A rental property can be a fantastic source of income and offers great tax breaks. Landlords can significantly reduce their tax liability by claiming specific rental property tax deductions, such as deductions for mortgage interest, depreciation, and maintenance. If you are a landlord, then knowing the available deductions and the rules for claiming them can help you make the most of every deduction you are entitled to. To ensure that your documentation is in order when it comes time to file your taxes, continue reading to learn more about common tax deductions and how to keep track of your expenditures.
Here are 10 rental property tax deductions you can’t afford to miss!
One of the most significant tax breaks available to owners of rental properties is depreciation because it lowers taxable income without reducing your property’s actual cash flow. Depreciation is the method used to spread out the cost of purchasing or improving rental property over the course of its “useful life”. The “useful life” of the entire residential property is 27.5 years. Meanwhile, items like a new water heater only have a “useful life” of 5 years. Depreciation can be claimed beginning on the day the property is ready for rental.
- 27.5 years – rental structure
- 15 years- fences, driveways, and landscaping
- 5 years – new appliances, flooring, and furniture
An improvement is defined as the addition of a new item or the upgrade of an already existing item. Generally, any change that raises a property’s worth use is considered an improvement and must be depreciated. Improvements to rental property may require up to 27.5 years of depreciation. Examples of improvements include:
- Roof replacement
- Installation of HVAC system
- Installing wall-to-wall carpeting
- Installing a wheelchair ramp
2. Cost Segregation
The cost segregation study is a helpful tax planning tool that allows real estate investors to reduce their taxes and increase cash flow by accelerating depreciation deductions.
Rental properties typically depreciate over 27.5 years for residential properties or 39 years for commercial properties. However, a property is made up of several parts, some of which can depreciate over a shorter period. The goal of cost segregation study is to segregate the cost components of a building into the proper asset classifications to identify the components of your property that can be depreciated over 5,7 and 15 years. Property that was acquired after Sept. 27, 2017, can even qualify for 100% bonus depreciation (until 12/31/2022) which means owners can immediately expense the entire cost.
By conducting a cost segregation study, which essentially splits up all of your property-related costs into the appropriate property classes, you can more precisely determine your depreciation deductions. Typically a cost segregation study reclassifies 20–40% of a property to an accelerated recovery period. A cost segregation study includes the following components:
- A property’s non-structural elements: Items that are not required for the building’s operation and maintenance are referred to as personal real estate assets. These could include house furnishings, equipment, and appliances.
- Land improvements: Parking lots, concrete stairs, pathways, fencing, driveways, and landscaping are all eligible for land improvement tax deductions. Landscaping itself can be separated into lighting, plants, trees, shrubs, and rocks into different pieces under cost segregation tax rules.
- Indirect construction costs: Architectural and Engineering fees, building appraisals, and construction management are a few indirect construction expenditures.
3. Repairs & Maintenance
The expenses incurred to keep a rental property in good operating condition can be deducted from your gross rental income.
Repair vs. Improvements
In general, if repairs and maintenance are done to keep your property in top condition, they are fully deducted from your taxes in the year they are completed. As previously mentioned, changes to a property that increase a rental property’s value would not qualify for a full deduction in a single year. They are considered capital improvements and are only partially deductible in the year they are paid.
The IRS has established three general guidelines, known as “Safe Harbor”, that can be used to distinguish between maintenance costs that can be written off and those that must be capitalized and depreciated:
1. De Minimis Safe Harbor: apply to small invoices of $2,500 or less.
2. Safe Harbor for Small Taxpayers: you may deduct the costs right away if the entire cost of repairs and maintenance for your property is less than $10,000 or 2% of the unadjusted property basis, provided that your total income is less than $10 million and the unadjusted property basis is less than $1 million.
3. Routine Maintenance Safe Harbor: if four requirements are satisfied, repairs are considered normal maintenance;
- Recurring activities performed with a rental property
- Result of normal wear and tear
- Keep the property operating efficiently
- Repairs will need to be done more than one time during a 10-year period
4. Interest Payments
The majority of property owners are aware that they may deduct their mortgage interest, but they frequently neglect to deduct the interest they have paid on other loans or credit cards. The most common deductible interest payments include:
- payments of mortgage interest on loans used to purchase a rental property
- mortgage interest payments made for loans taken out to upgrade the rental property.
- Interest on personal loans for any items used in a rental activity.
- Interest on credit cards for goods or services used in a rental activity.
Note: Any fees you paid to obtain the mortgage for your rental property are not deductible. These costs are added to your basis in the property and depreciated together with it. These include:
- legal fees
- mortgage commissions
- title protection
- recording fees
- installation fees for utilities
- transfer taxes
- any amounts that the seller owes but that you agree to pay, such as back taxes, mortgage fees, charges for upgrades or repairs, and sales commission.
5. Property Taxes
Property taxes are a recurring cost of ownership when purchasing a rental property. Nearly all state and local governments collect property taxes. Depending on the area where your rental property is situated, they could be as little as a few hundred dollars or several thousand. Fortunately, property taxes are fully deductible from rental income.
Utility costs may be covered by tenants directly or included in the rent, depending on the landlord. Frequently, tenants are in charge of paying their own bills and utility payments. However, landlords occasionally cover the cost of utilities. Landlords that provide the utilities deduct the cost of the utilities as an operating expense. Here are several common utilities that can be deducted:
- Heating bills
- Air conditioning
- Trash & recycling
- Internet, television & phone services
Landlords can deduct ordinary and necessary travel expenses if the purpose of the trip is to collect rent or manage, preserve, or maintain the rental property.
The following are some examples of traveling primarily for rental activities:
- traveling to show potential tenants the property.
- traveling to building supply stores to purchase supplies you’ll need for your rental property.
- travel costs incurred to speak with or interview members of your neighborhood real estate team, such as a general contractor, accountant, lawyer, leasing agency, property manager, or lender.
- travel expenses to attend a seminar, trade show, or other gathering to further your knowledge to help in your rental activity
Here are a few common rental property travel expense deductions:
- fares for airplanes, trains, or buses
- expenses for taxis, trains, and buses
- car rentals for days you work at your rental activity
- laundry and dry cleaning expenses
- lodging costs incurred while you are away; as well as meal expenses
- costs associated with shipping bags or other items needed for your rental property
8. Car Expenses
Landlords may deduct car or other vehicle expenses in the year it was incurred as long as the travel was ordinary and necessary for the rental business, either using the actual expense method or the standard mileage rate.
When using the standard mileage rate, you deduct a fixed amount (in cents) for each mile you travel for your rental activity. The IRS business mileage rate for miles driven between January 1, 2022, and June 30, 2022 is 58.5 cents per mile. The mileage rate increases to 62.5 cents per mile for the period of July 1, 2022, to December 31, 2022. To use the actual expense method, you need to figure out the actual costs of operating the vehicle for business use. Your deduction will be determined by multiplying the cost of your vehicle’s expenses by the percentage of business use.
You can write off the expense of any trips you take from your home to another location for your rental activity if you have a home office that qualifies as your primary place of business. This allows you to deduct quite a bit for travel. For example, you can write off the expense of traveling from your house to your rental property or to the bank.
9. Professional Services
It’s possible that you won’t be able to handle every part of renting a property by yourself. Hiring experts will save you time and money. Professional fees related to the rental property are deductible expenses. The following are a few examples of professional and legal fees:
- legal work to file LLC entity
- legal review or preparation of lease documents
- bookkeeping services
- tax planning and tax filing preparation
Any money spent on advertising your property, letting potential tenants know it is available, or on anything else linked to the property, such as looking for a contractor, is deductible as part of your ordinary operating costs.
There are several tax advantages to owning a rental property, but in order to claim them, you must have the evidence to back up your claims. Therefore, you must maintain records of your rental property tax deductions to show the IRS that the claimed expenses are valid. Documented proof can be in the form of receipts, canceled checks, or paid bills. The IRS may impose additional taxes, fines, and interest for the tax that should have been paid if you are audited and don’t have the documentation to support your cost deductions.
Rental property owners must constantly look for methods to boost their return on investment. Utilizing these valuable tax deductions is a great way to protect the income earned as a real estate investor. We recommend that you consult with an experienced tax accountant when starting, operating, and selling your rental property business because the tax laws affecting rental properties are complex and regularly change.
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