For most landlords, being able to deduct operating expenses can make a big difference on the amount of tax that they owe. Understanding the rental property tax deductions can be complicated, but well worth the time.
But when it comes to fully utilizing those rental property tax deductions, that’s where many landlords struggle. After all, there are so many different expenses that you can claim! Additionally, the IRS doesn’t have an exhaustive list of all the eligible expenses, just that they must meet their requirements to qualify as deductible. This means that they must be ordinary and necessary, current, directly related to your rental activity, and reasonable in amount.
Here’s a look at what you should know about operating expenses, and how you can claim them on your taxes.
Rental Tax Deductions: Current Vs. Capital
Deductions fall into one of two different categories: current and capital.
Let’s look at both now.
- Current Expenses: These are generally for one-off purchases or expenses to keep the property in good working condition or to help you run your rental business. Current expenses can be claimed in whole on your tax return, and deducted entirely in the year that they occurred.In order to qualify as a current expense, the purchase or repair must be considered “ordinary and necessary,” which means that it is an ordinary expense that’s considered common in the business. This includes interest, taxes, advertising, and more. It must also be “current,” which means that it must have more short-term value than long-term. A repair to a roof has a short-term value and can be claimed as a current expense. A new roof, on the other hand, has a long-term value. Finally, your current expenses must be reasonable in amount, so be realistic when claiming your expenses. A $400.00 door handle, for example, is likely to raise some eyebrows at the IRS.
- Capital Expenses: These, on the other hand, are improvements or purchases that are made to the property, that enhance its value –or, that will benefit your rental activity for more than one year. So, for example, a complete kitchen remodel, which would add value to your rental and benefit your property for more than one year, would be considered a capital expense.Unlike current expenses that can be claimed in the year that they were incurred, capital expenses must be depreciated, and can only be deducted a little bit at a time over the course of many years. The exact timeframe for depreciation varies depending on the item in question but it will be somewhere between 5 and 27.5 years.
Operating Expenses: What Are They?
Now that we’ve got that out of the way, let’s take a look at some of the deductions that you may be eligible for. Make sure you’re not forgetting anything this year!
Some valuable rental property tax deductions that landlords can claim include:
- Mortgage Interest – Interest from mortgage payments and even interest on credit cards that are used for the rental can be deducted. If you have a mortgage on your property, this expense could easily represent one of your largest and most valuable deductions.
- Depreciation of the Property Depreciation is another significant deduction. Depreciation of the property itself is considered a capital expense, and can’t be claimed all at once. Instead, it must be spread out over the course of 27.5 years.Just note that depreciation that you claim must be recaptured and paid should you sell the property at some point down the road. The IRS also doesn’t give you an option to opt out of claiming depreciation on the property, it’s a deduction that you’re required to claim. If you don’t, you could still be held liable for paying depreciation recapture tax when you sell your property.
- Mortgage Insurance (PMI/MIP): If you have a mortgage on your property, you can deduct mortgage insurance from your rental income.
- Taxes – Taxes, including property tax, city tax, and even taxes for any employees that you hire for your rental properties can all be claimed on your tax return. If you have a mortgage, your taxes will often be paid through this. You can find amounts on your 1098 form. If you’ve paid off your mortgage, you’ll have to keep receipts yourself, or look up your tax records online.
- Advertising: The cost of advertising your property, including online listings or ads that you take out, can also be claimed on your tax return.
- Insurance: Insurance for the rental or rental property business can also be deducted. This includes fire, theft, liability, and more.
- Utilities: If you pay the utilities for your rental, you can deduct them as well.
- Repairs and Maintenance: Repairs and maintenance for your rentals can also be deducted. Just remember that improvements must be treated as depreciation, and will have to be paid back at the time of sale in depreciation recapture.
- Professional Services: If you hire an accountant, attorney, property manager, or other professional –their fees can also be deducted.
- Travel Expenses: Whether your rentals are local or long-distance, your cost of travel to and from the property; including gas and airfare, can be deducted.
- Losses From Theft or Other Casualties: If your property was damaged in a fire or flood, or if valuables were stolen or the property vandalized, you may be able to deduct a portion of the loss.
- Tenant Screening: When it comes to tenant screening, all of the expenses associated with that can also be claimed. Credit reports, criminal background checks, identity verifications, employment and income verification, and more can all be claimed if you paid for them.
- Commissions: Commissions can also be deducted. This includes incentives that are paid to managers and salespeople, or any commissions that you pay for tenant referrals –say you offer outgoing tenants a bonus if they find a replacement tenant for you.
- Equipment, Supplies, and ExpensesNew equipment and supplies including a phone, laptop, camera, tablet, and even internet service, printer toner, paper, and more –as long as they’re used specifically for your rental business, can also be deducted. Just make sure you keep good records and are able to demonstrate that your purchases and expenses are for business purposes.
- Home Office Deduction: If you use a room in your home for conducting business, you can deduct this expense as well. You can use the IRS’ simple method for calculating this deduction and deduct $5 per square foot up to 300 square feet.
Learn more about available deductions for landlords here.
Business vs. Personal Use
If you purchase something or subscribe to a service that you use for both business and personal use, you can deduct only the portion that you use for business-related purposes. To determine this, you’ll need to pinpoint how much time you use your item for rental-related purposes, and how much for personal use. Then, divide the cost between the two purposes and deduct the rental-related portion. So, say for example that you use your internet connection for official business purposes 60 percent of the time. In this case, you can only deduct 60 percent of the cost of service.
Special Rules for Certain Expenses
The IRS has created specific rules for certain operating expenses, that spell out which expenses are tax deductible, how much is able to be deducted, and in some cases, even stipulate specific record-keeping requirements.
Here’s a look at the main areas that include special rules and requirements.
- Home Office Expenses: There are strict requirements for taking this deduction. Learn more here.
- Meals and Entertainment: There are some IRS requirements for meals and expenses. Including the requirement that someone who can benefit from your rental activity must be present. These expenses are usually 50 percent deductible.
- Travel: Travel expenses can be deducted from the IRS guidelines. The amount you can deduct will vary depending on the length of your trip and the time you spend on business while away. See this page for more information.
- Vehicle Expenses: The standard mileage rate for the cost of operating your car changes from year to year. For 2017, standard mileage is 53.5 cents (0.535) per mile.
- Business Gifts: The IRS limits business gifts to $25 per person.
- Bad Debts: Some bad debts are deductible, but unpaid rent is generally not one.
- Interest Payments: In most cases, you can deduct interest on money that you borrow for a business or investment activity –however, rules and restrictions apply for other types of interest.
- Casualty Losses: For losses due to a casualty, like theft, vandalism, or fire –you usually won’t be able to deduct the entire cost of the property destroyed. Instead, how much you’ll be able to deduct will depend on whether the property was stolen, completely destroyed, and whether the loss was covered by insurance.
- Taxes: While you can fully deduct your current year state and local property taxes on real property as an operating expense, any prepaid taxes must be deducted the following year.
- Education Expenses: In order to qualify for an education deduction, you must be able to show that they education maintains or improves skills that are required to be a successful landlord, or is required by law or regulation to maintain your professional status.
For more information on these rental property tax deductions, and the rules surrounding them, visit the IRS Publication 463: Travel, Entertainment, Gift, and Car Expenses.
Okay –so you have a lot of deductions that you can work with now. Your best option when it comes to claiming them is to be diligent with your record-keeping. This means keeping track of all of your receipts, invoices, and bills as expenses arise. Likewise, be sure to use a separate checking account for your expenses, and try to obtain documentation for every transaction that occurs.
So there you have it! As a landlord, there are a lot of deductions that you’re most likely eligible for.
Since taxes can easily eat into a significant portion of your rental income (up to 50 percent according to some estimates!) experienced investors know that taking advantage of the available deductions is key to maximizing their profits. Don’t miss out! Make this year the year that you save.
And don’t forget, if you’re stuck, it’s always a good idea to work with an experienced CPA –ideally someone who’s experienced in preparing taxes for landlords. A good accountant will be able to inform you of tax deductions that you may be eligible for and can keep you from making many common pitfalls that landlords often make when filing, helping you to save when tax time rolls around.
Please Note: While this article contains information that we’ve learned from classes and from working with our clients over the years, please keep in mind that we are not tax professionals. This information is intended to inform and to guide only, and it is not meant to serve in place of tax advice from a licensed tax professional. These principles should only be applied in conjunction with a CPA. To learn more about depreciation as it applies to your own financial situation, please consult a tax professional.