Whether you do your taxes yourself, or pass a pile of receipts to your accountant, being aware of tax write-offs for real estate owners helps you realize next-level profitability.
Homeowner and investor taxes can be complicated and conditional, so we suggest and highly encourage reaching out to your tax accountant to validate advice you get from anyone who’s not a CPA, including us. In the meantime, we have gathered some resources here to help improve your understanding.
Homeowners
The two biggest write-offs for homeowners are mortgage interest and property tax. A write-off or deduction (same thing) may allow you to reduce your federal taxable income by the amount of the deduction if you itemize your deductions on the Schedule A. Your tax accountant will ask you for the FORM 1098, that your mortgage company mails or has available to download from your online account. We’re not going to get into nuances to this tax advantage on mortgages over $750,000, but if that’s you, look into it.
Hopefully, the previous law will be restored, but the past administration capped local tax deductions (not Federal), which include Property tax, at $10,000. This means if your property taxes are above those amounts, you are being double-taxed, which if you remember from Civics or American History classes, is unconstitutional. The states of New Jersey, New York, MD CT have sued the Treasury Secretary and the IRS. Our fingers are crossed that this cap is lifted under the new administration. The good news is for most Philadelphia residents, our property taxes are well below those caps, which leads us to the discussion of standard deduction vs. itemizing.
Many homeowners choose to take the standard deduction vs. itemizing. If your property taxes are low (abated) and your interest rate is low, it could be advantageous to take the standard deduction. For married couples in 2021, it’s just over $25k. For single people, it’s $12,550. The standard deduction may include everything from medical deductions (subject to limitations), state and local taxes (remember that 10K cap), and more. If you think between all your itemized deductions you will surpass that standard deduction threshold, then it is worth taking the time to gather your receipts (you will need very good records) and fill out the necessary paperwork to itemize your deductions.
Bonus tip! It isn’t a write-off, but it is a tax savings; Take a moment to sign up for the Homestead Exemption. It can provide up to an average of $629 a year in property tax savings!
Here are some articles that can help with the tough call between itemizing or choosing the standard deduction:
Future Home Owners
If you’re considering buying a house, you’re already thinking of a million things, but here’s something you should learn, and not forget as you're shopping and negotiating. If your monthly mortgage payment including PITI (Principal Interest Taxes and Insurance) is the same as your rent per month, the above-mentioned tax advantages actually make the monthly payment much less once your deduction is applied.
When weighing renting against owning, remember to reduce your taxable income by your annual mortgage interest, and your property taxes. To estimate how much the savings is you can estimate your mortgage interest by using BankRate’s Mortgage Interest Tax Deduction Calculator. Add this savings to what you’d get back from paying your property tax. As this all can be complicated- speaking to your tax accountant is first and foremost.
Home Sellers
If you sell your home do you have to pay tax on the profits? No… and yes, depending on your circumstances. Rule number one, you must have lived in your home, as a primary residence for 2 of the 5 years prior to the date of sale, and they don’t need to be consecutive years. If you meet that requirement most homeowners can exclude the first $250,000 ($500,000 for married filing jointly) of gains from the sale of a primary residence. If your profits are over that you will need to pay taxes on the amount that exceeds the threshold. The good news is that any home improvements you have made over your time in the home can be added to your basis, so converting that garage into a rumpus room was worth it! In addition to major home improvements (sorry, repairing the leaky faucet doesn’t count), you can also deduct advertising the sale of your home, settlement fees, commissions, and a whole lot more. In a hot market, you could very well find yourself over that $250k or $500k mark, deducting all you can will help whittle that down.
Legal site, Nolo shares this example: Phil and Helen, a married couple who qualify for the $500,000 home sale tax exclusion, sell their home for $800,000. They pay a 6% sales commission to their real estate broker ($48,000) and another $32,000 for attorney fees, closing costs, and closing fees. They subtract these sales expenses from the sales price to determine the amount they realized from the sale. $800,000 - $80,000 = $720,000.
Their home’s tax basis (original cost plus improvements) is $200,000. They subtract this from the amount realized to determine their gain from the sale. Thus, their gain is $520,000. This is $20,000 more than the applicable $500,000 home sale tax exclusion. Thus, the couple must pay capital gains tax on $20,000 of their profit.
Assume that prior to selling their home, Phil and Helen from the example above spent $25,000 to extensively remodel their kitchen. They add this amount to their home’s tax basis. Its basis is now $225,000, instead of $200,000. They subtract $225,000 from the $720,000 realized from the home’s sale to determine their net profit: $495,000. This is less than the applicable $500,000 home sale tax exclusion for married couples, so they owe no capital gains tax on the sale.
If you want to read more about what to look out for when selling your home here are some recommended resources:
Investors
Savvy investors can take advantage of some serious tax write-offs. If you want to reap the benefits make sure you have a clear accounting system, save your receipts for all repairs and upgrades. Keep clear contracts, (hint: it doesn't help you out to have your leases lapse). If you have employees or a management company, keep track of payroll and invoices. All of this will help you get the best tax breaks each year.
Deducting interest from debt related to rental property activity is always at the top of a landlord’s list. You are able to deduct the interest expense on dept payments used for the purchase and costs of repairs on your investment property. Say you took out a loan and renovated the bathrooms in your rental property. The loan itself is not deductible, however, the interest payments that are made on that loan are deductible. The cost of improvements made with the loan proceeds can also be deducted via depreciation over the asset’s life.
One PHG agent shared “My partner and I purchased an investment property that needed a little love to get it up and running. We saved all receipts and invoices from the various contractors. At the end of the year, our maintenance and repairs totaled $13,000. We handed everything off to our tax accountant and were able to deduct $13,000 from our reported gross rental income
What if your rental property was vacant for months out of the year? Net rental income (after expenses) is taxable at the federal level and possibly the state and local level, depending on your location. If your rental activity produces a loss, some taxpayers may qualify to deduct the rental loss in the same year, resulting in less taxable income. Losses that aren’t deductible in the current year don’t just disappear, though. They may qualify to be carried forward and deducted against future taxable transactions. The specific treatment of rental activity income and losses depend on other factors that are unique to each taxpayer and is best discussed with a professional within the context of your individual tax scenario.
Here are some excellent resources that will explain additional write-offs that include, maintenance and repairs, commissions paid for advertising, tenant placement and lease negotiation, loan interest, and even legal services.
Common Real Estate Tax Deductions for Philadelphia Landlords
IRS Tips on Rental Real Estate Income, Deductions and Recordkeeping
Multifamily Program Guidelines and General Requirements (PFHA)
Whether an investor, homebuyer, or homeowner one thing that bridges all tax deductions is carefully kept records and finding “your tax guy” or gal! Don’t hesitate to ask experienced CPA questions, especially if you have recently entered into the investment game or have sold your property in the last year. There are so many opportunities and deductions that can set you up to save money and better yet, increase your refund!
Saving money for a downpayment and closing costs is the # 1 reason people are holding off on purchasing a home. PHG agent Rachel Shaw came up with a trusty list of some of her favorite homebuyer assistance grants and loan programs. With a little help, your dream of owning a home may not be as far off as you thought!