Rental Real Estate Tax Deductions
Own a Rental Property? Don’t Forget These Tax Deductions
Owning rental property is something to consider if you're interested in creating an additional stream of income. One important aspect to understand before you begin, however, is how much you'll pay to own and maintain the property.
As a rental property owner, you may be able to offset some of those expenses by claiming real estate tax deductions. If you're considering the landlord lifestyle to generate investment income, here are some of the most useful rental real estate tax deductions to know about.
If you own a home, you're likely aware that your mortgage interest is tax-deductible. But you may not know that you can extend that benefit to mortgage loans associated with a second property you own for rental purposes.
The Internal Revenue Service (IRS) allows rental property owners to claim real estate tax deductions for mortgage interest. If you paid $600 or more in mortgage interest, you should receive a Form 1098 showing the amount paid, which you would then use when filing your taxes for the year. This deduction is included on Schedule E of your Form 1040.
While mortgage interest for a rental property is deductible, expenses paid to obtain a mortgage on the property are not. That includes things like mortgage commissions and recording fees.
Owning a second home to rent means assuming more property taxes. But again, these expenses qualify for real estate tax deductions.
Ordinarily, the IRS caps the amount you can deduct for state and local taxes (SALT) each year. For 2021, the amount you can claim in SALT deductions is limited to a combined total of $10,000. If you're married and file separate returns, the limit is $5,000 each.
When you're claiming property tax deductions for rental property, though, these limitations don't apply. That's because rental property taxes are treated as a business expense, rather than a personal one.
To maximize rental real estate tax deductions, you can't use the rental property as a personal residence for more than 14 days of the year, or 10% of the total number of days you rent it out.
When you own rental property, it’s important that your investment is insured. That includes purchasing standard homeowners insurance, as well as any supplemental insurance that may be necessary, such as flood insurance or liability coverage.
While these types of insurance add to the expense of owning rental property, the IRS does allow you to claim them as another form of real estate tax deduction. You can also deduct mortgage insurance premiums (MIP) paid on a loan you used to purchase a rental property. These premiums are deductible in the year they're paid. If you prepay premiums for more than one year in advance, only part of the premium payment is deductible.
Depending on how long you plan to rent a property, you may need a landlord insurance policy in addition to a homeowners insurance policy.
Maintenance and Repairs
Keeping your rental property in good shape means regularly spending money on maintenance and repairs. According to IRS rules, maintenance and repair expenses are generally deductible if you aren't required to capitalize them, or, in other words, record the cost as an asset instead.
Improvements are treated separately for tax purposes. These expenses must be capitalized, but they can be taken as depreciation. Examples of rental property improvements that must be capitalize include:
- Upgrades to the septic or plumbing system
- Interior renovations or upgrades
- Replacement of heating and air systems
- Wiring upgrades
- Roof replacement
- Security systems
- Landscaping and outdoor improvements, including decking and driveways
If you're unsure whether something qualifies as a repair or improvement (for example, replacing the HVAC system or a roof, if defective) consider asking a tax professional who specializes in rental real estate tax deductions for help.
The IRS advises keeping receipts and records of maintenance, repairs, and improvements for your rental property, as you'll need to know the cost of upgrades, should you decide to sell the property in the future.
Depreciation is another way to refer to a decline in something's value, usually due to age or wear and tear. The IRS allows you to recover some of the costs of owning a rental property through depreciation.
The amount you can deduct for depreciation depends on:
- Your tax basis in the property.
- The recovery period for the property.
- Which depreciation method is used.
Depreciation can be calculated and reported on Form 4562. There are a few qualifications that must be met for claiming this deduction fo rental property:
- You own the property.
- It's used for business activity (in other words, as a rental).
- The property has a determinable, useful life.
- You're expected to keep it for more than one year.
Land is generally not considered a depreciable expense, as it doesn't wear out over time.
Aside from these expenses, there also are other things you may be able to claim as rental real estate tax deductions.
Additional deductible expenses include:
- Advertising expenses paid to attract renters.
- Auto and travel expenses to and from the rental property (when it's done for certain purposes, such as collecting rent).
- Cleaning, if it's considered a maintenance cost.
- Legal and other professional fees, including tax preparation fees.
- Local transportation expenses.
- Property management fees, if you pay someone to manage the property for you.
- Mortgage points.
- Expenses paid to maintain the property while it's vacant.
If you plan to deduct travel expenses for rental property, you must document them, according to the IRS guidelines specified in Publication 463.
Uncollected rent may also be deductible if it's considered a bad business debt and there's no chance of being able to recoup it. If you file an eviction notice for nonpayment of rent, be sure to keep all the related paperwork to support your claim for a bad business-debt deduction.