Real Estate Tax Deductions, Breaks & Regulations

Real Estate Tax Deductions, Breaks & Regulations

As the owner of a principal residence, vacation home, or rental property, there are numerous ways to maximize tax benefits and profit from your investments. Careful tax planning is also important if you’d like to sell your home or other real estate soon.

The TCJA (Tax Cuts and Jobs Act) impacts numerous home-related deductions and tax breaks for real estate investors and other real property businesses. These amounts will depend on the taxable value of the property. Let’s take a closer look.

Home-Related Tax Deductions

Home-related tax deductions include:

Property tax deduction: Under the TCJA, the property tax deduction is subject to a $10,000 limit (or $5,000 if you’re married filing separately) on combined deductions for state and local property and income taxes through 2025. High-income taxpayers who own expensive homes in high-property-tax locations have seen a significant drop in the federal tax benefit they receive from property tax payments.

Mortgage interest deduction: You can deduct interest on mortgage debt incurred to purchase, build, or renovate your principal residence and a second residence. Points paid related to your principal residence also may be deductible. Through 2025, the TCJA reduces the mortgage debt limit from $1 million to $750,000 for debt incurred after Dec. 15, 2017 — with some exceptions.

Home equity debt interest deduction: The TCJA limits the home equity interest deduction to debt that would qualify for the home mortgage interest deduction through 2025. (Under pre-TCJA law, interest was deductible on up to $100,000 of home equity debt used for any purpose, such as paying off credit card debt or buying a car.)

Home Office Deductions

Home office deductions have become more and more relevant due to the shift to work-from-home culture triggered by the COVID-19 pandemic. Unfortunately, per the TCJA, employees can no longer deduct home office expenses. This is true even if your employer required you to work from home during the pandemic.

However, if you are a self-employed business owner and your home office is your main place of business (and it is not a multi-purpose space) you may be able to deduct a portion of your mortgage interest, property taxes, insurance, utilities, and other expenses from your self-employment income. Furthermore, you may also be able to deduct direct expenses, such as a business-only phone line and office supplies.

If this all seems like too much to keep track of, there’s a simplified method for calculating the deduction: you can deduct $5 per square foot, up to 300 square feet (a maximum of $1,500 per year). While you won’t be able to depreciate the portion of your home that’s used as an office without filing Form 8829, you can still claim mortgage interest, property taxes, and casualty losses as itemized deductions on Schedule A without needing to apportion them between personal and business use of your home.

For more guidance and to find out if this break is applicable to your home office, discuss it with your Haynie & Company tax advisor in more detail.

Home Rental Tax Rules for Property Taxes

It’s important to understand the key rental reporting thresholds, especially if you own multiple properties. If you rent out certain rooms or the entirety of your primary residence or second home for less than 15 days during the year, you don’t have to report the income. However, expenses directly associated with the rental process (like advertising and cleaning) won’t be deductible.

On the other hand, if you rent out your principal residence or second home for 15 days or more, you’ll have to report the income — but you also may be entitled to deduct some or all of your rental expenses such as utilities, repairs, insurance, and depreciation. Exactly what you can deduct depends on whether the home is classified as a rental property for tax purposes. This determination is based on the amount of personal use vs. rental use.

Rental property: You can deduct rental expenses (including losses) subject to the real estate activity and passive loss limitation rules. Property tax attributable to the rental use of the home isn’t subject to the $10,000 limit on the state and local tax deduction. You can’t deduct any interest that’s attributable to your personal use of the home. However, you can take the personal portion of property tax as an itemized deduction (subject to the $10,000 limit).

Non-rental property/personal property: You can deduct rental expenses only to the extent of your rental income. Any excess can be carried forward to offset rental income in future years. You also can take an itemized deduction for the personal portion of both mortgage interest and property taxes, subject to the applicable limits. In some situations, it may be beneficial to reduce your personal use of a residence so it can be classified as a rental property instead.

Selling A Home

When you sell your primary residence, you may exclude up to $250,000 (or $500,000 for joint filers) of gain if you meet certain criteria and maintain thorough records. Gains that qualify for exclusion will also be excluded from the Net Investment Income Tax (NIIT). Gain on the sale of a principal residence generally isn’t excluded from income if the gain is allocable to a period of nonqualified use. Generally, this is any period after 2008 during which the property was not used as your principal residence. (There’s an exception if the home is first used as a principal residence and then converted to nonqualified use.)

Losses on the sale of any personal residence aren’t deductible, but if part of your home is rented or used exclusively for your business, the loss attributable to that portion will be deductible, subject to various limitations.

Because a second home is ineligible for the gain exclusion, consider converting it to rental use before selling. Then, it can be considered a business asset, and you may be able to defer tax on any gains through an installment sale or a Section 1031 exchange.

Depreciation-Related Tax Breaks

Three depreciation-related breaks may be available to real estate investors:

  1. Bonus depreciation note: Under the TCJA, real estate businesses that elect to deduct 100% of their business interest expense are ineligible for bonus depreciation.
  2. Section 179 expensing election: This tax break allows you to deduct (rather than depreciate over a number of years) qualified property, subject to certain limits. The TCJA also allows Sec. 179 expensing for certain depreciable tangible personal property used predominantly to furnish lodging and for the following improvements to nonresidential real property: roofs, HVAC equipment, fire protection and alarm systems, and security systems.

Tax Deferral Strategies for Investment Property

It’s possible to divest yourself of appreciated investment real estate or rental property but defer the tax liability. The strategies below may even help you keep your income low enough to avoid triggering the 3.8% NIIT and the 20% long-term capital gains rate.

Installment sale: An installment sale allows you to defer gains by spreading them over several years as you receive the proceeds. Beware: ordinary gain from certain depreciation recapture is recognized in the year of sale, even if you don’t receive any cash. You could also end up paying more if tax rates increase in the future.

Sec. 1031 exchange: Also known as a “like-kind” exchange, this technique allows you to exchange one real estate investment property for another and defer paying tax on any gain until you sell the replacement property. Restrictions and risks apply. For example, the TCJA prohibits Sec. 1031 exchanges for real estate held primarily for sale. Elimination of this break has been proposed.

For more Real Estate tax guidance contact a Haynie & Company tax advisor.

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