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2020 Could Be an Unprofitable Year for Rental Properties. Here’s How to Handle the Taxes

June 11, 2020

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Economic fallout from the COVID-19 crisis and civil unrest could cause many rental real estate properties to run up tax losses in 2020 and maybe beyond. This column covers the most important federal income tax questions and answers for rental property owners. Here goes.

What can I write off?

Nothing new here. You can deduct mortgage interest and real estate taxes on rental properties. You can also write off all standard operating expenses that go along with owning rental property: utilities, insurance, repairs and maintenance, care and maintenance of outdoor areas, and so forth.

What about depreciation write-offs?

For many rental property owners, the tax-saving bonus is the fact that you can depreciate the cost of residential buildings over 27.5 years, even while they are (you hope) increasing in value. You can generally depreciate the cost of commercial buildings over 39 years.

Example: You own a small apartment building that cost $1.5 million not including the land. The annual depreciation deduction is $54,545 ($1.5 million/27.5). The deduction can shelter that much annual positive cashflow from income taxes. So, depreciation write-offs are nice tax-savers, especially if you own an expensive property or several properties.

Variation: As stated earlier, commercial buildings must be depreciated over a much-longer 39-year period. Even so, the annual depreciation write-off for a $1.5 million commercial building is $38,462. The deduction can shelter that much annual cash flow from income taxes.

Can I claim 100% first-year bonus depreciation?

Yes, for qualified improvement property (QIP) expenditures on a nonresidential building. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) included a retroactive correction to the statutory language of the Tax Cuts and Jobs Act (TCJA). The correction allows much faster depreciation for commercial real estate qualified improvement property (QIP) that’s placed in service in 2018-2022. QIP is defined as an improvement to an interior portion of a nonresidential building that’s placed in service after the building was placed in service. However, QIP doesn’t include any expenditures attributable to: (1) enlarging the building, (2) any elevator or escalator, or (3) the internal structural framework of the building. Thanks to the CARES Act correction, you can write off the entire cost of QIP in Year 1, because it qualifies for 100% first-year bonus depreciation.

Alternatively, you can choose to depreciate QIP over 15 years using the straight-line method. That alternative might make sense if you expect higher tax rates in future years. Discuss your QIP depreciation options with your tax pro.

What else do I need to know about depreciation write-offs?

You ask such good questions. There’s more. The TCJA increased the maximum Section 179 first-year depreciation deduction for qualifying real property expenditures to $1 million, with annual inflation adjustments. The inflation-adjusted maximum for tax years beginning in 2020 is $1.04 million. The Section 179 deduction privilege potentially allows you to deduct the entire cost of qualifying real property expenditures in Year 1. I say potentially, because Section 179 deductions are subject to several limitations. Ask your tax pro for details.

The TCJA also expanded the definition of qualifying property to include expenditures for nonresidential building roofs, HVAC equipment, fire protection and alarm systems, and security systems.

Finally, the TCJA further expanded the definition of qualifying property to include depreciable tangible personal property used predominantly to furnish lodging. Examples of such property include beds, other furniture, and appliances used in the living quarters of an apartment house.

Can I claim the qualified business income (QBI) deduction base on my net rental income?

Maybe. For 2018-2025, the TCJA established a new personal deduction based on qualified business income (QBI) passed through to your personal Form 1040 from a pass-through business entity (meaning a sole proprietorship, LLC treated as a sole proprietorship for tax purposes, partnership, LLC treated as a partnership for tax purposes, or S corporation). The deduction can be up to 20% of QBI, subject to restrictions that kick in at higher income levels. For a while, it was unclear if you could claim QBI deductions based on net rental income passed through to you from one of the aforementioned pass-through entities. The IRS eventually issued taxpayer-friendly guidance that allows QBI deductions in most such cases, but you must follow complicated rules to collect the tax-saving benefit. As your tax pro for details.

What about the passive loss rules?

Ugh. If your rental property throws off tax losses (most properties do, at least during the early years and during years when the economy is suffering — like now), things can get complicated. The so-called passive activity loss (PAL) rules may come into play. Losses from rental properties will usually be classified as passive losses.

In general, the PAL rules only allow you to currently deduct passive losses to the extent you have current passive income from other sources, like positive income from other rental properties or gains from selling them. Passive losses in excess of passive income are suspended until you either have enough passive income or you sell the property that produced the losses. Bottom line: the PAL rules can postpone any tax-saving benefit from rental property losses, sometimes for years. Fortunately, there are several exceptions to the PAL rules that can allow you to deduct rental property losses sooner rather than later. Your tax pro can explain the exceptions and help you plan to become eligible, if possible.

Is that the end of the bad news?

Not exactly. Say you manage to successfully clear the hurdles imposed by the PAL rules for your rental property losses. So far, so good. But the TCJA established another hurdle that you must also clear to currently deduct those losses. For tax years beginning in 2018-2025, you cannot deduct an excess business loss in the current year. An excess business loss is one that exceeds $250,000 or $500,000 for a married joint-filing couple. Any excess business loss is carried over to the following tax year and can be deducted under the rules for net operating loss (NOL) carry-forwards. This loss disallowance rule applies after applying the PAL rules. So, if the PAL rules disallow your rental losses, this rule is a nonfactor.

COVID-19 Relief: Thankfully, the CARES Act suspends the excess business loss disallowance rule for losses that arise in tax years beginning in 2018-2020. That’s good news.

What’s the deal with net operation losses (NOLs)?

Say you manage to successfully clear both of the preceding hurdles for your rental property losses. Now we are talking, because you can generally use those losses currently to offset taxable income from other sources. If losses for the year exceed income from other sources, you may have a net operating loss (NOL) for the year.

COVID-19 Relief: The CARES Act allows a five-year carryback privilege for an NOL that arises in a tax year beginning in 2018-2020. So, you can carry an NOL from one of those years back to an earlier year, deduct it, and recover some or all of the federal income tax paid for the carryback year. Because federal income tax rates were generally higher in years before the TCJA took effect, NOLs carried back to those years can be especially beneficial. The TCJA kicked in starting with tax years beginning in 2018.

What if I have positive taxable income?

Eventually your rental property should start throwing off positive taxable income instead of losses, because escalating rents will surpass your deductible expenses. Of course, you must pay income taxes on those profits. But if you piled up suspended passive losses in earlier years, you can now use them to offset your passive profits.

Another nice thing: positive taxable income from rental real estate is not hit with the dreaded self-employment (SE) tax, which applies to most other unincorporated profit-making ventures. The SE tax rate can be up to 15.3%. Something to avoid when possible.

One bad thing: positive passive income from rental real estate owned by a higher-income individual can get socked with the 3.8% net investment income tax (NIIT), and gains from selling properties can also get hit with the NIIT. Ask your tax pro for details.

The bottom line

There you have it: most of what you need to know about the federal income tax issues that can come into play for rental property owners. The economic fallout from the COVID-19 crisis and recent civil unrest increase the odds that rental properties will suffer losses in 2020, but tax relief provisions may soften the blow.

The post 2020 Could Be an Unprofitable Year for Rental Properties. Here’s How to Handle the Taxes appeared first on Real Estate News & Insights | realtor.com®.

What Is a Foreign National Loan? One Way to Buy Investment Property in the U.S.

August 3, 2018

what is a foreign national loan?

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A foreign national loan is a special type of loan that helps noncitizens buy investment property in the United States. This loan has requirements (and interest rates) that slightly differ from standard Fannie Mae or FHA loans. Here are some key factors noncitizens looking to invest in property need to keep in mind.

You will need a bigger down payment

The down payment needed to qualify for a foreign national loan is much more substantial than the amount needed for a government-backed loan (e.g., an FHA loan) or a mortgage from a private lender.

“You need to put down at least 25%,” says Erika Borrero, a licensed mortgage adviser with Angel Oak Home Loans in Orlando, FL. U.S. citizens can qualify for standard home loans with as little as 3.5% to 5% down, but buyers from out of the country must have at least a quarter of the purchase price of the property to get financing.

It must be an investment property

If you’re hoping to buy a home to move into permanently, you’re out of luck.

“The purchase must be treated as an investment home. Their intention when purchasing must not be to move here,” says Borrero. “To qualify for a foreign national loan, you must be able to prove you’re living in another country and earning your income from that country.”

So why buy in the U.S.? Buyers can rent out the home for extra income, or invest capital that might not be able to provide as large of a return in their home country. Or, if they visit the United States frequently, they might just want a vacation home there.

The interest rate will be higher

In addition to requiring a bigger down payment, a foreign national loan comes with a higher interest rate. Borrero says it usually runs about 7% or so, while the interest rate for a 30-year, fixed-rate conventional mortgage has been averaging 4.5% to 5% in 2018.

Documentation requirements will be different

Because taxes work differently in every country, tax returns are not a requirement to qualify for a foreign national loan. Every lender has slightly different documentation requirements, so be prepared to provide any number of financial documents.

Borrero says she asks for two months of bank statements and, because many of her clients are self-employed, a letter from the borrower’s accountant verifying their income for the past two years.

Not every bank offers foreign national loans

Most local banks do not offer foreign national loans, though many international banks do, and there are lenders who specialize in this kind of loan.

Borrero suggests reaching out to mortgage brokers to find the right lender for your situation. Like with any mortgage, you want to shop around to find the best rate.

There are tax implications for a foreign national loan

Almost every local or state government charges homeowners annual real estate taxes based on a percentage of their home’s value. Tax rates range from Hawaii’s 0.32% to New Jersey’s 2.31%. If you own a home in the U.S., you will be required to pay these every year.

There are also taxes to pay when you eventually sell the property.

“The IRS requires that buyers (buying real estate owned by foreign nationals) withhold 10% of the gross sale price to prevent foreign sellers from avoiding the payment of taxes,” says Ines Hegedus-Garcia, a real estate agent in Miami. “The buyer must report the purchase and pay the IRS the amount withheld.”

There are exceptions to this tax, however, so always consult with a tax specialist or the IRS regarding how the federal government will apply this rule to your case.

The post What Is a Foreign National Loan? One Way to Buy Investment Property in the U.S. appeared first on Real Estate News & Insights | realtor.com®.

What Is a Multifamily Home? Owning Many Units Can Lead to a Steady Cash Flow

August 3, 2018

what is a multifamily home?

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Have you ever thought of investing in a multifamily home? Unlike single-family homes, these are dwellings with more than one unit that each have their own bathroom and kitchen.  Interested in how this type of property could pay off for you? Read on for our breakdown of multifamily homes, including how to find them in your area.

Benefits of buying a multifamily home

The most attractive part of investing in and renting out a multifamily home is the steady revenue stream you can get from collecting rent. Most people living in a multifamily home are looking to offset mortgage payments by using the income from renting out the other unit, says Lee Kiser, principal and managing broker at Kiser Group in Chicago.

There are also tax advantages to buying a multifamily home. You can write off expenses related to your rental income and deduct the prorated portion of the mortgage interest.

Also, an owner-occupied property may be a wise choice for homeowners living with members of their family, such as their adult children or elderly parents. They can live in one of the units for a period of time and not have to fork over all their savings on rent or a mortgage.

How to find multifamily homes

Searching for available multifamily homes is simple. You can find multifamily homes through a search tool like realtor.com and filtering by property type. That’s a good place to start to see what’s available in the town you’d like to buy in. Additionally, Kiser suggests checking with commercial brokers. They offer more multifamily investment possibilities.

If you think you could benefit from an expert’s opinion, Carol Greeley, a real estate agent in the greater Boston area, suggests you find a buyer’s agent.

A buyer’s agent helps guide you through the search and helps you round out your house wish list. They’ll also advise you on how to submit an acceptable offer. And since the seller pays the real estate agents’ commission fees, it’s virtually free for you.

Multifamily home as an investment

Just like any new home, a multifamily home may be move-in ready, or it might be a serious fixer-upper. Before buying a multifamily home, you should perform due diligence and assess just how much money you’ll need to put into sprucing up the units. Make sure the home has a sturdy roof and structure, and all major systems like plumbing and HVAC are in working condition.

Susan Haas, a real estate agent at Joyner Fine Properties in Richmond, VA, suggests getting quotes from contractors on any work that’s needed before making an offer on a home.

If anything is out of order, you’re looking at a project that will cost upward of a few thousand dollars. For example, a new roof for a standard ranch-style house will cost around $5,000 to $8,000 on the low end, according to roofingcalc.com.

Also, remember that you’ll likely need to perform work on the units before opening the doors for prospective tenants. A newly renovated home will attract more tenants and allow you to charge higher rent in the long run.

How much for regular upkeep?

The initial renovation costs are just the beginning; once you have tenants you’ll have to deal with maintaining multiple kitchen and bathrooms.

Kiser says a good rule of thumb is to expect $300 to $500 worth of annual home improvements for each unit. So, a multifamily home with three units will cost between $900 and $1,500 annually for regular home improvement tasks.

Of course, being handy can save money. Landlords of smaller multifamily homes may opt to perform basic maintenance tasks themselves instead of hiring someone like a plumber or painter. Some renters are cool with that, but others may prefer you hire a professional to take care of home projects.

The post What Is a Multifamily Home? Owning Many Units Can Lead to a Steady Cash Flow appeared first on Real Estate News & Insights | realtor.com®.