2007 may be my worst tax year ever.
Not only did I fail to qualify for the full energy credit and fall out of touch with my tax accountant, but I made it worse by having a great year with my rental properties.
A great year which I did not sufficiently offset, and that’s my next mistake:
4. Failing to Balance Rental Property Income with Deductible Expenses
Psychologically, rental property ownership is a funny thing. During years when I suffer through months of vacancy or renovations, I shudder to think of the losses, wondering how I’ll make it through. Throw in court costs for evictions and the like, and I’m nearly over the edge.
Once tax time arrives, however, my tune changes, and I’m thrilled by the deductions I get to claim due to the expenses and losses. Renovation expenses are depreciated across multiple years, but it still helps to offset my primary job’s income.
2007, however, was a profitable year, with the properties fully rented for all 12 months. The rent was even paid right on time. It was my lowest-stress year as a landlord on record, and yet this is the worst possible situation for tax purposes.
I should have used the positive cash flow to invest back into my rental properties, increasing their value while offsetting my taxable income for the year. My properties are some of the nicest houses in their neighborhood and fully compliant with local regulations and codes, but there are always enhancements which can be made.
What I Could Have Done with the Rental Income Instead of Nudging Myself Into a Higher Tax Bracket:
- Replace the Roof – One of the houses has a functional but aging and unattractive roof which will eventually need to be replaced. It would be minimally disruptive to the tenants, and since there’s no urgency here, I could have scheduled the work for late autumn and gotten a great discount from roofers looking for work off-season.
- Kitchen Upgrades – Ask anyone about home values, and they’ll point you towards kitchen renovations. My present tenants are fastidious, and I know that if I gave them new cabinets and perhaps even a granite countertop, they’d take good care of them. Plus, it might help me to retain these great tenants over time, adding even more ROI.
- Landscaping – The properties have functional lawns and some shrubbery, but I could have invested in some pretty evergreens and flowering shrubs to improve visual appeal year-round. I could also have taken advantage of the late season sales to get fabulous plants inexpensively.
I now have my list of improvements for 2008, but it’s a shame I’ll miss out on any meaningful tax deductions for the past year. I’ll ask my tax advisor to help me plan my upgrade spending so I can proceed with confidence.
For more information on rental property tax deductions, see my article 10 Tips for Buying a Residential Rental Property, Part 1: Buy at the Right Price.
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This is my first year as a home owner. I am interested to see how the mortgage deduction improves our overall deductions. I will miss my wifes deductions and credits from being a college student.
Sasha, I always enjoy reading your articles on the rental property front. I hope to see some more in the future.
For your properties, is cash flow to the point that depreciation deductions are not offsetting income? Or is the issue simply that tax losses offset less ordinary income than you’d like?