One of the many benefits to owning rental property, and a key to running a profitable investment is the deductions. The deductions include expenses related to buying, maintaining, and managing the property. As a real estate agent, I’m not licensed to give tax or legal advice. This article is meant to be a helpful aid for assessing the overall tax benefits of owning investment real estate. This is a list I’ve accumulated from my own experience and from my clients, so use it as a guide for when you consult with your accountant or attorney.
The most common tax deduction most homeowners and rental property owners use is mortgage interest. For many owners, mortgagee interest is their largest deductible expense. Just to clarify, you can’t deduct the portion of your mortgage payment that goes toward the loan principal. Instead, the deduction applies to payments towards your interest charges. Principal and interest are often listed separately in your monthly mortgage statement and your mortgage servicer should account for interest paid in an end-of-year tax form (e.g., IRS form 1098).
In addition to mortgage interest, you can deduct origination fees and points you paid to purchase or refinance your rental property, interest on unsecured loans used for improvements, and credit card interest for purchases related to your rental property. Come tax time, you must have already spent money on these purchases to qualify.
The second most common tax deduction on investment property is property taxes. In California property taxes are about 1% of the purchase price or assessed value plus any local Mello-Roos or assessments. Thanks to prop 13, taxes can only go up a maximum of 2% per year. If your property is located in a city that has rental licensing requirements, you may also be able deduct any accompanying landlord or vacation rental license fees.
In addition to being able to deduct property taxes, if you manage short-term rentals, you may be charged an occupancy tax, which is very similar to sales tax, and as the property owner you may also be able to deduct those too. Also, if you pay sales tax on business-related items or inspection fees, be sure to deduct those as well.
Real Estate Depreciation
The third most common tax deduction on investment property is depreciation. Over time, wear, tear and obsolescence lower the value of your rental property and its contents. This process, known as depreciation, is usually tax deductible. The deduction can be taken for the expected life of the property, but it must be spread out over multiple years. As far as the IRS is concerned, rental properties can depreciate over 27.5 years and in only pertains to the value of the structure, not the value of the land.
In addition to being able to depreciate the value of your structure, you may also be able to claim the value of the equipment that helps you run your rental business, like your computer or automobile.
You may also be able to claim deductions for improvements you make to the property that add value or extend its life. According to the IRS, examples of improvements include additions such as bedrooms, bathrooms, decks, garages, patios or porches as well as things like landscaping, heating, air conditioning, plumbing, insulation and interior upgrades such as built-in appliances, wall-to-wall carpeting, and other miscellaneous repairs like roofing, double-pane windows and security systems. To qualify as a deductible expense, it must be expected to last for more than a year, be valuable to your rental business, and lose value over time.
The fourth most common tax deduction on investment property are insurance premiums. Lenders can stipulate that homeowners get an insurance policy before securing their mortgage, and luckily, any form of insurance is considered an ordinary and necessary rental property expense and is thus deductible. The deduction applies to basic homeowners’ insurance as well as special peril and liability insurance.
If you have employees, you can usually deduct the cost of their health and workers’ compensation insurance too. Although insurance premiums tend to be a bit higher for rentals, this deduction can help offset that. Property owners can also deduct losses, including those caused by earthquakes, floods, or theft.
Maintenance and Repairs
The fifth most common tax deduction on rental properties are maintenance and repairs. While home improvements are deductible through depreciation, the tax code does allow you to deduct certain repair and maintenance costs separately. A big difference is that these efforts keep your property in rentable condition, but do not add significant value. This deduction is often taken fully in the year the expense was incurred, rather than over time.
When doing maintenance and repairs, If you hire someone else to do the work, you may be able to deduct the labor costs. The same goes for costs associated with hiring or employing property or on-site managers, as well as homeowner association and condo fees. If you take the “do-it-yourself” approach, you can often deduct any rental fees for tools and equipment.
The sixth most common tax deduction for rental properties is utilities. While every housing provider handles utilities differently, if you choose to cover things like gas, electricity, water, heating or AC for your tenant, those expenses may be deductible. If you pay for internet, cable or satellite, you should be able to deduct those as a utility expense as well. Even if your tenant agrees to reimburse you for utilities later, you can continue to file the rental property deduction and claim the reimbursement as income.
Legal and Professional Fees
The seventh most common tax deduction for rental properties is professional fees. Property owners can deduct certain professional fees in relation to the rental property. If you use a CPA or computer software to prepare your tax returns, be sure to deduct the cost. If you hire a lawyer to oversee rental paperwork at any point in the year, you can deduct those hourly fees. If you used a real estate agent to find your tenants, you may be able to deduct the commission as well as any advertising or marketing costs.
Even advisor services can often be written off so long as you meet to discuss the rental property. If you have to evict someone, your legal and court filing fees are usually deductible. These are all considered operating expenses.
Travel and Transportation Expenses
The eighth most common tax deduction for rental property is travel and transportation expenses. If you’re a property owner who travels to multiple properties or your rental is located far from your residence, your transportation expenses may be deductible. This includes paying to show your rental property, collecting rent in person, and keeping an eye on your rental property throughout the year. There are two ways that you can deduct travel. The first is actual expenses or you can use the standard mileage rate.
The ninth tax deduction for rental property is office space. Whether you conduct business in a commercial property or a spare bedroom, you can often deduct the accompanying costs. Square footage or rental cost will probably be the largest expenses. However, you may also be able to include the price of a printer, computer software and anything else you use to run your real estate business.
Keep documentation of the purchases you make and record the time you spend managing your rental property. This is one of the most commonly flagged deductions, so be sure you’re keeping good records and being honest about the breakdown between business and personal use.
How to Claim Rental Property Tax Deductions
You’ll most often file rental property tax deductions the same year you pay the expenses. Work with your tax professional to determine the extent of your deductions and you overall tax strategy. The process will be much more manageable if you keep detailed records of all income and costs related to the property as they occur. Plus, if you’re ever audited, you’ll have to provide proof for every deduction you claim.
Real estate has a myriad of tax deduction benefits that other investments like stocks don’t. This is one of the unique differentiators that can make real estate an exceptional investment, and why it is an outstanding go-to vehicle for wealth building.
If you have ideas for other tax deductions related to rental properties, I would love to know so that I can share the information.
If you would like to have a conversation about creating a personalized strategy for cashing out with minimal or no capital gains tax, or if you would like help with buying, selling or doing a 1031 exchange, I’m happy to help! Feel free to contact me. I can be reached at 714.330.9999, [email protected], or you can visit my website at InvestingInTheOC.com. I’m Mercedes Shaffer, a real estate agent with Coldwell Banker, helping you build wealth one door at a time. DRE 02114448.