Independent rental owners of homes, individual condos and apartment buildings are generally considered engaged in a trade or business. As such they enjoy key small business benefits under federal and state tax codes.
It is recognized that even the owner of a single house that is offered for rent is providing essential goods and services to the marketplace while taking on business risks to do so. Locally, almost half of the housing in San Diego is provided by rental owners. During the housing bubble many foreclosures have been the result of rental owners that either did not understand or ignored the business risks involved. Therefore, favorable tax treatment is the economic stimulus normally provided by government to encourage investment in real estate ownership and rental operations. The need for such stimulus will continue if we are to get real estate on solid footing again.
Fully utilizing the tax codes in order to enhance your investment return is an important piece of your rental ownership. Fully understanding your accountability as a small rental business owner subject to IRS regulations is also important.
Here is a short list of suggestions for current consideration:
• All rental income and expenses for 2011 should be documented and organized for review.
• If you are a self-managing landlord you should have a separate bank account that delineates all rental business income and expenses.
• If this financial information has been correctly coded and spread within a computer application it is easier to review and compare against your previous experience and/or your expectations.
• If you employ professional property management you will be provided with all of the above information monthly and at year’s end in a format that is easy to review with your tax professional.
• For a nominal year-end processing fee your property manager provides you with a 1099 for the total collected rent; information must go to you and the IRS. This independent third-party documentation of collected rent from a licensed manager will normally satisfy the IRS on this audit-sensitive information.
• It is also imperative that you (or you property manager) provide a correct 1099 for any independent supplier receiving compensation during the year for maintenance, repairs and other services rendered at your rental property. Failure to provide a copy of this information can result in a penalty to the rental owner of $50 per 1099 plus it invites an audit of your return(s).
• There is also strict compliance requirements within California to report rental income to FTB not required for every taxpayer. Where applicable reporting and deposits are needed quarterly.
• A tax professional can advise you on proper allocation of owner’s expenses that are separate from the daily operations. Examples- allocation for home internet services and computer, publications to keep abreast of local real estate, current events and economic trends; air and ground travel as well as other expenses to visit property and or manager(s).
• Advice on allocation of capital items vs. operating expenses, appropriate depreciation schedules, treatment of property assessments, mid-year acquisitions or dispositions, and special investment credits are examples of needed professional tax planning before filing an audit-ready schedule E with your federal 1040.
Too often we find that a rental owner’s dissatisfaction with their investment stems from not thinking like a small business owner, not taking full advantage of the tax codes, financial benefits of real estate ownership and not surrounding themselves with available professional resources that will attend to the business details that control risk.