Taxes. Who doesn’t love to think about taxes?
If you’re like most people, it’s probably not your favorite topic. But, taxes are actually a fairly favorable topic when we’re talking about how they apply to rental properties. If you’re a real estate investor with a thriving portfolio or even a landlord who is renting out only a single property, there are a number of deductions and tax benefits that will help you bring down your tax liability and keep more of your income in the long term.
You should always consult your CPA or your tax professional before you make any money moves at tax time. We are Santa Rosa property managers, and that means we have a lot of valuable insight and advice to provide you, especially around how to leverage what you earn and what you spend. However, we are not tax experts. We are not attorneys. We always encourage the property investors we work with to seek professional advice when it comes to taxes and money management.
Property taxes are both a bother and a benefit for rental property owners. Today, we’re shining a bright light on that part of the tax situation, specifically. Here’s what you need to know about paying your property taxes and deducting them when you’re filing your taxes and claiming what you pay as a deduction.
Property Taxes on Santa Rosa Real Estate Investments
California’s property tax rate is 1% of a home’s assessed property, and property owners in Sonoma County also have to pay amounts of any bonded indebtedness voted in by the taxpayers in Sonoma County.
The average overall tax rate in Santa Rosa and throughout Sonoma County is around 1.1% to 1.2%.
Santa Rosa real estate investors will pay their property taxes to the Sonoma County Tax Collector. You can view and pay your property taxes online, and you can also mail in your tax bill or visit the tax collector’s office in person. Owners who prefer to pay monthly instead of in one big payment annually can do so using the county’s Smart Pay system.
As you’re paying your property taxes, make sure you are paying an accurate tax rate. You can dispute what your property value is assessed at in order to bring your tax rate lower. You can also take advantage of disaster relief tax benefits if you qualify, and there are other ways to save on property taxes. Here are some of the things we recommend our property investors consider when it’s time to pay property taxes:
- Check whether you’re eligible for any exclusions. Determining whether you’re able to reduce your tax rate based on an exclusion can be complicated, so make sure you’re following every step. The process starts with a clam form, which you’ll have to file with the Assessor. You’ll also need to document that the required conditions are met before you’re able to take advantage of any deductions or exclusions.
- Understand your Proposition 19 impacts. Some of the most common inclusions that homeowners take advantage of at tax time are the Parent-Child and Grandparent-Grandchild exclusions. Reappraisals are not necessarily required if a property is passing from a parent or a grandparent to a child or a grandchild. Certain requirements must be met, and an application has to be filed.
- When you need to rebuild your property after a disaster, such as fire, your property taxes will likely increase. Calamity rebuilds are assessed differently than general appraisals, and you’ll have to apply for tax relief through the Assessor’s Office.
Property Taxes when You Sell an Investment Property
You’ll likely own your investment property in Santa Rosa for more than a year, and that means it’s subject to federal capital gains taxes. The amount will depend on your income-driven tax bracket. In addition to the federal capital gains tax, you’ll also have to pay between 1% and 13.3% in state taxes when you sell an investment property.
When you’re in the lowest possible tax bracket, your overall capital gains tax exposure can be as little as 1%. However, if you’re making millions of dollars and at the high end of the earnings ladder, your capital gains tax at the time of sale can be as much as 33.3%.
Ultimately, you’ll arrive at your capital gain (the amount that will be taxed) by subtracting the purchase price from the sale price. You’ll need to factor in the depreciation deductions as well, and the state rate will be different from the federal rate. If you’ve been taking the depreciation deduction on your rental property every year, at the point of sale, you (and the government) will notice that your rental property did not, in fact, depreciate…it actually increased in value.
There will be a recapture when you’re paying the capital gains tax on the investment property you’re selling, and the total amount of depreciation that you’ve deducted year after year will be taxed by the IRS at a 25% flat rate. But, that’s just the federal recapture. The state of California will take a flat 9.3% tax on that depreciation amount as well. Depending on how long you’ve owned the rental property, this could be a sizable loss.
A 1031 Exchange Can Help Santa Rosa Rental Owners Defer Taxes
That’s a lot of math and a lot of taxes to pay when you own an investment property and especially when you sell an investment property.
The 1031 exchange is a tax benefit that can help you defer those taxes that you would otherwise pay on the sale of an investment property.
Here’s how it works.
- Sell an existing income-producing investment property, but don’t take the profits. Instead, have an intermediary hold them in escrow while you identify and make an offer on a new property (or properties) that you will buy with the earnings from your original home.
- Identify the new property that you’d like to buy. Once you sell that original property, you have 45 days to identify the next property that you want to exchange into. It has to be a “like” property, but that doesn’t mean it has to be exactly the same. You could sell a single-family home and buy two condos, for example. Or you could sell a small apartment building and buy a new construction single-family home.
- From the date of sale, you will have 180 days total to close the deal on the new property. This includes the 45-day identification period.
You’ll buy the new investment property, and the money will move from escrow to escrow, without you touching or depositing it. This creates a fully tax-deferred exchange. You’ll avoid paying those capital gains taxes right away.
Rental Property Tax Benefits
Owning a rental property in Santa Rosa comes with property taxes and capital gains taxes that need to be paid, but there are also tax benefits.
When you’re filing your own taxes, you’ll have to declare all of the rent you collect as income. But, you can also deduct what you’ve paid for things like maintenance, marketing and advertising, property management, home office expenses, travel, and mortgage interest.
You can also deduct your property taxes on your federal tax return.
Because these taxes are an ongoing expense for your business (and the IRS considers your rental property a business), you can deduct what you pay in local property taxes when you’re paying your taxes and calculating your ultimate tax exposure. As a rental property owner, you can deduct up to $10,000 per couple and $5,000 when you’re filing separately for property taxes that you’ve paid on your rental investment.
Document Everything Related to Taxes and Investment Properties
There are always good reasons to document everything. Keeping good records, in writing, protects you and your property. You can see how well your property is performing and you can identify areas in which you may need to make some changes.
Documentation is especially important at tax time. The IRS or the state Assessor’s Office may ask for information that supports a claim or a deduction or an exclusion. Here’s what you want to make sure you’re doing:
- Preparing your financial statements with accuracy and attention to detail.
- Identifying the source of your receipts, invoices, and bills.
- Tracking all deductible expenses.
- Preparing your tax returns with the correct supporting documents.
Track all of your rental income and expenses so you can be prepared at tax time. Whether you’re paying your Santa Rosa property taxes or claiming deductions on your federal return, you want to have clear records that will show you how you’ve come to the calculations that you’ve reached.
You will be expected to substantiate the value of your property and the expenses that you deduct. Good records will help you prepare and support your tax returns.
This isn’t always easy, and it’s why surrounding yourself with professional experts is so important when you’re investing in real estate. Make sure you’re working with a great CPA or a tax accountant who can help you stay on course.
Santa Rosa property management is also valuable. If your’e not already working with a management company, think about the benefits you can enjoy, including help with taxes and expenses. We’d love to tell you more. Please contact us at Prestige Real Estate & Property Management. We manage homes in Sonoma County, including Santa Rosa, Windsor, Sebastopol, Petaluma, and Rohnert Park.
