Landlord? Don’t Overlook This Important Tax Info

Many Americans own rental property. Whether you inherited a home, decided to downsize or upsize your personal residence, or just came across a great investment opportunity, people get into the landlord game for many different reasons and via many different avenues. Regardless of which category you fall into, all landlords must be sure to keep detailed records of income and expenses related to the property for tax time.

Deductions
If you are making money from the rental of a property that you own, then you must report the rental income on your tax return. Owning a rental property also means that certain expenses become deductible – thereby reducing the total amount of rental income that’s subject to tax.

Deductions vs. Depreciation

Deductions are very straight forward – these are the costs of operating, repairing, some improvements, and managing your rental property. These expenses should be tracked by the landlord (or his/her employee) and included, along with rental income, on Schedule E of the tax return. Depreciation, on the other hand, is not as straight forward. Generally, the basis or cost of the building (but not the land) is depreciated using straight-line depreciation which is done over 27.5 years. An equal amount of the building’s basis is deducted each year on the tax return. Any additions or improvements costing more than $2500 are also depreciated but are done so separately from the building. Additions or improvements costing less than $2500 can be deducted fully in the year of purchase.

Depreciation must be carefully tracked for tax purposes. Once the property is fully depreciated, no additional depreciation can be taken. Additionally, when a rental property is sold, the depreciation must be recaptured if the sale price of a rental property exceeds the adjusted basis (i.e. the owner’s initial investment plus the cost of certain improvements during ownership). Recaptured depreciation is reported as ordinary income for tax purposes.

Reporting Income and Expenses
At Levesque & Associates, we recommend clients track income and expenses either through bookkeeping software such as QuickBooks (appropriate if you own multiple investment properties) or through a simple excel sheet. You can also easily make use of apps such as Expensify to maintain and categorize receipts. Even though you are tracking the information, be sure to keep receipts with your personal records for at least 7 years.

Management Companies
Some property owners utilize a management company for collections of rent payments as well as property maintenance and other expenses. Typically, these management companies provide a 1099 in January of each year which summarizes the income earned by the owner. If you utilize a management company, we STRONGLY encourage you to keep your own records and compare the information you receive from the management company with what you have on file. Mistakes do happen and property owners should take responsibility for ensuring the accuracy of the of the information reported to the IRS.

Record Keeping
Good record keeping will not only help you determine the profitability of your rental property, but it will help make the preparation of your tax return much easier. Maintain records of everything related to the property. This includes keeping detailed receipts for any expenses such as repairs and improvements. You should also keep detailed records of all rental income received. Should you be selected for an audit, you will need to provide these records to the auditor. If you are audited and cannot provide proof of the expenses and income reported on your return, you may be subject to additional taxes and penalties.

 

 

Do you own a rental property? Make sure you are keeping records of the following items and providing to your tax professional at tax time:

  • All loan and interest payments
  • Repair receipts
  • Personal property costs (such as new appliances or lawn equipment)
  • Driving – if you have to drive to your rental property for any reason, you can either deduct actual auto expenses (gas, upkeep, repairs, etc) or mileage (learn more about mileage write-offs here).
  • Overnight travel, including airfare, hotel costs, meals, and other expenses, can be deducted if they are directly related to your rental property. Be sure to keep detailed records as the IRS is known to scrutinize these kinds of deductions.
  • Home office expenses, provided the landlord meets certain minimum requirements. This includes a percentage of the cost of home expenses including utilities, insurance, and more. Your tax professional will require total square footage of your home, square footage of dedicated office space, and a total of home costs
  • Do you pay an employee or independent contractor for help with your rental? Their pay is a rental business expense.
  • Any insurance you carry related to rental activity should be kept and provided at tax time.
  • Fees associated with legal and professional services such as an attorney, accountant, management company, etc.

Looking for more information? Get in touch with Levesque & Associates by phone or email.

Child Tax Credit and Deductible Expenses

The Tax Cuts and Jobs Act (TCJA) brought with it the removal of personal exemptions, which had been part of modern income tax since 1913, and changes to tax credits related to children and dependents.  If you have children/dependents, you know that they can create significant tax benefit.

Loss of personal exemption

In previous years, taxpayers benefited from personal and dependent exemptions on their annual tax return.  This meant that for each taxpayer, (1 for single filers and 2 for married filing jointly) plus each claimed dependent, the taxpayer received a deduction of up to $4,050.  This amount could easily add up to a sizable sum, especially for those families with many dependents.  For example, married filing jointly taxpayers with 4 dependents received personal exemptions totaling $24,300 ($4,050 x 6) on their 2017 return.  Personal exemptions were in addition to an itemized or standard deduction.  Under TCJA, personal exemptions are no longer available (no exceptions) and the standard deductions were significantly increased for both single and joint filers.

Changes to credit

Under TCJA, the Child Tax Credit (CTC) increased to $2,000 per qualifying child.  The refundable portion of the credit is limited to $1,400 (up from $1,000 in 2017).  A new $500, non-refundable credit for other dependents (such as a parent or sibling that a taxpayer cares for) was also introduced.  Additionally, the earned income threshold for the refundable credit dropped to $2,500 from $3,000 (meaning you must have earned income of at least $2,500 for the tax year).  The income limit before credit phaseout increased to $200,000 or $400,000 for joint filers (meaning you cannot make more than $200,000 or $400,000 to be eligible for the credit).

What is meant by refundable and non-refundable in terms of the credit?

When a credit is referred to as non-refundable it means that the amount can reduce your tax liability, but it cannot give you a refund.  In other words, if a taxpayer had a tax bill of $400 and claimed a parent as a dependent and received the $500 credit, their tax bill would be reduced to $0, but they would not get the $100 difference as a refund.

For the CTC, the refundable portion is limited to $1,400 of the $2,000 credit so a tax payer with a $2,000 tax bill would have it reduced to $0 by the credit.  A taxpayer with a $1,000 tax bill would see that bill reduced to $0 but would also receive a refund of $1,000.  However, the refund resulting from the credit could never be more than $1,400.

Is there an age limitations to the CTC?

In order to claim the credit for a child, he or she must be under the age of 17 at the end of the tax year.  Additionally, you (the taxpayer) must claim him or her as a dependent on your tax return.

What if my child’s other parent and I are now divorced?  Who can claim the credit?

The first step in determining who should be claiming the credit is to refer to your divorce agreement.  If there is not specific instruction, then IRS guidance indicates that the parent with primary custody can claim the credit.  For 50/50 custody, there is a precedent for the IRS to side in favor of whomever makes the most money.  Consult your divorce attorney or CPA for more information.

I have a legal right to claim my children, but my ex-spouse filed before me and claimed the kids.  What can I do? 

If you are filing electronically, your return will be rejected since your child/children’s social security numbers are attached to an already filed return.  We recommend filing your state and federal returns on paper.  The IRS and your state will review the return and see that the SSNs are associated with another return.  At this point you will receive official written notice from the taxing authorities about this issue.  Respond with a detailed description of the issue and explain your claim.  Provide copies of any supporting documentation such as the custody agreement in your divorce decree.

What are the rules for the $500 credit for other dependents?

For the most part the same rules apply to the $500 dependent credit and the CTC.  The significant difference is the age limit.  The $500 dependent credit can be claimed by the taxpayer for anyone over the age of 17 (the limit for the CTC) who lives with the taxpayer for at least 6 months out of the year that the taxpayer claims as a dependent on his/her tax return.  In other words, a taxpayer could claim their 20-year-old son who is a full-time college student. They could also claim their elderly mother whom they care for full time.

Other deductions related to children/dependents

In addition to the CTC, parents/guardians who pay for childcare can also benefit from a deduction of these expenses.  Deductible expenses include:

  • Day care
  • After school program (at child’s school)
  • Summer camps

You can also claim care expenses for a spouse or another individual you claim as a dependent (such as a parent or sibling) if he or she has lived with you for at least half the year and that person is unable to take care of him or herself.

What expenses do not count?

For children/dependents, extracurricular activities such as sports or music lessons are not considered deductible expenses.

You cannot claim childcare/nanny expenses paid to your spouse, the parent of the child (for example an ex-spouse), anyone listed as a dependent on your tax return, or your own child aged 18 or younger even if he/she is not claimed as a dependent.

If you are a single filer, you must have earned income to benefit from the deduction.  If you are married, both you AND your spouse must have earned income.  You must have paid for the childcare to work or to find work.  Childcare costs paid so that the parent/guardian can be a full-time student or because he/she is unable to care for the child (such as from the result of a medical complication) doesn’t count as “working” for the purposes of the credit.

Important Note

Credit vs. deduction – what’s the difference?  To fully understand the tax implications of the CTC and deductible expenses you need to understand the fundamental differences between a tax credit and a tax deduction.  A tax credit is a straight reduction of tax due.  In other words, if your total tax bill for a year is $5,000 and you receive a tax credit, such as the CTC for one child in the amount of $2,000, your tax bill would be reduced to $3,000 ($5,000 – $2,000).

Deductions, on the other hand, reduce your taxable income.  For example, if you are a single filer with $55,000 in income, your tax bracket is 22%.  Deductions move the needle.  If you took the standard deduction of $12,000 your adjusted gross income would be $43,000.  You would still be in the same 22% bracket, but your tax due would be based on $43,000 instead of $55,000.  If you itemized deductions totaling $19,000, your taxable income would be reduced to $36,000.  Not only would you be paying tax on significantly less income, but your new tax bracket would be 12%.

 

Other questions about changes to the personal exemptions, the CTC, or deductible expenses?  Get in touch with us!  We’re happy to help.

Surprised by a Balance Due or Decreased Refund? Here’s What You Should Know

This year was the first-time taxpayers filed returns under the new tax law.  There was a lot of information (and misinformation) in the news leading up to the official opening of the 2019 filing season and the frequency of news stories has continued.  We’ve had many clients receive a bit of a shock when given the results of their 2018 return.  Many were pleasantly surprised by a larger than normal refund or, for some, their first refund in a long time.  For others, however, the new tax law resulted in a smaller than normal refund, a balance due for the first time, or a larger than normal (or larger than expected) balance due. I want to help shed some light on the possible causes of these surprising results and help explain the steps you can take for a preferable outcome next year.

First, a quick overview of the changes affecting the largest percentage of taxpayers (i.e. changes to the standard deduction, reduction in withholdings, and loss of the personal exemptions).

  1. Standard deductions were increased significantly from $6,350 to $12,000 (single), $12,700 to $24,000 (married filing jointly), and $12,200 to $18,350 (head of household). On your tax return, you can take a standard deduction or the sum of your itemized deduction – whichever is higher.
  2. A new withholdings table was introduced under the tax law resulting in the automatic reduction of withholdings. This is the “more money in your paycheck” part of the new law. This means that the amount of money being withheld for tax purposes from paychecks and retirement distributions generally dropped unless you requested a change to your withholdings.
  3. Personal exemptions are gone ($4,050 per person). There are no exceptions!
  4. Changes to tax brackets resulted in an overall decrease in the tax liability for many tax payers.

*There are MANY other changes, but these are the specific items that had the greatest effect on many of our clients.

In previous years, the standard deduction or the amount of itemized deductions (whichever is greater) was added to total personal exemptions and dependent exemptions.  This amount was used to reduce a taxpayer’s adjusted gross income and arrive at taxable income.  This is the amount used to calculate tax due and is income tax calculation in its simplest of terms!  Income limits exist and there are many more moving parts in tax calculation.  However, for further explanation of the effects of the new tax law, this is really the key concept you need to keep in mind.

Group #1: A surprise refund!

If your return is the same as last year and you made no changes to withholdings and yet you find yourself with a larger than normal or first-time refund, this is probably the result of the increased standard deduction.  If you are a single filer and have not itemized deductions on your return in previous years, then you were most likely taking the standard deduction of $6,350 (in 2017) plus the personal exemption of $4,050 (2017).  This gives you a combined income reduction of $10,400.  Even though the tax law has taken away the personal exemptions, the increase in standard deduction gives the same individual an income reduction of $12,000.  That’s a $1,600 increase.

Here’s an example: in 2017 a single filer who receives a W-2, has no children, and does not itemize has $6500 withheld for federal tax from his paycheck during the year.  At the end of the year, the tax due is $5,100 so this individual will get a refund of $1,400 ($6500 – $5100).  In 2018, this same individual, with no changes to his filing status, has $5,900 withheld from his paycheck (a result of the withholding changes) and ends up with a balance due of $4,100.  This gives him a refund of $1,800 for the year.  Not only does he get $400 more from the refund, but he also kept an additional $600 throughout the year as a result of the decreased withholdings ($6500 – $5900).

20172018
Standard Deductions$6,350$12,000
Withholdings$6,500$5,900
Total Tax Liability$5,100$4,100
Refund$1,400$1,800

Group #2: Taxpayers with a smaller than normal refund 

This is still a group most people are okay with because it means they didn’t have to write a check on April 15, however we have many clients who had grown accustomed to a sizeable refund and were surprised by a decrease on their 2018 return.  For some, the drop has been only a few hundred dollars, but others have received refunds for many thousands less.  Most commonly with our clients we saw this as a result of the loss of unreimbursed business expenses deduction or write-off.  In the past, taxpayers who have received a W-2, but incurred personal expenses in order to do their job (i.e. mileage, car expenses, home office expenses, travel, client meals, office supplies, etc) could write-off many of those expenses against their W-2 income.  For many, these write-offs could be substantial – tens of thousands of dollars in some cases.  These high write-offs could give a W-2 employee with appropriate withhholdings a refund of, for example, $8,000 because of the significant reduction of taxable income created by the unreimbursed business expenses.  With those write-offs gone, an $8,000 refund could be closer to $1,500 this year.

Here’s an example: a sales rep with a total income of $100,000 in 2017 itemized her deductions at an amount of $55,000.  This included $50,000 in unreimbursed business, home office, and vehicle expenses.  This individual ended up with a taxable income of $45,000 and a tax bill of $12,750.  Her withholdings were based on a $100,000 income so total tax withheld from her paycheck during 2017 was $20,000.  This resulted in a refund of $7,250 ($20,000 – $12,750).   In 2018, however, this person goes from taking an itemized deduction of $55,000 (remember – $50k in unreimbursed business expenses) to taking the standard deduction of $12,000.  That is a $43,000 drop in deductions!  Her withholdings automatically decreased by about $2,500 (more money in her pocket throughout the year) and her refund dropped to $1,350.  That’s a total of $3,850 back ($2,500 + $1,350), but it’s a far cry from the $7,250 refund she had gotten the year before.

20172018
Income$100,000$100,000
Deductions$55,000$12,000
Withholdings$20,000$17,500
Total Tax Liability$12,750$16,150
Refund$7,250$1,350

Group #3: First time balance due or a larger than normal balance due

Unfortunately, we encountered many people belonging to this group during tax season. Tax payers typically found themselves in Group #3 for 2 reasons:  an increase in income (from W-2 or 1099s, retirement accounts, stock sales, etc) and a decrease in withholdings.  Many of our clients who found themselves in Group #3 on Tax Day typically had a balance due with their filing in previous years.  For most, they were actually paying less total tax for the year even in instances where they had a slight increase in income.  It was the decrease in withholdings and, occasionally, the loss of exemptions that really get them in trouble.

Here’s an example: a married couple with one dependent took the personal exemption deduction of $12,150 (4,050 x 3) in 2017 alongside an itemized deduction of $16,500. That’s a total deduction of $28,650.  That same couple in 2018 took the standard deduction of $24,000 resulting in a $4,650 drop in deductions without changing anything about their household or deductions.  Both individuals receive W-2s and had a combined income of $155,000 and a total tax liability of $24,500.  Their withholdings totaled $20,000 and their tax bill on April 15th was $4,500 ($24,500 – $20,000).  In 2018, their income increased to $163,000, but their withholdings dropped to $15,000 ($8,000 more in income, but $5,000 less in taxes withheld).  Their total tax liability dropped down to $21,000.  If their withholdings had stayed at $20,000, even with the $8,000 increase in income, their tax bill would have only been $1,000.  Unfortunately, the automatic drop in withholdings gave them a $6,000 tax bill ($21,000 – $15,000).

20172018
Income$155,000$163,000
Deductions$28,650$24,000
Withholdings$20,000$15,000
Total Tax Liability$24,500$21,000
Balance Due $4,500$6,000

 

Key points to remember:

  • The increase in standard deduction resulted in a sizeable increase in deductions for tax payers who did not itemize in the past.
  • The loss of personal exemptions is less than added benefit of the standard deduction in single or married filing jointly households that do not have dependents. However, households with multiple depends or households that typically itemized a significant amount of deductions on their return likely saw a negative effect from this change.
  • Unreimbursed business expenses (which includes mileage and home office expenses) are no longer deductible if you receive a W-2. There are no exceptions.
  • Changes to the tax brackets resulted in an overall decrease in tax due for most taxpayers. Even if you had a balance due this year (for the first time or a balance that was larger than normal), you likely paid less tax total for the year.

Quick tips for 2019:

  • Don’t find yourself with a surprise tax bill this time next year. Do a withholding check-up and increase your withholdings where necessary.  If you are a contractor or are self-employed, talk to your tax professional about making estimated payments.  Remember that the IRS adds a penalty if you owe more than $1,000 at tax time even if you are a W-2 employee with withholdings (see our previous blog post on estimated payments for an explanation of our “pay as you earn” system).
  • If you received a sizeable refund, consider updating your withholdings to allow yourself to keep more money throughout the year. A refund is better than a balance due but getting thousands of dollars back in April isn’t always for the best.  After all, the US government is the only bank that will hold your money all year and not pay you any interest!
  • Review which expenses are still deductible under the new tax law and keep good records throughout the year so you can make the most of your deductions.
  • If you are a W-2 employee who typically has significant unreimbursed business expenses, consider talking to your employer about becoming a statutory employee. This will allow you to retain the benefits of your W-2 while also bringing back many write-offs you have lost under the new law.  Only a few categories of workers qualify for statutory employee status.  Learn more about this option on the IRS website
  • Take advantage of retirement benefits offered by your employer or explore options on your own to reduce your taxable income while also saving for the future (401ks, IRAs, HSAs, etc).