Rental property tax deductions represent some of the greatest benefits awarded to today’s passive income investors. However, most beneficial deductions aren’t going to make themselves; you have to know which deductions you can take advantage of and apply them to your business come tax season.
If you are interested in the rental property tax deductions you are made privy to, pay special considerations to the following and — above all else — be sure to consult a tax professional before calculating any deductions of your own.
Rental Property Tax Deductions Checklist
For those of you looking to ease your tax obligations this April, it is a good idea to keep a rental property tax deductions checklist handy. That said, here’s a list of the most important tax deductions you don’t want to miss out on:
- Loan Interest: The single largest deduction for most rental property owners, the loan interest deduction allows qualifying owners to write off the interest they pay each year. It’s worth noting, however, that most loans are front loaded with interest payments. As owners pay down their mortgage obligation, there’s a good chance their write-offs will decrease in the later stages of the loan.
- Rental Property Depreciation: Qualifying rental property owners are allowed to write off a portion of the original purchase price each year over what has been deemed by the I.R.S. to be the “useful life” of a property (typically 27.5 years).
- Taxes: Business-related wage taxes, permit fees and personal property taxes are considered allowable deductions when tax season comes around.
- Repairs: According to the I.R.S., “an expense for repairing or maintaining your rental property may be deducted if you aren’t required to capitalize the expense.”
- Maintenance: Not to be confused with repairs, maintenance doesn’t require that you fix anything, but rather maintain it. Cutting the lawn, for example, represents maintenance.
- Monthly Utilities: It is entirely possible to deduct the monthly utilities spent to keep the property operating.
- Local Transportation Expenses: You may be able to deduct your ordinary and necessary local transportation expenses if you incur them to collect rental income or to manage, conserve, or maintain your rental property.
- Management Fees: Fees associated with hiring a third party management company can be written off.
- Advertising: Savvy rental property owners can write off their advertising expenses incurred to make sure the property remains in operation.
- Commissions: Whether they are tenant referral commissions or for other managers, commissions can be written off.
- Legal & Other Professional Fees: Fees incurred from legal or professional assistance can be written off in the same tax year.
- Points: Because points are prepaid interest, you generally can’t deduct the full amount in the year paid, but must deduct the interest over the term of the loan.
Before you add any of these items to your own rental property tax deduction checklist, confirm that they are still viable in the eyes of the I.R.S. If for nothing else, the powers that be are constantly changing what they deem to be acceptable deductions. Perhaps even more importantly, be sure to hire a trained tax professional to assist you in your own rental property deductions. The above list is subject to change in a moment’s notice. That said, do not attempt to make any rental property deductions on your own; hire a professional to make sure things are done in accordance with the law.
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What Qualifies As A Rental Property Expense?
Understanding what qualifies as a rental property expense isn’t as cut and dry as many would like to believe. That said, it’s best to let the I.R.S. decide what qualifies as a rental property expense. That way, you know you are making the right deductions come tax time.
According to the I.R.S., “If you receive rental income from the rental of a dwelling unit, there are certain rental expenses you may deduct on your tax return. These expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs.”
To be clear, the I.R.S. focuses on ordinary and necessary expenses. Those deemed extravagant or luxurious are most likely not going to be accepted as viable deductions when April comes around. That said, there’s a good chance that any ordinary and necessary expenses incurred from managing, conserving and maintaining your rental property will most likely be deducted from your tax obligations at the end of the year.
Just so we are on the same page, ordinary expenses are those that are par for the rental property industry course; they are generally accepted in this particular business. Necessary expenses, on the other hand, are those that have been deemed appropriate by the general consensus.
What Qualifies As A Rental Property Income?
As its name would lead you to believe, rental property income is essentially the money made from an asset. However, don’t let the simple definition fool you. Rental property income isn’t relegated solely to the rent your tenants are paying; it consists of several other factors. In fact, the following list represents the most common types of rental property income owners will need to report on their taxes:
- Advanced Rent: Any rent you receive before the period it is designated for is considered income for the year you receive it.
- Canceled Leases: Any money you receive from a tenant canceling their lease is considered income in the year you receive it.
- Expenses Paid By The Tenant: “If your tenant pays any of your expenses, those payments are rental income. Because you must include this amount in income, you can also deduct the expenses if they are deductible rental expenses,” according to the I.R.S.
- Property & Services: If you receive property or services, instead of rent money, you must declare as much. The price of the property or service should be evaluated at fair market value, unless proven otherwise.
- Security Deposits: Only declare a security deposit if you keep it from the tenant at the time of their exit.
- Lease To Buy Options: Any payments you receive under a lease to buy agreement are considered income, and must be declared on your taxes.
- Part Interest: Even if you are only a part-owner in a rental property, you must report your portion of the income.
In it’s simplest form, rental property income represents the money you make from an asset. However, most people are unfamiliar with all of the ways they may receive said income. If you received money from any of the above, you must claim it on your taxes. To be sure that you are making the right claims, consult a tax professional, as they will see to it that your taxes are filed in accordance with the law.
Are Closing Costs Tax Deductible On A Rental Property?
The closing costs themselves are not deductible. However, the interest you are charged on the closing costs, additional mortgage points and any real estate taxes incurred at the time of closing are deductible.
Consequently, the settlement fees and closing costs associated with buying a rental property can usually be added to your basis in the property. What’s more, some of the closing costs can be figured into your rental property depreciation.
Rental Property Tax Write Off Tips To Keep In Mind
Rental property tax write offs are extremely important to today’s investors. That said, it’s in your best interest to make sure you are realizing the maximum benefits. To do so, here are a few tips to heed:
- Always Consult A Tax Professional: Rental property tax deductions can intimidate even the most savvy of investors. That said, they are an integral component to every investor’s bottom line, and should be taken seriously. To make sure you are maximizing the deductions you receive, hire a professional tax consultant. Only then can you be absolutely certain that you are contributing to your bottom line in the way you intend.
- Keep Detailed Records: It should go without saying, but every rental property owner needs to keep detailed records of everything. In fact, it’s in your best interest to retain documentation every time money changes hands. It is the records, after all, that will prove each and every one of your claims. Your tax return is only as good as you can prove it, so make sure you keep good records of all your income and expenses related to your property. You will be asked to prove everything, so make sure you can come up with the correct documents.
- Beware Of The Recapture: Rental property depreciation is a great tax benefit that can significantly limit one’s tax obligations over several decades. However, rental property owners need to be careful if they sell the home for more than the value they have already depreciated it. In the event you sell, there’s a chance you’ll have to add some or all of the depreciation back into your taxable income. Otherwise known as “recapture depreciation,” the addition of this little-known tax code could be a nasty surprise for anyone not expecting it.
Rental property tax deductions are just as important to your bottom line as the income your individual assets produce. The specific deductions you claim aren’t as transparent as many would like them to be, and nobody is going to make them for you. No, it’s up to you to take advantage of them and realize their true potential. And to do so, I suggest hiring a trained tax professional, as they will know the best way to maximize your returns.
- Do not attempt to make rental property tax deductions on your own. Consult with a trained tax professional before filing.
- Rental property tax deductions are just as important to your bottom line as the income your individual assets produce.
- Rental property tax write offs come in all shapes and sizes, but it’s up to you to figure out which ones you can bank on.