Rental Real Estate

Multi-story residential building with balconies, some with outdoor furniture and fabric privacy screens, set against a blue sky with the sun shining through a nearby tree.

Rental real estate can be an attractive form of investment for many taxpayers. Our real estate clients are not limited to rental real estate investors. Our clients in the real estate industry include various forms of property ownership and management, including development, appraisal, marketing, selling, leasing, and managing commercial, residential, industrial, and agricultural properties. 

Cooke, Lavender, Massey, & Company, P.C. provides real estate businesses the best tools and resources to navigate the complex tax and accounting issues that face this growing industry. 

We specialize in accounting and tax preparation for rental real estate owners who have multifamily housing properties, single-family rentals, short-term rentals, condominiums, vacation rentals, collegiate housing, and other types of rental properties. 

Our clients reside in Blacksburg, Christiansburg, Radford, the New River Valley, and the surrounding region. We pride ourselves on providing the highest quality accounting and tax preparation services for our clients in the real estate industry. These services include: 

  • Accounting

  • Bookkeeping

  • Payroll Services

  • Income Tax Preparation

  • Audits and Reviews

  • Compilations

Unique Accounting and Tax Challenges Faced by Rental Real Estate Owners and Real Estate Professionals

The real estate and rental industries must manage a variety of accounting and taxation challenges. These challenges are amplified for investors that own multiple rental properties or several LLCs. 

  • Owners of rental real estate are particularly concerned about whether their real estate activities can be considered a Section 162 trade or business and, therefore, treated as a trade or business for the purposes of the Qualified Trade Income (QBI) deduction. This deduction can be significant for any business owner, including owners of rental real estate. Our firm works closely with our rental real estate owners to determine their ability to qualify for, and optimize benefits from, the QBI deduction.

  • Rental real estate is generally considered passive, unless the taxpayer meets the strict requirements for being classified as a real estate professional. Also, certain short-term rentals are not automatically treated as passive. Passive activity losses deductible in any given tax year are limited to passive activity income. Losses not allowed under passive activity loss rules are carried forward until subsequent tax years where they are either offset by passive income or the property that generated the losses is disposed.  Up to $25,000 in passive losses from rental real estate for individuals that actively participate in the rental activity can potentially be deducted each year against nonpassive income, with some exceptions. The $25,000 special allowance is reduced by 50% of the amount by which the taxpayer’s modified adjusted gross income exceeds $100,000. Therefore, the special allowance is eliminated when the modified AGI benchmark reaches or exceeds $150,000.  For married filing separate returns the special allowance is reduced to $12,500 and the AGI phase-out begins at $50,000 instead of $100,000. Numerous nuances exist in the tax code regarding passive activities and their reporting. Our accountants have extensive experience with optimizing the ability to deduct rental activity losses and planning for the future sale of appreciated rental properties.

  • Many contractors also own rental real estate properties. A significant determination for anyone in this situation is determine whether or not the taxpayer should classify themselves as a “real estate professional”. This decision can have very significant tax implications. Rental real estate activities in which real estate professionals materially participate are required to be treated nonpassive activities for income tax purposes. As a result of this requirement, net rental losses from rental losses can be deducted against other nonpassive income (such as W-2 wages). The $25,000 special allowance limitation does not apply to real estate professionals. Several conditions must be met to make this classification. Our firm can help you make this determination and navigate the complex tax implications.

  • A significant tax deferment tool available to rental real estate owners is the ability to exchange real property held for productive use in a trade or business or for investment for another property of a “like kind”. In this type of exchange, potentially all of a gain resulting from appreciated real property can be deferred and not recognized in the year of the exchange. This is a powerful tax strategy utilized by savvy taxpayer’s and our firm has the knowledge and experience necessary to navigate these transactions. 

  • Security deposits received that are to be attributed as a final payment of rent are considered advance rent. The receipt of this deposit should be included in your income when you receive it. A security deposit that you plan to return to your tenant at the end of the lease is not included in your income when you receive it. The amount you keep and do not return to a tenant after the tenant moves out of your property is included in your income in that year.

Frequently Asked Questions

  • Revenue Procedure 2019-38 details safe harbor requirements that allow certain interests in rental real estate to be treated as a trade or business for purposes of the QBI deduction under Section 199A of the Internal Revenue Code. This deduction can be very significant for owners of rental real estate. Our firm works closely with our rental real estate owners to determine their ability to qualify for, and optimize benefits from, the QBI deduction. Many variables can impact your eligibility for a QBI deduction. Our team of experts can help you determine whether you qualify for this tax deduction.

  • Generally, costs that result in improving a property are capitalized. Amounts paid that result in the betterment to a property, restoration of a property, or an adaptation of a property to a new or different use generally result in an improvement to a property. However, some costs can qualify as a repair instead of a capital improvement. Safe harbors for routine maintenance and small taxpayers (average gross receipts under $10 million for the last three tax years) are some of the avenues available to rental real estate owners for expediting the deduction of qualifying maintenance and repair costs and avoiding years of unnecessary depreciation. Our accountants offer years of experience helping real estate owners identify repairs versus capital improvements and characterizing these transactions accurately and advantageously.

  • Ordinary and necessary expenses for managing, conserving, and maintaining your rental property are deductible. Ordinary expenses are those that are common and generally accepted in the business. Generally, expenses are that are deemed appropriate for the business should meet the definition of “necessary”. Deductions for certain materials, repairs, maintenance, and supplies, that are directly spent on your rental activity may also be available.

  • Many variables can impact the gain from a sale of real property. Depreciation recapture is one of these significant variables. Gains to the extent of allowed straight-line depreciation for real property are “unrecaptured Section 1250 gains” which are taxed at ordinary income tax rates, with a maximum 25% rate. The gain in excess of allowed depreciation is taxed at capital gains rates. Passive activity losses are also generally deducted in the year of disposition. This includes current year losses and losses suspended and carried forward from prior years.

Common Mistakes

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    Deducting non-deductible expenses

    As in any industry, it is essential to avoid trying to deduct expenses that are not tax-deductible. One example of this in the real estate industry is attempting to deduct your own labor and time as an expense. 

    For example, if an individual owns a painting company and rental properties, they cannot deduct the time and labor for painting their own property. They could have their rental business pay the painting business for the work, but in most cases, that would only result in much paperwork with very minimal benefit. 

  • A bar graph with colorful bars and a red downward arrow, a dollar coin in front, on a green background.

    Not correctly determining and tracking depreciation

    You can recover some or all of your improvements to your rental property by using Form 4562 to report depreciation beginning in the year your rental property is first placed in service, and beginning in any year you make an improvement or add other furnishings, fixtures, etc. Only a percentage of these expenses are deductible in the year they are incurred. However, depending on the type of asset placed in service and the type of rental property (residential or commercial) some accelerated depreciation options are available.

  • An illustration of a calculator placed on a sheet of paper with text, against a dark background.

    Tracking Suspended Passive Activity losses

    Passive activity losses are limited to passive activity income. Losses not allowed under Passive Activity Loss rules are carried forward to following tax years. Many people have a substantial taxable gain when disposing of rental real estate. Successful and accurate tracking of passive activity losses can help offset a taxable gain. It’s essential to track your passive activity losses accurately. 

  • Icon of a yellow key with a round head and a notched blade inside a red circular background.

    Self rental

    If an individual rents property to a trade or business activity in which the taxpayer materially participates, net rental income from the rental property is considered nonpassive income. Conversely, a net loss from the rental property is still treated as passive. Taxpayer’s with self-rental property and other passive activities must accurately report self-rental income in order to accurately report taxable income in a given tax year.