Keep in mind that tax laws are constantly changing. Before you go hog wild on any project, talk with your accountant and determine the tax consequences. Remember, it’s not how much money you make on a project that is important – it’s how much money you keep.
If you have owned a house and lived in it for two of the last five years, you don’t pay federal income tax on the profit up to $250,000 ($500,000 for a married couple). Just for simplicity sake, let’s say you make a profit of $100,000 and your tax bracket is 37%. You save $37,000. If you could do that every five years, the tax saving alone would be more than many people make in a year.
Isn’t that an interesting thought? Imagine improving the value of your personal residence by $100,000 every five years. You would make $20,000 per year after tax. That is a pretty good second job! (Remember tax laws are constantly changing.)
Keep good records. You will need receipts for all purchases of materials and labor. These are your expenses and can be added to the purchase price of the property (check with your accountant.) The purchase price of the property plus the cost of the improvements becomes your basis for tax purposes. You will determine your profit by taking the sales price and subtracting the cost of the sale and the basis.
Also remember that interest on your personal residence may be deductible from your income for tax purposes. So once again, if you are in a 30% tax bracket and you pay $10,000 in interest, you save 30% or $3,000 in taxes. Property tax on your personal residence may also be deductible.
Interest on investment property is an expense of the business. Other expenses of business property can include advertising, depreciation, maintenance, property management fees, property taxes, and professional fees (legal and accounting.) Have your accountant create a list of expenses which you can track and report to her at the end of the year.
Ask your accountant about depreciation expense on your rental house. The house may be going up in value, but for tax purposes it may be depreciating. Depreciation considers that the house deteriorates over time. At some point it will need paint, a new roof, plumbing, etc. Keep in mind that as you claim depreciation the value of the property, for tax purposes, goes down.
For example, if a house is worth $200,000 and it depreciates by $10,000 per year, then after one year it is worth $190,000. If you sell it for what you paid for it, you will think you didn’t make any money. However, for tax purposes you will have made $10,000. You got back your depreciation expense. It simply means that this year you will pay the taxes you did not pay last year.
