While running a rental property can be a lot of work, one of the best benefits for landlords is the amount of tax deductions available. Tax deductions can reduce the income tax on your rental properties and save you hundreds, if not thousands, of dollars during tax season.
There are several tax deductions rental property owners can take advantage of to save money. Let’s cover the top deductions all investors should take on rental properties, what documentation is needed for the Internal Revenue Service (IRS), and how to claim the deductions when filing taxes.
1. Mortgage Interest
The mortgage interest expense allows rental property owners to deduct any interest paid on a loan taken out to purchase, build, or improve a rental property. Your mortgage company will send you a Form 1098 that shows exactly how much interest you’ve paid over the year, and you can deduct that amount from your taxable income. You can deduct the total interest, but not the money paid toward the principal.
Rental property owners are not subject to a limit on the amount of the debt for this deduction, unlike homeowners itemizing this deduction on their primary residence.
2. Property Taxes
Most state and local governments collect property taxes, and the good news for landlords is that these taxes are deductible from your rental income. If you have a mortgage on your rental, property taxes are usually included in your monthly mortgage payment.
Property taxes are calculated based on the assessed value of the property, and the total amount can vary from year to year. Your local government or mortgage lender will communicate any changes in your property taxes that affect your mortgage payment and how much you can deduct from your rental income.
If your local municipality charges you a hospitality tax or occupancy tax on your investment property, those taxes are deductible as well.
3. Rental Property Depreciation
Like any residence, rental properties lose value over time due to wear and tear from use or obsolescence. The IRS allows landlords to deduct a portion of the property’s cost each year as depreciation expenses if the property meets these requirements:
- The property is used for business or income-producing activity.
- The property has a determinable useful life (meaning it’s something that wears out, decays, gets used up, or loses its value from natural causes).
- The property will last for more than one year.
- The property was not placed in service and later no longer used for business within the same year.
Depreciation only applies to the property structure and any improvements made to it. The land isn’t depreciable since it never gets used up. Property depreciation for residential rental properties is calculated evenly over 27.5 years (the time period the IRS considers the “useful life” of the property). That means your yearly deduction is 1/27.5th of the property’s cost.
Improvements to the property, such as a new roof, are also depreciation deductible if they meet the requirements. The depreciation life of the improvement may be less than 27.5 years, which will affect the yearly depreciation deduction you can take on that particular upgrade. Report each depreciation deduction with Form 4562 from the IRS.
It’s important to note that the rental property tax deduction is a deferred benefit. If you sell your property for more than its depreciated value, you’ll owe depreciation recapture taxes on that profit. To avoid this, savvy real estate investors use a 1031 tax-deferred exchange, which allows investors to purchase another investment property and carry the proceeds and the taxes owed forward into the next property.
4. Business Expenses
Landlords can deduct business operating expenses to lower their total taxable rental income. To qualify for a tax deduction, the expenses must be considered ordinary and necessary, meaning the expenses are common in the real estate industry and the expense is needed to run the business.
Here are some common fully deductible expenses for residential rental properties:
- Advertising and marketing
- Property management company fees
- Garbage collection
- Pest control
- Leasing costs or commission fees
- Equipment rentals
5. Insurance Premiums
Landlords typically have insurance to protect their assets in the event of property damage or other potential losses. Luckily, these insurance premiums are tax deductible for rental property owners. Premiums for landlord insurance, flood insurance, eviction insurance, and any other coverage you have on your rental property are eligible for a tax deduction.
6. Maintenance and Repairs
Repair and maintenance costs for rental property can get tricky when it comes to tax deductions. Regular maintenance or repairs, such as changing air filters or fixing plumbing issues, are fully deductible for landlords.
However, if you have work done that increases the value of the property, such as installing new flooring or a roof, it’s considered a capital improvement. Capital improvements do not qualify under a maintenance and repair deduction. Those costs can be recovered through a depreciation deduction.
Rental property utilities expenses are deductible, such as internet, electric, water, sewer, or trash collection. If you require tenants to cover some of their utilities, you can only deduct the expenses you pay for. Depending on your situation, it might be worth raising the rent and covering more utilities to have more deductions against your rental property income. Discuss your options with a tax professional to see what works best for you.
8. Legal and Professional Fees
If you use any software or consult a professional to help you run your business, those expenses are deductible. Here are a few examples of common legal and professional fees for landlords:
- Fee for a CPA to file your taxes
- Fee for an attorney to draft lease agreements or other legal documents
- Legal fees or court filing fees to evict tenants
9. Homeowners Association Fees
If your rental property belongs to a homeowners association, you’ll have to pay those fees as the property owner. However, you’re able to deduct these fees to lower your total taxable rental income.
10. Travel and Transportation
All costs associated with traveling to or from your rental or travel taken for business purposes are tax deductible. Here are a few examples of when you might travel for your business that qualify for a tax deduction:
- Showing the property to potential tenants
- Collecting rental income at the property
- Meeting with a contractor at the property
You can take this deduction using the IRS standard mileage deduction rate and the Schedule C Form 1040. Log your travels with the date, the trip’s purpose, and the distance traveled if you’re driving.
11. Office Space
Whether you work on your rental business at a home office or at another building, you can deduct office space expenses from your rental income. This includes office supplies, utility expenses, and the cost of the space. The IRS has a simplified home office deduction that can make it easy for you to calculate and claim on your tax return.
What Rental Property Expenses Are Not Deductible?
Landlords can deduct many of their business expenses from their taxable income, but some expenses are not deductible, such as:
- Lost rent because it wasn’t paid or collected or because the property was vacant
- Personal expenses
- Fines or penalties
How to Claim Rental Property Tax Deductions
Keep detailed records of expenses and income from your rental property business throughout the year to make filing taxes easier. You’ll need itemized proof for each deduction you claim. Here are a few examples of itemized proof for rental property tax deductions:
- Form 1098 to prove the mortgage interest paid
- Receipts from property repairs and maintenance
- Receipts from insurance premiums
- Receipts from professional services, like legal fees
- Schedule C Form 1040 to log business car expenses and the standard mileage deduction rate
When you’re ready to claim your rental property tax deductions during tax season, all of your deductions must be filed with Form 1040 or 1040-SR, Schedule E, Part I. List your total income, expenses, and depreciation for each rental property. You will also need to complete and view the instructions for Form 4562 to list the correct amount of depreciation. If you have more than three rental properties, the IRS asks investors to submit as many Schedule E documents as are needed to list all the properties.
While you might be tempted to get rid of your records and receipts after filing your taxes, hold on to those documents. The IRS recommends keeping your tax records for at least seven years in case you are ever audited.
Tax deductions are key to running a successful, profitable business, but tax regulations and filing deductions can get complicated. Don’t be afraid to reach out to a tax professional for help as you fill out the forms (their fees are deductible, after all).
Dreading tax season?
Not sure how to maximize deductions for your real estate business? In The Book on Tax Strategies for the Savvy Real Estate Investor, CPAs Amanda Han and Matthew MacFarland share the practical information you need to not only do your taxes this year—but to also prepare an ongoing strategy that will make your next tax season that much easier.
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.