Owning property is a huge part of the American dream, and at times it seems the IRS is trying to reward such behavior. In this article, I review the best federal tax deductions available to rental property owners in the United States.
What Qualifies as an Expense?
There are two types of expenses: Current Expenses and Capital Expenses.
These are generally one-off items that help keep the property in good working condition and habitable, or help you operate your rental business.
The entire expense can be deducted from your taxes in the same year that it was incurred – hence “current” expenses. Repairs are generally expected to restore an item to its previous working condition.
To qualify as a current expense, it must be considered:
- Ordinary and Necessary
Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance.
Must have more short-term value than long-term value. Fixing a hot water heater has short-term value. Replacing the appliance has long-term value.
- Directly Related to your Rental Activity
The expense must be business related.
- Reasonable in Amount
If you claim to have paid $500 for a toilet seat, you will get audited.
Anything that increases the value of the property or extends its life is categorized as a “capital expense” or “improvement” and must be capitalized and depreciated over multiple years.
My general rule of thumb is any item that costs hundreds of dollars (or more) to replace should probably be deducted as a capital expense.
For a more detailed explanation and specific examples of each, read the article: Repairs vs. Improvements – What Can I Deduct from my Taxes?
Top 12 Tax Deductions for Landlords
Before claiming any of these deductions, be sure to have detailed and thorough records to back them up. Rental Management One provides all these records and documents for you to supply to the IRS. The IRS scrutinizes these deductions (some more than others), and you need to be prepared should you get audited. If you fail to have proper receipts and cannot validate the business necessity of each expense, you will have to pay the amount due, with interest, if you get audited.
1. Loan Interest/Points
If there is a mortgage on the property, the loan interest will probably be your single largest deductible expense.
In 2013, I paid $19,000 in interest on one of my mortgages. Further, if you paid buy-down points on the property purchase or mortgage refinance, you’ll be able to deduct those as well.
- Mortgage Interest (primary & secondary)
- HELOC Interest for loans used to repair or improve the property
- Credit card interest on items used for the property
- Mortgage Points to purchase or refinance a rental property
Keep in mind, you can only deduct interest on money that was actually spent on your rental business. Therefore, you wouldn’t be able to deduct the interest of a withdrawn line of credit that is sitting in your bank account.
2. Depreciation of Assets
There are, in general, three types of costs you need to capitalize and depreciate:
- The value of the structure, not the land
- The value of improvements – such as appliances, carpet, windows, countertops, etc.
These expenses cannot be deducted in a single year, but rather must be spread out (depreciated) over multiple years.
Otherwise, people would abuse the system by claiming $100K in repairs in a single year to remove all tax liability, and then sell the property the next year to recoup their renovation ROI.
Often the real estate taxes are paid through the mortgage company, and therefore show up on the Form 1098 that is sent from the bank.
If the property is free and clear of any mortgage, CONGRATULATIONS!, but you’ll have to look up your tax records online if you didn’t keep receipts of those payments. Other business-related wage taxes, permit fees, or personal property taxes are considered allowable deductions as well:
- State, County and City Taxes
- Social Security Taxes for Employees
- Medicare and Unemployment Taxes for Employees
- Personal Property Tax/Vehicle Tax
- Permit Fees/Inspection Fees
Repairs are defined as any effort to maintain the current condition of a property or asset.
- Painting/Spot Patching
- Plumbing Repairs
- Air Conditioning Repair
- Fixture Repairs
- Labor Costs/Contractors
- Incidentals related to a repair
- Rental Fees for Tools/Equipment
Maintenance costs are often confused with repairs, however with maintenance, you’re not necessarily fixing anything. For example, the lawn will always need to be cut but it is never really “broken.”
You can also hire a pest company to treat the property every few months to prevent further infestations, even if the original pests are long gone.
- Landscaping and Tree Trimming
- Homeowner Association Fees
- Pool Cleaning, Chemicals and Maintenance
- Pest Control and Treatment
- Tune-ups on Lawn Mowers, Chain Saws, Leaf Blowers, etc.
- Light Bulbs
- Smoke Detector Batteries
- HVAC Filters
- Janitorial Items
6. Insurance Premiums
All business-related insurance premiums are tax-deductible. When trying decide if the insurance is business related, I ask myself, “Would I buy this insurance if I didn’t own a rental?”
I have an Umbrella Policy which covers my personal assets and legal liability above and beyond the coverage on my rental properties. Because of the added risk involved with one of my less-polished properties, I decided to purchase this additional coverage.
I would not have purchased this policy otherwise, and therefore I can classify it, in good conscience, as a business expense.
- Homeowners Insurance
- Mortgage Insurance Premiums
- Fire/Damage/Liability Insurance
- Flood Insurance Riders
- Theft Insurance
- Workers’ Compensation Insurance
- General Liability Insurance
- Personal Umbrella Insurance
You can deduct the cost of any rental property utilities that you pay for. You are still allowed to claim utility expenses even if the tenants reimburse you later, but you also have to claim that reimbursement as income.
- Heating Oil
- Water & Sewer
- Trash & Recycling
8. Travel Expenses
50% of American Landlords do not live near their properties. Any long distance travel to visit your assets or to conduct rental business can be tax-deductible as a business expense.
- Airline Fares
- Car Rentals and Taxis
- 50 percent of meal expenses during long-distance travel
When expensing business vehicles, the actual asset must be depreciated over multiple years, however the upkeep can be deducted in the year the expense was incurred.
You have the option of deducting actual expenses, or utilizing a standard mileage rate of 56.5 cents per business mile driven (as of 2013).
- Business Vehicles (depreciable)
- Mileage or Gas/Maintenance/Usage of Business or Personal Vehicles
10. Management Fees
Even the best landlords need help, if you’ve hired a property manager, like Rental Management One, you are allowed to deduct that expense.
- Property Management Companies
- Individual Property Managers
- On-site Manager
- Condominium Association Fees
- Special Assessments
11. Legal and Professional Fees
If you need to hire a pro, be it a lawyer, accountant or tax professional, you can expense the cost. If you ever have to evict a tenant, you can expense all reasonable court and filing fees.
- Accounting Advice
- Professional Tax Preparation
- Tax Preparation Software (like TurboTax)
- Structural Engineering and Consulting
- Legal Fees
- Lease Review and Editing
- Court Filing Fees
Occasionally, I will offer a $50 incentive to my current tenants if they find a replacement tenant upon their departure.
- Commissions to Managers and Salespeople
- Commissions for Tenant Referrals
A $25K Limit on Losses
According to the IRS, if you or your spouse actively participated in a passive rental real estate activity, you may be able to deduct up to $25,000 of loss from the activity from your nonpassive income.
For Example: Lets pretend, you had $60,000 in depreciation and expenses for a given property in a single year, however that property only generated $20,000 in rental income.
This leaves you with a $40,000 loss (ouch!).
You can claim $25,000 of losses that year, but then you are allowed to “recapture” the other $15,000 in losses against your income the next year. If you continue to have losses beyond $25,000 year after year, you can recapture the sum of the unused losses against the gains when you sell the property.