Maximize Landlord Tax Savings

Alex Reeves: Welcome to Invest with Steadily. I am Alex Reeves, brand marketing lead for Steadily Insurance, and today we are so excited to have Amanda Han and Matt McFarland, who are CPAs and tax strategists who specialize in helping real estate investors use their real estate to save massive amounts of money on their taxes and keep their hard-earned money. Amanda and Matt, welcome to Invest with Steadily. I'll give you all a second to introduce yourselves.

Matt McFarland: Thanks for having us, Alex. Appreciate it, excited to be here.

Amanda Han: Nice to meet you. My name is Amanda Han. I am a real estate CPA.

Matt: And I'm Matt McFarland, also a real estate CPA. Our firm, Keystone CPA, is located here in Southern California. We specialize in working with real estate investors all over the country on proactive tax planning advice and ways to keep more of your hard-earned money. As an investor myself, it's the most important thing.

Alex: It's tax season upon us, so everybody's looking for what are the best strategies to save on your taxes. Today we want to talk about landlord insurance — which is obviously what we are known for — and taxes, and what are some of the things that we can deduct regarding insurance and any type of related expenses. Starting with the basics: what types of insurance premiums can landlords typically deduct from their taxes?

Matt: The stuff we typically see is just the normal what you would call homeowners insurance, but for rental property owners. They also have mortgage insurance premiums — that's also a deductible thing. Sometimes earthquake insurance, fire insurance — which is going to be going away in Southern California, obviously, which is not funny, but it's one of those crazy things. And sometimes you'll see umbrella insurance policies that investors have. Those you have to be a little more careful with because they're obviously going to cover more things than just your rental properties, so something like that is probably going to involve taking a pro-rated amount of the expense that you can reasonably apply to your rental properties.

Amanda: One quick tip you can do is to ask yourself: is this expense ordinary and necessary to my real estate investment? So as a landlord, is it ordinary for me to have landlord insurance? Yes — if so, it's properly deductible. Is it necessary for me to have earthquake insurance? Probably, if you're in an earthquake-prone area or flood-prone area. So that's a little tip, because people are always wondering what they can write off.

Alex: That's great. On that same note, are there common misconceptions or mistakes that people make when they're not going through a tax expert like your firm — that you see when you're reviewing taxes after the fact?

Matt: I think the biggest one we probably see is people missing out on deductions. There are various reasons for that — maybe they don't understand what they can deduct, but a lot of times it's from not being as organized as they need to be. They forgot that they paid something, or they're trying to go back 12 months later and recreate financials and they're just overlooking things. Maybe they paid with personal funds but it was related to a rental property and they forgot to look over there. There are various reasons, but I think that's one of the big ones — people just miss and overlook deductions.

Amanda: I think another reason it's missed a lot — it's interesting because when we first work with a client, one of the things we do is review tax returns from previous years. Believe it or not, the two things we look for that are frequently missed are the insurance deduction and property taxes, and those are things that 99% — maybe 100% — of landlords actually have. Matt covered some of the reasons why people miss it, but I think another reason is especially for people who don't self-manage. A lot of times if they have a property management company handling their properties, they'll just take the management report and that's what they use for their tax returns. Well, if your property management company is not paying your insurance expense, there's a very high likelihood that it's missed on the tax return. Or not paying your mortgage payment — sometimes people, believe it or not, forget about that too.

Alex: That makes sense. Those are important. And it's really topical right now — we've had incredible damage from hurricanes, we've had fire claims obviously, and then just typically what we see day in and day out is water damage claims. When you have a claim and the money is coming back to you, reimbursed by insurance, how do those reimbursements impact taxes? We can use a typical burst pipe scenario — say it's a $20,000 claim with a $2,000 deductible, you're replacing floors, replacing some drywall. What are the reimbursements that come to you, and what's tax deductible?

Matt: Typically, most of those reimbursements are not going to be taxable. For a rental property, what's going to happen is they've got their property, they paid — pick a number — $300,000 all in originally, and they've got this $20,000 reimbursement for damage. What's going to happen is that reimbursement is going to reduce what we call their basis in the property, so it's not taxable to them. Now, to the extent they also spend money to fix it outside of insurance, that would increase the basis of the property. Usually the only time that insurance reimbursement might be taxable is if it's more than the basis of the property — so in my example, $300,000, if you had a $400,000 reimbursement for some reason, then that excess $100,000 might be taxable. But there are exceptions to that too — did they spend that money on fixing up the property? If so, it would reduce what was taxable. It kind of depends on the scenario, but in most situations like you're describing, it's not going to be taxable. It's just going to be a reduction in their basis.

Amanda: For the most part, people are often confused — they think they get a large reimbursement check and they get concerned like, "Oh my gosh, I have to pay taxes on it." Thankfully the law is kind of written in our favor in that you generally are not paying taxes currently. Now there's a big misconception though, because a lot of insurance policies do pay or reimburse you for lost rent — like when your property is being rehabbed and you're not able to receive rent. That is a little bit different than reimbursement for property damage. The lost rent part is actually taxable. So as a landlord, we want to make sure we're clearly separating the two. Usually an insurance company does a really good job of it, but that's something to keep in mind — the record keeping, like is this amount of money for property insurance reimbursement, and how much of that is for lost rent?

Matt: Something else I was thinking of too — sometimes when new clients come in, you'll be talking to them and they'll say, "Hey, I had this damage on this property," and from a reporting perspective maybe the person they were working with didn't really know how to do it right. So they added the insurance reimbursement as part of rents on their tax return, but then they added the repairs they paid for as depreciable assets down below. If you're familiar with taxes, those don't usually offset each other one to one. So there's the right way to report and there's the wrong way, and that's one of those wrong ways where you think it's going to offset each other but it doesn't necessarily.

Alex: Let's dig in a little bit more with a specific example. Going back to my water damage example — say you've got a $20,000 claim and a $2,000 deductible. That $2,000 deductible, can you write that off on your taxes since you're paying for that out of pocket?

Matt: In that situation, that would be something that's probably going to be added to the basis of the property, depending on the extent of the damage — whether it's more extensive versus less extensive. But yeah, that would be something you definitely want to capture for sure.

Alex: And let's say you're upgrading the floor — say you've got floors you didn't like anyway, linoleum floors, and you're going back in putting in luxury vinyl plank or something like that, so there's an additional $4,000–$5,000 you're putting into the flooring. What's deductible on that difference?

Matt: Whatever you're going above and beyond what's part of the casualty loss is usually just treated like any other improvement. For improvements, you're just looking at what is the quickest way for me to take depreciation on it. If it's extensive enough, do I do a cost segregation to accelerate the write-off of these major improvements I'm making? At that point it's very similar to just making improvements to a rental property.

Alex: That makes sense. Let's switch gears a little bit to putting a new roof on the property — maybe it's not part of an insurance claim, maybe you buy a new property that needs a lot of renovations or rehab. Roofs are one of those items where if you proactively put on a new roof, it can actually make a significant difference in how much you're paying in premiums. A new roof is more durable, you're probably using more hail-resistant materials potentially, so it could make a big difference from an insurance cost perspective. But what does it do to your taxes if you're proactively putting on a new roof or improving the property?

Amanda: That's a great question, and I think it's another area where people probably miss out on some opportunities on the tax return. Obviously in our example we are replacing the old roof — there was a roof there before. What the tax code allows you to do is to actually take a deduction for the unrecovered cost basis of the old roof. You are going to add the new roof into your depreciation schedule and write it off over a few years, but at the same time you are allowed to write off the old roof. There are different ways to calculate what the deemed cost of that is, but I think people overlook this because they just forget to write off the old one and just add the new one. So theoretically you're now depreciating two roofs instead of one. They do give that opportunity to take that write-off and I think people need to take advantage of that, because that could be a big number depending on how much you're paying for your roof.

Alex: That makes sense. I'd love to get a quick overview of the short-term rental loophole — can you talk about that a little bit?

Amanda: A lot of our clients are investing in short-term rentals and from a tax perspective they can be a really great opportunity if you can self-manage your own properties. There are certain rules you have to meet, but if you can do that and create a loss on paper through maximizing depreciation and cost segregation studies, there are ways you can use that loss to offset your W-2, other business income, and other types of income. So it is a great opportunity for those who are investing in that space.

Matt: The short-term rental investment works for virtually everyone. You could be someone who's full-time in real estate, but you can also just be someone working a full-time job in technology, or you're a doctor or a teacher, and be able to invest in real estate and use those tax losses that are created strategically to offset all types of income. The reason for that is, unlike long-term rentals, for short-term rental properties you just have to be materially participating with the property — that really means you're meeting specific hours for being hands-on. It does not matter how many hours you're working at your job, which is one of the hurdles for people investing in long-term rentals, where you have to have more hours in real estate than at your job to be able to use it against other income. That's why we love short-term rental investing, because it works for virtually everyone when it comes to taxes.

Alex: That makes sense. To help our landlord audience — you mentioned that when using a property manager, things maybe aren't divided out in the cleanest way. Are there any tips or software you recommend that helps with those different line items?

Amanda: One of the foundations to saving on taxes is capturing your expenses, because if we're not capturing our expenses, we are not writing them off on our taxes. Sometimes people get lazy and say, "Hey, my property management took care of everything, let me just print this report and send it to my CPA." But when you do that you have to think about what are all the other things I'm spending money on that's not captured in there. For example, if I'm paying for different software, is that captured? If I have memberships to BiggerPockets or other real estate forums, is that on there? I took a trip to some conferences — those are all things that the property management company is not paying for. So if you're just using their report, you're not able to capture that.

Amanda: There are two different things to consider. One is: do you have access to the software they're using, and if so, are you able to add in your own expenses in that platform? We don't see that frequently unless it's a self-managed platform. So for most of our clients, they keep their own record of expenses they're paying personally or out of their LLC, and at tax time they consolidate the two. You print out the management report, then you either put it into QuickBooks or transfer to Excel and add in all of your out-of-pocket things — insurance, property taxes, travel, education, things like that that won't be captured on the management report — and that's what you send to your tax person so they have a comprehensive list of all income and expenses for the property.

Alex: Awesome. It's not as quick as we want it to be, but you want to make sure — garbage in, garbage out — you go through it and make sure you've got all those expenses captured. Anything else you guys want to add from a tax perspective that we didn't cover yet?

Amanda: Continuing the conversation about accounting and bookkeeping — we all love to talk about tax savings, it's very sexy: you buy real estate, you make money, you pay less taxes. But nobody likes to talk about bookkeeping. It's tedious. One good thing we can all do is create systems and processes so that our record keeping is easier and streamlined. One simple way to do that is to have a separate bank account for your rental real estate. If it's an LLC, the LLC bank account should be used only for real estate. If your rental is in your personal name, I would suggest having a separate personal bank account and a credit card account that are used exclusively for real estate. Whenever you have expenses relating to real estate, they're paid from those accounts, because that goes a long way at the end of the year — you just have to go through those accounts to pick out your expenses rather than going through your personal bank statement of thousands of transactions trying to figure out which was for which property.

Matt: The other thing I was thinking of is we're expecting 2025 to be a big year of changes in the tax world, just with the new administration and everything. I would encourage everybody to stay up to date — whether it's us or other CPAs, whoever you follow — to make sure you're staying current on the information, because we do expect it to change significantly throughout the year.

Alex: That's great advice. There's always something different happening in the tax world year to year. Thank you guys so much. Where can somebody go to find you, especially given it's tax season? Where can investors learn more about Keystone CPA?

Amanda: The best place for additional tax strategies and how you can save on taxes is our website, KeystoneCPA.com. We have a lot of great free resources. We also have a tax risk assessment tool that you can use yourself just to see what your risk of overpaying taxes is. If you're looking for daily tax tips, the best place to find me is on Instagram as @AmandaHanCPA. We also have a lot of really good educational content on YouTube as well under Amanda Han CPA.

Alex: Awesome. Thank you guys so much for joining us at Invest with Steadily. We look forward to tax season and getting all of our deductions — we're excited for that.

Amanda & Matt: Thanks, Alex.