You work hard. You deserve a little extra from your real estate investment. After all, who wouldn't want the tax advantages that come with owning rental real estate?
The information related to deductions is too much to fit in a single article, but the hope is that this will help you understand the basics of what deductions are available to you and how they affect your taxes.
Understanding Tax Deductions
Before we get into specific deductions, it's important to understand what a tax deduction is. In simple terms, when you write a check for your rental property (repairs, office expenses, etc.) it is not a dollar-for-dollar savings. Sorry to burst the bubble.
If you're in the 22% tax bracket, your $4,000 expense becomes a tax savings of $880. Keep this in mind as you read on. It's more accurate to think of a deduction or write-off as a discount. You were going to spend the money anyway, but at least you save some in taxes. This is key.
Understanding this can help inform what kind of expenses you pay for, before you go hog-wild and buy that new G-Wagon "for your business".
Side note: don't let the tail wag the dog. Most people are in the cash-saving business, not the tax-saving business. My goal is to help you do both, but at the end of your life, you're going to measure your financial success based on the wealth you built not the tax you saved. Of course, wealth building includes tax savings, but reducing your taxes by spending cash doesn't make you the coolest person at the Christmas party.
Common Rental Property Expenses Tax Deductible
Mortgage Interest
One of the largest deductions for rental property owners is mortgage interest. If you finance your rental property with a mortgage, you can deduct the interest from your taxable income. This expense is often one of the highest for property owners.
For example, if your mortgage interest payment for the year is $10,000, this amount will significantly reduce your taxable income, saving you hundreds or even thousands of dollars in taxes, depending on your tax bracket.
Property Taxes
Property taxes are also deductible for rental property owners. You can subtract the amount you pay in property taxes from your rental income. This straightforward deduction can lead to significant tax savings.
Operating Expenses
In addition to mortgage interest and property taxes, several operating expenses are deductible. These include:
Repairs and Maintenance: You can deduct costs for necessary repairs, such as fixing plumbing issues or replacing appliances. Keep in mind that repairs are different from improvements, which may require capitalization and depreciation.
Management Fees: If you outsource property management, those fees can be deducted. For example, if a management company charges you $1,200 annually, you can fully deduct this expense.
Utilities: If you pay for utilities like water, gas, or electricity, whether the property is rented or vacant, these costs are deductible as well.
Depreciation
Depreciation is another powerful deduction that is unfortunately often overlooked by property owners. It allows you to deduct a portion of your property's purchase price over its useful life (27.5 years for residential properties). For instance, if your property was purchased for $275,000, you can claim a depreciation deduction of about $10,000 per year. This deduction can help lower your taxable income significantly.
Travel Expenses
If you travel to your rental properties for inspections or meetings, those travel expenses can also be deductible. You can track mileage or actual travel costs based on your record-keeping method. For example, using the standard mileage rate of 65.5 cents per mile (as of 2023) can add up quickly if you make multiple trips for property management.
Insurance Premiums
Insurance premiums, including homeowners insurance and landlord insurance, are also deductible. These costs can take a bite out of your profits, but the good news is they can be deducted on your taxes.
Legal and Professional Fees
If you seek legal advice or hire professionals to assist with managing your rental property, those fees are typically deductible. Yes, this includes tax advisory and preparation fees (let me know if you want to increase your tax prep fees to increase your deduction. Win win?)
Casualty Losses
Unforeseen events, like natural disasters or theft, may cause property damage. In such cases, you can claim a casualty loss deduction for the decrease in property value. This deduction can be significant if faced with substantial damage.
What is Not Deductible?
Just as important as knowing what you can deduct, is knowing what you can't deduct. IRS regulations will vary based on specific situations, but certain expenses are not allowed to be deducted.
Personal Expenses
Generally, you cannot deduct expenses that are completely personal and not affiliated with the rental property. This might include personal purchases of food, clothing, or travel.
Expenses During Vacancy
You might not be able to deduct expenses associated with a rental property when it is empty or not earning rental income. This might include mortgage interest or advertising costs. If you run into this situation, speak with your tax professional. Depending on the nature of your situation, these expenses may be allowed as deductions.
Cost of Travel
Commuting costs are almost never tax deductible. Travel costs from your home to the rental property are considered personal expenses and not tax deductible. You can deduct the cost of getting to and from the property for upkeep or management though. What's the difference? Ask your tax professional If they don't know, find a new tax professional who does know.
Fines and Penalties
You are likely not allowed to deduct the cost of fines and penalties. This is especially true if they were incurred because you broke laws, rules, or homeowner association guidelines. How sweet would it be to write off a speeding ticket? Fat chance.
Record-Keeping
It must be said. The IRS allows miscellaneous expenses above and beyond what was mentioned in this article, providing taxpayers with a lot of flexibility for deductions. But be prepared to back up your claim. Have the proper records and documentation in place. This might include time logs.
Closing Thoughts
Rental property ownership benefits can be maximized when you consider the tax rules before you start. It pays to know which deductions you qualify for so you can maximize your take home cash. It's also important to understand how taxes work on your rental income and the eventual sale of your property. If you need more guidance, don't hesitate to reach out to a qualified tax professional!
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