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October 29, 2009
If You Can’t Sell…..Rent
The current recession has forced some real estate owners to hold on to their property, waiting to sell until the economy improves. In addition to the usual problems that come along with being a landlord, you should think about income taxes, insurance and how title should be held.
INCOME TAXES – The net rental income is added to your income like most any other item. Initially, the hardest item to compute is depreciation. Since 1986, residential rental property has been subject to depreciation over a 27 ˝ year period. That’s the easy part. Figuring the amount of your cost that can be depreciated is more difficult.
Your basis, or the amount of your cost that can be depreciated, depends on how you acquired your property. But no matter how you acquired your property, there is one general rule that says; You can’t depreciate dirt! That means that the allocable portion of the cost of the building is subject to depreciation, but not the land. We commonly use real estate tax bills to get the ratio of the land to the building, and apply that to the cost to figure out what portion of the cost is allocable to the building.
Like I said, the cost that you can depreciate, depends on how you acquired your property. If you purchased your home, what you paid, plus the cost of any improvements is your cost. If your mom gave you the house, you get a carryover basis, this means that whatever mom’s cost was will be your cost. If you inherited your property, you get what is called a “step-up-basis” and your cost is equal to the fair market value on the death of the prior owner.
Unless you fall into the simplest category, meaning that you purchased your property, you should contact your tax specialist to make sure that you have properly calculated what your depreciation allowance should be.
Depreciation is not optional. The IRS says that your cost is reduced by the allowed or allowable depreciation. This means that if you are entitled to depreciation, your cost basis will be reduced for tax purposes even if you do not deduct it. Ouch!
INSURANCE – There is no substitute for good insurance when something goes wrong. Personally, I hate insurance. I look at those tall buildings in Boston and think that based upon how much insurance I pay, I should own a portion of them. But, to protect not only the rental real estate, but your other assets too, it is essential to properly insure.
HOW TO HOLD TITLE - For some people, properly insuring is not enough. They want to completely protect their assets from law suits under all conditions. Is it possible? Yes. Should you do it? Maybe.
The typical types of ownership are, individual ownership, trust, corporation and limited liability of company. Probably the most common method of ownership is keeping the title in your own name. Trusts are next and provide avoidance of probate. Limited liability companies are becoming more popular with the advantage of protecting the assets of owners, in most cases. Corporations may own real estate, but due to the system of double taxation, should be avoided in almost all occasions.
Before you decide to rent your property, seek professional advice on how to own the property and how to report the income and expenses for tax purposes. You’ll be glad you did.
This article gives general information and not specific advice on individual matters. Persons wanting individualized advice on matters discussed should contact an advisor experienced in those matters. To the extent this article provides information on legal matters, it is based on law in effect in Massachusetts on the date of posting (laws in effect in other states are often quite different).
Ronald H. Surabian is a CPA and attorney who works at the Elder Law Center in Saugus, Massachusetts. He also holds Masters in accounting and a Masters in tax law. He currently serves on the board of directors of the Friends of the Saugus Senior Center and is a member of the Massachusetts Chapter of the National Academy of Elder Law Attorneys. If you have any questions, please call me at the Elder Law Center, One Essex Street, Saugus, MA 01906 (781)233-4444. To view this or any prior article, please visit our web site at www.elderlawcenter.org