Last minute tax tips for landlords

Please note that this post is an excerpt of the webinar hosted by our sister company, The Landlord Code, where our co-founders coach DIY landlords how to avoid problem tenants and maximize rental profitability. Get access to more training like this in our (free!) private Facebook group HERE.   

-[Darcy] We’re gonna let Richard have the floor. He is going to deliver three last minute tax tips for landlords to consider for 2020 to help maximize their return,

[Richard] Hopefully the tips I’m gonna give are pretty basic, easy to follow, easy to understand. But before I always get in, I always like to ask; the IRS is about to change their slogan. And I always like to get, what do you call it?  The slogan is, “We have what it takes to take what you have” or “We’re not happy until you’re not happy,” so Well, as the survivors of not less than, I think two different oddity type things, we can concur.

– [Christopher] We’re not happy unless you’re not happy. I love that one, looks great. I mean, I’ll endorse that one all day long. – [Richard] But as homeowners and landlords, especially, we’re kind of now at the tail end of the year, but here are a couple of tips that will help you to prepare for your taxes and to actually try to save as much money as possible. First off, you should already know where your gross income and your net income lays. So if you are looking at your portfolio and right now you are showing income, taxable income, taxable net income, there’s a couple of ways that you might be able to reduce that, so you don’t have to pay. The first one is to accelerate as many of your expenses, right now as possible, so what does that mean? So here in December, can you pay your property taxes in advance? Can you, do you have an HOA due? Can you pay that in advance? Do you have maybe even utilities? Can you put anything in advance right now, so that you can bring your taxable income for 2020 down to zero or showing a loss? That’s actually a powerful tool because most people, for example, a big one is property taxes. If your property taxes, let’s say are due in January, February, but right now you’re showing net income. Why do you wanna pay that tax bill in 2021, when you could pay it now in December, you’ll prepay it. And that becomes an expense on your 2020 bill and basically bring your net taxable income down, lower or to zero. So something that a lot of people don’t realize that they can do. And so that’s probably one of your bigger ones you can do. So take a look at all of your expenses that you can prepay now and do so. It’s a flip side too, if you’re showing a net loss right now you wanna try to make as little payments or expenses as possible to push those expenses into January, right? So key number one, you should already know where your net income is, if you’re showing a net profit, try to accelerate as many expenses into this month as possible, if you’re showing a net loss, try to defer as many expenses as possible into January. That’s tip number one.

– [Christopher] I like that one.

– [Richard] Tip number two, I think this is some place that confuses a lot of, especially a lot of newer landlords, is the repair versus improvement expense. So what’s the difference? So a repair is basically something that fixes a prop, fixes an item and brings it back to its normal working life. Whereas an improvement is a work that prolongs the life of the property, enhances its value or adapt to a different use. So why do you wanna be cognizant of the two? So let’s say in my bathroom I have an issue with the pipes and it floods. So I get the plumber to come in, I get a $5,000 bill to fix the issue. Well, I can expense that entire $5,000 this year. But now let’s say I do an entire bathroom remodel and it costs me 50, $60,000., well guess what? I can’t take that entire $60,000 this year, I’ve got to now take depreciated, or basically every year, take a little bit of that expense on my tax returns. So what I find is a lot of people will come in and say, “Oh, I’ve got 60, 70, a hundred thousand dollars of improvements, I’m not gonna have any tax liability this year cause I spent way more than I took it as rental income.” Well, let’s say they took it in, to make it easy, let’s say they took in a hundred thousand in rental income, and they’ve spent a hundred thousand dollars in improvements while they think they have zero income that they have to report. But since it’s a home improvement, they can’t take that a hundred thousand dollars all this year as an expense. They have to spread that out possibly up to 27 years. So maybe they can only take 10,000 of that, and now they have $90,000 of taxable income, and they’re like, “Oh my goodness, now I gotta pay taxes on $90,000.” All right, so tax tip number two, is you should be working along with your accountant to understand if you’re making improvements or repairs, you know, how does the IRS view it? Are they going to allow you to take the entire expense this year? Or do you have to spread the expense over several years? You wanna know that cos’ you don’t wanna get surprised. And especially now in December, there might be possibility where you can take, you already know that you have an improvement that you wanna do, or you have a repair that you wanna do, and if you’re showing a net income right now, and you have a repair that’s expensive, but you have the funds to do it, go ahead and make the repair this month as soon as you can. If it’s an improvement, well an improvement, you probably wanna take a look at your cashflow. That’s probably what will benefit you either this month or next month, big thing is repair.

– [Darcy] I ask to clarify so that non tax person’s might understand. So for our property management clients, what I’m hearing from you is all repairs. So like leaky faucet, your general repairs, dishwasher repair, those are all going to generally be tax deductible that same year that you pay for the repair versus we look at them as capital improvements, anything that’s improving the property, so like a new roof, new floors, new refrigerator, that write off can not be captured in the year that it is spent, it’s captured and then depreciated, depending on probably a few things. – [Richard] Yes, that’s exactly right, simply put. – [Darcy] Awesome, so the advice we should be giving our portfolio, our clients, and our property management portfolio, is if they’re showing positive income, if there are repairs we’ve been putting off, November and December are a good time for them to do those repairs. – [Richard] Yes. – [Christopher] And they may not be able to capture the full cost- – [Darcy] On repairs.

– [Richard] Okay, I mean, and just even that story alone, I have a client now that I think about it, but the reason I’m even bringing this up, spent a good, I’m gonna say a hundred, $150,000 cause they had a problem with their foundation. So they had to do a whole bunch of work on the foundation. So didn’t really consult with me until now, it’s time to file their taxes. Oh, I don’t owe any taxes because I had all this money on expenses. Well guess what, foundation work is considered capital improvement. So the $150,000 that she thought she could write off this year, she couldn’t, she could only write up a fraction of that and she ended up owing money on taxes. So that’s why it’s good for all landlords to understand that concept of what’s a repair and what’s a, you know, an improvement because it really has a major effect on what you’re gonna owe in taxes at the end of the year. – [Christopher] You’re not saying no, to maybe improvement, just so as long as you understand the tax. The tax that you can work . Okay, and then another simple, might not be simple for you guys, not simple to understand, but simple to actually execute is a concept, another concept that a lot of landlords don’t realize, is prepaid rent, and that comes into play especially in December, right? Because you’ll have tenants now that are gonna pay January rent, but they pay it when? They pay it in December. – [Darcy] This plagues our bookkeeper every year

– [Richard] Because tax, for tax, it’s a cash basis. So you have to report your rental income when you receive it, so even if it’s January, for January for rent, but if it’s received in December, it’s got to be reported on your, in this case, on your 2020 tax return. So that sometimes takes people by surprise, cause now they’re expecting, you know, January through December, they’re expecting 12 months of gross rent to report on their income. But now they have basically 13 months because of that extra rent that came in early. So a way to combat that, it’s kind of difficult because you’re either got to tell the tenants that don’t prepay sometimes, you know, which I don’t know how effective that really is. – [Darcy] By now I think everyone really just wants tenants to pay. – [Richard] Yeah. you don’t wanna get them into the habit of not paying. Prepaying is good all the time for you. So you wanna buy, as property managers, as soon as you get the rent, then it becomes effectively rental income that your landlords have to report. So for landlords, just keep that in mind, prepaid rent that you receive, January prepaid rent that you’re gonna receive in December, is reported on your 2020 tax return. – [Darcy] And then this comes into play for our clients as we’re negotiating deals at the end of the year, sometimes tenants prepay six months upfront as a cure for any number of reasons. And that discussion does come up with our owners that sometimes that’s not the most attractive offer for them as you’re in the end of the year, because we pay six months or 12 months up front- [Richard] Yes, that takes like the bonus to get our money early out of it.

– [Darcy]  So I have a question as it pertains to the costs of working your investment property, but say you hire a professional to manage it, or to lease it up, are those costs tax deductible? – [Richard] Yes, any expense associated with your rental property is tax deductible. So property management company, that expense is deductible. Your account is deductible, basically anything you spend on your rental property, it can be deducted. So then that’s a good point. Make sure that you just keep good records. And that’s the advantage of having a property manager too, is that they’re recording all the expenses and they’re giving you a monthly report and an annual report, that’s easy to prove to the IRS if they come and give you an audit. “Oh, where does all this money going, can you prove it?” Well, yeah, here’s my financials. I can get you the invoices if you need to see them. But one thing about the IRS is this, they like easy work. So in other words, what does that mean? If you’re in an audit, they’ll take your first, they’ll take the tax year in question, let’s say, they’re going to audit your 2020 returns, they’ll say, “Okay, you have X amount of expenses, can you prove this?” Okay, yeah, here’s my financial statements from my property manager, here’s what I spent. Okay looks good they might look there one to two line items. And if they see that everything’s organized and everything looks legit, they’re not gonna fish for any more, cause they don’t wanna waste their time. But if they say, “Oh, you don’t have any proof for this expense? Well, if you don’t have proof for this expense, I’m gonna keep digging, cause you probably don’t have proof for any of other expenses, not only this year, but in the years prior.”

And one of the auditors in business to do the audit department is to make money, right? That’s why, you know, the IRS computers and the California computers are extremely sophisticated. They can catch a mistake as soon as you submit your tax return, but why don’t you hear from them? Why is it that you hear from them maybe a year or two later? Because by then all the penalties and interest have piled up and that’s where they’re making their money. That’s why they do it that way, it’s by design. So an audit is nothing to be scared of if you have all your documentation, but it’s something to be terrified of, if you have nothing to prove what you’re claiming. – [Darcy] Well, and we know that a lot of our DIY landlords are not necessarily keeping track of these records because when our DIY landlords come to us and they’ve got a question maybe about, they want our help with normal wear and tear and discussing how the security deposit should be handled, then we’re saying, okay, well, where’s your proof that this is the new carpet, where’s your receipt? How much did you spend? We’ve got to depreciate it on 10 years and they look at us like, huh! – [Christopher] And that’s not a great reason for using a licensed vendor because they will likely keep those receipts versus your Bob handyman down the street. He’s got a hammer, right? – [Richard] Exactly. -[Darcy] Well but if the IRS is coming after you two years later, are you gonna be able to call up this carpet company and be like, “Could I get the receipt from that job?” I mean, maybe- – [Christopher] More often than not, you can. – [Darcy] You think, 2 years later, all right. – [Christopher] Any reputable company stores them on a computer. Another question, Richard so this is along the lines of preparing your property for rental. So let’s say you’re living in a house. You bought another property that you’re gonna be moving into, where you’re thinking about doing the same thing down the road, and we’ve got to prepare, we got to move out. We’ve got to clean it, we gotta do all this things. Now, can you write off the cost of moving out of your current house into your new house, is part of preparing your rental property for rental as a business? Its just a question comes up. –

[Richard] Good question, good question. Now the IRS would consider that a personal expense.

– [Christopher] Okay. – [Richard] The only way it would not be a personal expense is if you had a rental property and it was furnished. So it’s a rental property to begin with and it’s furnished. And now let’s say the person who’s gonna come in, doesn’t want it furnished. They’re gonna bring in all their stuff. Well for you to move all the furniture in a rental property, into storage or wherever, then that could be deductible. – [Darcy] Well that’s good, that comes up a lot. – [Richard] But if it’s your own personal property and you’re moving out, then that’s considered a personal expense, so you could deduct that. – [Christopher] Okay, yeah, that’s good, it come up that’s why I’m asking, it’s come up before, like people are like, “What else can I write off?”  – [Darcy] So on that topic, here’s another question we get a lot, it’s been a primary residence, same scenario, the homeowners are moving out, they’re turning it into a rental, but let’s say we’ve given them advice of a bunch of upgrades we want them to make, we want new floors, we want new appliances, we want new paint. All of that, does that count under that these are all improvements, so these are now going to be depreciated over the next X number of years?

– [Richard] Yeah, that’s a good question, and it’s also a tricky one, because prior to a property becoming a rental, any cost going into it has to be capitalized or in other words, anything to make it rent ready, you know, painting, repairs, whatever, you can’t write that off all in one lump sum in the same year, that’s gonna be depreciated over time. But once you make it ready for rent, in other words, the property manager, you give it to property manager, they start advertising it for rent. Then whatever expense after that, if it’s a real repair, can be written off in full in the same year. – [Darcy]  All right. – [Christopher] That’s a strategy thing. So for example, if like you give it to a property manager or you put it on the market, and then someone is looking at it and like, “Oh, I want it, Can you repaint that room for me? I don’t like the color,” and you do that, you can write that off as a- – [Richard] As a repair right away. – [Darcy] But I think it’s important to go back to the delineation because in our personal portfolio, this is just what comes up a lot for our clients. So the homeowners are still living there and they say, “Oh, don’t worry about it, I’m gonna do all these repairs while am here before I give it to you as the management company,” that then is not going to be able to be captured as the homeowners living in the property. – [Richard] Right. – [Darcy] Okay, so that’s an important strategy to think about, so it would probably be more beneficial for most of our clients to move out, give it to us, let us start doing the repairs, tracking those, so that they can take advantage of that tax.

So that’s it for today, the link to watch the full video is below this post. Happy Holidays, Stay in your home, wear a mask. Be positive and test negative everybody, take care.

Video link : https://app.searchie.io/watch/OlDd08JgDy