Economic realities change every day but for owners of real estate, federal tax obligations are a constant. Luckily, while rental income must be reported, there are multiple ways to take advantage of tax deductions that can help you make savings and recoup from would-be losses. Since most of us are not tax experts, it is important to stay up to date with the basic considerations that apply to rental property tax deductions.
This article examines common rental property tax deductions, including tips on how you should go about filing and what you must never overlook.
Common Tax Breaks for Landlords
Running a rental business comes with its fair share of headaches, but one of the upsides is that just about every rental activity associated with buying, maintaining, and operating a rental property is tax-deductible. We’ll walk through a checklist so you remember to keep track of your actual expenses and get the maximum tax benefit.
At the end of the day, the logic is that you should only have to pay tax on your profits, which is your rental income minus all of your expenses. That’s the number that will be entered on Schedule E when you file your taxes.
1. Mortgage interest and other loans
We all want to own homes and mortgages help us make these dreams a reality. However, when you’re seeking tax deductions, mortgage interest is a tax incentive that you can take advantage of. One aspect that makes mortgage interest deductible is when it is secured by the home, but not in other cases where personal loans are involved. In this case, it is said that the mortgage is a secured debt and the home could satisfy the payment of the debt.
Hence, to qualify for tax deductions, your home can be a primary or secondary residence and even a rental real property where you have a mortgage. An exception is when the owners live in the said property, in which case the interest deduction is limited to $750,000 mortgage debt. In the case where married individuals are filing separately, the debt limit is halved to $375,000 or less.
Other conditions you need to satisfy to deduct home mortgage include:
- You file Form 1040 or 1040-SR. When doing this, you must itemize deductions on Schedule A (Form 1040).
- The mortgage is secured debt by a home where you have an ownership interest. Essentially, you can only deduct the interest when the funds are used to purchase, construct, or improve your home.
- You can fully deduct your mortgage interest if you satisfy a set of conditions. The conditions include the dates of the mortgage, amount, and usage of mortgage funds.
To know how much you should file as deductible interest, inquire with your mortgage company. They should send you an IRS form 1098 showing all the interests paid that year.
2. Property Taxes
Property taxes are often high, but you’ll get a break on your personal income tax return because property tax on rental properties is a deductible expense.
Property tax deduction makes it possible for homeowners to write off state or local taxes paid on a property. A write-off is an accounting term that refers to the reductions to the values of an asset, and by declaring these items, they are debited to the liabilities accounts. According to the Tax Cuts and Jobs Act of 2017, the deductions for state and local taxes (SALT) were capped at $10,000. For married couples that file separately, the amount is $5,000. Both state and local government property taxes are deductible as well as miscellaneous fees. For example, some cities have started charging a “hospitality tax” or “occupancy tax” on homeowners who rent out their properties on AirBnB or VRBO. Those short-term rental taxes are certainly deductible.
But how do you know which property taxes are deductible? Some property taxes that can be deducted include your primary home, vacation home, land, boats, and vehicles. But not every property tax payment is deductible and these include:
- Unpaid taxes
- Payments made on rental or commercial property
- Taxes paid when transferring sales of a house
- Taxes paid for a property you don’t own directly
- Costs incurred on home renovations or constructions for improvement
- Utilities like water and trash collection
Experts usually advise those filing for property tax to choose between standard or itemized deductions when claiming reductions. While some people might choose to go for standard deductions, itemized deductions make it easier to list all your eligible expenses. So, before filing, pay attention to whichever amount lowers your tax bills the most to avoid as they differ from one individual to another.
3. Asset Depreciation
Normally, when you have a business expense it is deductible in the same year you spent the money. However, when you spend money on something that’s expected to last several years, the IRS won’t let you claim all of that expense in one year. Instead, you’re required to follow a “depreciation schedule” that will tell you what percentage of the expense you can claim every year.
The full schedule is written down in IRS Publication 946 and 527, but we’ve pulled out the categories that are relevant for landlords and what the useful life period is (how long it takes to fully depreciate):
- Appliances, carpet, and furniture: 5 years
- Cars, trucks, and construction equipment: 5 years
- Computers: 5 years
- Office furniture and equipment: 7 years
- Roads, shrubbery, and fences: 15 years
- Buildings, furnaces, and roofs: 27.5 years
Landlords would prefer that depreciation didn’t exist — it would be nice to be able to spend $20K on a new roof and have the whole thing be tax deductible right away. But, at least now you won’t be surprised when your accountant tells you that you can’t deduct all of that expense in the first year.
4. Insurance Premiums
Insurance premiums, especially mortgage insurance premiums are some of the most overlooked deductions. Since getting the lowest tax liability should be a priority, you need to know which deductibles you can make on your insurance premiums. Yes! You are permitted to make a tax deduction for the entire landlord insurance premium for your rental property. The IRS considers this a normal business expense when renting out real estate.
Some people own real estate in their own name and manage it personally, then claim the expense on their personal tax returns. Others choose to hold property in an LLC as a business entity. Either way, all insurance premiums associated with the rental property are tax-deductible.
Umbrella insurance policies that offer extra liability insurance are also a deductible expense along with mortgage insurance and flood insurance.
You can even deduct a proportional amount of the homeowner’s insurance for your primary residence if you have tenants. The amount you can deduct will be proportional to the overall square footage of your home.Take a deep dive into how insurance companies record the premiums that you pay.
5. Repairs
Since we just talked about spreading out cost depreciation on long-lived assets over several years, you might be wondering: “What about repairs?” Yes, they’re always tax deductible, but whether or not they are subject to depreciation rules depends on the “improvement” standard.
If you were repairing something to get it back to rentable condition, but did not add significant value to your real estate, then there’s no need to worry about depreciation. For example, painting the interior, doing basic landscaping, or replacing an old toilet are not improvements.
However, if you gut-rehabbed several rooms to increase the value of the property, you’re now in “improvement” territory and your accountant will need to split hairs to figure out what needs to be depreciated.
6. Cleaning and Maintenance
This category of operating expenses mostly consists of employee and contractor wages, which are fully deductible. Naturally, all the products and materials you purchase to do the cleaning and maintenance costs are also deductible.
7. Utilities
Utilities are not deductible if your tenants reimburse you. For example, it’s fairly common for landlords to keep some of the utilities in their name but pass through the cost to the tenants. You can only claim a deduction for the actual expenses you incurred, meaning the total amount you paid minus the amount the tenant paid you back.
Any other utilities or services that you pay for and don’t charge tenants for, like trash collection, are deductible.
8. Property Managers
If you’ve outsourced property management of your properties, their fees and anything they spend on your behalf are tax deductible. Even if they’re not a full time professional manager, if you pay someone to help out, keep track of that business expense and deduct it.
9. Legal & Professional Fees
Paying for tax professionals, legal fees for contract review, and memberships in professional organizations are deductible as long as they are used for a legitimate business purpose.
10. Advertising
The posting fees for Craigslist and Zillow, plus any banner or sign printing you might do are deductible.
11. Commissions and Referrals
Any referrals fees for finding tenants, even commissions paid to current tenants, are a business expense that should be deducted.
12. Travel and Transportation
We saved this one for the end because travel expenses can get tricky. The IRS is suspicious of travel expenses because historically a lot of people have abused this deduction by trying to get a deduction for personal expenses.
As of 2020, the IRS allows you to choose one of two ways of calculating your deduction for driving:
- 58 cents per mile standard mileage rate
- Actual expenses (itemized)
What that means is that if you want to maximize your deductions, you’ll need to keep track of both how far you drove and what your actual expenses were and then claim the greater of the two. If you have to travel a long distance to visit your property, you can also deduct meals, taxis, airfare, and hotels.
13. Office expenses
Just like with travel expenses, the IRS scrutinizes office expenses more carefully if someone takes a home office deduction. For example, what people used to do was claim a $1,000/month deduction for using a room in their house as an office.
So, if you’re planning to take a home off deduction:
- Save your receipts
- Make a fair assessment of how much of your use of the home office is legitimate business use
- Be prepared to justify your decisions on the IRS form
On the other hand, if you’re renting an office somewhere outside your home, that’s a very straightforward deduction.
How Do I Report Rental Income and Expenses?
For rental property such as buildings, rooms or apartments, a landlord would use Form 1040 or 1040-SR Schedule E, Part 1 to report the rental income and expenses. For more than 3 rental properties, include and attach Schedules E for each of the properties you own. Complete lines 1 and 2 for each property including street address but only fill the "Totals" once in one of the Schedule E, not on all of them.
Key Takeaways
The list of deductible aspects in rental property reveals that indeed, rental property owners need to be aware of tax reductions available to them. There are numerous tax deductions for those that buy or run rental properties depending on the local and federal guidelines involved. Yet, regardless of the tax deductions sought, one major consideration is that you should always pay attention to two major things: documentation and timing.
- Good documentation protects property owners by ensuring they can tick all the right boxes when preparing financial statements and returns. Hence, maintaining accurate records is important because you will have to prove the rental income and expenses you need to be deducted. These documents are diverse but they generally include receipts, bills, checks, and other documentary evidence.
- File on time. Almost all tax deductions apply to expenses incurred within a year. So, in case you pay forward, for instance, pay bills two years in advance, deductions only apply to the current year filed. These guidelines ensure that real estate activity and tax returns match current legal frameworks.
FAQs
What tax deductions are available to landlords?
It is possible to deduct the insurance premiums you pay for your rental property, including coverage premiums for fire, theft, and flood. You can also deduct the health and disability insurance you pay for any employees related to your rental property business.
What is a pass-through tax deduction?
Most landlords quality for the pass-through tax deduction that was established in 2018 as part of the Tax Cuts and Jobs Act. This deduction is a special income tax deduction and is not related to your rental deduction. Income dependent, landlords may be able to deduct up to 20% of their net rental income.
What are operating expenses for a rental property?
Common operating expenses for a rental property include advertising, property management, repairs, insurance and property taxes.
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