While there may be plenty of potential benefits to owning an out-of-state rental property, paying taxes in another state can be complicated.
In this article, we’ll take a look at how taxes on an out-of-state rental property work, how real estate investors can use state tax credits to avoid double taxation, and list income tax rates by state (including 8 states with no income tax).
- Taxes on rental property are paid based on the state the property is located.
- Taxes may also need to be paid to the state an investor resides.
- State tax credits can help to avoid the risk of double taxation.
Overview of How Taxes on Property Owned in Another State Work
Real estate investors generally need to pay income tax in the state the rental property is located in by reporting rental income and filing a non-resident tax return, even if the investor does not live in the same state the property is located in.
For example, if a real estate investor is a resident of California but owns a rental property in North Carolina, taxes will need to be paid in North Carolina even though the investor does not live in the state.
At the same time, rental income earned from an out-of-state property is also reported on the state tax return for the state where the investor resides.
How to Use State Tax Credits to Avoid Double Taxation
Fortunately, reporting the same rental income to two different states usually does not mean a real estate investor has to pay tax twice.
Most states provide a tax credit for taxes paid in another state to help avoid double taxation. State tax credits are usually for the amount of tax paid to the state the real estate investment is located in.
As an example, assume the rental property is located in North Carolina where the top state marginal individual income tax rate is 5.25% and the investor resides in California where the top state marginal individual income tax rate is 13.30%.
If the taxable rental income from the North Carolina property was $5,000, the investor would pay $262.50 ($5,000 x 5.25%) in nonresident tax to North Carolina and receive a state tax credit for the amount of tax paid to North Carolina. The resident tax due to California of $665 ($5,000 x 13.30%) would be reduced to $402.50 ($665 – $262.50) because of the North Carolina tax credit of $262.50.
On the other hand, if the rental property is located in a state with a high marginal income tax rate like California, a real estate investor would pay taxes based on the California rates even if the investor resides in a state like Texas where there is no state income tax.
By the same token, if the rental property is located in a state with no income tax, a real estate investor would pay tax on the rental income as if it were received in the state where the investor resides. A certified public accountant, enrolled agent, or other tax professional can provide more guidance.
Are Taxes Higher on Out-of-State or In-State Property?
Each state has a different tax structure. According to the Tax Foundation, these are the 2021 state individual income tax structures:
States with No Income Tax
- South Dakota
States with a Flat Income Tax
- New Hampshire (only for interest and dividend income)
- North Carolina
States with a Graduated-Rate Income Tax
- New Jersey
- New Mexico
- New York
- North Dakota
- Rhode Island
- South Carolina
- West Virginia
- District of Columbia
Income Tax Rates by State
The Tax Foundation has also compiled a list of the 2021 state income tax rates and brackets. The following ranks each state based on the top marginal individual tax rate:
|District of Columbia||8.95%|
How to File Tax on a Rental Property in Another State
While owning rental property in another state may be financially rewarding, filing taxes can be complicated. Rental income needs to be reported to the state where the investor resides, and taxes may also need to be paid to the state where the rental property is located.
There are four general steps to follow to file tax on a rental property located in another state:
1. Complete a Federal Tax Return
Begin by filling out a federal tax return, such as Form 1040, Form 1040EZ, Form 1040A, Form 1040-SR, or Form 1040-NR. List all rental income and expenses from the property, including the depreciation expense to reduce taxable net income.
2. Complete a Nonresident State Tax Return
Complete a nonresident tax return for the state the property is located in, listing only the income and expenses for the rental property. Any income earned in another state, including the investor’s home state, should not be included on the nonresident tax return.
3. Complete a State Tax Return
Fill out a tax return for the state where the investor resides, listing rental property income and expenses, along with any other income earned in the home state.
4. Claim a State Tax Credit
Claim a credit on the tax return for the state where the investor resides for income tax paid to another state. The state tax credit will reduce the tax liability owed to the home (resident) state by the amount paid to non resident state the rental property is located in.
Keeping track of taxes owed on property in another state can be complicated, especially when a remote real estate investor owns more than one rental property. That’s why investors use tools like Stessa to help keep rental property finances simple.
Real estate investors can maximize profits by automatically tracking income and expenses. When tax time rolls around, the Stessa Tax Center provides investors with a personalized tax package to help make tax prep simple and easy.