Real estate investment properties are a great way to boost your income, and they also offer you plenty of chances to deduct from your taxable income. However, before you can minimize your income tax liability, you need to be aware of the deductions available to you. Here are some of the most important rental property tax deductions for rental property owners to claim when tax season comes around.
12 Rental Property Tax Deductions Every Real Estate Investor Should Know
- HOA Fees
- Insurance Premiums
- Local Taxes
- Professional Fees
- Travel Expenses
- Property Management Fees
- Cleaning Fees
- Advertising and Marketing
- Pass-Through Entities
Keep in mind, this list is for general information purposes— consider it your convenient checklist for rental property tax deductions. It’s always a good idea to seek the advice of a real estate tax professional to be sure that all of your deductions are legitimate and are categorized properly.
In some ways, depreciation is the oddball among real estate rental property tax deductions. Most deductions pertain to expenses that are incurred and used up within a single year, so you apply the entire amount of the deduction to your current year’s tax form. However, some rental expenses, like improvements to the building, have a useful life of more than one year. Therefore, the IRS requires you to spread those costs over that time span. This is referred to as depreciation.
Let’s look at an example: Imagine that you decided to renovate the kitchen in a rental property. That kitchen is certainly expected to last more than one year, so the IRS does not allow you to write off the entire amount for a single year. Instead, you must depreciate it across the entire useful life of the property. The IRS defines the useful life of a residential property as 27.5 years, so when calculating how much you can write off in a single year, you would divide the total cost of the kitchen by 27.5. In most cases, the key to understanding which rental property tax deductions must be depreciated is to determine whether it is a repair or an improvement. That might sound simple enough, but sometimes the categories can be a little hazy. According to the IRS 1040 Schedule E instructions, “repairs in most cases do not add significant value to the property or extend its life.” In some cases, whether the work being done is a repair or an improvement is fairly obvious.
Fixing broken electrical outlets, replacing a pipe under the sink, or replacing a few shingles on the roof that were lost during a storm are all repairs. Repairs are considered work that is necessary to keep the property in good working condition or to keep it habitable. On the other hand, an improvement is something that does “add significant value to the property or extend its life.” Redoing a property’s entire electrical system, replacing the entire plumbing system, or replacing the roof would all count as improvements because each of these projects would add significant value or extend the life of the property. Therefore, each would have to be capitalized and depreciated over the entire useful life of the property.
Depreciating the Property Itself
So far, we have talked about how to determine when you must depreciate additions and improvements to the property. But we still haven’t talked about the biggest capital asset you have: the purchase of the actual house or building. This is the biggest of all of your rental property tax deductions, and it must be depreciated as well.
There are several rules that taxpayers must follow when depreciating the property. Be aware that you can only depreciate the property if you plan to own it for more than one year.
If so, then the first step of calculating your depreciation amount is to determine the “basis” of the property or the total cost of acquiring it. This includes more than just the purchase price; it also includes some of your settlement costs and closing fees. However, not all of these fees are applicable to the basis, which is why it’s always a good idea to consult with a real estate tax professional when determining how to calculate the basis of your property.
Next, after determining the basis of the property, you have to separate the structure from the land it’s built on. The IRS does not consider land to have a “useful life” (i.e., it’s not something that wears out over time like a house or apartment building), so you can’t depreciate your land. Only the structure can be depreciated. There are multiple ways you can estimate the costs of the building and land in order to separate them. Using the services of a tax assessor, property appraiser, or insurance agent are a few options.
Determine the Beginning and End Points for Depreciating Your Property
You can begin depreciating your property when it is “placed in service.” This means that the depreciation begins when it is ready and made available for rental.
For instance, let’s say you buy a property in January. You then spend three months preparing it. You list it for rental in March and finally secure a tenant whose lease begins in June. In this case, you would begin depreciating the property in March because that is when it was placed in service, even though it remained vacant until June.
You can continue depreciating the property (and writing off that amount on your yearly tax return) until one of three conditions is met:
You have deducted the entire cost of your property (as determined by your basis);
You sell, exchange, abandon, demolish, or otherwise relinquish the property;
You retire the property from service (no longer use it to derive rental income).
It is important to note that you can also continue depreciating the property while it is idle — for instance when you are in between tenants or during a period of low rental activity.
2. HOA Fees
As you probably know, many planned developments – such as condos, gated communities, and some apartment buildings or building complexes – have a Homeowner Association (HOA) that is responsible for setting and enforcing certain rules and guidelines, as well as maintaining common areas that are shared by the community.
These services, of course, come with a yearly fee. There is often some confusion as to whether HOA fees are deductible. Because these fees are assessed by a private entity, the IRS does not allow you to deduct HOA fees for an owner-occupied property.
However, if the property is rented out, then HOA fees are considered a business expense and they are allowed as one of your rental property tax deductions. Also keep in mind that if you only rent the property out part-time and live there for the rest of the year, you are only allowed to deduct the HOA fees for the portion of the year when you rent out the property.
3. Insurance Premiums
Landlord insurance policies are significantly more expensive than homeowner insurance. In most cases, the premiums range from 15 to 25% higher, because landlord policies typically cover issues like loss of use (which replaces your income if something should happen that makes the property unrentable for a period of time), higher risk of liability, and so on.
Fortunately, the IRS allows you to claim the full amount of your landlord insurance policy as one of your rental property tax deductions.
4. Local Taxes/Fees
Depending on where your property is located, local taxes can greatly vary. In rural areas, they tend to be low, but in urban or high-demand areas (like popular vacation destinations) they can be very high. When local taxes and fees are high, claiming rental property tax deductions can save you a significant amount of money.
There are a few different ways you can find out how much you will be assessed in local taxes. For one, a local mortgage professional or a realtor from your area should be able to tell you the current tax rate in your city or county. The information should also be available on the county website where the property is located.
You can also call your County Office of the Assessor (different counties sometimes have different names for this office, like County Office of the Recorder) and request this information for your area. Alternatively, your mortgage lender can send you an escrow statement that shows the property taxes you have paid.
Along with local taxes, many states have licensing requirements for rental properties, which are also deductible (these are different from the business license you had to obtain for your real estate business).
Some popular vacation spots have special licensing requirements for short-term or part-year rentals. These licensing fees often vary depending on location and the size of the property (for instance, the number of bedrooms). These kinds of short-term licensing fees are also valid rental property tax deductions.
Also sometimes referred to as “tourist tax,” an occupancy tax is sometimes levied by states, counties, or municipalities against the amount of rent that you collect. It’s sort of like a sales tax for rental payments and is also deductible. This tax is typically applied in an area where a short-term rental (like a vacation home) is common.
5. Professional Fees
Most of the fees you pay for professional services related to managing or maintaining the property can be claimed as rental property tax deductions. These include fees paid for legal services, accounting, tax preparation, consulting, and even the preparation of your will if it includes the property in question.
However, the entire fee may not be deductible as a business expense, or as an expense for a given property. For instance, if you own multiple rental properties or the rental property is part of a real estate business, you might have to apply the deduction to your entire business or spread it out across the different properties.
Similarly, some of the professional services you pay for may involve personal as well as business interests (for instance, the making of your will), and the costs would need to be split accordingly.
As previously discussed, it’s important to differentiate between improvements and repairs. Repairs generally refer to fixes that maintain your property in good working order or keep it habitable. Improvements, on the other hand, are modifications that significantly increase the value of the property or meaningfully extend its life (these are sometimes referred to as capital expenditures). The line between repairs and improvements can sometimes be hazy, but improvements tend to be much more expensive, and sometimes involve modifying the structure of the building itself.
For example, replacing a few roof shingles after a storm is considered repair, while replacing the entire roof is considered an improvement. Repairs can include fixing electrical outlets, repainting a sun-faded wall, replacing a cracked window or broken screen, etc.
The functional difference is that repairs can be claimed in full on your return for the same tax year that they were performed, whereas improvements must be capitalized and depreciated across the entire useful life of the property.
7. Travel Expenses
When it comes to rental properties and tax benefits, the law is actually fairly generous about what you can claim in terms of travel expenses. If you live close to your rental property (in the same city, metropolitan area, etc.), then your travel expenses may not seem like much, but they can add up fast.
If you periodically fly to visit properties that are far away, or if you have to fly to attend a meeting or perform any other business activity related to your rental property, then you are perfectly aware of how fast these expenses can add up. A single trip, when you factor in things like airfare and car rental, can easily cost you hundreds or thousands of dollars in travel expenses.
Like any of the rental property tax deductions that you claim, you need to make sure you’re diligent about separating personal from business expenses. Only the portion of your travel expenses that relate directly to a business activity can be deducted.
It’s important to stay current and be consistent with your record keeping. Tracking business mileage can be challenging, especially if you need to tally the miles that you drive. However, there are apps available that make tracking your business miles much easier, faster, and more convenient.
If you use your car for business, one decision you must make is whether you plan to use the standard mileage rate provided by the IRS, or whether you want to claim your actual expenses. Using the standard mileage rate is simpler because the only thing you need to track is the number of business miles you’ve driven. The standard mileage rate for 2018 is 54.5 cents per mile. So to claim the standard mileage deduction, you would simply tally all of your business miles driven for the year, and multiply that by $0.545.
However, there are several reasons why you might want to claim your actual travel expenses instead of the standard mileage deduction. Actual expenses include all of the costs of maintaining a vehicle, like lease payments, gas, oil changes, repairs, insurance, tolls, parking, etc.
Claiming your actual expenses requires you to keep much more detailed records. You will need to keep receipts relating to every expense you want to claim. It may be useful to keep a spreadsheet specifically for these deductible expenses and enter your totals at the end of each day. And remember– you can only write off the portion of these expenses that relate to your business.
In order to calculate how much you are allowed to write off, you first have to determine the percentage of total miles driven that were business related. To do this, simply divide your business miles by your total miles.
For instance, if you drove 10,000 miles last year, and 6,000 of those miles were business related, then you would divide your business miles (6,000) by your total miles (10,000): 6,000/10,000 = 0.6. You would then multiply your total auto-related expenses for that year by that number (0.6) to determine how much you can claim in actual expenses.
8. Property Management Fees
Depending on the size and type of your property, management can be relatively simple or it can be complex and time-consuming. There are a variety of different activities that fall into the category of property management. The ease of deducting these expenses depends largely on how your business is structured, and whether you hire someone else to handle your management duties or attempt to do them yourself.
Broadly speaking, there are three ways to handle the management of your property.
Do it yourself;
Hire a property management firm;
Hire a dedicated property manager (who usually lives on-site).
Do It Yourself
Of these three options, doing it yourself is typically the most difficult way to claim a rental property tax deduction, especially if your business is a sole proprietorship. It may be possible to write off your management activities if you keep very diligent records. Property management software may help you keep the necessary records to substantiate your management activities.
If your business is an LLC or a corporation, on the other hand, the company may be able to hire you as a property manager, in which case you can deduct your salary and benefits.
Hire a Property Management Firm
If you decide to use the services of a property management firm, any fees associated with these services are deductible.
However, there are a few expenses that might not fit into the “property management” category. For instance, if you pay a commission to a property management service for referring a new tenant, that commission would need to be written off under “marketing.”
Hire a Property Manager
The final option is to hire a property manager. Many apartment buildings and large complexes have a property manager (or managers) who live on-site and handle the day-to-day management duties. All salaries and benefits paid to a property manager are deductible.
Since property management fees can be tricky, it’s a good idea to have a tax professional on hand who can make sure that your deductions are not miscategorized.
There are several types of interest that can qualify as rental property tax deductions. The most common are mortgage interest, unsecured loans, and credit card interest.
The amount of interest you pay on your mortgage is a deductible expense, but the amount that goes toward your principal is not.
In most cases, when you obtain a mortgage for the property, you typically have to pay points and loan origination fees. For tax purposes, these are both considered pre-paid forms of interest, and you can deduct the full amount of each.
If you have obtained any unsecured loans (loans that are not backed by collateral) and used them for the property in question, you can deduct the portion of the interest that relates to your property expenses.
As always, only the business portion is deductible. If any part of the loan has been used for personal expenses or sits in a bank account, the interest on those parts of the loan is not deductible.
Credit Card Interest
One of the advantages of a business credit card is that it makes it a lot easier to separate personal expenses from business expenses. Likewise, tax deductions become much easier to calculate. If you have a credit card that is dedicated solely to your business expenses, you can deduct all of the interest you pay on that card.
If you have credit cards that are used for both business and non-business expenses, any interest paid that is related to business purchases is also deductible.
10. Cleaning Fees
Cleaning is considered a normal, ongoing cost of maintaining a rental property, and all expenses incurred related to cleaning the property are deductible. This includes not only fees paid to professional cleaning services, but the cost of any purchased cleaning supplies as well.
11. Advertising and Marketing
Any money you spend to advertise your business also counts toward your rental property tax deductions. This includes paid advertisements in newspapers or online, as well as subscriptions and other fees that you may pay to real estate listing sites.
Also, keep in mind that this goes beyond listing vacancies or otherwise soliciting tenants. It also applies to advertisements for property manager positions, opportunities for contractors, or any other service you may need for your business. Any commissions paid (including to a property management firm) related to securing a tenant for your property would go under this category as well.
12. Pass-Through Entities
Under the new tax law for 2018, investment property owners will be able to deduct up to 20% of their business income on their individual tax return.
This applies to properties that are purchased by pass-through entities, such as a sole proprietorship, LLC, or land trust. Pass-through entities pay no business tax — instead, that income is claimed on the owner’s individual tax return. In the past, 100% of this income had to be claimed.
Keeping Track of Your Expenses
It goes without saying that to accurately claim your expenses (and to substantiate them in case you get audited), you need to keep diligent records of all of the relevant expenses throughout the year. This takes a significant amount of time and effort. It also requires you to have a plan regarding how to document all of the necessary information.
Keep any invoices or receipts (either paper or digital) and file them away in a dedicated place for easy reference. It’s a good idea to reserve a dedicated section of your filing cabinet– or even a separate filing cabinet altogether– where you can organize and store your physical receipts. Likewise, maintain and back up a dedicated folder on your computer for digital receipts and scanned documents. You’ll also want to sort them by expense category (i.e., travel, repairs, etc.).
You should also use some sort of accounting system, whether it’s a series of spreadsheets or dedicated accounting software so that you can add up your expenses as you go throughout the year. This will save you the nightmare of having to organize, sort, and add everything at the end of the year when it’s time to do taxes.
Rental Property Tax Deductions Can Save You a Lot of Money
Rental properties can be a great source of income, and they offer you plenty of opportunities to write part of your rental income off on your tax returns. In order to fully take advantage of these savings, however, you need to make sure that you know what is tax deductible (and what is not) so that you can keep proper records throughout the year.
Because there are so many categories that rental property tax deductions fall into, it’s a good idea to have someone knowledgeable on hand to guide you through the process. The experts at Anderson Advisors know property tax law inside and out, and they are here to help if you ever have any questions or need any guidance.