3 Safe Harbors for all the Landlords and Real Estate Investors
A safe harbor is a legal provision to eliminate legal or regulatory liability in certain situations, provided that certain conditions are met, Investopedia defined. These are rules by the Internal Revenue Service (IRS). Also, it eases the process of tax filings for eligible companies that generate smaller incomes.
Like any other business owner, landlords and real estate investors wish to save dollars in taxes. Thereby, they simplify tax filing and save money with safe harbors. So, we are spilling the secret sauce of three safe harbors. Continue reading for a brief guide on how and when to use these safe harbors.
The De Minimis Safe Harbor helps you to decrease expenses up to $2500 per invoice. This amount is double to $5000 with an applicable financial statement. These set limits determine whether a certain expense comes under the safe harbor. On contrary, the expenses falling outside the limits should probably be capitalized. Such limits are applicable to each invoice item and not in aggregate.
However, some expenses exceeding the limit need not be capitalized. For instance, payment for acquiring and producing tangible property, exceeding the safe harbor limit. It excludes amounts paid for inventory and land.
Routine maintenance safe harbor deals with the regular property maintenance expenses to be deductible regardless of the cost. This safe harbor has no annual dollar limit or income bar. Landlords spend regular and recurring expenditures to maintain efficient operating building conditions. There are two activities:
- Inspections, cleaning, and testing of building
- Replacement of the damages or worn parts
Expenses under the first activity are deducted. But, the expenses under the second activity benefit the landlords. Earlier, landlords had to capitalize and depreciate expenses related to replacements. But now landlords can deduct it if it’s for keeping the property in ordinary working condition.
However, note the first 10- year rule. As per this rule, any replacement is eligible as routine maintenance when it has been in service for 10 years. Once replaced, it must not be replaced within the next 10 years.
Safe Harbor For Small Taxpayers (SHST)
The SHST let the landlords deduct their Schedule E annual expenses. These include repairs, improvements, and other costs for a rental building. To use this safe harbor landlords requires to maintain a record of all such annual expenses. There are various restrictions to check if expenses qualify or not.
Rental Business Size Limitations
Landlords are restricted to use SHST if they exceed these limitations:
- $I million limits on an unadjusted basis. Ex: land, improvements in land and cost segregation study identifies a personal property.
- Annual expenses for repairs & maintenance should not exceed $10000 or 2% of the buildings’ unadjusted basis.
- For the last 3 tax years, landlords’ annual gross income should be less than $10MM
-by Dipali Nishad