Here in our Chicago South Loop Tax Preparation office and our Homewood Il Tax Preparation office, we work with homeowners and real estate investors that are looking to save on their taxes. As we always say, when it comes to taxes, the best tax benefit is a tax credit, because you receive the amount on a dollar-for-dollar basis, versus tax deductions which only slightly reduce your taxable income. To say it another way, a $2,000 tax credit saves you $2,000 in taxes.
Energy Efficient Home Improvement Credit
Per the IRS, “if you make qualified energy-efficient improvements to your home after Jan. 1, 2023, you may qualify for a tax credit up to $3,200.” The Efficient Home Improvement Credits help homeowners pay for various types of energy efficiency improvements. The credit is 30% of energy property cost up to $1,200, and $2,000 per year for qualified heat pumps, biomass stoves, or biomass boilers. Since more people will qualify for the energy-efficient improvements, we’ve outlined the details below.
Exterior doors (energy star approved). Max 2 doors, $250 each, total credit amount $500. Example, door cost $1,300; 30% of $1,300 is $390. Although 30% of the cost is $390, the taxpayer can only get $250 of the $390 (per door up to $500).
Exterior windows & skylights that meet Energy Star Most Efficient certification requirements; max credit amount $600.
Electric panel upgrades. 30% of the cost up to $600.
Home insulation. 30% of the cost up to $1,200.
Central air conditioner. 30% of the cost up to $600.
Furnace, heat pumps, water heaters, and hot water boilers. 30% of the cost.
Home energy audits. 30% of the cost up to $150.
Heat pumps, biomass stoves, or biomass boilers. $2,000 per year.
What if I earn a high income?
The great thing about this credit is that even those that earn higher incomes can take advantage of the credit (because there are no maximum income thresholds).
How many times can I claim this credit?
Although the Energy Efficient Home Improvement Credit has a $1,200 annual cap (with limits on specific items), you can claim the credit each year through 2033. Some homeowners are choosing to perform energy efficiency projects over several years, so that they can claim the credit each year.
Will this credit increase my tax refund?
It depends! The credit is nonrefundable, meaning if you don’t owe any tax, you will not receive the credit as a refund check. However, the credit can reduce what you owe, helping you to receive a refund of the income taxes withheld by your employer.
Can I carry this tax over to another year?
No, you can’t carry the credit over to a future tax year.
Who can claim the credit
Homeowners that use the property as their main residence, or a vacation home.
In our South Loop of Chicago Tax Preparation office, and our Homewood, Il tax preparation office, we often encounter taxpayers who want to generate additional revenue without having to take on a second job or a time-consuming activity. In most cases, taxpayers express an interest in becoming a commercial or residential landlord; however, prior to becoming a rent-collecting landlord, you’ll likely have to spend a lot of money researching and preparing the property for rental. The good news is that the tax code treats some of those monies as start-up expenses.
What Are Start-Up Expenses? “Start-up expenses” are certain costs (money spent) you incur before a new business begins. In the case of a rental property business, these are costs incurred before you offer the property for rent.
Unlike operating expenses (the cost you spend on monthly bills such as internet, rent, office software etc.) for an existing business, start-up expenses can’t automatically be deducted in a single year because the money you spend to start a new rental (or any other) business is a capital expense—a cost that will benefit you for more than one year.
Normally, you can’t deduct start-up expenses until you sell or otherwise dispose of the business. But a special tax rule allows you to deduct up to $5,000 in start-up expenses the first year you are in business, with the remaining cost being deducted over the next 15 years.
There are two broad categories for startup cost:
Investigatory–Cost incurred as part of a general search to determine whether to acquire or enter a new business and which new business to enter. For example, you may deduct fees paid to a market research firm to analyze the demographics, traffic patterns, and general economic conditions of a neighborhood.
Pre-opening costs, such as advertising, office expenses, salaries, insurance, and maintenance costs.
Your cost of purchasing a rental property is not a start-up expense. Rental property and other long-term assets, such as furniture, must be depreciated (cost spread out over time) once the rental business begins.
On the day you start your rental business, you can elect to deduct your start-up expenses.
The deduction is equal to
the lesser of your start-up expenditures or $5,000, reduced (but not below zero) by the amount by which such start-up expenditures exceed $50,000, plus
amortization of the remaining start-up expenses over the 180-month period beginning with the month in which the rental property business begins.
When you file your tax return, you automatically elect to deduct your start-up expenses when you label and deduct them on your Schedule E (or other appropriate return).
Additionally, travel expenses to get your rental business going are deductible start-up expenses with one important exception: travel costs to buy the targeted rental property are not start-up expenses. Instead, they are capital expenses that must be added to the cost of the property and depreciated.
Costs you pay to form a partnership, limited liability company, or corporation are not part of your start-up expenses. But under a different tax rule, you can deduct up to $5,000 of these costs the first year you’re in business and amortize any remaining costs over the first 180 months you are in business.
Note that the cost of expanding an existing business is a business operating expense, not a start-up expense. As long as business expansion costs are ordinary, necessary, and within the compass of your existing rental business, they are deductible.
The IRS and tax court take the position that your rental business exists only in your property’s geographic area. So, a landlord who buys (or seeks to buy) property in a different area is starting a new rental business, which means the expenses for expanding in the new location are start-up expenses.
You can’t deduct start-up expenses if you’re a mere investor in a rental business. You must be an active rental business owner to deduct them.
In our South Loop of Chicago Tax Preparation office, and our Homewood, Il tax preparation office, we often come across taxpayers that want to reduce their tax bill and save money (legally). Because we specialize in small business owner and real estate investor tax preparation & tax planning, we often come into contact with new landlords.
Most of your purchase costs when acquiring a rental property will be detailed in the real estate closing statement or the closing disclosure. The closing statement is a financial instrument, not a tax document.
You need to go through each line item in the statement and assign it to one of the three following tax categories:
Basis
Loan Acquisition
Operations
Then, once you have divided your expenditures into these three categories, you often need to consider the best tax strategies for each. For example, in the basis category, you assign costs to land, land improvements, buildings, and personal property. Each dollar assignment has an impact on your profits.
This article provides a useful guide of information to help you build your rental property profits on the day you close escrow.
1. Basis
Generally, your basis (a fancy way of saying the money you put into something) is the total cost you pay for the property, including your costs of obtaining and perfecting the title. Once you have this total cost, you allocate that cost to land, land improvements, buildings, and equipment, and then you depreciate all but the land.
1.1 What Goes into Basis
Examine the closing statement to identify expenditures that you should include in your basis. The following list gives you some of the items you usually would include:
Contract price
Personal property
Abstract (title search) fees
Escrow fees
Legal fees (for the title search, sales contract, and deed but not for the loan)
Real estate commissions (generally paid by the seller; include in your basis if paid by you, the
buyer)
Recording fees
Surveys
Transfer or stamp taxes
Title Examination
Amounts you paid on behalf of the seller, such as back taxes, back interest, recording fees,
mortgage fees, charges for improvements and repairs, and sales commissions
In addition to what appears on the closing statement, make a review of your credit card statements and checkbook
to identify other costs that apply to the purchase of this property.
1.2 Allocating Basis to Assets
You allocate basis to land, land improvements, buildings, and equipment based on fair market values at the time of purchase.
2. Loan Acquisition
When you buy rental property, tax law divides your loan costs into two categories:
Costs you incur to obtain the loan
Costs, like points, that decrease the mortgage interest rate
2.1 Costs to Obtain the Loan
You write off the costs of obtaining the mortgage over the life of the mortgage using the straight-line amortization method. Costs you include in this write-off include:
Mortgage commissions
Abstract fees
Mortgage recording fees
Mortgage stamp and other taxes
Credit report
Lender’s inspection report
Appraisal fee for the loan
Mortgage insurance application fee
Mortgage assumption fee
Example. You incur $8,000 in costs to obtain a 10-year mortgage loan. You deduct $800 a year.
Loan origination fees, brokers’ fees, maximum loan charges, and premium charges are not points. These are costs of obtaining the loan and, like the costs above, you amortize them on a straight-line basis over the life of the loan.
2.2 Loan Costs That You Treat Like Interest
Points. The term “points” is often confusing. In a financial sense, the point represents a prepayment that you make to obtain a discount on the loan interest rate. In general, the more points you pay, the lower the interest rate.
Essentially, the payment of points is the payment of interest in advance, and the tax law gives special treatment to your payment of points.
Since points are nothing more than prepayment of interest on your loan, tax law treats points as original issue discount (OID). The amount of your OID determines which method you may use to write off points paid on a rental property acquisition.
3. Operating Items
At closing, you might pay real property taxes, fire and property insurance premiums, and city and town taxes. Look at these expenses. See whether they apply to your current and future holding of the property. If so, you may deduct these costs as current-year operating expenses, assuming you place the property in service at closing.
Per IRS publication 551, “If you pay real estate taxes the seller owed on real property you bought, and the seller didn’t reimburse you, treat those taxes as part of your basis. You can’t deduct them as taxes. If you reimburse the seller for taxes the seller paid for you, you can usually deduct that amount as an expense in the year of purchase.”
You also want to look through your checkbook and credit card statements for other operating expenses and perhaps some start-up expenses.
Takeaways
The closing statement examination in this article is the perfect place to start your property on the track for maximum profits by getting the best tax benefits at inception.
When you are thinking about acquiring a rental property, make it a point to review this article so that you can get the most out of both your closing costs and your cost to buy the property.
Summer is fast approaching, and with the weather change, businesses will soon be hosting office picnics, award ceremonies, and holiday parties. As is the only constant in tax matters, there are changes (again) in what meals the IRS will allow small business owners to deduct at 100% or 50%. Here in our Chicago South Loop Tax Preparation and our Homewood Il, Tax preparation offices, since you no longer can deduct all restaurant meals at 100%, we’ve done the research for you so that you can plan accordingly when organizing an office outing, having a business lunch, or providing meals for an employee meeting.
As you may already know, there have been some major changes to the business meal deduction for 2023 and beyond. The deduction for business meals has been reduced to 50 percent, a significant change from the previous 100 percent deduction for business meals in and from restaurants, which was applicable only for the years 2021 and 2022 due to Covid.
To help you better understand what you can deduct, please see the table below:
Amount Deductible for Tax Year 2023 and Beyond
Description
100%
50%
Zero
Restaurant meals with clients and prospects
X
Entertainment such as baseball and football games with clients and prospects
X
Employee meals for the convenience of the employer, served by an in-house cafeteria
X
Employee meals for required business meetings, purchased from a restaurant
X
Meal served at the chamber of commerce meeting held in a hotel meeting room
X
Meal consumed in a fancy restaurant while in overnight business travel status
X
Meals cooked by you in your hotel room kitchen while traveling away from home overnight
X
Year-end party for employees and spouses
X
Golf outing for employees and spouses
X
Year-end party for customers
X
Meals made on premises for the general public at a marketing presentation
X
Team-building recreational event for all employees
X
Golf or theater outing or football game with your best customer
X
Meal with a prospective customer at a country club following your non-deductible round of golf
X
Chart of what meals you can deduct at 100% and what you can deduct at 50%.
Here in our Chicago South Loop Tax Preparation, and our Homewood Il, Tax preparation offices, we specialize in helping business owners and real estate investors reduce their tax liability. One topic that always comes up is the topic of self-employment taxes. Regardless of age, all individuals with self-employment income must pay self-employment taxes. Even if you have a regular W2 job, if you earn additional income through a side gig, then you have self-employment income. Self-employment income can be earned through rideshare (Uber or Lyft) driving, delivery driver (Doordash, GrubHub, Instacart, etc.) work, independent contractor work (construction, life insurance sales, cleaning business, etc.) selling things online (Mercari, Eba, Amazon, etc.) or simply selling dinners out of your home.
The government claims that the reason self-employed workers need to pay self-employment taxes (in addition to income taxes), is so that when business owners reach retirement age, they’ll be able to collect Social Security and Medicare part A (hospital insurance) benefits if they paid self-employment taxes for at least 10 years (40 quarters). It is important to note that self-employment taxes are paid on your net earnings from self-employment, not your entire business income. In this article, we will discuss:
What is the self-employment tax
How Much Are Self-Employment Taxes?
Do employees pay less in tax than self-employed people?
Individuals Subject to Self-Employment Taxes.
Net Earnings from Self-Employment.
What happens if I own two businesses?
What happens if you work a job and have side self-employment income?
Will having self-employment income allow me to write off everything?
Income Not Subject to Self-Employment Taxes.
If you own an unincorporated business, you likely pay at least three different federal taxes. These three taxes are:
Federal income taxes.
Social Security taxes.
Medicare taxes.
Social Security taxes and Medicare taxes are collectively called self-employment taxes.
The self-employment tax totals 15.3% and has two parts:
1.) 12.4 percent Social Security tax up to an annual income ceiling adjusted for inflation each year ($147,000 for 2022) 2.) 2.9 percent Medicare tax on all net earnings from self-employment.
If your self-employment income is more than $200,000 (if you’re single) or $250,000 (if you’re married filing jointly), you must pay an additional 0.9 percent Medicare tax on self-employment income over the applicable threshold for a total 3.8 percent Medicare tax.
Do employees pay less in taxes than self-employed people?
Excluding the additional Medicare tax that’s levied solely on employees, the self-employment tax rate is the same as the combined Social Security and Medicare payroll tax paid by employees and employers. But with employment, employers pay half of the taxes while withholding the other half from their employees’ wages.
At first glance, it looks as if W-2 employees personally pay half as much as the self-employed. But that’s not so. The tax code allows the self-employed to make up for some of this unfairness by allowing them to reduce net income subject to self-employment taxes by 7.65 percent and deduct on their Form 1040 half of their self-employment taxes.
Individuals Subject to the Self-Employment Tax.
You pay self-employment tax if you:
operate as a single-member LLC.
earn income on a 1099-NEC.
operate as a single-member LLC.
do business as a sole proprietor.
are a general partner in a partnership.
are an LLC member in a multi-member LLC.
or are a co-owner of any other business entity taxed as a partnership (there is an exemption for limited partners).
You determine if your activity is a business under the same rules you use for deducting business expenses. The general rule is that a business is an activity you engage in regularly and continuously to earn a profit. You don’t have to work at a business full-time, but it can’t be a sporadic activity.
Net Earnings from Self-Employment.
The self-employment tax is not a progressive tax. It starts immediately—on dollar one, once you have over $433 in Schedule C, E, or F net income from a business ($433 x 92.35 activity = $400 which is the starting amount that requires reporting of self-employment income, & the payment of self-employment taxes).
Example. Nancy earns $1,000 from her single-member LLC, and reports this income on Schedule C. Her net earnings from self-employment are $935 ($1,000 x 92.35 percent). Her self-employment tax is $143 ($935 x 15.3 percent).
Your net earnings from self-employment start with the gross income from your trade or business minus valid allowable business deductions. Because you get to deduct valid business expenses, it makes it even more important to keep up with your bookkeeping, so that you can identify the expenses that will allow you to lower your income tax and self-employment tax. It’s important to note that, personal itemized deductions (charity donations, property taxes, medical expenses, etc.) and “above-the-line” adjustments to income don’t decrease net earnings from self-employment.
What happens if I own two businesses?
If you have more than one business (say two Schedule Cs), you combine the net income or loss to determine your net earnings from self-employment. Thus, a loss from one business offsets the income from another profitable business. But all is not roses: when calculating net earnings from self-employment, you may not deduct:
Net operating loss carryovers from past years,
Deduction for health insurance premiums for the self-employed,
Contributions to a self-employed retirement plan such as an IRA, SEP-IRA, or 401(k).
Section 199A qualified business income deduction.
Deduction for one-half of your self-employment taxes.
What if I Have Both W-2 Wages and Self-Employment Income?
If you earn both W-2 wages and self-employment income, you count your W-2 first as if you had no self-employment income. If your W-2 wages exceed the annual ceiling ($147,000 in 2022), no Social Security taxes are due on any of your self-employment income. In this case, you pay less in taxes under the ordering rule because it allows you to use all or part of the Social Security wage ceiling with your employee income (taxed at 6.2 percent).
Will having self-employment income allow me to write off everything?
Despite what some may believe, becoming self-employed will NOT allow you to
Write off all your meals as a business expense.
Write off all the utility bills in your home.
Write off 100% of your cell phone usage.
Deduct the cost of taking your friends to sporting events or bars.
Deduct all your travel and transportation expenses.
Write off the entire cost of owning or renting a residence that contains your home office.
Some types of income are not subject to self-employment tax at all, including:
most rental income,
most dividend and interest income,
gain or loss from sales and dispositions of business property, and
S corporation distributions to shareholders.
S Corporation Distributions
The income earned by anS corporation passes through the business to the individual shareholders as dividends or distributions. Such pass-through S corporation income is not trade or business income to the shareholders and is not subject to self-employment taxes.
Key point. The S corporation is the one business form that can save its owners substantial self-employment taxes, which is why it is so popular. However, most first starting out don’t need a S-Corp as the cost to maintain the S-Corp, payroll, and bookkeeping will outweigh the benefits until you net at least $35,000-$40,000.
Example Jason owns a landscaping business that generates $100,000 in net profit. If he operates as a sole proprietor, 92.35 percent of his $100,000 net business income is net earnings from self-employment subject to self-employment taxes. Instead, he incorporates his business with him as the sole shareholder and works full-time in the business as the corporation’s employee. Jason has his corporation pay him $60,000 as employee salary, on which payroll taxes must be paid. In addition, the corporation distributes $40,000 to Jason during the year as a distribution. The $40,000 is not subject to self-employment taxes, saving $5,652 in taxes ($40,000 x 92.35 percent x 15.3 percent)
Here are five things to know from this article:
The self-employed must pay a 12.4 percent Social Security tax and a 2.9 to 3.8 percent Medicare tax on their net earnings from self-employment.
The 12.4 percent Social Security tax is subject to an annual income ceiling ($147,000 for 2022).
You must pay self-employment taxes if you earn income from a business, side hustle, or side gig that you report on Schedule C or F, co-own as a general partner in a partnership, or own as a member in a multimember LLC, or if you co-own any other business entity taxed as a partnership.
Net earnings from self-employment do not include real estate rental income (unless you provide services to tenants), dividend or interest income, or gain or loss from business property other than inventory.
Distributions from S corporations are not subject to self-employment taxes. S corporations must ordinarily treat shareholders who work in the corporate business as employees and pay them a reasonable W-2 salary
Although we’ve given you the basics, this is not an all-inclusive article. Should you have questions, or need business tax preparation, business entity creation, business insurance, or business compliance assistance please contact us online, or call our office at 855-743-5765. Make sure to join our newsletter for more tips on reducing taxes, and increasing your wealth.
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