Summary: In this article, you will learn about landlord tax deductions that will help maximize your profits. Learning about these rental property tax deductions will minimize your out-of-pocket expenses and ensure you are taking advantage of every landlord tax deduction available.
One of the best things about owning a rental property is that every dollar you spend on the property, whether it’s mortgage interest, repairs, maintenance, business expenses or depreciation, is tax deductible. What can you deduct on rental property? We’ve put together a comprehensive list of deductible items and services you don’t want to miss out on this tax season.
1 – Interest From Your Rental Property Loan
Interest will likely be your largest deductible expense, assuming you take out a mortgage loan to buy your property. The most common deductible interest examples include: (1) mortgage interest (primary or secondary) on loans to purchase or improve a rental property, (2) credit card interest used to purchase goods or services for the rental, and (3) HELOC loan interest used to improve or repair property. Utilizing mortgage interest deductions on rental property will save landlords thousands of dollars a year and maximize your profit.
TIP: Interest is only tax deductible on purchases used for your rental or property.
Loan for Rental Repairs
If you take out a loan for repairs on your rental, all interest accrued can be deducted on your taxes that year. The rules for what qualifies as a repair are clearly outlined by the Internal Revenue Service (IRS), and will be explained in greater detail under #3 “Repairs & Maintenance” below.
2 – Depreciation of Rental Property
A rental property will naturally experience wear and tear over time. The process of depreciation basically accounts for the cost of buying and improving rental property and allows money spent to be tax deductible. Instead of one large deduction during the year you purchase or improve your property, depreciation deduction is distributed over the “useful life” of the property. Understanding the specific rules of depreciation will be extremely important when buying and owning a rental property. Keep reading to learn more.
Rental Property Depreciation Rules
- You must own the property.
- You use the property for business or income.
- The property has a “useful life”, in other words, it wears out, decays or loses its value due to natural causes.
- The property is expected to last more than a year.
Things to remember…
If a property meets all of the requirement above, but you stop using it for business purposes in the same year, it no longer qualifies for depreciation. Additionally, land is not considered to be depreciable because it doesn’t wear out or decay. Cost of any changes to the land, i.e. landscaping or clearing, are considered part of the cost of owning the land.
3 – Repair & Maintenance Costs
While most repairs and maintenance costs are tax deductible, make sure that these expenses are “ordinary” and “necessary”, as outlined by the IRS. Ordinary and necessary means that owning a rental property demands certain repairs and maintenance made by landlords in order to make the property livable. Keep track of all the money you spend throughout the year, as these costs can only be deducted during the year they occurred. Next we will break down eligible deductible expenses.
Painting and patching is typically the largest maintenance cost for landlords. The good news is all of these costs are tax deductible. Materials, supplies, labor or any expense it takes to get the job done should be deducted from your current year’s tax return.
If you use a cleaning service for the interior or exterior of your property between tenants, or you perform the cleaning yourself, make sure you keep the receipts so that money isn’t coming out of your pocket. Blowing out a sewer line, mowing the lawn, trimming shrubs, renting equipment or labor costs are all considered maintenance and thus, tax deductible. Broken windows, leaky pipes, plumbing or appliance issues, flooding, mouse traps, etc., are also eligible deductions. Basically any expense to keep your property up and running, without adding market value, will lower your tax liability each year. Again, keep your receipts!
Repairs vs Capital Improvements
The IRS has made a clear distinction between what qualifies as a repair and what qualifies as a capital improvement. If an improvement is made that extends the useful life of your property, or adds value to it, this is considered a capital improvement and is not fully tax deductible during the year it is paid.
For instance, if you replace a broken toilet, this is considered an ordinary repair and is fully tax deductible. On the other hand, if you update an entire bathroom that is outdated, this is considered a capital improvement because it adds market value to your rental and is deducted over a longer period of time. If the new bathroom costs $10,000, a smaller amount of the cost ($364) can be deducted each year for the useful life of the bathroom. The IRS determines the length of the useful life period, but any major improvements will typically be deducted each year for 27.5 years.
4 – Property Management Expenses
If you plan on deducting the cost of managing your own property or multiple properties (as a sole proprietor), it can be difficult to prove your active management. However, it can be done, especially if you’re using tools like tenant screening systems or property management software. Many property owners who want to manage their property themselves, may choose to establish an LLC or corporation, to make deducting taxes less messy. Let’s say the LLC employs you as the property manager, your salary is considered entirely tax deductible.
Are Property Management Fees Tax Deductible?
If you’d rather invest in a rental property, but don’t want to deal with the demands of being a landlord, consider hiring a management firm. Fees and services paid to a property management firm are 100% tax deductible.
Property Manager Deductions
Onsite property managers are often hired by real estate investors with multi-unit properties or apartment buildings. Any salary or benefits paid are considered deductible rental property expenses.
Employees and Independent Contractors
The main difference between employees and independent contractors is how they are taxed. According to the IRS, an employee fills out a W-2 tax form, while an independent contractor uses a 1099. An employee is classified as someone a boss or manager directly oversees, has a set schedule and place of work, including the use of equipment (computers, phones, office supplies, etc.) provided by the employer.
On the other hand, an independent contractor typically does not work on business premises, sets his or her own schedule and has the ability to accept or reject projects or assignments.
Employers withhold income and payroll taxes for employees who are paid a salary or hourly wages, and must provide a W-2 at the end of each year, for tax purposes. For independent contractors, no deductions are made on money earned throughout the year and he or she must pay income and self-employment taxes based on fees, commissions and compensation outlined on a 1099-MISC at the end of the year.
The good news for employers is that any money paid to both employees and independent contractors is completely tax deductible. Contract labor and wages can be claimed as a business deduction.
Home or Business Office
Using a room in your home as an office to perform business? Home office deductions can be used for all types of homes, including homeowners and renters. There are two options available to claim a home office deduction: (1) Simplified Option and (2) Regular Method.
The IRS explains the Simplified Option as, “…significantly reduce the burden of record keeping by allowing a qualified taxpayer to multiply a prescribed rate by the allowable square footage of the office in lieu of determining actual expenses.” This option became available on January 1, 2013 and makes it easier for business to calculate deductions.
The Regular Method requires business owners to determine actual expenses like, utilities, repairs, insurance, mortgage interest and depreciation. These deductions are based on how much of your home is devoted to business use.
Whichever option you choose to go with, two basic rules must be met for your home to qualify for business deductions: (1) Regular and exclusive use and (2) Principal place of business.
Auto & Travel Expenses
If you decide to do all the maintenance work yourself, keep track of your mileage and travel costs of going to and from your rental property. If your rental is out of state, airfare, hotel, rental cars, meals, tolls, etc., are all deductible. However, make sure you are only deducting business-related costs versus personal.
5 – Legal & Professional Service Fees
Real estate investment businesses and single proprietary investors often use professionals for accounting or legal work. Any expenses incurred using these services are tax deductible. If it’s a business, the deductions will be made to the overall business. If they are directly related to a specific property, then these expenses can be deducted from the actual property themselves.
6 – Rental Property Losses
What are rental losses? If your operating expenses are greater than the money you make from the property, this is considered a rental loss. If you have multiple properties, each property is combined or netted to determine if annual income or losses have occurred.
It’s not uncommon to have a rental loss, even if your operating expenses don’t exceed your income made on the property. This is where depreciation comes into play. You can deduct a portion of your rental property costs every year without having to spend more money.
Passive Income Losses
The next obvious question is: are rental property losses tax deductible? It’s important to understand how rental losses are classified for tax purposes. These losses are considered “passive losses”, which include real estate or any activity you don’t “materially participate” in (or work at for a minimum of 751 hours annually). Because the money you make or lose on rental properties is considered passive, it limits your ability to deduct them. Basically, you won’t be able to deduct passive losses without offsetting passive income.
There are two exceptions to passive loss rules: (1) you or your spouse qualify as a real estate professional, or (2) your income is small enough that you can use the $25,000 annual rental loss allowance. If you own a property and your modified adjusted gross income is $100,000 or less and “actively participate” in rental activity, you qualify for the $25k deduction in rental losses per year. Unfortunately, there are no tax deductions on rental losses for high-income landlords (MAGI over $150k). Exception #1 will be covered in the next section under non passive income losses.
Non Passive Income Losses
If you or (or your spouse) are real estate professionals, you qualify for a 100% deduction on any amount of rental losses. This deduction can be applied to other non-passive income if you spend more than half (a minimum of 751 hours) of your working time on one or multiple properties. Other exceptions are also available for working fewer hours.
7 – Start-Up Costs
New to being a landlord? You can deduct up to $5,000 of start-up expenses in the first year of operating your rental property. Any money you spend to get your property ready to rent is considered a start-up cost.
Using personal property, like furniture, appliances and gardening equipment for instance, can be deducted using the de minimis safe harbor deduction (up to $2,000). Or take advantage of 100% bonus depreciation on personal property, in effect now through 2022.
8 – Landlord Insurance
Is landlord insurance tax deductible? You can and should deduct any amount paid toward insurance premiums related to your rental property. This can include, theft, fire, flood and liability insurance. You can also deduct health and workers’ compensation insurance costs, if you have employees working for you and your properties.
9 – Advertising & Marketing
Sometimes it’s not easy to find tenants to rent out your property. This is where marketing and advertising become necessary. Costs associated with using an online service like Zillow, to advertise your property are tax deductible, as well as lease-up commissions for real estate agents or property managers. Commission paid to these professionals, either to find a new tenant or renew leases, can often cost several hundred dollars, all of which should be recorded and deducted from your annual taxes.
10 – Rental Property Utilities
The cost of utilities every month can add up fast. If you are paying for any utilities associated with the property, along with trash removal, recycling services and internet or cable, these expenses can be deducted. The most common utility expenses include: heating, electricity, air conditioning, water and sewer. Please note, if you lump utility costs into monthly rent, the landlord must count this as income from the tenant.
11 – Capital Expenses or Improvement of Property
We touched on capital expenses or improvement of property in section #3 of this article. Capital expenses are defined as anything that increases the value of your property or extends its life. It can sometimes be difficult to decipher between what is considered a repair versus a capital expense or improvement.
A good rule of thumb is if anything you buy for your rental that costs over $100, is likely a capital expense, which adds value to your property and is therefore not fully tax deductible. They can however, be claimed and count towards depreciation over several years, as described above. Examples of capital expenses include, replacing a roof, any major appliances, new flooring or carpet, etc.
12 – Commissions or Incentives
Oftentimes, landlords will offer a cash or rent-reducing incentive to current tenants if they find a quality replacement tenant to fill the rental upon moving out. This could be a $50 incentive or commission paid to tenants, managers or salespeople for referrals. These incentives can be added to rental expenses and claimed on your taxes.
13 – Oops! I Can’t Sell My House and Now I’m a Landlord
Homeowners struggling to sell their property can often become accidental landlords. If you find yourself in this position, don’t panic! You can sell your property within two years without claiming capital gain and are entitled to the same tax deductions as a landlord.
14 – Client Entertainment Costs
In 2017, The Tax Cuts and Jobs Act made major changes regarding meals and entertainment deductions. Starting in 2018, the IRS eliminated entertainment expense deductions. Businesses can no longer claim expenses for taking clients to sporting events, concerts, resorts, etc.
Deductions for meal expenses can still be deducted, but with strict qualifying guidelines. If meals at entertainment events can be separated out from entertainment costs, they are deductible. Meals for all-employee events, business meals and while traveling can be deducted at 50%. Finally, meals or food provided for employees at your business location are now only 50% deductible, instead of 100%.
Make sure you’re familiar with the three-step process it takes to prove money was spent on actual business meals. This process includes, verification, documentation and understanding which expenses fall under the “50% rule”.
15 – Casualty Losses
In the event that your property is damaged due to a catastrophe, like a fire or flood, some or all of your losses may be deductible. Just how much is deductible will depend entirely upon your insurance coverage and how badly your property was damaged.
16 – Make Your Property Handicap or Elderly Accessible
By making your property accessible to those with disabilities or the elderly (i.e. elevators or wheelchair ramps), you can credit or deduct 100% of those costs.
17 – Go Solar with Commercial Properties
If you own a commercial building and are thinking of ways to save on high utility costs, consider making your property energy efficient. It is completely tax deductible and helps the environment. A win-win!
18 – Make Sure You Don’t Disqualify for Tax Deductions!
Do Not Rent to Family or Friends
If you’re thinking of renting to friends or family, think twice as this will automatically disqualify you from almost all tax deductions.
Keep Good Records of Expenses
One of the biggest challenges real estate investors face is keeping good, consistent records of expenses throughout the year. Failure to keep good records will make it much more difficult to claim deductions come tax season.
Report Accurately on Tax Forms
Make sure you are using the correct tax forms to report and file your rental property and income taxes. If you own one or multiple rental properties it may be wise to hire an experienced CPA or tax professional to maximize your deductible expenses and profit.
Bonus: Other Types of Tax Deductions
Don’t forget to look into other types of deductions you may qualify for. Like, Pass-Through Tax Deductions, an income tax deduction that benefits landlords, and other deductions real estate investors can take advantage of with the New Tax Act of 2018. Check it out!
It’s never too late to start keeping good records of all your investment property costs. You have already taken the initiative to learn more about all the available tax benefits of buying and owning a rental property. Now it’s time to put that knowledge to use and hold yourself accountable to good record keeping habits, while making purchases and management decisions for your rental property that will take advantage of tax deductions and maximize your profit.