Value of a Rental Property Tax Deduction

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Here is another concept that many rental property owners miss. Every December, we field hundreds of phone calls and emails from clients asking if they should buy something to save on taxes. Or do that big cost segregation study. Or buy that short-term rental property. Our response is a simple flowchart-

• If you are buying equipment like an automobile, do you need it for improved business operations or personal desire? If No, then stop. Don’t buy anything. If Yes, or if you considering a cost seg or rental property purchase, then continue to the next question.

• Is the current year’s income unusually high, or do you expect to earn more next year?

Without sound snarky, why would you buy something on December 31 if your tax rate will only increase the following year? Wait 24 hours, buy the cool thing you need and get a better yet delayed tax deduction. If you don’t need it, why would you spend money unnecessarily only to get a portion of that back in tax savings? Another way of saying this is- keep some tax deductions in your pocket for next year. You don’t want to be in a position where you ran out of perfectly good deductions in a year of increased taxable income.

Conversely, if your current taxable income is unusually high and you expect it to go down next year then perhaps you should accelerate your timelines for major purchases. What do we mean here? Timing your cost segregation study with your taxable income is good business. If you have an unusually high-income year, and you can find a way to not be limited by passive activity loss limits through real estate professional status (REPS) or the short-term rental loophole, then smash that cost seg purchase. WCG can help with the tax modeling and planning.

At times you might want to skip tracking your rental property expenses because you are unable to deduct passive activity losses. For example, your W-2 income is too high and the rental property does not qualify as a short-term rental. Therefore, you tell yourself, “why bother?” Keep in mind that unallowed losses are not lost forever. Rather, they carried over year after year, and can be used when you have rental profits or when you sell the rental property. As such, pile on those expenses!

Finally, all too often we hear people at cocktail parties say something silly like “Don’t worry, it’s a write-off.” Remember that money is still leaving your person, and the money you are getting back in the form of a tax deduction is substantially less. Just because it is a “write-off” or a business tax deduction doesn’t mean that you are using Monopoly money. Yes, it is easy to spend someone else’s money but calling it a write-off doesn’t change who owns the money.