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6 Accounting And Tax Matters Landlords Should Keep In Mind
In the running of any business, it goes without saying that proper accounting and records are maintained not just for your own review, but also for filing to the relevant authorities too.
While modern technology has given business people the gift of accounting software that keep financial records accurately, there are various issues that software just cannot solve for a landlord.
Qualitative matters are as important as quantitative ones, especially when the IRS is concerned.
Here are 6 important accounting and tax issues that landlords should keep in mind when managing financial records for real estate operations.
Do be mindful that professional tax advice should only be taken from tax attorneys and certified public accountants (CPA).
1) 1031 Exchanges
The 1031 Exchange is a legal transaction that property investors can apply to avoid capital gain tax rates.
While rental property will automatically qualify for it, not all property will be categorized as rental property in the eyes of the law.
In this transaction, all proceeds for the sale of an investment property should be used for the acquisition of another investment property. This is also known as like-kind.
Balances of proceeds that are not used for the purchase of the new house will be subjected to capital gains tax.
Proceeds from such a sale will go to a qualified intermediary before being used for the new purchase.
Another criteria to meet to be eligible for 1031 Exchange is that the replacement property must be identified within 45 days of the initial sale. On top of that, you have 180 days to close the transaction of the new property.
Do work with your intermediaries to ensure that these deadlines are met.
2) Capital gain tax
Even though capital gain taxes are not something new, you might be surprised at the sheer number of real estate investors who have little knowledge of it and think it’s absurd.
But capital gain taxes is a reality in life. Especially in the world of investments.
So do take it in your stride. It’s just the rules you have to get in line with as an investor of capital assets.
For more clarity of how capital assets are categorized, it is best to consult with a proper CPA who should be well-versed with asset classifications.
Basically, short term capital gains involve assets held for up to one year. While long term capital gains concern assets held for more than a year.
3) Schedule E
Schedule E is where individual taxpayers report their rental activities.
Few business people should need to be reminded not to mix personal money with business money.
It can be a horrific mess when the time comes to put everything in order.
Yet there are a lot of landlords who are only landording part time. They are not fully fledged real estate businesses and are just trying to make a passive income via real estate.
This is why many landlord continue to operate their rental property as individuals… which can be one hell of a mess when the landlord owns multiple properties.
When you own multiple properties, a good management tip is to keep a separate account for each property. This is because when reporting taxes, the income and expenses of each property is required to be listed separately.
4) Passive income and losses
Passive income come from investments that does not require material participation.
While income from rental properties are usually considered passive income, it is not a given that they will be classified as such.
Sometimes, depending on the type of operations, they can be considered self-employment income… putting you in a different tax bracket.
An important point to note is that losses from passive activity may be brought forward to the next financial year.
The biggest reason why financially savvy business people use corporate entities to operate businesses is business deductions.
These are basically expenses that can be deducted from profits when calculating the taxable income.
A capable accountant should be able to easily categorized expense items as deductible or not.
This can make a serious difference to your overall bottom line.
There are pros and cons for running your landlording business under sole ownership or a company.
And most of the pros and cons are centered around reporting requirements and to a certain extent, liabilities.
The structure in which to form a company will depend on various factors. Especially the profiles of partners involved.
The 3 most common entities are typically:
- Limited partnership
- Limited liability partnership
- Limited liability company
Do not hesitate to contact a CPA when you are unclear about the subtle differences between them. They can have a huge impact when a time arrives when they matter.
As a final reminder, remember that the IRS is not a government agency that anyone should contemplate messing with.
Should you have any accounting and tax issues that needs to be clarified or resolved, do consult a CPA or tax attorney. Or at least call up the service hotline at IRS for help.