Real estate is one of my absolute favorite areas in the tax law because there is so much flexibility in how to do things to legally maximize the tax benefits available.
Real estate is also one of the most complex areas of the tax law. This makes it easy to overlook important steps, which can lead to missing out on tremendous tax savings.
I recommend reviewing your tax strategy throughout the year, particularly as it relates to real estate. This makes it much easier to make adjustments timely, minimize oversights and reduce stress at the end of the year and tax return time.
With the end of the year approaching quickly, it is an ideal time to implement a year round strategy to review your tax strategy as it relates to your real estate. Start with my year-end checklist for rental real estate and then adapt it to use throughout the year.
Year-End Checklist for Rental Real Estate
Here are a few items from the checklist my team and I use when working with clients:
#1 Identify Improvements and Repairs
What is the difference between an improvement and a repair? The general difference is this:
A repair simply keeps the property at its normal operating condition.
An improvement extends the useful life of the property, enhances the value or modifies it for a different use.
Here is what to identify:
Have there been improvements made to your real estate?
If so, identify the cost of the improvement and when it was completed. Improvements are items that are capitalized and depreciated (deducted over a period of years) for tax purposes.
Have there been repairs made to your real estate?
If so, review each repair expense to make sure it is indeed a repair.
Here is why this is so important. Repairs can be deducted immediately and do not have to be capitalized like improvements. This can have a huge impact on your taxes.
Often times, improvements are incorrectly treated as repairs and repairs incorrectly treated as improvements.
This can really throw your numbers off! This can also cause a hold up in the preparation of your tax return, or worse, if it goes undetected, it can lead to filing a tax return with incorrect information.
#2 Review Your Depreciation
Determine if maximizing your depreciation deduction will help your tax situation.
It’s very easy to assume that maximizing your depreciation is always a good thing, but that is not always the case.
For example, if your real estate losses are limited, then maximizing your depreciation deduction may not be your best move.
On the other hand, if your real estate losses are not limited, then maximizing your depreciation may create HUGE tax savings.
If your real estate losses are not limited, look into having a cost segregation study done on new rental properties or rental properties that have never had a cost segregation done.
Get your study done now so it doesn’t hold up your tax return preparation next year.
#3 Understand Your Losses
Rental real estate losses have very specific rules.
It is very common for rental real estate to have losses for tax purposes even if there is positive cash flow. This is usually the result of depreciation – a non-cash deduction that when done correctly can be quite large.
Depending on your specific facts, your rental losses may be allowed in full, partially allowed, or disallowed in the current year. Any amount that isn’t currently allowed will carryover to the following year.
It is critical to understand how your rental real estate losses will be treated.
It’s important to not assume your rental real estate losses will be treated the same every year.
Sometimes a minor change in your facts can impact how your real estate losses are treated so this is an important item to review every year.
If you claim “real estate professional” status for tax purposes, make sure your log of hours and activities are up-to-date.