Tax considerations for landlords and homeowners
More and more people are finally selling their formerly underwater rental homes or upgrading to their dream forever home as the economy continues to grow and as home prices strengthen. It’s a great problem to have, and home ownership is one of the greatest wealth building investments in America.
Short Term Rentals Can Be Tax Free
Companies such as Airbnb make it easier than ever to rent your home or even a bedroom on a short-term basis. Savvy homeowners can command attractive rental rates during football weekends, graduations or other events in which the demand for short-term lodging exceeds the supply.
The best part is that under the current tax law, homeowners can rent out their home for fewer than 15 days during the year, and take all the profits tax free! You cannot deduct the expenses related to the short-term rental, but you don’t have to report any of the income. That’s a great way to pocket free money.
Gains on Sale of Primary Residence Can Be Tax Free
Selling your primary residence can provide another excellent wealth-building opportunity that isn’t subject to tax. Federal law allows single taxpayers to exclude up to $250,000 in profit ($500,000 for married taxpayers) on the sale of their primary residence. Profit is broadly defined as the realized gain (sales price, less costs of sale such as commissions, less your basis in the home). You typically must have lived in the home for at least 2 of the previous 5 years.
Considering how much home prices are increasing in the current market, this represents an excellent opportunity to shelter substantial profits from tax.
The best part is you can take advantage of this benefit multiple times – as long as you own and live in a home as your primary residence for the minimum required time. As with most tax benefits, there are exceptions and nuances (such as waiving the 2-year requirement for active servicemembers who relocate due to military orders).
Rental Income for Landlords Is Complicated
Taxpayers who own rental property can face complicated tax situations. The new Qualified Business Income Deduction (“QBIC”) covered under Section 199A provides a 20% deduction of business income, and I have seen arguments on all sides regarding whether you can include rental income under this deduction.
Typically, home rental income and expenses are reportable on your taxes, and items such as depreciation on the home and improvements (land is never depreciated), property taxes, HOA dues, insurance and repairs must be considered. Mortgage interest is deductible, but the principal payments are not. When you sell the home, capital gains taxes must be considered along with depreciation recapture.
Ultimately, it’s best to consult with or engage a tax professional when you become a landlord. However, even with taxes considered, renting property can be a great wealth building tool. You may not “get rich quick” in real estate rentals, but you can get rich.