Owning rental property isn’t just a proven way to receive an income, it is also an equally good way to provide revenue to the U.S. Treasury via the IRS. Property investors should have some knowledge of how rental income is taxed, because significant tax relief on rental property is available for those who know how to take advantage of it. The Tax Cuts and Jobs Act (TCJA), passed in December , extended the bonus depreciation to personal property used in qualified property beginning in 2018. The act also doubled the bonus depreciation deduction, bringing it to 100 percent in the first year.
Expense Deductions Provide Tax Relief on Rental Property
You can deduct 100 percent of the expenses associated with your investment rental property from your personal income tax. These expenses might include:
- agent fees
- employment costs
- insurance premiums
- mortgage interest
The wages of third-party property managers, maintenance workers, and other staff members are deductible, as are the labor fees of independent contractors. In addition to the service costs of plumbers and electricians, you can also deduct the fees of landscapers, painters, carpenters, and similarly specialized tradesmen. In previous years, travel expenses related to rental property ownership was deductible as well. However, that deduction was eliminated in the TCJA. Finally, expenses should not be confused with improvements. The cost of improvements is depreciated rather than directly deducted.
Bonus Depreciation Expanded
Depreciation is the gradual deduction from your taxes of the cost of an asset that loses its value over time. This loss of value is often purely theoretical, especially in the case of real estate, since a property can increase in value sharply while it is being depreciated. This can lead to a situation known as depreciation recapture, where the owner is liable for a sizable tax bill to make up for the deductions taken (mandatorily) on property that has increased in value.
The timeframe for depreciation ranges from 39 years for nonresidential commercial real estate and 27.5 years for residential commercial real estate to five years for many personal items. If depreciation is not applied evenly over the course of an asset’s putative service life, it is known as accelerated depreciation. The recently expanded bonus depreciation, sometimes called “Section 179 depreciation” after the IRC section in which it’s described, is one type of accelerated depreciation.
Bonus depreciation originally gave a taxpayer the opportunity to accelerate 50 percent of the depreciation of the cost of purchasing equipment. Now, bonus depreciation is being applied to more items and it has been raised to 100 percent of the cost of purchase. The new rules for bonus depreciation are retroactive to September 28, 2017. This does not change the amount of the deduction—100 percent of the cost will be depreciated and deducted in any case; the difference is that you can now receive that money as a lump sum.
Previously, bonus depreciation was limited to the purchase cost of newly manufactured equipment. That was changed in the TCJA to newly acquired equipment, making it possible for you to deduct the cost of purchasing used equipment.
Not every improvement you make will be eligible for bonus deduction. Improvements to the land, including parking lots, swimming pools, and buildings are not eligible, although they are still subject to standard depreciation. Equipment used for the operation of your rental property—lawnmowers and leaf blowers, computers, company cars, office furniture, telephones, cell phones, and more—whether located on the property or not, has always been eligible.
Personal items were not previously deductible under bonus depreciation, but now are. These include kitchen appliances and window coverings, as well as other personal items that can only be identified by a specialist in a process known as cost segregation. Sometimes a large amount of personal property can be identified through an expert cost segregation study.
Significant tax relief is available to rental property investors, but it is not always easy to find. The best way to ensure full deduction of expenses and optimal depreciation accounting is to consult a qualified professional.
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