Taxes aren’t the most exciting aspect of real estate investing (even coming from a CPA), but they are very important to understand, nonetheless. After all, tax benefits are the reason I started investing in real estate many years ago. After years of preparing tax returns for high net worth individuals, I realized the common denominator across most of my clients was their investments in real estate.
As the October 17th income tax extension deadline approaches, we thought it was a good time to remind investors of the key forms to review for tax planning purposes. An error on one of these forms could cost you thousands of dollars in tax savings.
1. Form 8582
As a passive investor, this is the most important form to review each year. This form consolidates all your passive activities together in one location. It also confirms (from a tax perspective) that passive activity from one activity can offset passive losses from another activity. For example, if you have passive income from a real estate investment property sale, you can offset this gain with losses from another investment property (ie losses from depreciation).
Here are the three reasons you need to review this form:
- As I mentioned in a previous article, not all CPAs are created equally. You should be reviewing this form to ensure your CPA or tax preparer is netting your passive income with all of your passive activity losses. I can’t tell you how many times I’ve talked to investors who have said their CPA was not netting this activity, ie allowing losses to offset gains from passive activities. This is a completely legal way to reduce your taxable burden on your passive income.
- This form is critical to tax planning for real estate investors. It tells you the amount of passive losses you are carrying forward to the following tax year. If you want to sell a property in your rental portfolio or if you invested in a real estate syndication in which the property is going to sell in a given year, it’s critical to know the amount of passive losses you are carrying forward. These losses will be able to offset any gains from sales that take place in your investment portfolio, allowing your capital losses from real estate activities to offset your real estate capital gains. Timing these capital losses and gains facilitate and build tax free wealth!
- The review of this form is especially critical when you hire a new CPA. You want to ensure that when you engage a new tax professional, they include your carryforward passive losses from the prior year when preparing your return. If you take five minutes to log your carryforward loss on form 8582 from your prior year return, it can save you from potentially losing out on thousands of dollars of tax savings. I once had a client who had a previous CPA/tax preparer who missed carrying forward losses from a previous year return. It resulted in having to amend and restate several year tax filings so they could get the benefit of their carryforward losses.
2. Schedule E – Rental Income & Expense reporting
You should be reviewing this schedule to ensure you’ve provided your tax preparer with all expenses incurred for your rental properties. If you’re understating your expenses, you are missing out on the ability to reduce your taxable rental income and generate losses to reduce tax on passive income. Make sure you’ve included your insurance costs, repairs and maintenance, HOA fees, supply costs, property taxes, mortgage interest, and any other expenses you’ve incurred related to your rental activity.
Along the same lines, make sure you are keeping clean and organized books and records for your rental activity. The better your books are maintained, the easier it will be for your tax professional to accurately report your businesses’ results. It wasn’t long after I first started investing in real estate that I outsourced my bookkeeping so I could focus on higher value tasks that would continue to increase the value of my portfolio.
Annual Tax Form Review Conclusion
By investing in real estate, either actively or passively, you can qualify for significant tax advantages. Unlike capital gain treatment from your stock portfolio, you can use the deductions earned from real estate investments to time capital gains and losses in order to minimize your tax burden from these investments. In order to ensure you are maximizing your tax benefits from real estate investments, it’s crucial for investors to review Form 8582 and their Schedule E on an annual basis.