by Susan Paige
So, you are looking to invest in property, but naturally you want clarification over the tax implications of owning an investment property. Look no further, as we go through both the perks and the drawbacks of when it comes to owning property and the tax you are subject to.
While owning rental property is not always a truly passive income, owning rental property, irrespective of tax can build a long-term income. Here we look at breaking down the tax ramifications of owning rental property.
The benefits to owning property
Before delving into tax, there are benefits to remind you of when it comes to investing in property, the obvious initial benefit being when renting out the property, the mortgage (should you likely have one) is being covered by the renters – essentially paying for the asset for you.
Depending on the level of rent you charge, you may even be able to make a profit on top of property expenses. This will of course depend on if you have done your research before purchasing your property, choosing the right property type and size in the right area.
You have to consider expenses on top of the tax though, this can include vacant periods, repairs, property management fees, maintenance and other expenses. The difficulty here when it comes to budgeting is that this can fluctuate every month.
Significantly though, and the purpose of this piece is that the tax is considered. You may first jump to the outgoings, but there are some benefits.
Tax as a benefit
The biggest benefit here is the ability to deduct certain expenses on your personal tax. Taxes related to the care, maintenance and upkeep of the property can be mostly deducted. This also includes homeowner’s insurance, property tax and even what most would not consider tax deductible – including services to keep the house maintained!
Be careful here though, maintenance and upkeep are handled differently. You cannot deduct cost of improvements, only maintaining the existing structure. You can recover ‘some or all of your improvements’, so long as depreciation has been clearly stated and maintenance made at the beginning of each year.
Surprisingly, you can benefit from the depreciation of the property in tax terms also. Landlords are able to write off part of the loss in value of the property due to age and deterioration. In residential terms and for a typical but-to-let, this can be applied over 27 years.
You can also deduct rental property income losses to a certain extent. Where many landlords believe they are entitled to this, landlords only can to a certain extent. Where this includes all typical losses, the limit of this loss is anything that exceeds income by $25,000.
Anything over this amount can be carried over to future years or when the property is sold. If your income is high however, your ability to write this off is cut by 50%, and if you are earning over $150,000 across the year, the ability to deduct taxes on rental loss is reduced to nothing.
Talking of when the property is sold, if you sell the property, you will be subject to capital gains tax. This can end up being quite substantial.
Rental property does not benefit from the gain on sale exclusion. This means that any appreciated value above the taxable basis, including any improvements you made to the house, counts as short-term or long-term capital gain. This difference depends on whether the property has been owned for less than a year (when flipping a property) or over a year.
The rates for long-term capital gains are currently set at 0, 15 or 20 percent depending on your level of income. If you are clever here though, looking into this further, the tax situation is compared to your own residence.
You can sell the home you live in and avoid paying tax on as much as $250,000 in profits (this is doubled for married couples filing jointly!). Therefore, if you have the ability to plan with foresight, and you don’t have a large amount of property in your portfolio, living in the property for two of the last five years allows you to benefit from this.
There are a number of ways you can mitigate the potentially damaging levels of tac that you could be subject to on the purchase, letting out and sale of your property. Make sure you plan for the duration of the process, and hire a lawyer specialising in tax if you wish to find out more about any of the above.