Owning rental property can be a good way to supplement (or even replace) your regular income. After all, if you are able to find good tenants who pay on time every month, you can make substantial money while you’re at your day job, playing with your kids or even lying on the beach.
According to Business Insider, one of the ways that people get and stay wealthy is to have passive income sources, such as rental income. However, making money while you sleep isn’t the only benefit to owning rental property. Being a landlord also qualifies you for a number of tax deductions that can help ease your tax obligation or increase your refund each year.
Top 15 Tax deductions for landlords
1. Mortgage Interest
If you borrowed money to purchase your rental property, the interest you pay to the lender can be tax-deductible. If you are yet to pay off your mortgage, you will most likely be paying real estate taxes through your mortgage broker or bank. The bank will outline this in form 1098, Mortgage Interest Statement form. You will need to report your share of the interest when submitting your tax using Form 1040 Schedule E.
Any commissions you offer property managers, salespeople and tenants can be deducted. This includes any monetary incentives given to tenants that find new tenants if they are moving out.
3. Depreciation of Assets
Depreciation is considered a capital expense, providing a means to recover the costs of an income producing property, over the life of that property. You can use form 4562 to claim your deduction and amortization for your property.
4. Repairs, Maintenance and Improvements
The money you spend on maintaining your properties can also be deductible. This includes paying to have the lawn mowed, having the carpet cleaned or having the gutters and drainage system cleaned each fall.
Repairs vs Improvements
There is a difference between ‘repairs’ and ‘improvements’ when claiming expenses. A repair is something you have done in order to maintain the property, or according to the IRS, something that “does not add significant value to the property or extend its life.”
In contrast, an improvement results in the betterment of your property. It can either restore the property or adapt it to a new or different use.
A betterment may include expenses spent:
- fixing a pre-existing defect
- increasing the capacity, strength or quality of your property
- enlarging or expanding the property
A restoration includes expensed used for:
- Replacing a structural part of the property
- Repairing damage
- Rebuilding your property to a like-new condition
Expenses used for adaptation can be claimed if they are used to alter the property beyond the intended use when you began renting to tenants.
Examples of home Improvements given by the IRS:
Full List of Deductions
Lawns and Grounds
- Retaining wall
- Sprinkler system
- Swimming pool
- Storm windows, doors
- New roof
- Central vacuum
- Wiring upgrades
- Satellite dish
- Security system
Heating & Air Conditioning
- Heating system
- Central air conditioning
- Duct work
- Central humidifier
- Filtration system
- Septic system
- Water heater
- Soft water system
- Filtration system
- Built-in appliances
- Kitchen modernization
- Wall-to-wall carpeting
- Walls, floor
- Pipes, duct work
5. Utilities and Energy
If you pay for any of the utilities at your rental property as stipulated in the lease agreement, you may be able to claim them as an expense. These utilities include electricity, gas, heating oil, water and sewer expenses, and trash and recycling not paid for by the tenant.
You may be able to claim a federal tax credit if you make any improvements or install appliances at your property that makes it more energy efficient. So get green and start reducing your impact by making your property energy efficient now!
Residential energy property expenditures
The goal of residential energy-efficiency tax credits is to encourage individuals to increase residential energy-efficiency investments.
There are two different types of credits that can be claimed on your property.
- The first credit, the nonbusiness energy property tax credit (IRC §25C) regards energy-efficiency improvements made to the building envelope (insulation, windows and doors) and for the purchase of high-efficiency heating, cooling, and water-heating appliances purchase.
- The second credit, residential energy efficient property tax credit (IRC §25D), allows taxpayers to claim a tax credit for properties that generate renewable energy (e.g., solar panels, geothermal heat pumps, small wind energy, fuel cells) installed on their residence.
For more information on how you can make your home or rental property more energy-efficient (and possibly claim it as an expense depending on state law), visit the US Department of Energy’s Energy Saver website.
6. Travel Expenses
Local travel for your rental business
Any local driving you do to manage your rental properties may also be claimed as an expense, if the driving is intended for collecting rental income, managing, conserving or maintaining your rental property. It can only be claimed, however, if your home is considered the place of business in which you manage your property (see below).
You cannot deduct the expense if the primary purpose of the trip to the property is to improve the property (the cost of improvements is recovered by taking depreciation).
You can use the standard IRS mileage deduction if you drive your own vehicle or deduct the cost of a bus ticket if you use public transportation. Parking and tolls are also deductible. You will need to use form Form 4562, Part V to deduct these expenses. For more information on how to deduct travel expenses, read chapter 4 of Publication 463 or page 4 of Publication 527.
Long distance travel
Most landlords won’t have overnight travel expenses associated with their rental business. However, if you market your properties to people looking to move into your area, you could potentially use hotel, flight, and meal expenses as a tax deduction if you live a considerable distance from the property, such as interstate or overseas.
7. Home office & Operating Expenses
If you use a portion of your home as the office where you manage your property as a business, you can deduct a portion of your home expenses including:
- Stationary such as ink, paper, pens, staples etc.
- Rental software
- Phone and internet bills
You can also deduct a percentage of those expenses equal to the percentage of square footage your home office occupies, compared to your entire home structure. For more information on expenses claimed for your home office, read publication 527 on business use of your home.
8. Marketing Costs
Another deduction you can claim is the costs associated with finding and keeping tenants. This includes advertising, the cost of application forms, flyers and even the cost of your website (if you use it to attract renters.)
9. Legal and other Professional fees
If you require the services of a lawyer, attorney, accountant, or tax professional you may be able to claim the fees as an expense. This can include tax preparation fees and expenses you paid resolving tax issues on your rental property (including preparing part I of Schedule E form 1040, Supplemental Income and Loss). If you feel like you might be too busy to manage your property, you might need to hire a property manager.
10. Start-up Expenses
Your property can be considered a start-up business and as such, you may be able to claim costs incurred for creating or investigating the acquisition of your active trade or business. These expenses can only be claimed if the cost is:
- incurred operating an existing active trade or business or
- incurred before the day your active trade begins.
Some of the costs you may be able to claim include:
- Analysis of the market including examining potential properties and researching local property markets
- Advertisements for gaining potential tenants
- Salaries and wages for any employees hired during this process
- Travel to and from the property or to real estate agencies etc.
- Fees for professional services rendered including property managers etc.
11. Employees and Independent Contractors
You might be able to deduct wages if you have hired staff to work on the property, either full time or part-time. This can include management fees as previously mentioned, but can also refer to contractors hired to maintain or fix the property, or if you have hired a superintendent or groundskeeper.
If you use your vehicle for the purpose of your business, e.g. the maintenance of your property, you can choose from the following two methods for deducting the expense:
- Standard Mileage Rate
- Actual Car Expenses.
The standard mileage rate refers to the use of a car you own within the first year of the business operation and the vehicle must be used throughout the entire lease period. You can then choose to claim either the standard mileage rate or the actual expenses after the first year. As an example, the standard mileage rate for 2015 was 57.5 cents per mile.
The actual car expenses refers to expenses like depreciation, licences, gas, oil, tolls, insurance, parking fees, repairs, registration, tires, garage rent and insurance.
Note: if you choose to use the standard mileage rate that year, you cannot deduct your actual car expenses in that year. You need to include form 4562 part V in your tax return. For more information regarding vehicle expenses read IRS publication 463.
The insurance premium you use to protect your property is generally deductible. The types of insurance that may be claimed as an expense include:
- Insurance that covers fire, storm, theft, accident, or similar losses.
- Credit insurance that covers losses from business bad debt.
- Group hospitalization and medical insurance for employees, including long-term care insurance.
- Liability insurance.
- Malpractice insurance that covers your personal liability for professional negligence resulting in injury or damage to patients or client.
- Workers’ compensation insurance set by state law that covers any claims for bodily injuries or job related diseases suffered by employees in your business, regardless of fault.
14. Theft and casualty losses
Theft is defined as the unlawful taking and removing of your money or property with the intent to deprive you of it. Causality refers to the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual. Such events include a storm, fire, or earthquake.
In the event your building is vandalized or harmed by a natural disaster or fire, the amount of loss not covered by your insurance can be considered a tax deduction. If your insurance company has paid you for losses incurred due to theft and casualty, you may also be able to claim it as a gain instead of a loss.
15. Passive Activity Losses
Most rental real estate activities are ‘passive’ activities, meaning, you receive income mainly for the use of tangible property, rather than services. Renting your property to a tenant is generally considered a passive activity, even if you materially participated in the activity. Deductions or losses from these activities are limited. Usually, you cannot offset income or losses from passive income activities. According to the IRS, there are two types of passive activities:
- Trade or business activities in which you do not materially participate during the year.
- Rental activities, even if you do materially participate in them, unless you are a real estate professional.
However, there is an exception: a special $25,000 allowance. If you or your spouse actively participated in a passive rental real estate activity, the amount of the passive activity loss that is disallowed is decreased and you can therefore deduct up to $25,000 of loss from the activity from your non-passive income. This allowance is an exception to the general rule, so ask your tax accountant if you qualify for it.
For more information on any of the above topics read the following publications:
Publication 463: Travel, entertainment, gift and car expenses.
Publication 527, Residential Rental Property by the Department of Treasury
Publication 529, Claiming Home Office expenses, Legal & Professional Fees
Publication 535, Business Expenses, Chapter 6: Insurance & Chapter 8: Business Start Ups.
Forms you will need:
Don’t let tax get you down, use it to your advantage!
Remember to save all documentation that supports your deduction claims including receipts for parts and supplies that you bought for the rental property, invoices from contractors or individuals that worked on the house, and credit card receipts for things like website domain registration. Preparing your tax return can get a little complicated, but keeping yourself informed can be an invaluable tool in calculating the deductions you deserve on your investment property.
If you’re having trouble with your tenants, thinking of terminating your lease agreement, or considering giving tenants a notice of eviction, understanding how to deal with tenant issues is crucial to a successful transition.