Paying taxes. No one likes to do it but we all have to contribute our fair share in this country. Luckily, the government tax code grants us a litany of deductions to help ease the tax burden each of us is responsible for every year.
Many individuals and businesses have a number of options that allow for deducting certain expenses when filing their taxes. For landlords, there are a multitude of benefits that they can refer to at the end of the filing year to help reduce their tax debt.
Unfortunately, many landlords don’t take full advantage of these deductions available to them. This is mainly because they’re not entirely aware of the options that exist to help them pay less in taxes. The government offers good opportunities to landlords to promote and support real estate ownership in this country and the many benefits that have been established for property owners are wide-ranging. These include anything from expenditures made on repairs to the costs associated with traveling to a property they currently own.
Knowing which deductions you can claim from your yearly spend on your real estate property can help you increase your wealth while still paying what you rightfully owe to the government. Owning real estate comes with many tax perks that should be fully researched by every landlord.
We just happen to have a list of the ten most popular and beneficial deductions the tax code currently offers landlords. Most of these apply to small residential rental property owners who are eager to keep more money in their pocket when April 15th comes around.
Eligibility of Expenses
Tax deductions are based around the yearly expenses that are applicable to your particular situation, we all know that. For landlords, there are certain types of expenses that qualify under the tax code. Knowing which ones are eligible and how they apply is crucial to claiming all of the deductions you are entitled. As per the code, landlords have two types of expenses that are considered applicable: current expenses and capital expenses.
These expenditures typically include anything that a landlord requires to maintain the property in livable condition. Current expenses also include standard overhead costs associated with running your rental company. The tax code considers these expenses “current” as they are deductible for the year in which you paid them.
Current expenses may include repairs or any other expenses in appropriate and direct correlation with the daily operation of your business. These can include the costs of advertising, insurance premiums, even your monthly Wi-Fi and cell phone bills. The IRS deems all of these as critical to the successful operation of your business.
The costs must also be considered reasonable and ordinary. If you claim that you paid $10,000 for a bathtub, then that might raise some red flags and the IRS could audit you. In addition, any current expense that you claim must have a short-term value attached to it, such as fixing a compressor on an air-conditioning unit. If you replace the compressor entirely, that would be considered a long-term expense and would not qualify under current expenses.
These are expenditures associated with any costs that directly affect an increase in property value, typically for items that need to be replaced. If you end up having to install that brand new compressor unit for the air-conditioning, that would fall under a capital expense. The same goes for renovating a kitchen or installing a skylight in the bathroom. Most large expenses will likely qualify as capital expenses for the purposes of claiming a deduction on your taxes, as long as they work to improve the property and grow its value.
The tax code defines capital expenses under various categories. These are required to be capitalized and depreciated. The first of these are “Improvements” which the IRS defines as an expense that improves the property, restores it in some way, or alters the property in any fashion that prepares it for use in a manner other than originally intended.
The IRS also recognizes “Betterments”. These vary from an improvement in that these are expenses that repair a pre-existing defect in the property. However, they may also expand the size of the property as well as the strength or overall quality of the dwelling.
“Restorations” are those expenses needed for restoring a property that might require damage repair, significant structural repair or replacement, or a rebuild of part or all of the property to its “like new” condition. Finally, there’s the “Adaptations” category which include any expenses that come with adapting the property for a different use than that which it was originally intended at the time you started to rent it out to tenants.
The Difference Between Repairs and Improvements
As we’re discussing current and capital expenses, the distinctions between them fall into short-term versus long-term value. That brings us to distinguishing between repairs and improvements. This will help us better understand which expenses qualify for a deduction and which ones do not.
You may deduct most repairs from the taxable income on the property unless that repair is deemed an improvement. I know, it already sounds confusing so let’s discuss the major difference between the two.
What Constitutes a Repair?
Repairs are typically one time expenses to fix something that maintains the value and quality of the property. These aren’t performed in order to improve or increase the property’s value but merely performed as a matter of overall upkeep.
This might include fixing a faulty light switch, repairing an inoperable garage door opener, or something as simple as unclogging the drain in the sink. Expenses such as those are all deductible for the year in which they were incurred.
What Constitutes an Improvement?
As you may have ascertained by now, improvements are made in order to extend the life and increase the overall value of the property on a long-term basis. These are capital expenses and the tax code only allows you to deduct a portion of your costs in the tax year in which they were incurred.
Improvements are work done to the property that are much larger jobs than a standard repair. You could be remodeling the kitchen, adding an extra room or an entire wing to the property. An improvement might also be a replacement of something bigger like an HVAC system.
The IRS considers all of these are improvements as they are labor-intensive and cost more in expenses. Since these jobs are performed to increase the value of the property over the long-term, you are not allowed to claim the entire expense in the tax year that you incurred that cost. Unfortunately, you can’t expect to deduct the full $12,750 for that roof replacement in one year.
Now that we have reviewed the types of expenses that are eligible for deductions and we’ve classified how those break down in consideration of the tax code, let’s go over the top ten tax deductions that every landlord should be claiming. All of these will help to ease some of the burden that comes with paying taxes on your rental property income.
Most landlords will likely qualify for a majority of these deductions. Be sure to read and review this list carefully to find out if your current expenses satisfy the requirements necessary in order to claim them for the tax year.
1. Loan Interest Expenses
The interest you’re paying on mortgage payments for a loan taken out to purchase or make improvements on a property is the number one deduction landlords can take. This category also includes any interest you’re paying on a credit card that you use for payments directly related to renting out the property. This is often the largest and most common expense that is eligible for a deduction.
You can also include any points that came with a refinancing or outright purchase of a rental property and applicable HELOC interest on loans for repairs or improvements. Just remember that the interest you can claim must be in conjunction with actual spend associated with any of your properties or overhead costs of running the business within the taxable year.
You may not deduct any interest on funds that are still unused in your bank account that is from a line of credit or other source of funding. The applicable interest must only be from money that was used in the purchase of property, goods, or services related to your business.
2. Start-up Expenses
Let’s say you were just getting your rental business off the ground this past year and weren’t a full-fledged operating entity until, say, the third quarter. Under the tax code, you may deduct up to a maximum of $5,000 in start-up related expense in your first year of operation.
The law views any operating expense that could be incurred during normal business operations as a start-up expense if that cost was incurred before the business was officially up and running. However, you won’t be able to claim the extent of your start-up costs in the first year of filing because, unlike operating expenses, these costs are considered a capital expense. That means that you will see a potential financial benefit from those expenditures for more than just the one year and thus they must be claimed over an extended period of time.
3. Repair Expenses
We’ve already discussed these at length, but to qualify under the tax code definition, a repair expense may only be deducted on common, standard repairs that were absolutely necessary and done for a reasonable price. Any repair expense may also only be claimed in the year it was incurred, not any year after that.
Most repairs involve painting, gutter repairs, plumbing repairs, plastering, fixture repairs, heating and air conditioning repairs, replacing broken windows, and a variety of other simple fixes around the property. Deductible repair expenses include all labor and contractor costs, incidentals necessary for the repair, rental fees on tools and equipment used to perform the repair, and materials needed for the job. Be sure you are able to delineate between a repair and an improvement when you start to claim your deductions so you’re not mandated to owe more than you initially thought the first time.
4. Depreciation Expenses
If you pay a certain amount any year for any type of property including a house, apartment building, or various other forms of rental properties, that number isn’t fully deductible for that year. However, landlords see a return on those costs by way of deprecation which allows for deducting a portion of that cost across several years.
When considering what your costs might be, you need to capitalize and depreciate three different types: the value of the property itself but not the land it has been built upon; the value of any improvements that have made or added to the property: and any equipment that is related to the successful operation of the property.
All of these costs may only be deducted over a span of time to prevent people from trying to take advantage of the system. Without these restrictions, anyone could claim they made $85,000 in repairs for one year in order to avoid the tax liability then sell the property after that in order to get their money back on the improvements that were made.
5. Tax Expenses
Speaking of tax liabilities, a number of different taxes are allowed for deduction if you are eligible to receive them through operating a rental company. Typically, any taxes on real estate are submitted by way of your mortgage company. However, if your mortgage is all paid off then you’ll want to keep clean files of your tax records and payment receipts on your own.
The types of taxes that are applicable for deduction include wages paid through your business, personal property taxes, various inspection and permit fees, state, county, and city taxes, Social Security, Medicare, and Unemployment taxes for your employees as well as any taxes you may owe on your vehicle.
Not all landlords live near their rental properties, particularly those who own multiple dwellings. That might require long distance travel to visit various locations throughout the country in order to run your rental business. You may deduct any expenses that you incur for travel including airfare, car rental, taxi or Uber trips, overnight hotel accommodations, and 50% of your meal expenses while you are on your trip.
Some landlords might fit in some pleasure time while they’re on a business trip which may also be tax deductible. Just be careful about what you deduct and how much, because if the IRS starts to get suspicious about deducting your long-distance travel habits, then they could audit you. Just make sure to keep all of your receipts and organize all records of your business trips so you can support the deductions that you are claiming in the event of an audit.
7. Maintenance Expenses
Maintenance does not refer to repairs as nothing is being fixed. In this case, maintenance refers to the costs that are incurred for things like a landscaping service to cut the grass and trim the hedges or a pool service to clean the pool. When an exterminator shows up three or four times a year to ward off pests such as insects and other vermin, that is also considered a maintenance cost.
It’s not just having workers come to the property for maintenance, however. Other things like Homeowners Association fees, batteries for the smoke detectors, HVAC filters, costs for maintaining equipment to perform these tasks, even light bulbs and other expendables around the property can all be deductible under the tax code.
8. Business Expenses
You can deduct start-up costs for any expense that would qualify as a business expense prior to the rental business being established and operational. What are those expenses exactly? They may vary depending upon the company and its particular needs.
Some landlords will hire outside help in the form of a property management individual or company, an on-site manager, and any other management related fees such as property assessments and association fees. Then there are the legal and professional fees for hiring a lawyer, accountant, certified tax preparer, and any court fees and case filing fees associated with bringing a tenant to court for an eviction or other dispute.
Of course, you’re also going to have expenses associated with your office. That might include the space itself along with the myriad of office supplies you’ll need to purchase on a routine basis. Those can range from printer ink and paper to equipment like a printer, copy machine, fax machine, or anything you use in the office. You can deduct all of those costs from your taxes.
9. Insurance Expenses
Any insurance premiums related to your business and the applicable properties that you own are tax-deductible for every year that you pay those costs. The amount of coverage you purchase for your business properties is entirely up to you. The extent of your policy could be determined by the amount of risk associated with a property.
Most business owners take out umbrella policies to cover their assets and legal liability in addition to the individual coverage on each of the properties. However, when you’re considering your business-related insurance costs, the following are deductible on your taxes: homeowners insurance premiums, mortgage insurance premiums, flood insurance, theft coverage, fire and damage insurance, liability, workers’ compensation, and any umbrella coverage that protects you and your assets personally.
Additionally, you could be eligible to take a tax deduction should your rental property become damaged or ruined. This would include any such incident in which you not only needed to have a proper insurance policy but also have taken out a claim. The deduction could cover the entire cost of your casualty loss, or at least some portion of it.
This can be somewhat confusing to some property owners as the deductions only applies to the cost of the loss, not the cost of the property that was damaged or destroyed in the event of a fire, hurricane, flood, and so on. The amount of your deduction may hinge on how much damage was caused to the property and if it was covered by your insurance policy.
The cost of rental property utilities that you pay every year is also tax-deductible, even if you are reimbursed for those expenditures by tenants after the fact. If you arrange for that reimbursement from your renters, then you’ll need to claim that money as income when you file your taxes as well.
As for those utilities that you can claim for a deduction, they’re pretty much all of the common services that any rental property relies on to remain inhabitable for tenants. This includes electricity, gas and heating oil so that the property can be warmed up in the cold months, water and sewer services, and trash and recycling pickup.
Our Final Thoughts
These are just some of the major common deductions that landlords and owners of rental properties may claim when they’re filing taxes. Some other deductions may include wages you pay employees and independent contractors on jobs that you need worked on, any money you pay out on a commission basis (for referrals of your company from property managers and tenants to other prospective tenants), and even any advertising costs that you might incur to help get your business out into the public eye.
Landlords are already facing a laundry list of costs and expenditures when it comes to operating a rental business with any modicum of success. The government has put incentives in place to help you grow that business by offering deductions on your annual spend. Any savvy business owner must take advantage of those opportunities to lighten their tax liability each year if they truly want their business and their wealth to increase. You’re a smart person, make sure to deduct all you can this year!