Investors who own rental property can deduct the costs of maintaining and marketing the property. Depreciation is calculated on the theory that assets lose value over time as they wear out. If you like your rental property enough to live in it, you may be able to convert it into a primary residence to avoid capital gains tax. However, there are some rules that the IRS enforces.
You have to own the home for at least five years. And you have to live in it for at least two of the five years before you sell it. If you decide to sell your rental property, you must be prepared to pay capital gains taxes. Capital gains taxes occur whenever you sell an asset for any amount of gain, and are considered either short-term or long-term.
The IRS defines a short-term gain as a gain on a property that was held for one year or less and is taxed at the same rate as your regular income tax. Many buy-and-hold real estate investors use their free cash flow to pay off the debt on their rental property as quickly as possible. If you own your rental property free and clear, or have a very small mortgage balance, a seller carryback is another way to reduce your capital gains tax. For depreciation tax purposes, residential rental properties are assumed to have a useful life of 27.5 years.
In the "Long-term" section above, approximately one year of depreciation was recaptured. The most recent IRS Publication 527 explains to investors everything they need to know about depreciation of residential rental real estate. Tax-deferred retirement accounts, such as an IRA, Roth IRA or 401(k) plan, allow investors to purchase rental property with their retirement savings while allowing rental income and capital gains to accumulate tax-free until the investor begins making withdrawals. Section 1031 of the Internal Revenue Code allows real estate investors to sell a rental property, purchase another property of equal or greater value, and defer payment of capital gains taxes.
The IRS also calls 1031 exchanges "in-kind exchanges," although that phrase can be a bit misleading. For example, the IRS considers property to be like-kind as long as it is of the same nature or character. Therefore, giving up a single-family rental property and replacing it with a larger portfolio of rental properties would qualify as a Section 1031 like-kind exchange. The same would be true for the sale of a commercial property, such as an office building, in exchange for the purchase of a group of single-family rental properties.
In fact, Roofstock makes it easier for real estate investors to maximise a 1031 exchange. Of course, selling a property does not mean getting out of the real estate investment business altogether. In fact, many investors increase their real estate holdings by using a 1031 exchange to trade a single-rental property for a larger portfolio of professionally managed single-family homes. Jeff has over 25 years of experience in all segments of the real estate industry, including investment, brokerage, residential, commercial and property management.
While his real estate business runs on autopilot, he writes articles to help other investors grow and manage their real estate portfolios. Scott Boyar, a Southend CPA, is one such accountant and tax advisor, knowledgeable and adept at helping North Carolinians take advantage of all the tax benefits available to homeowners while limiting tax liabilities and avoiding penalties altogether. As far as taxes on rental income are concerned, they are subject to the same treatment as any income you may have from your employment or secondary activities. If you have more than three rental properties, you will have to use more than one copy of Schedule E, although the totals only have to appear on one.
Or you may not make enough profit to offset all your capital gains from the sale of a rental property. Keeping an eye on real estate market conditions and reviewing your overall financial situation can help you determine if it's the right time to sell to minimise taxes. Those who miss the deadline must pay full capital gains taxes on the sale of the original rental property. If you have not claimed depreciation on a rental property, you will still have to pay depreciation recapture tax.
If your rental property is breaking even or even making some money, it is advisable not to sell it, unless you can offset your losses to lessen the capital gains tax burden. It is up to you and your tax advisor to calculate which short-term rental options would best serve your financial goals and needs, taking into account your intentions of how long you intend to reside in a property versus renting it out. For example, if you hold business meetings for your own company in your home or holiday home once a month, that would equate to 12 days of rent per year. When selling stock at a loss, you can use tax loss harvesting to help offset the taxable gain from the sale of your rental property.
The depreciation expense you are entitled to each year can save you a lot of money at tax time.