Starting Up: Tax Tips for New Landlords
Imagine you’re in college and after two years of on-campus living you’ve been upgraded to your own apartment, and it makes you feel like a real adult. But you don’t have income like an adult, so the $50 weekly food budget mom and dad send has got to be carefully managed.
You buy all the college classics: Carl Buddig lunch meat, American cheese slices in flimsy plastic wrappers, that $1 sandwich bread, and of course ramen. You also pick up a five-pound bag of russet potatoes for soup.
Making the soup requires you to peel all five pounds of potatoes. But what to do with these peels? A sane person may look to the trash can, but nobody is there to stop you as you shove every last peel into your garbage disposal, run the water, and flip the on-switch.
Seconds later, your sink is backed up, and then you notice potato peel water coming out of your dishwasher. Panicked, you turn everything off, phone maintenance, and then get out of dodge.
When you return, the issue is fixed and a note is scrawled on a paper towel from the exceedingly patient maintenance man, “Please no potato peels in the disposal”.
This isn’t hypothetical, it’s a confession. I’m the potato peel bandit. I loved having a maintenance man around in college, especially the night I went out, accidentally leaving a window cracked and a light on inside my apartment. I came back later to an infestation of small moths and other bugs swarming around my ceiling fan. I broke it trying to shoo them out with a broom.
I wasn’t an ideal tenant. Landlords take on a lot of risk when deciding to rent property, even if they manage to find tenants with more common sense than I had in my twenties.
Are you thinking of becoming a landlord? If so, you’ve got some stuff to tend to. Among other things, potential landlords need to understand their corner of the tax code. Here are some things you should know about taxes before you start living that landlord life.
You’ll likely have to shell out plenty of money before ever collecting a dime in rent. The tax code treats some of those monies as start-up expenses, the costs you incur before you offer a property for rent.
Your cost of purchasing a rental property is not a start-up expense. Rental property and other long-term assets, such as furniture, must be depreciated once the rental business begins.
On the day you start your rental business, you can elect to deduct your start-up expenses. The deduction is equal to:
the lesser of your start-up expenditures or $5,000, reduced (but not below zero) by the amount by which such start-up expenditures exceed $50,000, plus;
amortization of the remaining start-up expenses over the 180-month period beginning with the month in which the rental property business begins.When you file your tax return, you automatically elect to deduct your start-up expenses when you label and deduct them on your Schedule E (or other appropriate return).
Costs you pay to form a partnership, limited liability company, or corporation are not part of your start-up expenses. But under a different tax rule, you can deduct up to $5,000 of these costs the first year you’re in business and amortize any remaining costs over the first 180 months you are in business.
The cost of expanding an existing business is a business operating expense, not a start-up expense. As long as business expansion costs are ordinary, necessary, and within the compass of your existing rental business, they are deductible.
The IRS and tax court take the position that your rental business exists only in your property’s geographic area. So, a landlord who buys (or seeks to buy) property in a different area is starting a new rental business, which means the expenses for expanding in the new location are start-up expenses.
Finally, you can’t deduct start-up expenses if you’re a mere investor in a rental business. You must be an active rental business owner to deduct them.
Landlording is, in my opinion, an extreme sport. Outside of the complex tax environment, there are legal, insurance, and cash flow issues to be addressed. And you must always be weary of college kids carrying sacks of soup-bound potatoes.
If you’ve recently become or are considering starting a rental business of any size, give us a shout so we can analyze the impact on your financial plan. It’s important to be informed before making big decisions like these. Your money should be put to work aligning with what matters to you and aiding you on your journey towards your life’s vision.