Residential Rental Real Estate: Part 1

We get many questions regarding the wisdom of Residential Rental real estate, both from an investment and federal tax point of view. We are not real estate professionals, and we strongly suggest you consult with one to determine the investment potential. As Accounting, Tax, and Payroll experts, we will cover the Tax and Accounting issues in a series of articles. As you know, from our prior Blog articles, we cover a Tax and Accounting issue in considerable depth, as we find that simple overviews rarely satisfy the reader’s information needs. We kick this series off with general overview. We will then cover each of the subtopics in considerable detail. As always, please feel free to call us at 239-596-6050, to arrange for a completely no obligation free consultation on this or any other tax or accounting issue.

There are two ways you can approach the residential real estate rental business;

  • As a Real Estate Professional
  • As a Passive Investor

This series of articles will focus almost exclusively on the NON professional, as professionals know and understand their business and the associated tax issues.

Generally, most people are Passive Real Estate investors, owning one or two rental properties and use Schedule E on their personal Federal Tax return to report their rental revenues and expenses.

You have probably heard that rental residential real estate is a good tax shelter. This is true, but there are limitations on the amount you can write off. There may be some tax consequences when you sell the rental property, that you need to understand. The following items cover the basic facts related to residential rental real estate. We will cover each of these items in greater detail in future articles.

  • Residential rental real estate is a tax shelter because the rental property almost always results in a loss on Schedule E of your federal tax return. Usually, this loss is created or amplified by the annual depreciation write-off. Within certain limitations, you can use the loss to offset other income.
  • The loss limitations and phase outs can be confusing, and we will cover them in depth in a separate article.
  • As a large part of your operating expense is depreciation, your rental can operate with a tax loss, but have positive cash flow. This means your rental property can carry itself, with rental income being equal to or greater than your non depreciation expenses, while the depreciation expense creates the operating loss.
  • Depreciation is not optional, nor discretionary. You must take depreciation. Depreciation reduces your basis in the property.
  • If you sell your property, you will have either a Capital gain or loss, which you will report on Schedule D. Your gain or loss is the difference between your adjusted basis and the selling price. Once again, these terms need detailed explanation.
  • You should retain, indefinitely, all records and documents associated with the purchase, maintenance, improvement, and sale of your rental property.

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