How Do Changes in Tax Laws Impact Rental Property Owners

A lot of people like to invest in rental property, but they don’t know how changes in tax laws impact rental property. There are many changes that have taken place over the last few years that directly impact owners of rental properties and investors alike. In this article, we will discuss some of those changes and what they mean for you as an investor or property owner.

Changes in Tax Laws Impact Rental Property Owners

First-Year Bonus Depreciation

First-year bonus Depreciation is a 100% deduction for the cost of equipment, machinery, and other tangible property that is purchased and put into service during the year. The cost of this property must be more than $2,500.

The tax rules have changed since they were first introduced in 1986: First-year bonus Depreciation has been reduced from 50% to 40% (and then 30%) at various times between 1986 and 2018; now it’s only 20%.

Expanded Section 179 Expensing

Section 179 Expensing

Section 179 Expensing is a special tax deduction that allows you to write off the full cost of equipment purchased and placed in service in one year. Under the law, you can deduct up to $500,000 ($200,000 for married taxpayers filing separate returns) worth of qualifying purchases (excluding new homes).

This means that if your property is generating income from rental properties and generates more than $500K per year, then you may be able to claim an additional deduction under Section 179.

This change will apply only if it applies retroactively;

“Otherwise, it will remain unchanged from its current status as an annual adjustment factor which determines how much depreciation is allowed each year based on historical record-keeping methods used by landlords who own rental properties with significant investment value like buildings or land near airports or highway corridors where there’s demand for renting out rooms during peak times like holidays or college breaks.”

New Passthrough Tax Deduction

 

The new tax law allows for a 20% deduction on income from pass-through entities. This is a big deal, as it’s the first time that Congress has allowed this kind of deduction in over 30 years.

The deduction is limited to income below $315,000 ($157,500 for singles) and above $415,000 ($207,500 for singles).

Pass-Through for Deduction Income Below $315,000 ($157,500 for Singles)

The new law allows individuals to deduct up to 20% of their pass-through income. This means that if you have a salary of $100,000 and are in the 25% tax bracket, you can deduct $20,000 from your income before paying taxes on it. If your business earns $100,000 in taxable income (which includes rental property), then you will only be able to deduct up to 20% of that amount as well.

Pass-through entities include partnerships and corporations but not limited liability companies (LLCs).

Pass-Through Deduction for $250,000/$500,000 Annual Loss Limit

If you are married and file a joint return, your deduction is limited to $315,000 ($157,500 for singles) per year.

If your loss exceeds this amount, it will be treated as a capital loss and carried forward to future years until used up.

Pass-through deduction for Income Above $415,000 ($207,500 for Singles)

The pass-through deduction is an important tax break for rental property owners because it allows you to deduct your rental business expenses from the income statement of your tax return. It’s also worth noting that this deduction can only be claimed if you’ve paid yourself at least half of this amount as wages during the year.

The pass-through deduction for income above $415,000 ($207,500 for singles) is $5,950 or 10% of up to $315,000 in AGI. If you make less than that amount and file jointly with a spouse who has earned more than $157k/year then they will get 20% back themselves on their W2 income while they can claim 10% each on theirs unless they have fewer than two dependents which would mean getting nothing back at all!

Passive Activity Losses

• Passive activity losses are defined as the difference between your rental income and expenses.
• Passivity is usually a result of owning rental property. For example, if you lease out your house to a tenant and receive rent from that tenant, then it’s considered passive activity because you’re not doing anything with the property directly and instead are just leasing it out.
• Passive losses can be deductible against income if they exceed 2% of adjusted gross income (AGI). If you have more than $2 million in AGI, then all passive activities will be considered active ones—meaning they will impact your taxes!

New Limits on Deducting Rental Losses

The new law limits the deduction for rental real estate losses to $25,000 ($12,500 for singles) and applies it to all rental income. This includes any passive income from real estate activities too.

Net Operating Losses

Net operating losses (NOLs) are the amount you have to recognize as a loss on your taxes. NOLs can be carried back or forward to future years, but there is a limit of 90% of taxable income.

For example, if you have $100,000 in taxable income, and then incur an NOL for the year because of investment activity in prior years (for example: buying rental properties), that loss will not only reduce your current tax liability—it also reduce any future capital gains tax liability as well!

New Limits on Interest Deduction

To take advantage of the interest deduction, you must be able to deduct your mortgage interest and property taxes. The amount that can be deducted is limited by statute.

• Interest Deduction: The first $750,000 of acquisition indebtedness (including principal) is deductible in the year paid. This includes any amount owed on home equity loans or lines of credit if they meet certain criteria.
• Home Equity Indebtedness: If there are two properties, then up to $250,000 per property qualifies for this deduction within 30 days after the purchase date; otherwise it must be taken over time periods specified by statute as follows:

• Up to six years with respect to 1st-time homebuyers who purchased for less than $500k;

• One year if purchased between $500k-$1m;

Expanded Section 179 Expensing

• Expanded Section 179 Expensing

Section 179 expensing has been expanded to include more types of business property, including:

• Buildings and improvements to real property used in a trade or business;
• Machinery and equipment used in a trade or business;
• Computer software (including custom software) is designed to be marketed as a separate tangible product by the taxpayer. This category also includes computer hardware but excludes computer software sold at retail. It also excludes any other tangible personal property that is used by you as an agent for the sale of your services (e.g., if you are an attorney and buy office supplies).

The amount claimed cannot exceed $1 million ($2.5 million if married filing jointly). You must claim this deduction on Form 4562 each year using Schedule A (Form 1040), Schedule C (Form 1040A), or Form 8938

Other General Impacts You Should Know

These are other important impacts when there is a tax change or the status of the property changes. Whether you sell it buy it or rent it. These are important things that can impact taxes.

Depreciation?

Depreciation is an accounting method that allows you to record the decrease in the value of your rental property. When you own real estate, it is expected to lose value over time due to wear and tear.

The tax code allows you to deduct the amount of the loss in value of the property each year. This can help you lower your taxes each year if you have rental property. Conventional wisdom is that the best time to purchase rental property is during a downturn in the economy.

You can usually find great deals on rental properties during this time. The prices are much lower than they would be if the economy was booming. In accounting terms, the property’s value must be reduced by a certain percentage each year. For example, you might decide that the property should be worth 80% of what it was when the property was new. Over time, you will continue to deduct this percentage from the value of the property.

Tax Loss Harvesting

Tax loss harvesting is the practice of selling a stock that has fallen in value to offset the capital gains from another investment. Changes in tax laws have made this strategy much more difficult to implement. However, investors who have rental property can still benefit from tax loss harvesting, thanks to the 1031 exchange.

This allows investors to swap their property for a like-kind investment without triggering a taxable event. The IRS has created procedures that investors must follow in order to ensure that tax loss harvesting is done correctly. Investors must be careful because the penalty for not following the rules is extremely expensive.

Tax Liability on Rental Property

The most important thing to understand when calculating the tax liability on a rental property is that you must use the cash method of accounting. The cash method of accounting calculates your revenue and expenses based on the amount of cash that changes hands during the year. If you use the accrual method of accounting, you may have to report income on your taxes even if you have not received it in cash form. This could result in a lower net profit for you.

Changes in the Standard Deduction

The standard deduction has increased from $12,000 to $12,200 for single taxpayers and from $24,000 to $24,400 for joint filers. Most taxpayers have increased standard deductions. This could result in lower tax liability for many people. This could have a positive effect on rental property investors if they have high medical expenses.

These will likely be considered itemized deductions. Medical expenses are one of the only expenses that can be subtracted from rental income when using the standard deduction.

Conclusion

It is important to understand that these changes are not retroactive and do not apply to transactions completed in 2017 or prior years. However, it’s also worth noting that a lot of the tax changes we just covered could potentially have an impact on your rental property. For example, if you were thinking about selling your rental property or refinancing because of a recent escalation in interest rates or other reasons, now would probably be the best time!