 Income tax 2021-2022, residential rental property, rental income and expenses if no personal use of dwelling part number 3. Get ready to get refunds to the max, diving into income tax 2021-2022. Most of this information can be found in publication 527 residential rental property tax year 2021 on the IRS website irs.gov, irs.gov, income tax formula looking at line 1 income. Although we would have another schedule, basically an income statement with income and expenses, expenses basically being deductions. The net then is what rolls into line 1 income on the income tax formula as well as eventually page 1 of the form 1040. This is the schedule E the supplemental income and laws were looking at the rental real estate information. This is basically the income statement form that we're considering points. The term points is often used to describe some of the charges paid or treated as paid by a borrower to take out a loan or a mortgage. These charges are also called loan origination fees, maximum loan charges or premium charges. When we're thinking about points, we have to think about what the points are being applied to or they have been applied to charges or they being applied to basically interest. And if they're interest, they're possibly going to be prepaid interest. So any of these charges points that are solely for the use of money are interest. So if the charges are for using money, we basically the rent on money is interest because points are prepaid interest. You generally can't deduct the full amount in the year paid, but must deduct the interest over the term of the loan. So if you're talking about interest, we're talking about basically the rent on the purchasing power of the money in essence. And if we have prepaid interest, that's kind of like prepay rent. We paid for it. You know, we got the we paid for the interest before we actually, you know, used the money in this case. So that means that you might have to allocate it then over basically the life of the loan to allocate it to the time frame that's actually being kind of used for the interest. So the method used to figure the amount of points you can deduct each year follows the original issue discount or the OID rules. And this case points are equivalent to OID, which is the difference between the amount borrowed redemption price at maturity or principle and the proceeds that issue price. So the first step is to determine whether your total OID, which you may have on bonds or other investments in addition to the mortgage loan, including the OID resulting from the points is insignificant or de minimus. So if it's insignificant or de minimus, or you could think of it possibly as in material, basically to the decision making or, you know, a fairly small amount in relation. Then, which oftentimes would be you might be able to use a more simplified method, such as like a straight line kind of method. If the OID isn't de minimus, it's fairly significant. Then you must use the constant yield method to figure how much you can deduct constant yield method that that's a little bit more complicated because the rate could then change as as time goes kind of like on a on an adjustable loan. So it gets a little bit more complex. A straight line method would be the easier thing to do, but not exactly the not exactly proper, right? It would be the easier, but less exactly proper thing to do. So points de minimus OID. The OID is de minimus. If it is less than one fourth of 1% or 0.0025 of the stated redemption price at maturity, principal amount of the loan multiplied by the number of full years from the date of original issue to maturity. The term of the loan, if the OID is de minimus, you can choose one of the following ways to figure the amounts of points you can deduct each year. So the easier methods, if the loan is fairly, if it's fairly small the points, then you might be able to use an easier method such as on a constant yield basis over the term of the loan on a straight line basis over the term of the loan in proportion to the stated interest payments in its entirety at the maturity of the loan. So you make this choice by deducting the OID points in a manner consistent with the method chosen on your timely file tax return for the tax year in which the loan is issued. So obviously when the loan is originally issued, you got to go through the closing statement and kind of look look up all this stuff in terms of the points and the points on the statement and whether or not those are being reported on the interest statement as well. Determine the deductibility of it and then if you have to basically allocate the points because their prepayments determine the method that you're allowed to use and the method that you are going to choose to use at that point. And then you'll establish that method by using it on that first year and then after that it should be fairly straightforward going forward once you set up the routine. Obviously that's the biggest problem or pain is doing that in the initial year to get everything lined up. So example, Carol took out a 100,000 mortgage loan on January 1st, 2021 to buy a house she will use as a rental during 2021. The loan is to be repaid over 30 years. During 2021, Carol paid 10,000 of mortgage interest stated interest to the lender. When the loan was made, she paid 1500 in points to the lender. So the points reduced the principal amount of the loan from 100,000 to 98,500 resulting in a 1,500 OID. Carol determines that the points the OID she paid are de minimis based on the following computation. So we had the redemption price at maturity, the principal amount of the loan 100,000 multiplied by the term of the loan in complete years. It's a 30 year loan multiplied by that rate that they gave us, which was 25% of a point 025. So the de minimis amount would be the 7,500 7,500. So the points the OID she paid 1,500 are less than the de minimis amount of 7,500. Therefore Carol has a de minimis OID and she can choose one of the four ways discussed earlier to figure the amount she can deduct each year. Like a straight line method and a fairly easy method. She could take that amount and say, I'm going to deduct each year. Now notice no matter what you do, the fact that you have to basically allocate it over the 30 years is kind of a negative because you get the deduction. But if you have to allocate it, if you have to allocate it over a 30 year period, you're going to get a fairly small amount of the 1,500 over 30 years. No matter how you, how you, no matter how you account for it, you know, it's going to be it's not going to be the nicest thing. So it's nice. The easier thing you would think would be the appropriate thing to do like a straight line method in the event that it's a small amount and basically de minimis to the overall decision making that would be the general idea. So under the straight line method, she can deduct $50 each year for 30 years. So that would be like the easiest thing to do usually constant yield method. If the OID isn't de minimis, you must use the constant yield method to figure how much you can deduct each year. You figure your deduction for the first year in the following manner. Number one, determine the issue price of the loan. If you paid points on the loan, the issue price is generally the difference between the principal and the points. Number two, multiply the result in one by the yield to maturity defined later. And number three, subtract any qualified stated interest payments to find later from the result in two. This is the OID you can deduct in the first year. So yield to maturity, the YTM, this rate is generally shown in the literature you receive from your lender. It's the literature. It's like classic literature that you get from, I would call it documentation or something. But now it's literature. It's like a fine text. Any case, if you don't have this information, consult your lender or tax advisor. In general, the YTM is the discount rate that when used in computing, the present value of all principal and interest payments produces an amount equal to the principal amount of the loan. Qualified stated interest, the QSI in general. This is the stated interest that is unconditionally payable in cash or property other than another loan of the issuer, at least annually over the term of the loan at a fixed rate. So here's an example. Example year one, the facts are the same as in the previous example. The YTM on Carol's loan is 10.2467 compounded annually. She figured the amount of points, the OID she could deduct in 2022-21 as follows. So she's got the principal amount of the loan, the 100,000 minus the points, the OID, the 1,500. That gives us the issue price of the loan, 98,500 multiplied by the YTM. That rate that we have up top gives us the total of 10,093 minus the QSI of the 10,000 gives us the points of the deductible amount of the 93. Notice either method, it's still a relatively small amount on either method because, again, you're still going to have to allocate it over the life of the loan. But now you've got to allocate it in a way where the rate is going to change per year and it's a little bit more complex to do than a straight line method, which would be the easy thing to do. So to figure your deduction in any subsequent year, you start with the adjusted issue price. To get the adjusted issue price, add to the issue price figure in year one, any OID previously deducted, then follow steps two and three earlier. So example for year two, Carol figured the deduction for 2022 as follows. You get the issue price 98,500 plus points the OID deducted in 2021 at the 93. That's what we got two last time. The adjusted issue price is the 98,593 multiplied by the YTM. That's the, you know, 0.102467 and that gives us the 10103 minus the QSI, which is the 10,000. And so now in the next year, 2022, we've got 103, which is different than the last year, which was 93, which is pretty small difference. Like why does it matter? Why can't we just do a straight line? You might say, well, in her case, she might have been able to because it was de minimis, which would be the reasonable thing to do. You would think unless this was significant, in which case you got to do the more exact method. So loan or mortgage ends, if you're loan or mortgage ends, you may be able to deduct any remaining points. OID in the tax year in which the loan or mortgage ends. So you might say, okay, well, what if I do this points thing and I'm deducting these points over the over the life and then, but then the loan or the mortgage ends for whatever reason? Well, then you would think that you would get the benefit of of the remaining points that haven't been taken at that point. So if you're loan or mortgage ends, you may be able to deduct any remaining points in the tax year in which the loan or mortgage ends. A loan or mortgage may end due to refinancing. So you might say, I'm taking out a new loan. What about these points that are still hanging on there for the next another 20 years? Well, then you might be able to take those at that time. So prepayment for closure or similar event. However, if the refinancing is with the same lender that are remaining points, the OID generally aren't deductible in the year in which the refinancing occurs, but may be deductible over the term of the new mortgage of the loan. So again, if now if you refinance with the same lender, you can't really refinance like just to take the points earlier. So if it's the same lender, you might have to then take those points and allocate them over the term of the new loan, which would be not good. So points when loan refinance is more than the previous outstanding balance. You refinance a rental property for more than the previous outstanding balance. The portion of the points allocate allocable to loan proceeds not related to rental use generally can't be deducted as rental expense. Example, Charles refinanced a loan with a balance of 100,000. The amount of the new loan was 120,000. Charles used the additional 20,000 to purchase a car. That's interesting. So it gets kind of tricky. Well indicates the points allocable to the 20,000 would be treated as non deductible personal interest. So it gets kind of, you know, obviously once you take out, you know, a loan with the home as collateral and then you use it for something other than the home. It complicates, you know, it's going to complicate things. So now you got a business property thing, but you took out the loan that you had and used the business property as collateral to buy a car, which we're presuming is not the business property. So in any case, so repairs and improvements generally and expense for repairing or maintaining your rental property may be deducted if you aren't required to capitalize the expense. So now you got the repairs and the improvements. And the question there is, is this something that a repair, which I can deduct this year or an improvement, which I have to capitalize and possibly then deduct over multiple years in the future, unless I can get like an accelerated deduction like a 179 or special deduction. So usually you want to be categorizing it in repairs to get the benefit upfront. And examples would be like if I like repaired my roof. If I repaired my roof, then it's a repair, even though it can be quite expensive, you would think, but what if I put a whole new roof up there? Now it sounds like an improvement. So what if I leave like one shingle of my old roof and then I put all the other shingles I replaced them? Is that like a repair or an improvement? You get these kind of sticky mid areas of people, of course, wanting to categorize more likely in a repair. And you can find, and so there's a lot of, you know, you want to try to categorize that as best you can. So improvements, you must capitalize any expense you pay to improve your rental property. And expense is for an improvement if it results in the betterment to your property, restores your property or adopts your property to a new or different use. So let's go through that again, because this is going to be important, right? If I have my roof got a hole in it, and I've fixed the hole in my roof, you would think that would be just putting it back to its normal use, right? But if I put a whole new roof on it, then you would think maybe now it's improving the roof, especially if it was like a fancy kind of, well, in any case. So that's the question. So let's see. So it results in betterment to your property. So your property's been betterment. That's not the most specific term right there. Restores your property. So it wasn't up to condition. It restores it, but not, I guess, to the normal use, which would be kind of like a repair. Adopts your property to a new or different use. So obviously if you do something that's changing the whole perspective of your property, then that would be an improvement, you would think. So betterments. So expenses that may result in a betterment to your property include expenses for fixing pre-existing defect or condition enlargening or expanding your property or increasing the capacity, strength or quality of your property. Restoration. Expenses that may be for restoration include expenses for replacing a substantial structure part of your property, repair damage to your property after you properly adjusted the basis of your property. As a result of a casualty loss or rebuilding your property in a like new condition. Adoption. Expenses that may be for adoption include expenses for altering your property to a use that isn't consistent with the intended ordinary use of your property when you began renting the property. So if you like converted your house into a restaurant or something like that, then that's different. And so you probably have to capitalize that. So de minimis safe harbor for tangible property. If you elect this de minimis, we got the small thing like this, like this small kind of exception thing. If you elect this de minimis safe harbor for your rental activity for the tax year, you aren't required to capitalize the de minimis cost of acquiring, producing certain real and tangible personal property and may deduct these amounts as rental expenses online 19 of schedule E. So you're saying, okay, these might qualify for like an adoption or something these costs, but they're pretty small. So I don't think it's worth the time to do the more complex thing of having to capitalize them and then allocate them because they're fairly small. So is there a safe harbor due to that due to them being relatively small in dollar amount that I can just write them off as an expense, which would be easy thing to do. So that's that's that. So for more information on electing and using the de minimis safe harbor for tangible property C chapter one publication 535 safe harbor for routine maintenance. And now you got the routine maintenance maintenance shouldn't be capitalized. Now you're going to expense it. So you want to expense it. That's usually what you want to do. You don't really want to capitalize it. If you determine that your cost was for an improvement on a building or equipment, you may still be able to deduct your cost under the routine maintenance safe harbor. You could see publication 535 for more information there. The expenses you capitalize for improving your property can generally be depreciated as if the improvement were separate property.