Tax Benefits

It’s important you speak to your accountant about the tax benefits below. Laws change which affects whether or not a homeowner can still claim deductions. The deductions are also different for married and unmarried people.

Investment Property

• Improvements 100% tax deductible
• Insurance 100% tax deductible
• Mortgage Interest 100% deductible
• Property Taxes 100% deductible
• Write off depreciation
• Must pay income and capital gains tax on the sale of the property
• 1031 Exchange allowed
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Primary Property

• Improvements NOT tax deductible
• Insurance NOT tax deductible
• Mortgage Interest: – $12,000 cap single person. – $24,000 cap married couple
• Property Taxes – $10,000 cap
• Can’t write off depreciation
• No income tax or capital gains tax on the sale of your home*
• 1031 Exchange not allowed
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Tax benefits of Investment

Improvements

An improvement means anything that adds value. Preserving the value is a “repair.” Improvement is something an appraiser would count as value.

For example, a new roof is an improvement; patching a hole in the roof is a repair. So if you are selling or renting your primary and moving to another primary, then do improvements on the original home after you’ve already purchased the new primary. An auditor wants to see you’re in the process of getting out of the primary and moving to another home to write off improvements. Improvement is something an appraiser would count as value. Landscape improvement for investment.

Business write offs- working from home (home office). 30-40% deduction business write off for home office, internet, cable, utilities. Need proof of business, evidence like income or website from the business.

Expenses that can be claimed on your tax return:

• Advertising
• Cleaning and maintenance
• Commissions to Realtor
• Legal & Professional fees
• Management fees
• Interest, Taxes, Insurance, & Depreciation
• Repairs
• Vacancy Rate

Rental Income and Depreciation

Depreciation is used to account for a decline in value of an investment property used exclusively as a rental.

• The IRS allows you to depreciate the entire value of the building.
• The value of the home is fixed from the first time you claim depreciation.
• The higher the value of the home the larger the depreciation.
• Calculating depreciation by dividing the value of the building by 27.5
• Claim rental income on tax return
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Formula for Depreciation

$300,000 (property value) ÷

27.5 = $10,900 annual depreciation

1031 Exchange

Unlike a primary home sale, there is no cap for investments and thus you have to pay both income tax and capital gains tax on ALL proft. A 1031 exchange is a way to defer taxes on your capital gains from selling an investment property. A 1031 provides an exception and allows you to postpone paying tax on the gain if you reinvest the proceeds into a similar property. (Tax deferred- not tax free).

Read the book Rich Dad Poor Dad as a great example of how to grow wealth through 1031 exchanges. A smart investment strategy is to start small (like a 1 bedroom condo) and over time you can exchange that property to a house, then to multifamily and then apartment complexes.
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Scenario

• Property Value: $300,000
• Depreciation: $10,900 / yr
• Gross Rent: $24,000 / yr, $2,000 / mo
• Expenses: $2,400 / yr, $200 / mo

PITI:

• Principal Payment = $3,900 / year
• Interest = $10,700 / year
• Taxes = $7,200 / year
• Insurance = $950 / year
• PITI: $22,750 / year, $1,895 / month

Accountant will write off 100%:

• Depreciation
• Mortgage Interest (no cap)
• Taxes
• Insurance
• Improvements
• Expenses

Total = $32,150
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Formula Accountant Uses

Gross Rent – Write-offs = Total Write-Off

Total Write-off: $24,000 – $32,150 = -$8,150
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Even if you are cash flow positive (rent exceeds your mortgage payment), the write-offs will show a loss on your tax return. This saves you money!

A mortgage lender doesn’t consider depreciation a “loss”. So when you want to buy another property, the lender will add the write-offs back as income. This improves your Debt to Income ration and thus increases the loan amount you can be approved for.
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Formula Mortgage Lender Uses

Net Rental Income (or loss) = Total Income – Total Expenses
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Total Income:

• (Gross Rent + Annual Depreciation + Interest + Taxes + Insurance)
• $53,750 / year or $4,479 / month

Total Expenses

• (PITI + Expenses)
• $25,150 / year or $2,095 / month

Net Rental Income (or loss) = $28,600 / year or $2,383 / month

When turning your current home into a rental property and buying a primary home, a lender can count 75% of future “gross rent” towards your income to improve your DTI ratio. The lender will need a signed 12-month lease that states the rental rate and lease start date, as well as evidence the homeowner has cashed the first month’s rent (or security deposit).

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