When you own rental property, you are essentially running a small business. This means that you can use your business expenses to reduce your business income, thus reduce your overall taxes. It is not uncommon for rental property investors to pay no income tax at all. Here are ten primary tax deductions for rental property owners that you can use to reduce your rental income for income tax purposes.
1. Mortgage Interest
Just as you would report your mortgage interest on your primary residence on Scheduled A of your income tax return, you can do the same with mortgage interest from a rental property. However, the interest deduction is reported instead on Schedule E, Supplemental Income and Loss, where the interest is fully deductible against rental income.
2. Real Estate Taxes
Likewise, real estate taxes are also fully deductible as a business expense of the property.
3. Utilities Paid by the Landlord
Any utilities paid on the property directly by the landlord are considered deductible for tax purposes. For example, the tenants may pay their own heat and electric, while the landlord pays for water and sewer and trash removal. The landlord can deduct the expenses for water and sewer and trash removal, but not the heat and electric.
4. Landlord Insurance
You can also deduct the cost of any insurance for the property. Homeowners insurance can obviously be included, but so can flood — or earthquake-insurance if is either are necessary.
Private Mortgage Insurance (PMI) is also deductible for landlords, even though it is not usually deductible for individuals who live in owner-occupied homes.
5. Repairs and Maintenance
As the owner of a rental property, there will always be maintenance costs as well as occasional major repairs. Maintenance costs can include engaging the services of lawn service, a pest or termite service, cleaning services in between tenants, as well as the cost of painting and other minor repairs.
Major repairs, such as the replacement of the roof or any major component systems such as air conditioning or heaters, are considered capital improvements that must be depreciated over several years.
6. Homeowners Association Dues
This is a common fee associated with condominiums and with swim and tennis neighborhoods. There is usually an association that maintains common elements in the community, such as the physical structures in the case of condominiums, or the pool and tennis courts in a neighborhood. The neighborhood association will assess monthly or annual fees to pay for the maintenance of these amenities.
Those fees can be fully deducted as a business expense if the rental property is located in such a neighborhood.
One of the finer aspects of depreciation is that it can eliminate an actual profit on a rental property. For example, after collecting rents for the year and deducting all expenses paid, you might show a $5,000 profit. But once depreciation is factored in as an expense, the profit is gone, and the tax liability disappears with it — even though the property actually made money for you.
Generally speaking, depreciation is based on the purchase price of the property. It is calculated based on physical improvements on the property only. For example, let’s say that you purchased the property for $250,000; out of that $50,000 represents the land value of the property, and $200,000 are the improvements.
Depreciation is calculated on the value of the improvements, or $200,000. As a residential rental property, this value will be depreciated over 27.5 years according to IRS charts. Any improvements to the property after purchase are set up on a separate depreciation schedule, based on the expected life of that particular improvement.
8. Management and/or Broker Fees
As the owner of rental property, you may have management fees or even broker fees. Management fees are fees you pay to a property manager who manages your property for you. Usually, they collect a certain percentage of the rental income so that the expense can be substantial, and it is also fully deductible.
Broker fees can apply if you ever use a real estate agent or apartment broker to help you find tenants for your property. Brokers typically charge a percentage of the annual rent, or even a full months rent as a fee for their services, and this fee is also fully deductible for tax purposes.
9. Your Travel Expenses
As the owner of rental property, you will have to make trips between your home and the rental property. You can deduct these expenses. You can either deduct the actual cost of expenses you pay for your car, and allocate a percentage to your rental property activities, or you can take the standard mileage allowance. The IRS allowance is 54.5 cents per mile for 2018 and 58 cents for 2019.
If the property is located more remotely, you can deduct airfare, hotel costs, and any other expenses related to your trips.
10. Incidental Business Expenses
You will probably have general business expenses not specifically related to the property itself. These can include a home office, bank account fees on an account specific to the rental activity, postage, office supplies, and an allocation of the percentage of your tax preparation fees related to your rental business.
Each of the expenses listed above — and some that aren’t — can be deducted for rental property purposes. If the expenses on the property are higher than the income, resulting in net loss, there are special rules that apply as to whether or not the loss can be fully deducted. The calculation is relatively complex, but it is fully addressed in the IRS Publication 527.
There are a lot of tax benefits for being a landlord. Your best policy is to keep track of all the income and expenses associated with your rental property, along with your travel log. Find a tax advisor with a good understanding of real estate investing to help you maximize your tax deductions and avoid mistakes.