Implications of Tax Codes for Landlords

by Karina Gafford

For landlords who just completed their taxes for 2013, and are hoping to prepare responsibly for 2014, you will find that not many changes are yet noted in the real estate tax codes. The sky is not yet falling for military families who purchased homes at multiple duty stations that they have since converted to rental properties; however, the future remains uncertain, as the implications of the tax codes for landlords are only extended for this current tax year.  Next year remains unwritten. 

It is challenging to live in an environment where tax codes only permit short-term planning.  For those who wish to create a long-term real estate portfolio of rental properties, navigating a tax system that only offers one year and two year extensions of current tax codes pertaining to that property simply does not suffice.  If the taxes and deductions that a prospective landlord calculates when purchasing a new rental property change drastically only two years after making the purchase, then the property may no longer cover its own costs, making the property a liability instead of an asset.  Yes, it is true that a rental property is a business, and any investment in business involves risks; however, an individual purchasing a property should reasonably expect the ability to make a calculated risk based on tax codes.  Whether the area in which the purchased property thrives or ceases to survive, meanwhile, remains the more challenging risk that can make or break a landlord’s rental portfolio.

Deductions and Credits for Now

Fortunately, many of the tax deductions for property owners and rental owners remain for yet another year.   We’ll take a look at several tax deductions that may benefit military family landlords for this year, though their continuation in the tax code remains tenuous.  The deductions and credits we will review are:

  • Mortgage Interest Deduction

  • Rental losses

  • Energy efficiency improvement credits

For now, the mortgage interest deduction—the blessing for all new homeowners who quickly learn that mortgage interest amounts for the vast majority of most mortgage payments for the first few years, thanks to carefully calculated lending industry amortization practices—remains.   For landlords with a fixed rate 30-year mortgage who have been faithfully paying each month for less than 10-years, the mortgage interest deduction significantly helps in making the early years of rental income to mortgage expenditure ratio calculation less painful.  Later, when majority of your monthly payment goes to principal instead of interest, the mortgage interest deduction will count for significantly less, but hopefully by that point, the rental rates for your property will have appreciated.  Therefore, even though you will receive less of a tax deduction, you should be earning more rental income while still only paying the same mortgage amount. 

One additional benefit for couples who file their taxes jointly and make less than $100,000 in their modified adjusted gross income (MAGI) is the ability to claim up to $25,000 in rental losses.  Most military families will qualify in this income bracket.  The average military member age is approximately 28, and the average military member earns just less than $50,000 annually in base pay.  Even if you live in an area that earns a high rate of Basic Housing Allowance (BAH), since that amount is untaxable, the service member’s MAGI remains far below the $100,000 threshold.  Given that most military spouses earn less than their civilian counterparts, according to the national Hiring Our Heroes studies, the average military family landlord should be able to continue to claim rental losses.  For married couples who file their taxes separately, they can each claim up to $12,500 in rental losses, but this only applies to couples filing separately who also live separately; therefore, couples who are geographic bachelors for the year, or who choose to live separately can consider this option.  

Though including key industry buzz words such as "energy efficient home" may continue to help you rent your property to those concerned with utility bills and the environment, the tax boon that helped make some of the pricier upgrades worth the investment has disappeared for 2014.  Since 2007, property owners could receive a $500 tax credit for the installation of items, such as certain windows and HVAC systems, but unfortunately this credit expired at the end of 2013.  Some credits, however, do remain for solar and wind energy-focused upgrades, such as solar water heaters.  These are currently set to expire in 2016.  For some good news about changes that you make to your rental property throughout the year, though, is that repairs—not improvements—are still considered deductible by the IRS. 

What Does the Future Hold?

The continual failure to pass budgets and, effectively, shut down government is unsustainable.  Such practices make for an unfriendly business environment that challenges investment and growth.  Fortunately, the Chairmen of both the Senate Finance Committee and the House Ways and Means Committee have expressed their commitments to completing comprehensive tax reform legislation in 2014.  As part of the reform, the National Association of Realtors suggests, they will move to create certain tax items a permanent part of tax law.  The actual list of prospective permanent tax items remains to be seen, but this news is promising for landlords, particularly for those interested in planning the creation of a long-term rental portfolio, as a permanent tax code that applies to real estate will allow for better calculations and projections of income, helping rental owners better prepare for future investments.     

At the State and Local Level

For military family homeowners who face a PCS, the relocation often comes with an unpleasant tax situation, a higher tax bill for non-residents or non-owner occupied properties.  As a military family rental property owner, our own tax bills jumped from $1,100 and $1,400 to $2,600 and $3,100, respectively once we had relocated to new duty stations out-of-state, as we no longer qualified for the primary residence tax break.  Increasingly, governors are recognizing that their state is saddled with large numbers of rentals and abandoned properties, left behind by military families who could not sell their properties, and thus becoming reluctant landlords, or who could not continue to afford to retain the property left behind at a previous duty station.  In the case of the latter, homes that typically wind up as foreclosures often leave behind hefty unpaid tax bills.  In states where it can take a couple of years for a property to even get to the foreclosure status, a tax bill may have been left unpaid for several years.  

In the State of South Carolina, for one example of changes at the local level, Governor Nikki Haley recently issued a policy statement addressing the tax problems faced by military families who own homes in the state.  Recognizing that military families do not choose when to leave their homes, Haley offered a tax break to those who PCS, permitting those families to retain the tax break while attempting to sell the property even if the property is currently occupied as a rental unit.  This means that as long as the house remains on the market, despite its status as a rental, military families can continue to pay the lower tax rate that they paid when the home was owner-occupied.

Do you own properties in multiple states? Have you received notice on tax changes that will affect military family homeowners in your state? If so, please share them with us on Facebook!