Why first-time landlords shouldn't fear tax time

On athe Money

Your Money

February 11, 2007|By Gail MarksJarvis | Gail MarksJarvis,Chicago Tribune

Perhaps you're a reluctant landlord.

Caught in the housing downturn and unable to sell your house or condo at a decent price in 2006, you may have decided to rent out the property. Now, at tax time, you are left with a jumble of rules you never encountered in the past.

Here's what to do:

Look for expenses.

The rent you have been paid by your tenant is going to be income. But don't assume you will pay taxes on all, or even any of it.

Before you record rental income on your 1040 form, you should try to whittle away the income you received from the renter.

You will do this by adding up all the expenses you incurred during 2006 to attract and serve a tenant. Then you subtract those expenses from the rent your tenant paid, and that will be your income from the property. To do the calculation, use Schedule E.

Say you had to go to a condo in the middle of the night to fix a leaky toilet. Anything you spent on the repair is an expense - the cost of driving to the condo, or driving to the hardware store to get a part. If you paid for parking, that's an expense, too, said John Scherer, a financial planner in Madison, Wis. You can take 44.5 cents per mile.

Did you advertise for a tenant or use a lawyer to draw up the lease? Did you bring in a cleaning service? Do you have a cell phone to conduct the business? Even paper for a flyer tacked onto a grocery store bulletin board will count as an expense, Scherer said.

You will need a record of the expenses. Scherer suggests dumping receipts in an envelope and sealing it at the end of each month.

Under tax laws, you can take as much as $25,000 in a loss if your adjusted gross income is $100,000 or less. Up to $150,000, you can use some loss, but not as much as $25,000.

The most helpful expenses could be large items such as property taxes, insurance, condominium assessments and mortgage interest payments.

Depreciation is your friend.

Besides all the expenses that might come to mind, you also are going to be able to depreciate some of the value of the home or condo.

In other words, every year for 27 years, you are going to be able to remove some of the value of the property, and use it to reduce the income you had from your tenant that year.

That, of course, will lower your tax bill.

The concept is that your property is wearing out. It might not seem that way. After all, you might be able to sell it in the future for a lot more than it is worth today. But from a tax standpoint, Uncle Sam lets you account for wear and tear. Each year as your property deteriorates in value - theoretically - you toss away a portion of the value. And that helps you on your taxes.

Keep in mind that buildings and equipment wear out, but land does not. So when you start figuring out what you can depreciate, you will have to determine what portion of the property value is attributed to land, and what portion to the building.

So if the property cost you $300,000, and the tax assessor or an appraiser says $25,000 of the value is the land, you could depreciate $275,000 said Noel Hastalis, a certified public accountant with Virchow Krause & Co. in Chicago. Simply put, that would mean each year for 27 years you could take $10,000 a year in depreciation expenses.

To make matters more complicated, certain improvements in the property also can be depreciated. If you add a refrigerator or stove, for example, you depreciate the appliances over seven years. Presumably, after seven years the machine will wear out and you will need to buy a new one. If the stove wears out sooner, you can write off the appliance sooner than seven years.

gmarksjarvis@tribune.com

You can leave a message for Gail MarksJarvis at 312-222-4264.

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