It's time to schedule a sit-down with your tax advisor. Why now? Well, your tax advisor won't have much time for strategic planning when you turn in an overflowing box of receipts on just before Tax Day.
Mid-year tax planning for landlords—well before the general filing deadline—can pay some big dividends, as your tax advisor will frequently have tax savings ideas that are worth their fees many times over.
4 Smart Mid-Year Tax Planning Tips for Landlords
#1: Invest in Your Business Now
If it looks like it's going to be a good year, now may be the perfect time to make some long-term investments. These can take the form of newly acquired properties, or renovations to increase the market value of the properties you already have.
The idea is to take ordinary income—taxable at full income rates—and convert it to assets. These generate more future income, but are either not currently taxable, or will generate future tax deductions against income if you are depreciating them over time.
Think of it this way: If your properties have earned you $20,000 so far this year, and you pay an effective income tax rate of 25%, you only get to keep $15,000. If you don't need that cash to live on, why not take that same amount of money and convert it to $20,000 worth of assets? These assets will presumably generate more income later.
In addition, this principle applies to more than real estate. For example, if you think that upgrading your computer system will help you to generate revenue in the future.
#2: How to Use Section 179 Deduction
Section 179 allows businesses that put fixed assets, equipment, and machinery into service during the year to fully deduct their costs in the current year, rather than deducting the costs slowly over time. This provides a much better cash flow for the business, and also keeps more cash in the business owner's hands over time.
Section 179 can also provide big tax savings by potentially qualifying you for accelerated depreciation, or even a full first-year deduction, even with depreciable assets. For 2017, the maximum Section 179 deduction is $510,000, subject to a $2,030,000 phaseout threshold.
You can't use a Section 179 deduction for most rental properties, nor for items that go inside of a rental. However, you can use Section 179 to generate an immediate tax benefit on a lot of other items that landlords and property managers use on a regular basis. Examples include computers, telephones, office furniture, software programs, maintenance equipment, and vehicles.
There is one exception: While Section 179 prohibits taking first-year deductions on most residential rental properties, you may be able to take deductions on resort or hotel properties where the average guest stays for less than 30 days.
How to Check Your Section 179 Eligibility
To be eligible for Section 179 treatment, you have to be running your property investment practice as a business, as opposed to an investment. If you want to use this strategy, your CPA or enrolled agent will be able to assist you in determining what you need to do for your practice to qualify.
Mid-year tax planning for landlords leaves more time to place equipment in service to qualify for the tax break. This means you have more time to plan, shop, get a good deal, and make smart decisions—which won't be the case if you let things go and have to scramble at the end of the year.
Incidentally, your business may qualify for bonus depreciation, over and above what you claim under Section 179. Currently, the maximum bonus depreciation amounts to 50% of what you claim under Section 179. If you have some capital to work with, now's the time to take advantage of this provision because next year, the maximum allowable bonus depreciation you can take will be capped at 40%, and then at 30% in 2018, before the bonus depreciation allowance under Section 179 expires altogether.
#3: Funding Retirement with Rental Income
If you have some extra cash coming in from the rentals you own or manage, now is a great time to set some money aside for retirement.
If you have no full-time employees, consider starting a solo 401(k) plan. Currently, a solo 401(k) plan normally allows for the biggest pre-tax contributions. The max contribution that you can make in your role as an employee of your own company or practice (even if you're a sole proprietor) is $18,000 as of 2017. Those over 50 years of age can contribute an additional $6,000 in "catch-up" contributions.
But for self-employed individuals or those who are owner-employees of their own corporations, you can make further contributions in your role as your own employer. You can contribute up to 20% of your compensation if you're a sole proprietor or own a single member LLC, or up to 25% if you own a corporation up to a combined maximum of $54,000.
The SEP, or simplified employee pension plan, also allows for tax-deferred contributions of up to $54,000 in 2017 (capped at 25% of the employee's compensation). But the solo 401(k) plan also allows you to set it up as a Roth account. While contributions to Roth 401(k)s, like Roth IRAs, come from post-tax dollars, Roth accounts potentially grow tax-free after that point. Roths also spare you from having to make required minimum distributions once you turn age 70, which can be a nice perk when you get older.
Furthermore, if you so choose, you can set up your business with a 401(k) that allows for plan loans. That is, you may be able to borrow up to $50,000 from your 401(k) for any reason you like—just pay it back, with interest, within 5 years. The 401(k) loan option isn't for everyone, but veteran real estate investors can readily see the advantages of access to this quick line of credit.
Both the SEP and the solo 401(k) allow you to choose self-directed investing. That is, you can use your SEP and solo 401(k) plans to purchase investment real estate directly, while enjoying all of the tax benefits of the retirement plan. Rental income and capital appreciation will compound tax-deferred (tax-free for Roth accounts) for as long as the asset remains within the retirement plan.
What's more, you may even be able to qualify for a tax credit—up to $500 per year for 3 years—just for setting up your small business retirement plan. This tax credit is designed to offset some or all of the set-up costs.
#4: How to Project Estimated Taxes
If you're filing quarterly—as most businesses should be doing—mid-year tax planning for landlords is a must. Sit down with your tax advisor to ensure that you don't overpay on taxes, crimping your cash flow until you get a return. You also don't want to underpay your taxes during the year and risk big penalties. Your tax advisor may be able to help you stay on track with estimated tax payments, including self-employment tax.
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