20141126_Resident-Property-Managers-Apartment

Tax Benefits of Hiring Resident Property Managers

Owning rental property takes work – a lot of work. From marketing your property, to screening tenants, to collecting rent, performing repairs, and keeping the books, most owners are not prepared to handle the gamut of responsibilities on their own. According to Karim Jaude, veteran California real estate investor and author of The Smart Real Estate Investor’s Guide, “the top reason investors fail to generate cash flow is poor property management”. This is why many of our clients choose to hire property managers.

Resident Managers in California

In California, a residential building that has 16 or more units must have a resident manager on-site. A resident manager is a property manager that lives at the rental property. Often times, resident managers are compensated with free (or significantly reduced) rent – and the IRS holds that they are classified as employees (regardless of whether they receive reduced rent).

No Federal Payroll Taxes Paid on Reduced Rent

Federal payroll taxes on employee wages equal 15.3%, up to the Social Security tax ceiling ($118,500 for 2015).[1]  Half of this, 7.65%, is deducted from employee wages while the other 7.65% is paid by the employer. However, payroll taxes do not apply to reduced rent paid to resident managers so long as “the employee is required to accept such lodging on the business premises of his employer as a condition of his employment”.[2]

Example: John and Jane own a 10-unit building in Redondo Beach. They rent 9 of the units. Their resident manager, Bob, lives in the 10th. Bob lives on-site, performing maintenance, collecting rent, and screening new tenants. As part of his compensation, he receives wholly- compensated rent, valued at $2,000 a month – or $24,000 a year. If John and Jane had paid Bob $24,000 a year in salary, they would also be required to pay a 7.65% payroll tax of $1,836.

The employer may also save additional amounts in unemployment insurance and benefit costs.

Benefits for the Resident Manager

In addition to helping the property owner, the resident manager also receives significant benefits. The employee is also not required to pay the 7.65% payroll tax on the reduced lodging. Furthermore, they are not required to report the lodging as income.[3]

Example: Continuing with the example above, this would mean Bob saves $1,836 per year (7.65% of $24,000) on payroll taxes. On the income tax side, let’s say Bob receives $24,000 a year in free lodging and is in a combined 25% federal and State income tax bracket. He would save an additional $6,000 in income taxes ($24,000 x 25%).

As a property owner, this means you’re in a better bargaining position to give someone reduced rent – rather than a higher salary.

Hiring a Property Management Company

Many property owners hire outside property management companies instead of (or in addition to) a resident manager. Outside companies are considered independent contractors, and are subject to a different set of rules. There are pros and cons to each approach – which depend on your unique situation.  Chris Adishian, a Southern California-based attorney who has operated a companion property management firm for nearly 10 years explains “The right property management firm can add value to the property, ensure efficient operations, deliver timely financial information to the owners and free up the owner to pursue other activities.”

If you have questions on this topic, we’re happy to help. Richard Welling LLP focuses on tax services for real estate – and we have experience in all stages of the real estate life cycle, from acquisition to disposition. Contact us today for a complimentary review of your tax situation.

[1] http://www.ssa.gov/news/press/factsheets/colafacts2015.html

[2] 26 U.S. Code § 119 and IRS Publication 15-B  (see http://www.irs.gov/publications/p15b/ar02.html).

[3] 26 U.S. Code § 119 and IRS Publication 15-B  (see http://www.irs.gov/publications/p15b/ar02.html).

Return to Insights