property that's considered rent in lieu 
[00:02:20] of actually giving you the cash for it. And then if you have a lease cancellation, and it doesn't matter how you collect your rent, so cash, Venmo, checks, all of it is 
[00:02:30] considered income. Now, whether you report it or not, that's up to you, but all those, the IRS is gonna call income. Now, if you do rent out a property, then you're considered a landlord, 
[00:02:40] right? That's kinda your old school moniker for that. But from a tax standpoint, you're gonna report that on Schedule E because real estate is considered a passive activity.
[00:02:50] Even if it's a short term rental. Unless you are providing like hotel type services, you're gonna file it as a passive activity on your Schedule E, and you will pay income tax 
[00:03:00] on that, on any profits you have, but you will not be subject to self-employment tax. You also could pay net investment income tax if you're a higher income earner.
So if you're 
[00:03:10] single and you make over $200,000 or you're married and you make over $250,000, if you do have any positive. Rental income, you're gonna pay an extra 3.8% tax on 
[00:03:20] that rental income. We talked about that a little bit before, so there's a little nuance to that calculation, but just know that, hey, that is something you could potentially pay as well.Now when it comes to your 
[00:03:30] deductions, we're gonna look at those in the four categories. So you have operating expenses, you have capital expenses, you have depreciation, and then you have other taxes and fees. Now operating 
[00:03:40] expenses is what most people think about when they're renting. So number one, as we've talked about in the past, your expense just has to be current, ordinary, and necessary and reasonable. So as 
[00:03:50] long as you paid for something in that current year that was for the ordinary or reasonable upkeep of your property or use of the property, you can deduct it. I would 
[00:04:00] encourage you to go back to a past episode because sometimes when you do pay for expenses, those expenses areimprovements or added to the value of the property versus being deducted in the current year. 
[00:04:10] But it's important that you distinguish that because you can probably miss out on deductions that you would currently use and avoid some depreciation recapture or if there are things you can deduct in the current 
[00:04:20] year versus kind of spreading them out. But here's just a few things that would normally qualify as the deductible that you can be aware of. And when you are filing your taxes, you wanna 
[00:04:30] be able to look at your Schedule E form and be aware that, Hey, am I including all these items? So you may have property management fees, cleaning and maintenance, lawn care repairs, 
[00:04:40] pest control, utilities, advertising. Commissions to your real estate agent for finding a property or your property management company travel to and from the property. You could have 
[00:04:50] mileage, office supplies, postage, legal and accounting fees, home office deduction if you do have a exclusive place in your house that 
[00:05:00] you conduct your rental activities. As far as. Screening tenants, doing your bookkeeping, all that kind of stuff. You can qualify for a home office. Also, bank fees. If you have bank fees that are tied 
[00:05:10] to your business account, any screening cost, so background checks, any software costs like QuickBooks or anyproperty management software that you might have, the cell phone portion 
[00:05:20] that you use. So hey, 20% of your cell phone is used for business. Then you'd wanna write that off I would say the four things that I always look for, that every property generally is gonna have, unless it's paid off, it's 
[00:05:30] gonna be interest depreciation. Taxes and insurance. If you don't have those four, then I wanna make sure, okay, is the property paid off? If it's not, then you're gonna have all four of those. Now, 
[00:05:40] when it comes to depreciation, that's one area that I see people miss. So let me tell you a little bit about thep appreciation as it relates to if you've realized that you haven't taken it. So, number 
[00:05:50] one, if you filed your tax return for 2023, let's say, and you didn't file a depreciation, I would encourage you to go back. Amend that tax return to add the depreciation 
[00:06:00] expense first. Whenever you sell the property, the IRS is gonna calculate your depreciation recapture as if you had taken the depreciation. For example, you 
[00:06:10] own a property for 10 years and the annual depreciation was $50,000 total. Whenever you sell the property, you're gonna have to pay tax on that $50,000. Either at 
[00:06:20] 25% or at your current tax bracket, whichever is lower. So if you are in a 12% tax bracket, you'll pay 12%. If you're in a 30% tax bracket, you'll pay 
[00:06:30] 25. When it comes to that 50,000 depreciation, even if you didn't claim it on the property. Then you will need to pay it. Okay, so if you only took 
[00:06:40] 40,000, the IRS is gonna treat you as if you took 50. And so you're basically gonna pay tax on money you never actually got a tax benefit for. So that's why if you missed it the first year, you're gonna go wanna go back and correct it. 
[00:06:50] After the first year, and you've been doing it two years or more, you're gonna actually have to do what's called an accounting change. So you're gonna have to tell the IRS, Hey, sorry. I missed [00:07:00] taking depreciation on this property, or like I've had recently where someone was depreciating a residential property as if it was a commercial property or in a cost segregation 
[00:07:10] situation where you were taking normal depreciation and you decide you wanted to take a bonus depreciation. Instead, you go and tell the IRS I wanted to take a different type of depreciation. And 
[00:07:20] so you'd have to fill out a Form 31 15 to indicate that depending on which method you were changing to, and you would actually be able to take the depreciation that you hadn't taken . In that 
[00:07:30] year. So for example, let's say I'm in year three and I missed taking $10,000 of depreciation from the prior two years. in year three , I can take essentially $15,000 of 
[00:07:40] depreciation. So the 10,000 depreciation I should have taken And then $5,000 of the current year , I'll be able to take that in the first year. That's called a section 4 81 
[00:07:50] adjustment. And so that's obviously a little more nuanced, so make sure that if you're in that situation, you work with a qualified professional to help you walk through that.
Now, a few other commonly missed deductions, I always ask people [00:08:00] before are if they had education cost. If you did some kind of education cost relating to your rental, then that can be deducted in most situations. If you pay for meals or something, let's say 
[00:08:10] for your contractors or property managers, if you gave gifts to your tenant, which is a cap of $25, you can deduct those. If you pay for utilities during vacancy periods, then 
[00:08:20] that would be something you'd want to deduct. Also, storage unit fees. So let's just say you moved your stuff out. If you're paying for a storage unit, you can deduct that.   Now when it comes to 
[00:08:30] travel, you're gonna use your car similar to how you would in any other business. So you're gonna either take the actual expense method, which. Requires you to track the cost of gas, repairs, all [00:08:40] that stuff, and then take the percentage that is considered business use. If you use your car, let's say 10% for business, then 10% of those expenses are gonna be deducted or simply you just take your miles.
[00:08:50] So for last year, 20 24, you take 67 cents per mile and that's something you'd wanna make sure you document it on your tax return. So those are operating 
[00:09:00] expenses. Those are gonna be most common. So make sure that you are reviewing those every year, you're keeping good records. Secondly, we have capital expenses. So those are things that we've talked about before are gonna be kind 
[00:09:10] of improvements to the property. For example, I put on a new roof, or I added a deck or I put in flooring. Those are gonna be added to the value of the property, and you're gonna depreciate them over the life 
[00:09:20] of the property. Fourth is gonna be depreciation, so we got into that. On a residential property, you're going to depreciate it over 27 and a half years, minus the land cost, and 
[00:09:30] then commercial property, you're gonna do it over 39 years. We also talked about the ability to do potentially a cost segregation study where you broke out the property into its four 
[00:09:40] components. Which are gonna be the personal property, which are gonna be things like the oven, items that maybe didn't come with the house, land improvements, which would 
[00:09:50] be your landscaping, your concrete, the deck, all that kind of stuff. And then you have the actual structure of the building, which is, you know, what was built into the ground 
[00:10:00] whenever you constructed the house and then the land. So land isn't depreciated, but the land improvements and the personal property, those things that you could depreciate in an accelerated 
[00:10:10] method. So instead of having it spread out over 27 and a half years, you can actually either do it at five years, or you could even take 40 to 60% of the depreciation in the first year, depending on the year you're 
[00:10:20] doing it. So we talked about that a little bit on past episodes, so you can check those out And then you have other tax and fees, Obviously if you have property taxes, you can deduct those trash pickup 
[00:10:30] fees, sewer and water charges, special assessments.On a special assessment, the maintenance portion is deductible. The improvements must be capitalized. So that happens a lot of times with
[00:10:40] like condos or something like that. If you have a condo association, they might do a special assessment and then you'll have to actually add that to the value of the property and depreciate it from there.Okay, so let's get 
[00:10:50] into a few things that aren't deductible. So your time, I get this quite often where people think, Hey, I spend X amount of time, I bill at whatever rate you bill 
[00:11:00] at. Well, the IRS doesn't necessarily care about your time. And so even though it's great that you're spending time and you wanna make sure that the investment returns you're getting are factoring 
[00:11:10] in the time you're spending, but as far as tax deduction is concerned, your time is not deductible. Now, if you pay someone their time is deductible, but not your own. The personal portion of any 
[00:11:20] expense that you use. So just because you buy something that you used a little bit for the rental doesn't mean that all of it is gonna be deductible. So you're gonna have to look at the percentage of 
[00:11:30] use. Entertainment let's say I'm entertaining, potential client or a tenant or whatever the case is, that entertainment amount is not gonna be deductible. Lost rent due to vacancies. That is not 
[00:11:40] deductible. That just lowers the amount of rental income that you're gonna report. And then if you do return the security deposit, that's not a deduction.That was just money you were holding. So that kind of isn't 
[00:11:50] rental income, but it's not gonna be a deduction whenever you send the money back. Okay, now one deduction you're gonna want to be aware of is what's called the path through deduction. That 
[00:12:00] deduction allows you to deduct up to 20% of your rental income profits. Many people will do what's called a safe harbor, which just means that you're, the IRS will 
[00:12:10] consider you having a business, which is what's necessary for you to actually qualify for this deduction because they want to consider it qualified business income. Well, if you don't have a 
[00:12:20] business, you can't have a deduction that's tied to business, so in order for you to be able to deduct the rental income. You would have to be considered a business, which means that if you spend 
[00:12:30] at least 250 hours on your rental per year, the IRS says, you are considered a business. And so you could actually put this Safe Harbor election on your tax return and that will qualify for you with that 
[00:12:40] extra 20%. Now, I would encourage you, if you are losing money on paper and you are operating this rental, then I would not use that safe harbor. If it's just like a 
[00:12:50] one-time rental because you're gonna have a negative QBI deduction and that negative QBI I deduction is gonna carry forward. And so just how we've talked in the past about rental 
[00:13:00] losses carry forward where, hey, I can't use the losses to reduce my income. I can only use them to reduce future income if I sell the property or I have rental income that's positive.Well, 
[00:13:10] these QBI deduction, that will also carry forward. So for example, if I have five, $10,000 of QBI deduction. And because I have a loss for my rental 
[00:13:20] property, once I do have positive income, then that's gonna actually reduce my QBI deduction at the time. So let's just say I have a negative $10,000 of QBI from prior 
[00:13:30] years, and I finally break. The barrier where I start having rental income that's positive and I have $10,000 of positive rental income. Well, normally I get a $2000 
[00:13:40] deduction because it's 20% of $10,000, which is $2000. However, if I have a negative $10,000 that carries forward, that would wipe out my QBI deduction. So my QI deduction in that year would be 
[00:13:50] zero. Needless to say, don't take a safe harbor deduction if you have a loss on the property, specifically if it's in your first year. Now let's get into what is a 
[00:14:00] not-for-profit rental? So I see this, I don't know why I see more often than this is the case, but many times people have their mom, they have their brother, their cousin living in the 
[00:14:10] property, or their kids. The IRS says this rental is not for profit, which means it's more like a hobby. So if you're renting way below market, they're not gonna let you take 
[00:14:20] deductions on that rental as if it's a, a regular rental. So you can't take a loss on a rental that's not really a business property. Now what would be positive is 
[00:14:30] if you only rent out the property for 14 days or less, then the rental income is tax free to you.But you just can't make any of the deductions. So that's where it's positive, where, hey, someone's 
[00:14:40] actually paying me to rent my space, but it has to be 14 days or less. But if you're just renting out under market, then we're not gonna be able to take those losses on the property. So 
[00:14:50] if your rent, the fair market is $3000, and your mom is staying in your property for a thousand bucks, and you're like, well, you know, I can just start writing off my expenses.Well, the IRS is 
[00:15:00] gonna say, hold on, that's not a legitimate rental. And so you can't take a loss on that. Now you do have to report the income you receive, but you can only take deductions up to the income that you receive. 
[00:15:10] So you can't claim like depreciation or your home office and business meals on stuff like that. So be aware if you are renting below market to someone that you know that it's not gonna give you a 
[00:15:20] tax positive benefit. we've gone through, you know, some ins and outs as far as what is real income, what deductions are available to you, what are commonly missed, and then not-for-profit 
[00:15:30] rentals, and a little bit about depreciation. So hopefully. You are able to apply that to your tax return for 2024 and plan ahead for 2025. And if you decide to get into the rental 
[00:15:40] game, you'll be able to keep good records to make sure that you capture all the deductions that are available to you. To illustrate this point with a. Below 
[00:15:50] market Reynold. There was a tax court case back in 1998. This was Ronald p Barte versus Commissioner, and this specific individual was renting 
[00:16:00] to his brother a property that. Fair market would suggest it should have been 700 to $750 per month. But he was renting to his brother for $500 a 
[00:16:10] month plus utilities. And so obviously he's over here writing off utilities, the taxes, the insurance, and so he's creating this tax loss.And so the IRS looked at the 
[00:16:20] facts. They, throughout the loss, went to tax court. The tax court upheld that, according to section two 80 a says. No deduction is allowed for a dwelling 
[00:16:30] unit used as a residence by the taxpayer during the taxable year, except for deductions allowable without regard to their connection to an income producing activity, which is just tax jargon. And say, 
[00:16:40] you weren't trying to make money on this, so we're not gonna give you the same deductions on this property as if you were trying to make money on it. So that's why they consider it not a business, not an activity that he was trying to 
[00:16:50] make money from. And they pretty much treated it as a personal residence. So you can't. The take deductions on your personal residence outside of the regular schedule A amounts. So keep that in 
[00:17:00] mind if you are out there renting to a family member that you're basically just doing them a favor, okay? And if the gap is big enough, it could actually be considered a gift if 
[00:17:10] you have a very high income property that you're actually just giving to them or letting them live in it for free keep that in mind. Be sure to keep more of what you earn, and we'll talk to you next week