Is passive income taxable? The answer to this question is yes. Passive income, regardless if it’s money that you earn from a multi-family rental property, limited partnership, or another enterprise that you’re not actively involved with is still taxable.
Even though you still have to pay taxes on passive income, it shouldn’t stop you from creating as many passive income streams that you possibly can, especially when it comes to investing in multifamily properties.
Now is the best time in recent history to create passive income from multifamily properties, or other sources. This is why in this article; I will break down how passive income is taxed so that you know what to expect from the IRS once you start creating passive income streams.
Understanding Passive Income
Before I start talking about how passive income is taxed, I want to talk about the basics of passive income so that you can understand how the IRS views it once you start creating multiple passive income streams.
In a nutshell, passive income is defined as money that you are earning with having to put in little to no effort on your part. Some of the most popular methods for earning passive income in 2020 include multifamily real estate, peer-to-peer lending, dividend stocks, crowdfunding, and work-from-home opportunities.
Passive Income Activity Vs. Material Participation
The key to success with learning how the IRS taxes passive income is to define if the owner of the property is truly engaging in a passive activity or is materially participating in the operation of the multi-family property that they own.
According to the Internal Revenue Service, a passive activity is defined as the owner of the rental property not doing anything to actively participate in managing that property.
When it comes to material participation, however, it’s obvious that the IRS reviews this differently especially when an owner works for more than 500 hours per year conducting business activities.
It doesn’t matter if you only work on the property for as little as 100 hours per year, the key to success with passive activity is for it to be hands-off from the very beginning. This means that if you purchase a multi-family property, you cannot start as a multifamily investor by actively managing that property, you should immediately hire a property management company so that it’s viewed as “passive income” from the very beginning.
Understanding How Passive Real Estate Activities Get Taxed
Now that you understand the difference between material participation and passive income, the next thing to understand is how passive real estate activity is taxed.
Long-term capital gains, or assets that you may have held for over one year, are taxed at three different tax rates; these rates are as follows: 0%, 15%, and 20% (based on your current income bracket).
The great thing about the IRS is that there are a wide variety of deductions that you can enjoy as a multifamily investor so you can pay less money in taxes every year.
Since the interest that you’re going to pay if you finance a loan will be one of your biggest expenses, you can deduct those interest payments as well as interest payments on specific credit cards that you may use to maintain your multifamily property.
Besides deducting your interest payments, you also can deduct money that you spend on repairs to your multifamily property in the year that those repairs were made. Some of the most common repairs include plastering, retaining, fixing, or replacing broken windows and also fixing broken floors.
The key to success when deducting money spent on repairs is that the repairs that you make to your multifamily property must be made to get that property in better condition than it was before or for the purpose of converting one of the units in your property to a laundry room.
Besides the deductions that I mentioned above, you also can deduct any travel-related expenses as well.
To clarify, travel expenses must be 100% related to the rental activity and the deduction must be for the same year that they were incurred.
This means that if your multifamily property is located in Miami, and you live in Chicago, you cannot come to Miami to also take a vacation while conducting business related to your multifamily property at the same time, any travel expenses that you deduct must be 100% related to your multifamily property.
The last deduction is that I want you to be aware of his appreciation. Although you can’t deduct the entire cost of your property in the same year, you can deduct a portion of the cost of the property every year for about 28 years.
As of 2020, the Internal Revenue Service defines depreciation as allowances for exhaustion or wear and tear to the property. Investors typically begin to depreciate a real property when it’s placed in service and they can recover the entire acquisition cost of the property simply by using IRS form 4562 (Depreciation and Amortization).
Contact Trier Capital
Owning multi-family properties is a smart investment because they will continue to pay you regular passive income for years to come but, dealing with the IRS can be complicated, especially if you’re doing everything yourself.
What’s the solution to the problem? Instead of sourcing, acquiring, and managing multi-family properties yourself, the key to success it’s to partner with Trier Capital and let us handle every aspect of managing a profitable multi-family property for you.
We are a private equity firm that makes it easy for you to passively invest in lucrative apartment building syndications.
Finally, you can invest in tax-advantaged real estate without having to deal with the nuance or complication of purchasing and managing a property yourself.
Learn more about how we can help you to get started investing in multifamily properties while avoiding the “headaches” of having to do all of the work yourself.
Get started by contacting me at (630) 229-2383 or click here to connect with me online.