Below is a straightforward breakdown to help you evaluate your options—and to highlight what Washington homeowners should consider before making a decision.

1. What Exactly Is A Short Sale and Is It Worth It?

A short sale happens when your lender agrees to let you sell the property for less than the remaining mortgage balance. While it can offer a clean break, it’s not a simple or fast process.

Pros of a Short Sale

• Avoid foreclosure (less damage to your credit than a foreclosure or bankruptcy).
• Potential debt forgiveness if the lender waives the deficiency (not guaranteed).
• Finally walk away from an underwater home you can’t afford to keep.

Cons of a Short Sale

• Lengthy approval process. Expect weeks—or months—of bank reviews, document requests, and follow-ups.
• Lender can still pursue the deficiency. In Washington, deficiency judgments after a short sale depend on the specific loan type and whether your lender waives the remaining balance in writing.
• Credit score impact. Less severe than foreclosure, but still significant.
• Possible tax implications. If the forgiven debt is treated as taxable income, you may owe tax unless you qualify for insolvency or an exclusion.

Is the paperwork really that bad?
Short sales require full financial disclosures, hardship letters, income proof, and repeated negotiations. It’s not a “sign and done” situation. Homeowners often underestimate the complexity, so if you’re considering this route, be prepared for administrative friction.

2. Should You Rent It Out Instead?

Renting can sometimes bridge a difficult financial season—but many homeowners underestimate the hidden costs.

The Upside of Renting

• Keeps the home as an asset so you can sell later when the market improves.
• Rent can offset part (or all) of your payment.
• Rental losses may be deductible (subject to passive activity rules).
• You maintain credit stability since you’re continuing to pay the mortgage.

The Downside

• You may still lose money each month. Even a small negative cash flow adds up quickly over a year.
• Wear and tear + repairs. Vacancies, tenant turnover, and maintenance can eat significantly into your budget.
• Becoming a landlord is a job. Especially true if you self-manage.
• Depreciation recapture tax later. When you eventually sell, depreciation you’ve taken (or should have taken) can increase your tax bill.

When renting makes more sense

• You expect property values to rebound within a few years.
• You can comfortably absorb a monthly loss.
• You’re open to being a landlord or can outsource property management.
• You want to delay selling for tax reasons (e.g., conversion back to primary residence).

3. Washington State–Specific Considerations

While Washington doesn’t have a state income tax, it does have unique rules worth noting:

Mortgage Types Matter

• Washington is primarily a non-recourse state only for certain foreclosure situations—not automatically for short sales.
• Always verify whether your lender plans to waive deficiency. This determines whether you walk away clean or still owe money after closing.

Strong Tenant Protections

• If you rent, expect detailed rules around security deposits, notice periods, and habitability.
• Some cities (Seattle, Tacoma, Burien) have additional local landlord regulations.

Market Conditions

• In many Washington regions, rents are rising, but home prices may still be plateauing.
• Negative cash flow may tighten, loosen, or flip depending on your local rental market.

4. Other Options You Might Be Missing

Before deciding between renting and a short sale, consider these alternatives:

• Loan Modification
  Lenders sometimes reduce monthly payments through:
  • Lower interest rates
  • Extended loan terms
  • Principal forbearance

Not guaranteed, but worth exploring.

• Forbearance or Repayment Plan
  Temporary relief if your hardship is short-term.
• Sell With Cash to Cover the Difference
  If the deficiency is small and you can afford it, this avoids the credit impact of a short sale.
• Rent-to-Own or Lease Option
  If your market supports it, this attracts long-term tenants who may eventually purchase the home.
• Wait and Reassess
  If you are not in immediate financial crisis, holding the home longer may improve your position — especially in appreciating Washington markets.

Should You Walk Away, Rent It, or Short Sell?

Short Sale Might Make Sense If:

• You’re underwater with no realistic path to break even.
• You cannot cover monthly losses.
• You’re ready for a clean break and okay with the credit hit.

Renting Might Make Sense If:

• You believe the home will recover value soon.
• You can comfortably manage the monthly shortfall.
• You want to preserve the asset or convert it back to a primary residence later.

Other options might make sense if:

• Your hardship is temporary.
• You qualify for assistance or modification.
• The deficiency in a normal sale is small enough to cover.

Final Thoughts

Choosing between a short sale and renting out your home is stressful, and Washington’s unique housing landscape adds complexity. The right decision depends on your financial stability, your risk tolerance, and your long-term goals.

If you’re facing this decision, consider speaking with:

• A tax professional (for tax implications of short sales, debt forgiveness, and rental losses)
• A real estate attorney (for deficiency and liability issues)
• A local real estate agent (for market-specific rental and sale projections)

The more clarity you gather, the easier it becomes to choose the path that aligns with your financial future.

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This exact situation can be stressful and confusing. Below, we’ll break down your options, what you should consider before taking your next step, and how to protect yourself moving forward.

Understanding the REPS Rules

The IRS and state tax authorities both use strict criteria to determine whether someone qualifies as a Real Estate Professional. In general, two requirements must be met:

1. More than 50% of personal services performed during the year must be in real estate trades or businesses in which you materially participate.
2. At least 750 hours per year must be spent materially participating in those real estate activities.

If you have a full-time W2 job unrelated to real estate, state auditors often take the position that it’s nearly impossible for you to meet the “more than 50% of time” test—even if you’ve logged hours that suggest otherwise.

Option 1: Appeal the Audit Decision

If you truly have detailed logs, calendars, and other evidence of your real estate activities, you may be able to appeal the state’s decision. Strong documentation should include:

• Contemporaneous time logs (not recreated after the fact).
• Evidence of active participation (emails, contracts, invoices, property management activities).
• Proof that your real estate activities were substantial enough to outweigh your W2 hours.

Keep in mind: appeals can be costly and time-consuming, and success depends heavily on how convincing your evidence is relative to your W2 obligations.

Option 2: Amend Your Return

If your evidence isn’t strong—or if the cost of fighting outweighs the potential tax savings—you may decide it’s more practical to amend your return. By removing the REPS claim and paying the resulting tax, you can reduce penalties and interest, and avoid prolonging the dispute.

This option also helps you move forward with more certainty rather than spending months in appeals.

Option 3: Consider Recourse Against Your CPA

If your CPA assured you that you qualified for REPS but failed to account for the obvious limitation of your W2 job, you may have grounds for a professional negligence claim.

Your options could include:

• Requesting the CPA cover penalties and interest (many firms carry errors & omissions insurance for this).
• Filing a complaint with the state board of accountancy if the advice was clearly below professional standards.
• Consulting a legal professional to evaluate whether you have a malpractice case.

Before taking action, review your engagement letter with the CPA—some agreements limit liability.

Key Takeaways

• Appeal if your documentation is airtight. Logs and supporting evidence are crucial.
• Amend if your case is weak. It’s often better to pay and move on than risk larger penalties.
• Evaluate your CPA’s role. If their advice was clearly flawed, consider seeking reimbursement for costs tied to their mistake.

Final Thoughts

REPS status can be incredibly valuable, but it’s also one of the most heavily scrutinized tax positions. If you’re considering claiming it, work with a CPA who has deep experience in real estate taxation and who will evaluate your eligibility conservatively.

If you’re already facing an audit dispute, talk with both a tax attorney and a different CPA for a second opinion before deciding whether to appeal or amend. The right choice depends on the strength of your evidence, the size of the tax bill, and your tolerance for risk.

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1. Cost segregation,
2. Accelerated depreciation,
3. Bonus depreciation

When used together, they can significantly reduce taxable income and increase cash flow, especially in the early years of property ownership.

Let’s break down what each means, how they work together, and why they’re particularly valuable in the current tax climate.

What is Cost Segregation?

Cost segregation is a strategic tax planning tool that allows property owners to reclassify certain components of a building from standard 39-year (commercial) or 27.5-year (residential) depreciation schedules to shorter-lived asset classes (such as 5, 7, or 15 years). These components can include things like carpeting, lighting, HVAC systems, cabinets, landscaping, and even certain electrical or plumbing systems.

By accelerating the depreciation of these components, cost segregation can significantly increase deductions in the early years of ownership—resulting in substantial tax savings.

How Accelerated Depreciation Works

Accelerated depreciation refers to methods of depreciating assets more quickly than the traditional straight-line method. In the context of real estate, this usually applies to assets identified during a cost segregation study. Instead of spreading deductions evenly over 27.5 or 39 years, accelerated depreciation allows for larger deductions in the earlier years of the asset’s life.

This front-loading of deductions lowers taxable income in the short term, improving cash flow.

Bonus Depreciation: Supercharging Cost Segregation

Bonus depreciation allows you to deduct a significant percentage (formerly 100%, and now phasing down — 80% in 2023 and 60% in 2024) of the cost of qualified property in the year it’s placed in service. When paired with cost segregation, this means that all those components reclassified into 5, 7, or 15-year asset lives can be deducted immediately.

For example, imagine you buy a commercial building for $2 million. A cost segregation study determines that $500,000 worth of assets can be moved into short-lived categories. With bonus depreciation still in play, you could deduct up to $300,000 of that in the first year (if using 60% bonus depreciation in 2024). That’s a huge tax break that wouldn’t be available under traditional depreciation rules.

Key Benefits for Real Estate Investors

• Increased Cash Flow: Lower tax bills in the early years of ownership mean more available cash for improvements, debt reduction, or new investments.
• Offset Passive Income: For those with other rental properties or real estate holdings, these deductions can help offset passive income, reducing overall tax liability.
• Short-Term Holdings Advantage: Even if you don’t plan to hold a property long-term, these front-loaded deductions can maximize ROI before a future sale.
• Immediate ROI on Renovations: If you’ve made significant improvements after purchase, those can often be segregated and depreciated separately.

Considerations and Caveats

• Cost Segregation Study: To take advantage of these strategies, you’ll need a formal cost segregation study performed by a qualified engineer or tax advisor. This does come at a cost, but the potential savings often far outweigh the expense.
• Recapture on Sale: When you sell a property, depreciation deductions are subject to recapture and taxed at a higher rate. That said, with good planning, many investors defer or minimize recapture through 1031 exchanges or careful timing.
• Bonus Depreciation Phase-Out: The 100% bonus depreciation rate under the Tax Cuts and Jobs Act is phasing out. In 2024, it’s 60%, and it will continue to decline unless Congress renews or modifies it. This makes it even more urgent to act while the benefit is still sizable.

If you own or are planning to acquire income-generating real estate, cost segregation combined with accelerated and bonus depreciation offers powerful tools to enhance your after-tax returns. While the strategies themselves are sophisticated, the end result is simple: more money in your pocket, sooner.

For property owners in Washington State — especially those in rapidly appreciating markets like Seattle, Bellevue, and Tacoma — these strategies can help manage growing tax burdens while still capitalizing on high-value real estate.

If you’re considering a new acquisition, renovation, or simply want to ensure you’re not leaving money on the table, get in touch with our team to explore your options.

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Here’s a breakdown of what Form 8825 is, who needs to file it, and how to go about filling it out.

What Is Form 8825?

IRS Form 8825 is titled “Rental Real Estate Income and Expenses of a Partnership or an S Corporation” — really rolls off the tongue. This form is used to report the income, deductions, and expenses from rental real estate activities carried out through a partnership or S corporation.

Rather than using Schedule E (which is used by individuals), business entities use Form 8825 to report these activities as part of their informational tax returns (Form 1065 for partnerships or Form 1120S for S corps).

The goal? To determine the net gain or loss from rental property operations, which is then passed through to individual partners or shareholders to report on their personal tax returns.

Who Needs to File Form 8825?

You’ll need to file Form 8825 if:

• Your business is a partnership or an S corporation,
• You have ownership or participation in rental real estate, and
• That rental activity generates income or incurs expenses during the tax year.

This applies to landlords who own residential rental properties through an LLC taxed as a partnership or S corp, as well as real estate investment groups operating under a partnership model.

Most importantly, C corporations do not use Form 8825, nor do individual property owners (they typically use Schedule E).

Important Note: Do not use Form 8825 if you’re filing as a sole proprietor — in that case, you’d typically report rental income on Schedule E of your Form 1040.

C corporations also do not use Form 8825. Rental income would be reported directly on Form 1120.

If your entity owns multiple rental properties, each one should be listed separately on Form 8825.

The income or loss calculated on Form 8825 carries over to the appropriate lines on the parent return (Form 1065 or 1120S), and eventually to owners’ K-1s, where it may be subject to passive activity rules.

How to Fill Out Form 8825

Filling out Form 8825 requires accurate records of your rental income and expenses. Here’s a basic walkthrough of how to complete it:

1. Property Information

Start by listing each rental property separately. For each one, you’ll provide:

• Property address or description,
• Type of property (e.g., residential, commercial),
• Number of days rented and personal use (if any).

If you have multiple properties, the form has additional rows and allows attachments for more entries.

2. Rental Income

Report the gross rental income received from each property — this includes rent payments but not security deposits (unless retained due to lease breaches).

3. Expenses

Next, enter all deductible expenses associated with each rental property, including:

• Advertising
• Auto/travel (related to property management)
• Cleaning and maintenance
• Commissions
• Insurance
• Legal and professional fees
• Management fees
• Mortgage interest
• Repairs
• Property taxes
• Utilities
• Depreciation or depletion

These expenses should be directly tied to the rental activity, not personal use.

4. Totals and Net Income

At the bottom, you’ll calculate:

• Total income,
• Total expenses,
• Net gain or loss for each property.

This net number flows into the overall partnership or S corporation’s return and then into each partner’s/shareholder’s K-1, which they report on their personal taxes.

5. Passive Activity Rules

Keep in mind: most rental activities are considered passive unless you’re a real estate professional. This matters because passive losses can’t always be deducted against ordinary income — they may be limited or carried forward.

Pro Tips

• Keep detailed records of all rental income and expenses throughout the year.
• Don’t forget depreciation — it’s one of the most valuable deductions and is often overlooked.
• If your entity owns multiple rental properties, ensure each one is separately reported — mixing property data can raise IRS red flags.
• Consult a tax professional if you’re unsure whether your activity qualifies as passive or active, especially if you materially participate in property management.

Final Thoughts

Form 8825 might not be well known outside real estate circles, but for partnerships and S corps with rental activity, it’s essential. Filing it properly ensures you stay compliant with IRS regulations and maximize your allowable deductions.

Image generated by Sora.

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What you can Deduct

As a Seattle-area rental property owner, you can typically deduct expenses like mortgage interest, property taxes, maintenance, repairs, insurance, utilities, and depreciation. These are reported on Schedule E of your federal return. Residential properties are depreciated over 27.5 years, while commercial real estate is depreciated over 39 years.

Passive Loss Limits: the $25,000 Rule

One of the biggest limits to be aware of is the $25,000 passive loss allowance. Rental income is generally considered “passive” unless you qualify as a real estate professional. If you actively participate in your rental — making decisions about tenants, repairs, and pricing — you can deduct up to $25,000 in rental losses against your other income if your modified adjusted gross income (MAGI) is under $100,000. This deduction begins to phase out and disappears entirely once your MAGI hits $150,000.

De Minimis Safe Harbor & Repairs

For small, routine expenses, the IRS allows what’s called a “de minimis safe harbor” — letting landlords deduct individual items that cost $2,500 or less without needing to capitalize them. That covers things like replacing a broken appliance or repairing a leaky faucet. But if you make larger improvements — like replacing a roof or remodeling a kitchen — those must be capitalized and depreciated over time.

Capital Expense Write-Offs: Section 179 & Bonus Depreciation

Some landlords also benefit from Section 179 deductions and bonus depreciation. These provisions let you write off qualifying assets (like new HVAC units or appliances) in the year you place them in service. Section 179 has a dollar cap, while bonus depreciation is currently available at 60% for 2024, with plans to phase it down further.

When Losses Exceed Income

If your expenses exceed your rental income, the IRS lets you deduct those losses — but only up to the $25,000 passive loss limit if you’re an active participant. If your income is too high or your losses are larger than the limit, the excess gets carried forward to future years. You can then apply those losses against future rental income or capital gains.

Seattle-Specific Considerations

• Cost Segregation studies are particularly worthwhile in in high-cost markets like Seattle. Seattle-specific factors also come into play. These allow landlords to reclassify components of the property into shorter depreciation categories, which front-loads deductions.
• Short-term rentals (Airbnbs) in Seattle may also be eligible to bypass passive loss limitations if they materially participate in managing the property.
• Don’t forget Washington Sales & B&O taxes on short-term rentals and lodging — those are separate from federal deductions.

To get the most out of your write-offs, make sure you’re actively involved in managing your property, track all receipts and documentation, and consider working with a local CPA who understands the nuances of both federal tax law and Seattle’s rental landscape. Maximizing deductions takes strategy — but doing it right can mean thousands in tax savings each year.

Photo by Andrew S on Unsplash

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Maximizing Boom Years

A hot housing market can dramatically increase your income, often pushing you into a higher tax bracket. While it’s tempting to celebrate your success, careful planning is essential to sustain your financial health:

Plan for Higher Taxes

• Make Quarterly Estimated Tax Payments: Stay ahead of potential underpayment penalties by making timely tax payments. The IRS expects its share, regardless of how temporary your windfall may feel.
• Work with a Tax Professional: A skilled CPA can help you minimize your taxable income and prepare for any surprises.

Boost Retirement Savings

• Contribute to Retirement Accounts: Use tax-advantaged plans like a 401(k), SEP IRA, or Traditional IRA to lower your taxable income while securing your financial future.
• Consider a Cash Balance Pension Plan: If you’re earning significantly more, these plans allow for large tax-deferred contributions beyond typical retirement account limits.

Invest for the Future

• Allocate extra income to investment accounts or create a reserve fund to weather future market downturns.

Surviving Lean Times

When the market slows, and sales dwindle, it’s essential to adjust your financial strategy to maintain stability.

Build a Cash Reserve

• Emergency Fund: Set aside enough to cover at least 6–12 months of living expenses during the good years. This fund acts as a safety net during downturns.

Optimize Tax Payments

• Adjust Quarterly Tax Payments: When income dips, adjust your estimated tax payments to avoid overpaying.
• Maximize Deductions: Claim all eligible expenses, such as business-related mileage, office supplies, and the 20% Qualified Business Income Deduction for pass-through entities.

Cut Non-Essential Expenses

• Trim discretionary spending to stay within your leaner budget.

Choosing the Right Business Structure

Your legal and tax structure as a realtor impacts your financial outcomes and liability protection.

Options to Consider:

1. Sole Proprietorship: Ideal for beginners testing the waters. It’s simple but offers no liability protection.
2. LLC (Limited Liability Company): Provides liability protection and flexibility in taxation.
3. S-Corporation: Combines liability protection with potential payroll tax savings, provided you pay yourself a reasonable salary and distribute remaining profits.
4. C-Corporation: Rarely used by realtors due to double taxation, but it may fit specific financial goals.

When to Transition:

• Start as a sole proprietor if you’re new and want simplicity.
• Consider forming an LLC or S-Corp once your income stabilizes and grows.
• Consult a tax professional to evaluate your specific situation and ensure compliance with entity-related tax obligations.

Starting Strong as a New Realtor

In your early years, focus on building a solid foundation for your business while keeping your finances in check:

Budget for Inconsistent Income

• Avoid overspending during profitable months. Instead, budget based on a long-term income average to manage cash flow.

Track Expenses and Deductions

• Keep detailed records of expenses like marketing, licensing fees, and vehicle costs. These deductions can significantly reduce your taxable income.

Seek Professional Guidance

• Partner with an accountant familiar with realtors to identify tax-saving strategies and help you start saving for retirement.

Thriving Through Real Estate Cycles

The key to success as a realtor lies in financial discipline and adaptability. By planning ahead during prosperous times and tightening your belt when the market slows, you can build a resilient business. With smart budgeting, proper tax planning, and a focus on long-term financial security, you’ll be well-equipped to navigate the inevitable ups and downs of the real estate world.

Image by HobokenHome7 from Pixabay

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1. Insurance Premiums

Insurance is a necessary expense for protecting your rental property. Most policies are prepaid for a specific coverage period, so it’s important to allocate the expense to the appropriate tax year.

For example, if you purchased a $1,200 insurance policy in March for coverage from April 1 through the following March 31, you would deduct only the premiums applicable to the current tax year. In this scenario:

• Coverage for April through December (9 months) would be deductible for the current year, amounting to $900 or $100 per month.
• The remaining balance for January through March would be allocated to the next tax year.

Important Notes:

• Bundled Policies: If your insurance carrier offers bundled packages (e.g., combining personal and business coverage), ensure only the rental property portion is deducted on your tax return. Personal coverage may qualify for a different deduction.
• Title Insurance: This is not deductible as a current expense. Instead, it must be added to the property’s Cost Basis for capital gains calculations.

2. Cleaning and Maintenance

Routine cleaning and maintenance are deductible expenses, provided they directly relate to the rental property during approved rental periods. Common examples include:

• Cleaning services for common areas.
• Window cleaning.
• Appliance upkeep.
• General property maintenance to ensure it’s in usable condition for tenants.

Limitations:

• Rental Period Only: Cleaning and maintenance costs are deductible only for days the property is available as a rental. Expenses related to personal use days are not deductible.
• Structural Repairs vs. Maintenance: Routine maintenance is deductible, but structural repairs or improvements (e.g., a new roof, major plumbing upgrades) must be added to the Cost Basis of the property and depreciated over time.

3. Repairs

Occasionally, you may need to address small repairs to keep the property functional and appealing. Examples include:

• Fixing appliances.
• Touching up paint.
• Repairing minor damages.

Key Points to Remember:

• Ordinary and Necessary Repairs: Deduct costs that are ordinary, necessary, and directly related to the rental property.
• Rental Days Only: Like maintenance expenses, repair costs must be prorated for the rental period. If the property is used personally for part of the year, repairs during that time are not deductible.

Where to Find More Information

For detailed guidelines, refer to IRS Publication 527: Residential Rental Property (Including Rental of Vacation Homes). This publication provides comprehensive information on allowable deductions, depreciation, and tax rules for rental property owners.

John Huddleston, a Seattle-based CPA and founder of Huddleston Tax CPAs, has been serving small business owners since 2002. He holds degrees from Washington State University and the University of Washington School of Law. With extensive experience in tax matters, he offers valuable insights for rental property owners navigating complex tax regulations.

Watch this video for more about Huddleston Tax CPAs:

 Image by Barbara Dondrup from Pixabay

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What Does the IRS Consider as Rental Income?

Rental income refers to any payments received for the use of your property. This includes:

1. Regular Rent Payments: Monthly payments from tenants.
2. Advance Rent: Rent received before the period it covers. This must be reported in the year it is received, regardless of when it applies.
3. Security Deposits: If you keep a security deposit (e.g., for damages), it becomes taxable income. However, if you intend to return it to the tenant at the end of the lease, it does not count as income.
4. Additional Payments: Fees for lease termination, services provided to tenants, or other non-rent income are also taxable.

Rental Expense Deductions

The IRS allows landlords to deduct certain expenses incurred while managing or maintaining a rental property. These deductions can be applied whether the property is occupied or vacant, provided it’s available for rent and not used for personal enjoyment.

Common Deductible Expenses:

• Maintenance and Repairs: Costs for fixing damages, repainting, or general upkeep.
• Mortgage Interest: Interest paid on loans secured by the rental property.
• Advertising: Expenses for marketing the property to prospective tenants.
• Homeowner’s Insurance: Premiums paid to protect the property.

Depreciation:

You can also claim depreciation to account for the wear and tear on the property over time, even during periods of vacancy. This deduction is calculated annually based on the property’s useful life, excluding land value.

Passive Activity Rules

Rental real estate is generally considered a passive activity unless you actively participate in its management (e.g., approving tenants, setting rental terms). Here’s what this means:

1. Passive vs. Non-Passive Activities: Income and expenses from passive activities must be reported separately from non-passive ones.
2. No Rental Income, No Deduction: If the property is not generating rental income and you are not actively involved in managing it, you cannot deduct rental expenses.

Impact of Property Usage

The tax treatment of your rental property depends on how it is used during the year:

1. Available for Rent: If your property is ready and available for rent, you can deduct expenses even if no tenant occupies it.
2. Personal Use: If you or your family use the property for personal enjoyment, deductions are limited to the proportion of time the property is used for rental purposes.
3. Transitioning Property: When converting a personal residence or vacation home into a rental property, you cannot deduct expenses incurred before the transition date. For example, cleaning or repair costs before listing the property for rent would be considered personal, not rental, expenses.
4. Minimal Rental Use: If a property is rented for fewer than 15 days in a year, you do not need to report the rental income, and rental-related deductions (other than mortgage interest) are not allowed.

Recordkeeping is Key

Maintaining detailed records is essential to track income and expenses accurately. This includes:

• Receipts for repairs, advertising, and other expenses.
• Copies of lease agreements or payment records.
• Documentation of the property’s rental availability and periods of personal use.

Accurate record-keeping ensures compliance with IRS regulations and maximizes your eligible deductions.

Navigating the complexities of rental income reporting and deductions can be challenging, but understanding the rules can help you make the most of your investment property. Deductible expenses depend on whether the property is being rented or held for personal use, and passive activity rules may limit some deductions without active involvement.

For personalized advice and to ensure you’re taking advantage of all allowable deductions, consider consulting with a Certified Public Accountant (CPA). Proper planning and accurate reporting can make managing your rental property both financially rewarding and compliant with tax laws.

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Property Tax vs. Real Estate Tax

First, let’s clear up the most common point of confusion: property tax and real estate tax are actually the same thing. Both terms refer to the tax levied by your local government (typically city, county, or state) based on the assessed value of real estate you own. These taxes help fund public services like schools, road maintenance, and emergency services.

When you hear “property tax” on your mortgage statement or tax bill, it’s the same as “real estate tax.” On your federal tax return, you can typically deduct up to $10,000 in combined state and local taxes (SALT), which includes property taxes, along with state income or sales taxes. However, this cap, introduced by the Tax Cuts and Jobs Act (TCJA) in 2018, limits how much property tax you can deduct if you live in a high-tax state or own multiple properties.

Mortgage Interest Deduction

The mortgage interest deduction is an entirely different benefit. When you buy a home and take out a mortgage, part of your monthly payment goes toward paying off the loan principal, and part goes toward interest. The IRS allows you to deduct the interest portion on your federal tax return — often one of the biggest deductions available for homeowners.

However, there are limits. As of 2024, you can deduct mortgage interest on up to $750,000 of qualified residence loans if you’re married filing jointly (or $375,000 if married filing separately). If your mortgage originated before December 15, 2017, you may still be grandfathered under the old $1 million limit.

This deduction applies only to mortgages on your primary home and one second home. If you have additional properties beyond that, they may not qualify unless used specifically for rental or business purposes.

Quick Summary of the Differences

• Property tax (or real estate tax) is based on the assessed value of your home and goes to fund local government services. You can deduct it as part of your state and local tax deduction, but it’s capped at $10,000.
• Mortgage interest deduction is based on the amount of interest you pay on your home loan. It reduces your taxable income based on how much interest you pay annually, up to IRS limits.
• Both deductions can help lower your overall tax bill, but they are separate and subject to different IRS rules.

Other Important Considerations

Keep in mind that to benefit from either deduction, you must itemize your deductions on Schedule A of your federal tax return. If you take the standard deduction instead, you won’t be able to separately deduct mortgage interest or property taxes.

Additionally, if you own rental properties, the rules change slightly. Property taxes and mortgage interest paid on rental homes are deductible as business expenses against your rental income, even if you take the standard deduction on your personal taxes.

Finally, if you’re paying private mortgage insurance (PMI) because your down payment was less than 20%, PMI premiums used to be deductible under certain income limits. However, the deduction for PMI has expired unless extended by future legislation. It’s a good idea to check the current tax year’s rules or work with a CPA to be sure.

Final Thoughts

Understanding the differences between property tax, real estate tax, and mortgage interest deductions can help you better prepare for tax season and take advantage of the savings available to homeowners. If you’re unsure how much you can deduct, whether you should itemize, or how to handle deductions for rental properties, it’s always smart to get advice from a qualified tax professional.

At Huddleston Tax CPAs, we help homeowners, investors, and business owners navigate the complexities of property-related deductions so they can keep more of what they earn. Ready for personalized help? Contact us today to schedule a consultation and make the most of your tax strategy.

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The post The Differences Between Property Tax, Real Estate Tax, and Mortgage Interest Deductions appeared first on Huddleston Tax CPAs | Accounting Firm In Seattle.

Here’s a comprehensive guide to the IRS rules for rental property and how they affect landlords.

Reporting Rental Income

The IRS requires you to report all income earned from your rental property. This includes:

• Rent Payments: The most obvious source of income is the rent paid by your tenants.
• Advance Rent: If a tenant pays rent for future months in advance, you must report that income in the year you receive it, not when it applies.
• Security Deposits: Security deposits are generally not taxable unless they’re used as the final month’s rent or kept for other reasons, such as covering damages.
• Additional Payments: Fees for services like parking, cleaning, or early lease termination must also be reported as income.

Failure to report all rental income accurately can lead to penalties and audits.

Allowable Deductions

One of the biggest benefits of owning rental property is the ability to claim tax deductions on eligible expenses. These deductions can significantly reduce your taxable income. Key deductions include:

1. Mortgage Interest: If you finance your rental property with a mortgage, the interest is tax-deductible.
2. Depreciation: The IRS allows you to deduct the cost of the property (excluding the land) over 27.5 years for residential properties. This non-cash expense can offset a significant portion of your rental income.
3. Repairs and Maintenance: Expenses like fixing a leaky roof or repainting walls are deductible in the year they’re incurred. However, improvements that add value to the property, such as a new deck or HVAC system, must be capitalized and depreciated.
4. Property Taxes: State and local property taxes are deductible.
5. Insurance: Premiums for landlord insurance policies are tax-deductible.
6. Utilities: If you pay for utilities like water, electricity, or gas, these costs can be deducted.
7. Professional Services: Fees paid to property managers, accountants, or attorneys related to the rental property are deductible.

Keep thorough records of all expenses to ensure you can substantiate your deductions if questioned by the IRS.

Passive Activity Rules

The IRS classifies rental property income as “passive activity,” meaning it’s generally not subject to self-employment tax. However, it also limits the losses you can deduct.

• Passive Loss Limits: If your rental expenses exceed your rental income, you may have a loss. For most taxpayers, passive losses can only offset passive income, not other types of income.
• Special Allowance: If your modified adjusted gross income (MAGI) is $100,000 or less, you may deduct up to $25,000 of passive losses against other income. This allowance phases out between $100,000 and $150,000 of MAGI.

Of course, if you qualify as a real estate professional, these limits may not apply, allowing you to deduct losses more freely.

Record Keeping Requirements

The IRS places a high emphasis on accurate record-keeping. Landlords should maintain detailed documentation, including:

• Lease agreements
• Receipts for expenses and repairs
• Records of rental income received
• Mileage logs for trips related to the property
• Tax forms such as 1099s for hired contractors

Digital tools like property management software can help streamline record-keeping and simplify tax preparation.

Selling a Rental Property

When selling a rental property, it’s crucial to understand the tax implications:

• Capital Gains Tax: If you sell your property for a profit, the gain may be subject to capital gains tax. Properties held for more than a year qualify for long-term capital gains rates, which are generally lower than ordinary income tax rates.
• Depreciation Recapture: The IRS requires you to “recapture” the depreciation you’ve claimed over the years and pay taxes on it as ordinary income. This can significantly impact your tax liability.
• 1031 Exchange: To defer capital gains taxes, you can reinvest the proceeds into another rental property through a 1031 exchange, provided you meet specific IRS requirements.

Common Mistakes to Avoid

Many landlords unintentionally run afoul of IRS rules. Here are some pitfalls to watch out for:

• Failing to Report All Income: Every penny earned from your property must be reported.
• Misclassifying Improvements as Repairs: Repairs are deductible, but improvements must be capitalized and depreciated.
• Neglecting Depreciation: Not claiming depreciation leaves money on the table, but incorrect calculations can trigger IRS scrutiny.
• Poor Record Keeping: Disorganized records can lead to missed deductions or difficulties during an audit.

Seek Professional Advice

The IRS rules for rental property are complex, and errors can be costly. Working with a qualified CPA or tax advisor ensures you stay compliant and maximize your tax benefits. They can also guide you through advanced strategies, like cost segregation studies, to optimize your tax position.

Owning rental property is a powerful way to build wealth, but it comes with responsibilities. By understanding and following IRS rules, landlords can focus on growing their investments while avoiding unnecessary tax headaches.

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