How Rental Property Depreciation Works: Taxes, Benefits, Benchmarks & More

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Taxes can greatly affect your finances. According to recent government stats, the average American family paid $15,748 in taxes in 2018. If you own a rental property, you can reduce your tax bill through rental property depreciation. It’s a deduction that spreads out the costs of owning and maintaining a rental property over its lifetime. Instead of a large deduction in the year of purchase, you can spread it out over many years for maximum benefit.

The IRS acknowledges that rental properties lose value over time due to wear and tear. Residential properties have a useful life of 27.5 years, while commercial properties have a life of 39 years. You can deduct the annual depreciation expense from your income over these years. After that, the property is considered worn out for tax purposes.

However, not all rental properties qualify for depreciation. The IRS has strict guidelines, which you can find on their website. The key factors include property ownership, business use, useful life, and property depreciation (not the land).

Depreciation begins when the property is ready for renting and generating income. It usually ends when the property reaches the end of its life or is no longer used for business purposes. For instance, if you purchased a property in 1993 and it has been a rental since then, its useful life would have ended in the 2021 tax year. If the property is no longer used for business, such as being turned into a vacation home, you cannot claim depreciation anymore.

Understanding rental property depreciation can help you make informed decisions about taxes and financial planning.

Now that we’ve explained real estate depreciation and its benefits for property investors, let’s discuss how to calculate depreciation for your rental property. If you purchased the property after 1996, follow the modified accelerated cost recovery system (MACRS) for depreciation calculation. This system offers various depreciation methods to choose from.

To calculate rental property depreciation using the general depreciation system (GDS), follow these steps:

  1. Determine the initial cost basis of the property: This includes the purchase price and certain closing costs like legal fees and transfer tax. Exclude appraisal fees, mortgage insurance premiums, and credit report costs.
  2. Segregate land and building costs: Separate the land cost from the building or structure cost based on real estate tax values.
  3. Establish the basis for the rental property: Allocate a percentage of the purchase price to the rental property structure and the remaining percentage to the land.
  4. Adjust the basis if required: Significant improvements can increase the cost basis, while damages or losses can decrease it.
  5. Determine your depreciation percentage: Use the GDS depreciation method, which allows for a 3.636% deduction from the property’s value each year over a 27.5-year recovery period.
  6. Calculate the total depreciation amount: Multiply the property basis by the depreciation percentage to get the annual depreciation amount.

Consult a tax professional for specific property-related queries. Depreciation can be reported as an expense on your income tax return, reducing your overall tax liability. It offers double-dipping benefits, allowing you to deduct both depreciation and maintenance costs.

Real estate depreciation can result in substantial long-term savings. In the example mentioned earlier, if you depreciated $6,908.4 and fall into the 24% tax bracket, you could save $1,658 on your next tax bill.

Invest in Rental Properties with Foothold: Tax Advantages & More

Investing in rental properties has become easier, and now many can benefit from substantial tax advantages through depreciation. In the past, only those with the financial means to buy and manage properties could take advantage of depreciation deductions. However, recent technological advancements have changed this. 

With Foothold, you can invest in real estate without needing significant capital. Foothold handles property depreciation and passes the savings to you, eliminating the need to buy or manage properties individually. Start building your real estate portfolio, reduce your tax liabilities, and explore our available properties at your convenience. You might find unexpected opportunities. 

Please note that the information provided here is for general purposes only and does not offer specific advice or recommendations for any individual or investment product. These views are subject to change without prior notice. Please review Foothold’s disclaimers for more information.

10 Vacation Rental Tax Deductions

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Owning a holiday property has benefits, including surprising tax savings. By renting out your property short-term on platforms like Airbnb, VRBO, and HomeAway, you can reduce or eliminate income tax. However, eligibility for these tax breaks and deductible expenses depends on IRS classifications. To qualify as a holiday let, the property must be available for rent for more than 14 days per year, with limited occupancy by the owner or their family. For homeowners planning to rent their primary residence, it’s categorized as personal, not rental. Mixed-use homes have specific tax regulations, allowing deductions based on rental and personal use ratios. Renting a personal residence for less than 14 days annually doesn’t require reporting as rental income, but no expenses can be deducted. Overall, understanding tax rules and deductions is crucial for holiday rental property owners.

Vacation rental income is taxable, but you can reduce it with deductions. Here are some tax deductions for vacation rentals:

  1. Property Taxes: Fully deduct property taxes as a business expense.
  2. Repairs and Maintenance: Deduct costs for property upkeep.
  3. Property Improvement: Deduct major improvements.
  4. Mortgage Interest: Deduct interest payments on mortgages.
  5. Guest-service Fees: Deduct fees charged by platforms like Airbnb.
  6. Insurance Premiums: Deduct insurance premiums.
  7. Cleaning and Maintenance: Deduct costs for cleaning supplies and housekeeping.
  8. Advertising: Deduct costs for advertising your rental property.
  9. Depreciation: Recover property costs through depreciation.
  10. Legal Fees: Deduct fees for accounting and legal services.

Consult a CPA or tax professional for more deductions. Remember to keep records and receipts for maximum savings, and hope you profit from your rental property with these tax benefits.

Discover investment opportunities in holiday lettings today! 

Running a vacation rental can be a rewarding venture, but the highest rental earnings usually come from owning multiple properties. Instead of handling all the responsibilities on your own, you can choose to invest in vacation rentals through Foothold. With options suitable for almost any budget, browse the available homes and consider where you might want to invest today.

5 Top Rental Property Tax Deductions

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Owning a rental property, whether it’s for long-term or short-term leases, can be promising. It offers the potential for extra income and various tax deductions provided by the IRS. Real estate investors commonly use deductions such as mortgage interest, operating expenses, insurance premiums, property taxes, and depreciation. These deductions can help lower taxes and increase profits, making the investment more lucrative. This article highlights five tax benefits that rental property owners often take advantage of. To learn how to maximize returns, read on to discover the top five tax deductions for rental properties.

  1. Operating Expenses: Deductions for costs associated with maintaining investment properties.
  2. Mortgage Interest: Deduction for interest paid on loans used to purchase, build, or improve rental properties.
  3. Insurance Premiums: Deduction for landlord insurance premiums.
  4. Property Taxes: Deduction for property taxes assessed by local governments.
  5. Depreciation: Deduction for the loss in value of a structure over time.

Reporting Rental Property Tax Deductions: Use Schedule E to report income and expenses from rental properties. Understanding these deductions ensures accurate reporting of profits and payment of necessary taxes. Passive income from rental properties is usually exempt from self-employment taxes.

Utilizing rental property tax deductions benefits property investors by reducing taxable income through offsetting rental revenue. For example, property depreciation expense can offset profits. Reporting rental income and expenses requires IRS Form 1040’s Schedule E. It’s crucial to report all rental income and deductions, including repairs, mortgage payments, and travel expenses. Document significant upgrades as capital expenditures and deduct them over time. Understanding rental property tax deductions ensures accurate profit reporting and minimizes unnecessary tax payments. Rental property income is typically not self-employment, exempting investors from FICA and payroll taxes.

Monitoring income and expenses for rental property investments is crucial for real estate investors. To effectively track rental income and expenses:

  • Consider using property management software like QuickBooks or Landlord Studio to simplify tracking.
  • Be proactive in tracking your earnings and spending throughout the year to avoid surprises during tax filing or future investment planning.
  • Maintain separate bank accounts for each rental property to ensure accurate tracking, proper cash flow reporting, and maximize tax deductions.
  • Automate record-keeping by linking your bank accounts to your property management software.
  • Pay attention to financial metrics such as total revenue, adjusted gross income, net operating income, vacancy rate, and capital expenses, and make necessary adjustments when needed.
  • Generate detailed reports on rent rolls, expense records, cash flow statements, balance sheets, and profit and loss (P&L) statements to gain a comprehensive view of your property’s financial health.
  • Consider hiring a Certified Public Accountant (CPA) or other tax professionals specializing in real estate investment to ensure accurate reporting of all rental property-related income and expenses.

By following these strategies and maintaining careful monitoring of income and expenses, you can ensure accurate reporting, minimize tax bills, and plan for future investments effectively.

Final Thoughts 

Investing in a property can be highly profitable, offering numerous tax deductions. Real estate investors can maximize their revenues by utilizing all the deductions associated with their property, thereby reducing their tax liabilities. Finding the right real estate investment can be a challenge, not to mention the complexity of tracking and recording every expense. 

Fortunately, Foothold offers a range of solutions that reduce risk and streamline the process of identifying, managing, and investing in properties. Explore our portfolio of vacation rentals today and envision the potential growth of your primary investment in the future.

What is Ad Valorem Tax?

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When it comes to real estate ownership, taxes are an unavoidable aspect that investors consider for profitability. This includes estimating purchase price and projecting earnings. One significant tax property owners deal with is the ad valorem tax or property tax. Let’s explore ad valorem tax and its evaluation process, vital for assessing property value as investments.

Key points:

  • Ad valorem tax is based on the appraised value of real property and differs from sales or income tax.
  • Local authorities typically impose ad valorem or property taxes annually, paid through an escrow account.

So, what is ad valorem tax? The term ‘ad valorem’ means ‘according to value’ in Latin. Unlike excise or transactional taxes, ad valorem tax is proportionate to the assessed value of the property. It is commonly used for real property like land or buildings.

The assessment of ad valorem tax is based on the property’s value. A public tax assessor estimates the fair market value, reflecting the estimated sales price. This assessed value is used to calculate property taxes, with the tax rate being a fixed proportion. The tax is levied annually.

While ad valorem taxes are typically imposed by local jurisdictions, they can also come from county governments, school districts, and other specific-purpose districts. Depending on the property’s location, investors may face multiple ad valorem taxes from various entities. Ad valorem taxes serve as a crucial income source for local and state governments.

Five types of real estate fall under ad valorem tax: residential, commercial, industrial, land, and special use properties. The tax percentage for ad valorem property tax is determined by the type of real property being assessed.

Understanding ad valorem tax: A practical guide

Before investing in property, it’s beneficial to have a clear idea of ad valorem tax. Don’t worry, it’s not as complex as it may seem. Here’s a simple formula to get started: Ad valorem tax = Assessed value x Tax rate. The assessed value is usually determined by a tax assessor, but you can estimate it using the listing price. The tax rate is based on the property’s location and can be obtained from your local tax commissioner’s office.

Let’s consider an example. Imagine you’re looking to invest in a single-family home in Tampa, Florida, listed at $499,000. The property is in Hillsborough County, which has a county tax rate of 1.09% based on the property’s value. So, the estimated annual county ad valorem or property taxes for this home would be $5,433.10, approximately $453.26 per month.

Keep in mind that this is a conservative estimate, as properties in Tampa are also subject to school levies, city levies, and four special district levies. City taxes are calculated using millage rates, where one mill is equal to 1/1000 of a dollar. Tampa’s millage rate is 19.71, resulting in approximately $19.71 for every $1,000 of the property’s taxable value. This adds up to an estimated annual property tax of $9,835.29 or approximately $819 per month.

Florida offers a homestead exemption for primary residences, which lowers the assessed value and reduces property taxes. However, since our example property is an investment, you would be subject to the higher tax rate.

This example serves two purposes: it demonstrates how to calculate potential tax obligations and highlights the importance of understanding local tax districts and exemptions. You can obtain all the necessary information from local tax authorities.

Ad valorem or property taxes fund public services such as schools, law enforcement, fire protection, libraries, infrastructure, road maintenance, parks, and community projects.

Typically, ad valorem tax is included in monthly mortgage payments. Mortgage services often collect tax payments in installments, deposit them into an escrow account, and pay them annually on your behalf. However, if permitted by your mortgage lender, you may choose to pay your taxes directly to the local tax collector’s office annually or semi-annually.

Final thoughts

Property taxes are inevitable when owning real estate. When considering property investment, use this knowledge to your advantage. It can help you determine housing affordability and monthly mortgage payments, crucial for setting a competitive rent price to ensure profitability.

Why deal with the complexities of ad valorem taxes when investing in real estate? 

We’re here to help. Our platform lets you fractionally invest in vacation rentals properties, earn rental income, and build equity without the hassle of managing a rental arbitrage business. Check out our available properties and start your real estate investment journey today.

How to Use Your Solo 401k to Buy Real Estate

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Successful real estate ventures rely on external funds to boost investment power and generate wealth over time. Aspiring real estate investors must understand this lesson early on to navigate a stable investment landscape and mitigate risks.

Many investors purchase real estate through retirement accounts, where it serves as an alternative investment option. Using a Self-Directed Individual Retirement Account (SDIRA) for real estate investment is a popular tax strategy. Profits from these investments remain untaxed until retirement, maximizing benefits.

For self-employed individuals or those running solo businesses, the Solo 401(k) plan offers a suitable avenue for real estate purchases. Unlike traditional company-sponsored 401(k) plans, Solo 401(k) retirement plans provide exclusive benefits of real estate investment. These plans allow diversification of retirement savings into various investment options, including real estate, precious metals, stocks, bonds, mutual funds, tax liens, and tax deeds.

A Solo 401(k) permits the acquisition of different types of real estate properties, such as apartments, single-family homes, commercial properties, condos, and mobile homes. However, note that using personal funds for real estate-related expenses incurs tax implications. All costs must be sourced from the Solo 401(k) bank or brokerage account. Depreciation from real estate owned by a retirement account is not permitted.

To utilize your Solo 401(k) for real estate investments, ensure that your plan offers alternative investment options. Qualifying for a Solo 401(k) requires being self-employed, generating income through self-employment activities, owning a small business without employees other than yourself or a spouse, or working as an independent contractor with part-time employees.

Investing in real estate through a Solo 401(k) offers benefits such as tax deferment, access to non-recourse business loans, and leveraging opportunities. Tax deferment allows tax-free growth, while non-recourse business loans provide additional financing options. Leveraging borrowed capital can amplify investment returns, and Solo 401(k) plans are exempt from the Unrelated Business Taxable Income (UBTI) tax, making them ideal for real estate investments. Moreover, the Solo 401(k) offers asset protection against bankruptcy and creditor claims.

There are various ways to purchase property through a Solo 401(k), including all-cash purchases, non-recourse loans, Limited Liability Companies (LLCs), and Tenants in Common purchases. Each method has its advantages, allowing you to choose the approach that aligns with your investment strategy.

Unlock Real Estate Investment Potential with Solo 401(k)

The Solo 401(k) is an excellent way to finance real estate investments, especially for individual entrepreneurs or small companies. It provides tax deferment and leverage, allowing you to climb the property ladder and generate a steady income from real estate. 

At Foothold, we believe in making property ownership accessible to everyone, regardless of their financial background. With our platform, you can start investing in vacation rentals properties with as little as $200, and grow your portfolio while earning consistent rental income. Check out our available properties here.