Although tax season isn’t fun for anyone, you can make the most out of it by taking advantage of deductions for landlords.
To have the chance to qualify for many of these deductions, you must be classified as a business owner. In this article, we’ll be going over how you can prepare as a business owner for tax purposes.
The 3 Classifications
The main landlord classifications are business owners, not-for-profit owners, and investors. Depending on your type, you may qualify for all available deductions, some deductions, or none.
To be classified as an investor, you must passively invest in a property because you believe its value will increase over time. An investor does not attempt to list the property, rent it out to tenants, or manage the rental units in any way. If you own property, but your tenants manage everything down to taxes and insurance, you’d fall under the investor category.
The next category is not-for-profit owners. If you lease a unit for charity, use your property for recreation, or live to inhabit the property part of the year and allow the family to use it when you aren’t there, you’ll be classified as a not-for-profit owner. Unlike business owners, the goal of not-for-profit owners isn’t to make a profit.
Finally, we have the business owner category. Business owners are consistently and continuously engaged in their rental activities, and their goal is to make a profit. With that being said, you don’t personally have to take care of the daily landlord responsibilities to be classified as a business owner. If you hire someone to list your property, perform tenant screening, manage maintenance, etc., you’d still be considered a business owner since someone you employ is doing that work for you.
You can take advantage of the most significant deductions as a business owner. Investors can take advantage of some deductions, but not all. Not-for-profit owners can’t deduct any rental expenses.
How to Qualify
Because business owners can deduct the most from their rental income taxes, you want to try to be classified as one. But how?
The IRS considers two main factors when classifying you: motive and behavior. All your reason has to be is to make a profit. If your behavior suggests that your goal is to make a profit—which means that you or someone you hire consistently manages your properties—then you qualify.
Here are two methods you can use to show the IRS that you qualify as a business owner:
- The Three of Five Test – By making a profit in three of five successive tax years, you show the IRS that your motive is profit. The amount doesn’t matter.
- The Behavior test – With well-kept records, consistent and continuous work, and industry knowledge, you can use your behavior to show the IRS that you have a profit motive.
Even if you don’t turn a profit, you can still qualify as a business owner by proving your motive is profit. Saving receipts, invoices, logging your working time, and creating a business growth plan are ways to help legitimize your business and intentions.
Tax Deductions for Business Owners
This article aims to show you why qualifying as a business owner for tax purposes is so important. But, specifically, what tax deductions for rental property exist for business owners that make being classified as a business owner so beneficial?
- The pass-through deduction allows pass-through businesses to deduct 20% of rental income from income tax.
- The start-up expense deduction allows business owners in their first year of operation to deduct the costs of starting their business (up $5,000).
- Section 179 allows landlords to deduct equipment and other depreciable personal property once a year. You purchased it.
- The Home Office Deduction lets landlords who manage their rental properties remotely deduct home office expenses as business expenses.
- Real estate loss allowance protects landlords who experience a net loss by deducting real estate losses from their passive income.
When October comes around, it’s always a good idea to do some calculations. There are many ways to save money this tax season by taking advantage of deductions and credits that other business owners can’t enjoy. To qualify for these deductions, you need to prove your rental property is for profit and that your behavior supports this motive.