Investment property is the riskiest designation for lenders to finance and refinance. The reason behind its high-risk level is due to layered risk that lenders attempt to hedge on the investment they make in their borrowers.
When considering to purchase an investment property, be sure to mitigate your risk by carefully evaluation the common types of General Market Risk, Asset-Level Risk, Idiosyncratic Risk, Liquidity Risk, Credit Risk, Replacement cost risk, Structural Risk, Leverage Risk; real estate investors should inquire about these risks and receive straight answers to be more confident in their investing decisions.
Then the easy part! Secure financing to leverage your returns and earn more significant profits.
Residential, Commercial, or Mixed-Use properties may be structured as a long-term investment with passive rent roll income or short-term investment purchased from a distress sale, then rehabbed and sold in less than 12 months.
The IRS defines investment property as
If you receive rental income for using a dwelling unit, such as a house or an apartment, you may deduct certain expenses. These expenses, including mortgage interest, real estate taxes, casualty losses, maintenance, utilities, insurance, and depreciation, will reduce the amount of rental income subject to tax. You’ll generally report such remuneration and expenses on Form 1040, U.S. Individual Income Tax Return or Form 1040-SR, U.S. Tax Return for Seniors, Schedule E (Form 1040), Supplemental Income, and Loss. If you’re renting to make a profit and don’t use the dwelling unit as a residence, your deductible rental expenses may be more than your gross rental income. However, your rental losses generally will be limited by the “at-risk” rules and the passive activity loss rules. Refer to Publication 925, Passive Activities, and At-Risk Rules for information on these limits.
Rental Property / Personal Use
If you rent a dwelling unit to others that you also use as a residence, limitations may apply to the rental expenses you can deduct. Rental Property considered to use a dwelling unit as a residence if you use it for personal purposes during the tax year for more than the greater of:
- 14 days, or
- 10% of the total days you rent it to others at a fair rental price.
You may use more than one dwelling unit as a residence during the year. For example, if you live in your main home for 11 months, your home is a dwelling unit used as a residence. Suppose you live in your vacation home for the other 30 days of the year. In that case, your vacation home is also a dwelling unit used as a residence unless you rent your vacation home to others at a fair rental value for 300 or more days during the year in this example.
A day of personal use of a dwelling unit is any day that the company is used by:
- You or any other person who has an interest in it, unless you rent your part to another owner as their primary home and the other owner, pays a fair rental price under a shared equity financing agreement
- Members of your family or of a family of any other person who has an interest in it, unless the family member uses it as their primary home and pays a fair rental price
- Anyone under an agreement that lets you use some other dwelling unit
- Anyone at less than the reasonable rental price
Minimal Rental Use
There’s a special rule if you use a dwelling unit as a residence and rent it for fewer than 15 days. In this case, don’t report any rental income and don’t deduct any expenses as rental expenses.
Dividing Expenses between Rental and Personal Use
If you use the dwelling unit for rental and personal purposes, you generally must divide your total expenses between the rental and personal use based on the number of days used for each goal. You won’t be able to deduct your rental cost over the gross rental income limitation (your gross rental income less the rental portion of mortgage interest, real estate taxes, casualty losses, and rental expenses like realtors’ fees and advertising costs). However, you may be able to carry forward some of these rental expenses to the following year, subject to the gross rental income limitation for that year. Suppose you itemize your deductions on Schedule A (Form 1040), Itemized Deductions. In that case, you may still be able to deduct your personal portion of mortgage interest, property taxes, casualty losses, and rental expenses from federally declared disasters on that schedule.
Net Investment Income Tax
You may be subject to the Net Investment Income Tax (NIIT) if you have a rental income. For more information, refer to Topic No. 559.
For more information on offering residential Property for rent, refer to Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
For more information on residential rental property income and expenses, refer to Topic No. 414 and Is My Residential Rental Income Taxable and Are My Expenses Deductible?