The Joy of Being a Landlord 

Being a landlord can be a rewarding experience that provides passive income, tax benefits, and long-term wealth accumulation. However, it also requires time, effort, and grit to deal with the challenges and responsibilities that come with property ownership.  

One of the responsibilities (or joy?) of being a landlord is maintaining the property. You may need to remodel as part of the maintenance. Remodeling is an investment and can be costly, and you want to make sure you can maximize your tax deduction with your remodeling expenses.  

Can You Deduct Remodeling Expenses? 

Typically, you can deduct remodeling expenses for your rental property as a business expense on your tax return. Remodeling expenses are considered capital expenses, which generally cannot be deducted in full in the year they are incurred. Instead, they are typically depreciated over a period of several years. 

The amount and timing of the depreciation depend on several factors, including the type of property, the cost of the improvements, and the applicable depreciation method. In general, the cost of major renovations, such as adding a new roof or replacing a heating system, will be depreciated over a more extended period than more minor improvements, such as painting or installing new carpet. 

What Can You Deduct? 

As a landlord, you can deduct a wide range of remodeling expenses related to your rental property. Some of those items include: 

1. Materials and labor costs for repairs and improvements made to the rental property, such as fixing a leaky roof or upgrading the electrical system. 
2. Costs associated with upgrading or renovating the rental property, such as installing new appliances, cabinets, flooring, or fixtures. 
3. Fees paid to architects, engineers, or other professionals for design or planning services related to the remodeling project. 
4. Permit and inspection fees paid to local government agencies for remodeling work. 
5. Rent or other temporary housing expenses for tenants who must vacate the property during remodeling. 
6. Travel expenses related to the remodeling project, such as mileage, meals, and lodging, if you need to travel to the rental property to oversee the work. 
7. Depreciation of the cost of the improvements over the useful life of the property. 

It is essential to keep accurate records of all remodeling expenses, including invoices and receipts. You may also need to provide a description of the improvements made and when they were completed. 

Should You Hire Help? 

Tax rules for rental properties are complex and difficult to navigate, particularly when it comes to depreciation, capital gains, and passive activity rules. It is recommended that you consult with a tax professional, as they can help ensure that you comply with applicable tax laws and regulations, maximize your deductions, and minimize your tax liability. In addition, your tax consultant can also help you plan for the future by providing advice on tax planning strategies, such as the use of tax-advantaged retirement accounts or the timing of property sales. Your tax consultant can be a valuable partner for providing you, the landlord,  guidance, expertise, and peace of mind when it comes to tax compliance and planning. 

Ordinary Income 

The term “ordinary income” can be confusing, as it might suggest that the income is common or normal. However, in the context of tax law, it has a specific meaning. It refers to income earned through the normal course of business operations or from other sources that are not considered investments. Ordinary income includes wages or salaries earned from employment, income from a business, commissions earned from sales, and fees earned for professional services. This income is subject to federal and state income taxes, as well as other taxes such as Social Security and Medicare taxes.

The term “ordinary income” is used to distinguish this type of income from other types of income that may be taxed differently, such as capital gains or passive income. For example, capital gains are generally taxed at a lower rate than ordinary income, and passive income may be subject to different tax rules and limitations. 

Passive Income 

Passive income is earned from sources where the taxpayer is not materially participating in the activity that generates income. This can include rental income, interest income, dividend income, and certain types of capital gains. Passive income is typically generated from investments or rental properties rather than from active business operations. The taxpayer may have some involvement in the investment or property, but they are not considered to be actively engaged in the day-to-day management or operations.

Passive income is generally subject to different tax rules than ordinary income. For example, passive income may be subject to a lower tax rate, and losses from passive income activities can only offset other passive income rather than ordinary income. 

Ordinary vs. Passive Income Tax Reporting 

When it comes to tax reporting (Americans’ favorite pastime), ordinary income and passive income are being treated differently. Ordinary income is generally subject to self-employment tax and is reported on Schedule C of the individual’s tax return. Passive income is typically reported on Schedule E of the tax return. In addition, losses generated from ordinary income activities can offset other ordinary income, such as salaries or wages, up to a certain limit, which can help to reduce the amount of taxable income. However, losses from passive income activities can only offset other passive income and cannot be used to reduce taxable income from other sources.  

For example, suppose you have a net loss of $5,000 from your rental property (which generates passive income) and a net profit of $10,000 from your consulting business (which generates ordinary income). In that case, the $5,000 loss from the rental property can only be used to offset other passive income and cannot be used to reduce the taxable income from the consulting business. There are also certain limitations on the amount of passive losses that can be used to offset passive income. For example, suppose you have $10,000 passive income from a rental property and $15,000 passive losses from another. In that case, you may only be able to use $10,000 of the losses to offset the passive income, and the remaining $5,000 of losses may be carried toward future tax years. 

It is essential to understand the difference between ordinary and passive income and the rules regarding loss offset when reporting income and losses for tax purposes. The IRS isn’t a very forgiving organization when it comes to making mistakes. The Accuracy-Related Penalty is 20% of the portion of the underpayment of tax. Not to mention the interest on the penalty! So save yourself from the heart and headache of making tax mistakes by consulting with a tax professional. In addition, your tax consultant may be able to maximize your tax benefits.  

The What 

As a business owner, you probably are familiar with these two words: budgeting and forecasting. But what do they mean? Budgeting involves creating a detailed plan for income and expenses over a specific period, such as a month, quarter, or year. A budget typically includes projected revenue, costs, and expenses, broken down into specific categories such as salaries, rent, utilities, and supplies. 

Forecasting involves predicting future business performance, such as revenue growth, market trends, and cash flow. A forecast can be based on historical data, current trends, or both. Generally speaking, there are two responses from business owners regarding the matter of budgeting and forecasting: 

1. Those who see it as an essential part of their business planning and decision-making process, or 

2. Those who find it a tedious and time-consuming task (if you are in this category and do not have a qualified in-house accountant, it is highly recommended to consider hiring an outsourced staff accountant, for reasons we will mention later). 

Regardless of your feelings about this task, budgeting, and forecasting are crucial tools for managing finances, planning for the future, and making informed decisions. 

The Who 

In small businesses, the responsibility of budgeting and forecasting may fall on the owner or manager, who may need to work with an accountant or financial advisor. The reality is that most small business owners have little to no training in bookkeeping. Hence, taking on the responsibility of budgeting and forecasting seems daunting, and hiring a full-time in-house accountant may be out of the budget, so they often put it off and just hope for the best. This leads to discovering problems when it is too late. 

According to BLS data, nearly 20% of businesses fail within the first year, and by year five, the failure rate has increased to almost 50%. And according to a study by Jessie Hagen of the U.S. Bank, 82% of businesses fail due to poor cash flow management. And guess what? Budgeting and forecasting are key to managing cash flow. 

The Why 

Budgeting and forecasting are critical for small businesses for several reasons: 

1. Planning for the future: Budgeting and forecasting allow you, the business owner, to plan for the future by projecting revenue, expenses, and cash flow. This is essential in making informed investment decisions, hiring, and other strategic initiatives. 

2. Managing cash flow: You can avoid cash shortages by creating a budget and forecasting future expenses and revenue. 

3. Identifying potential problems: Budgeting and forecasting can help small businesses identify problems before they occur. You can identify areas of overspending or under performing and take corrective action before it is too late. 

4. Tracking progress: Creating a budget and forecast allows you to track your company’s progress over time. You can see how your company performs against the projections and adjust as needed. 

5. Securing financing: Securing financing is getting harder and harder during a financial downturn, and many lenders and investors are tightening the requirements. Having a solid budget and forecasting plan in place can increase your chances of securing financing. 

But What If I Don’t Have An Accountant 

By now, we can all agree that budgeting and forecasting are essential to the survival of all businesses. You are on board but overwhelmed. You are unsure where to begin, and hiring a full-time in-house accountant or having a full-blown accounting department may not be in your best interest right now. The perfect solution is to hire an outsourced staff accountant. The outsourced staff accountant is becoming more popular, particularly in small and medium-sized enterprises, due to the variety of services provided and the cost-savings. 

So, don’t put it off any longer; it is time to tackle this task head-on and take your business to the next level.