Being a landlord takes a lot out of you! Even if you hire a property management company, there’s still a lot of resources that you need to expend. Luckily, the IRS lets you write off the cost of those expenses to make things easier. Unfortunately, not everyone knows just how much they can write off and just how accessible, as a result, investing in property can be!
What qualifies as an expense?
There are two broad types of real estate expenses: current expenses and capital expenses. A current expense tends to be a one time deal that keeps your rental property habitable or keeps your business running. A capital expense is anything that increases your property’s value or extends its life.
Current expenses can be deducted the year they’re paid. That’s why it’s called a “current” expense. To be deducted, however, the expense must meet the following criteria:
Necessary and Ordinary
These are technical terms. An ordinary expense is one that’s expected for your industry. For example, it makes sense for a landlord to pay a plumber to fix a leak. A necessary expense is one of the expenses presupposed by the very idea of running a business in the first place, like advertising, insurance, interest, maintenance, taxes, and utilities.
The expense’s short-term effect must be greater than it’s long-term effect. Think of the difference between repairing a roof and replacing a roof.
The expense must be directly related to managing your rental.
Reasonable in Amount
Obviously, you want to pay a reasonable amount for any goods or services that you pay for. But you also want to pay a reasonable amount so you don’t get audited. Can you imagine the double whammy of being ripped off and audited?!
Capital expenses are also known as improvements. They must be capitalized and depreciated. If you don’t feel like depreciating them for whatever reason, you still make use of depreciation because the government will treat you as if you did and, as a result, charge you a tax on the amount you would have deducted thanks to depreciation.
1. Deduct Mortgage Interest Payments
You can deduct mortgage payments interest, as well as the interest accumulated on credit cards when you pay for goods or services related to your rental property. The Tax Cuts and Jobs Act capped interest deductions for landlords who make over $25 million off their rentals yearly, but you can get around that by depreciating your rental property for a 30 year period instead of 27.5 years.
In January or early February, you’ll get a Form 1098 from your mortgage lender telling you how much interest you’ve paid in the year. Then, when you file your tax returns, you’ll take the deduction, in most cases, using IRS Schedule E, which is designated for residential property owners.
2. Depreciation for Rental Real Property
Depreciation is when you deduct the cost of owning and maintaining your property over the useful life of your property. Your property’s useful life is designated as 27.5 years for rental properties and 30 years for commercial and retail properties (useful life being the IRS’s term for the amount of time a property can generate cost-effective income). Land doesn’t count toward depreciation, so when you calculate how much you’re going to deduct off your taxes you first have to subtract the cost of land. After that, you just divide your property’s cost by its useful life and that’s how much you deduct yearly.
Keep in mind that when you sell your property that you’ll have to pay what’s known as depreciation recapture on the amount you deducted thanks to depreciation. This tax rate is 24%. As previously mentioned, but worth repeating, the IRS will charge this amount regardless of whether or not you actually take advantage of depreciation. So, you might as well take advantage of this deduction since you can.
To get around depreciation recapture, and capital gains taxes, you can do a 1031 exchange. That’s when you use the profits from the sale of your property to purchase a property (or properties) of equal or greater value soon after the sale. A 1031 exchange is a great way to diversify your investment or get a property that’s easier to manage. And if you die after having made a 1031 exchange but without having finally collected your profit, then your heirs don’t have to pay the deferred taxes! They may still have to pay the estate tax, though, so consulting with a tax professional is a good idea.
3. Repairs & Maintenance
So long as the repairs are ordinary, necessary, and reasonable in amount, you can 100% deduct their cost in the year that you made them. This includes fixing gutters or floors, plastering, repainting, etc. It does not include something like installing a hot tub!
4. Personal Property
Personal property used in rental activity can be deducted over the course of a single year thanks to the de minimis safe harbor deduction (for property up to $2,000 in value), or you can take advantage of a 100% bonus depreciation up until 2020. Examples of personal property are appliances, furniture, and gardening equipment.
5. Pass-Through Tax Deduction
This is a special deduction that’s in effect until 2025. It allows you to deduct the lesser of 20% of your net rental income or 2.5% of how much you paid for your rental property plus 25% of what you pay your W-2 employees. That 2.5% is important because most landlords don’t have W-2 employees. Even if you hire a property manager, you’re likely to do so through a separate entity and, as a result, they wouldn’t count toward your deduction.
6. Real Estate-Related Travel
Travel is a tricky deduction for landlords. You can deduct most of the driving you do for your rental property, like if you have to check out a complaint and then drive to pick up some replacement parts. The cost of travel to make the improvements, however, are deducted using depreciation. To calculate how much you’d deduct you can use the expenses incurred (gas, repairs, upkeep) or the standard mileage rate, which you should confirm on the official website of the IRS. To make use of the standard mileage rate you have to use it in the first year that you start to use your vehicle as part of your rental business.
If your travels require overnight activity, then you can deduct the whole shebang– airfare, lodging, food, etc. You can even have some fun during the trip and still count your trip as a deduction so long as everything is planned outright. Just make sure you document everything because if the IRS audits you you’ll want all of your bases covered. Otherwise, you may have to pay more taxes or even fines.
7. Home Office
A home office, workshop, or any other home workstation can be deducted so long as it meets minimum requirements. This is true even if the workspace exists within an apartment, home, or rental unit.
8. Employees and Independent Contractors
You can deduct what you pay anyone who performs any sort of service toward your rental business. This covers everyone from a property manager to a plumber.
Fire, flood, theft, you name it. Almost any type of insurance you pay for your rental property can be deducted from your taxes. This also includes the cost of the health and workers’ compensation insurance you pay for any of your employees.
10. Legal Fees
Running a rental property takes a lot of resources. It also takes a lot of know-how! Luckily, you can outsource everything to professionals, including knowledge experts. Given how important such services are, it makes sense that you can deduct the cost of accountants, attorneys, financial advisors, property managers, and anyone else whose help you pay for. The fees count as operating expenses so long as they’re related to your rental activity.
11. Losses from Theft or Casualty
In the event of a catastrophic event, like a hurricane or an earthquake, you might be able to deduct a portion of or even all of your losses. The amount you’re able to deduct will depend on your insurance and how much damage your property incurs.
Utilities can be deducted as well. This includes air conditioning, cable, internet, electricity, recycling collection trash removal, etc. If, however, the utilities get lumped into monthly rent then the landlord must count that as income from the tenant.
13. Closing Costs
You can deduct a lot of closing costs, while many others qualify for depreciation. Win/win!
14. Mortgage Insurance (PMI/MIP)
Mortgage insurance can be deducted from the income you make off your rental property.
15. Property Management Fees
It’s hard but not impossible to document the active management of your property if you’re the sole proprietor. Tenant screening systems and property management software make it easier to back up your claims because they provide documentation. To make taxes easier to file many investors who decide to go the route of managing their properties themselves establish an LLC or corporation. If your LLC employs you as the property manager then your entire salary is tax-deductible! If you decide to hire a management firm, then the fees you pay them are 100% tax-deductible.
16. Tenant Screening
All the usual steps you take to screen your tenants are tax-deductible. Background checks, eviction history reports, and all sorts of verification (employment, identity, income, and housing history). To make things easier, you can have the potential tenant to cover those costs directly. Software and websites exist that streamline this process and make it possible for the applicant to easily pay the fees themselves.
17. Phones, Tablets, Computers, Phone Service, Internet
Given that we’ve almost entirely shifted to a technology-oriented society, it makes sense that your phone, laptop, tablet, etc are things that you’d be using for business. So long as you document that you’re using these devices for business, you should be able to write them off your taxes. After all, if you can write off printer paper then why not the device from which you send the documents you print?
18. Licensing Fees
If you have to pay a fee to renew or purchase your landlord or rental license, then that fee is deductible. If you have to pay for a vacation rental license, which you may have to do if you intend to use your property for short term rentals, like an Airbnb, then you can deduct those fees as well.
19. Occupancy Tax
In some states, a tax comparable to sales tax is collected on rental amounts. This is more often done in states where short-term rentals are popular. Arizona, Florida, and New Jersey are three examples of such states. If you’re charged an occupancy-like tax, then you can deduct the amount you pay. Keep in mind, though, that the tax will vary from state to state and from local jurisdictions as well
You can depreciate the cost of a business vehicle, but the actual vehicle’s upkeep can be deducted the year the upkeep is performed. And, as you already know, transportation can be deducted using the standard mileage rate.
Any form of advertising you use can be written off. This includes mailers, newspapers, online ads, and radio. Although, printed rental ads have much more limited reach than online ads.
If you offer a commission or monetary incentive to your tenants to find their replacements before they move out, then that amount can be claimed as a rental expense and deducted on your taxes. So, if you offer $50 to your occupant if they get a friend to move in after them, then that’s a deduction! It also saves you far more than $50!
23. Start-up expenses
Start-up expenses are any expenses that are spent before a business begins. Were your business already running, there’s a good chance your startup expense would just be an operating expense. Although, what makes start-up expenses differently is that they can’t be automatically deducted in just one year. That’s because a start-up expense is a capital expense, which will benefit you for more than one year. In your first year, you can deduct upwards of $5,000 as a startup expense.
Is there a Tax Limit on Loss?
There’s a $25,000 limit on losses if you or your spouse are active participants in the passive real estate business. If, however, your losses exceed $25,000 then you can deduct the remainder the following year. You can keep doing this every year until you sell your property, and then you can recapture the sum of your unused losses against the profits you make from the sale.
Now that you know all the deductions you can make as a landlord investing in rental properties should appear more manageable. There’s, even more, to learn about how rental property income and sales are taxed, which makes investment simultaneously easier and harder. Harder because taxes require effort to file, but easier because there are so many opportunities to save money!