This is a quick snapshot of the benefits of being a landlord and one of the many Americans who provide necessary rental accommodation for the community.
Our tax system is complex at the best of times, so this article is not going to get into deep detail – that is best handled by your financial adviser. This information is provided as general information only.
There are three types of income taxed under our system – Earnings (your wages from running a business or being an employee); Portfolio (you play the stocks and bonds markets and are smart enough to make a profit); and Passive.
If you’re a landlord or property investor, then your investment is most likely going to fall into the Passive category. Folks who fall outside this rule are those who work in a real estate business.
The good news about Passive income is that it falls outside the Federal Insurance Contributions Act.
This levy is 15.3% and is usually split and paid equally by an employer and employee. You may have heard it called the “self-employment tax” because those guys pay all of it. If you’re wondering, FICA is split 12.4% for social security tax and 2.9% for Medicare.
“Passive” income from rentals means you avoid the FICA bullet. And the advantages don’t stop there. Operating expenses such as repairs, maintenance, and professional fees can be set against the cashflow received. So can the interest on the loan, insurances and taxes. But not the principal.
It is possible to have positive cash flow but a net loss, and this can benefit the tax rate on your earnings. It is essential that you seek professional financial advice so you can make a fully informed decision about entering the property rental market for the first time or expanding your portfolio to understand how this will specifically affect your own circumstances.
Here are the four basic principles under which rental income operates
- Rental income is passive income.
- Passive income is not subjected to the 15.3% FICA tax.
- If you earn a wage – that is, hold a W-2 job or run a business – potential tax benefits exist if a rental makes a loss due to interest costs of a loan, repairs and maintenance etc.
- The principal of any loan owed on the property is non-deductible.