The Federal government grants tax breaks to landlords and rental property owners. In fact, apart from passive cash flow, it is the many tax deductions available to landlords that makes owning rental properties such a profitable business. Following, you will find a list of the most common (lucrative) tax deductions for landlords.
Side note: You are only allowed to deduct the following expenses if they are deemed “ordinary” and “necessary” within the line of business. The Federal government gives the following definitions:
Ordinary Expense – common and accepted within the industry. E.g. pay a contractor to perform a repair on the property.
Necessary Expense – helpful and appropriate to the business. E.g. investment in an accounting software program to facilitate efficient management of business documentation.
The following deductions are not available to all landlords. E.g. many deductions do not apply to people renting out the home that they live in part of the year. Make sure you consult with your accountant and review appropriate IRS documentation in order to determine all the deductions your business qualifies for.
Now, with all the prefacing out of the way, lets take a look at that list common landlord tax deductions.
This is most often a landlord’s single biggest deductible expense. Landlords are able to deduct mortgage interest payments on loans used to acquire or improve rental property and credit card interest accrued through business related credit card purchases.
Landlords are not able to fully deduct the cost of a rental property in the year that it was purchased. However, landlords will recapture the cost of the investment through depreciation. Essentially, as a landlord, you are able to deduct a portion of the cost of the property over several years. In order for depreciation deductions to be realized they need to meet three criteria:
- Last more than a year
- A valuable asset to the business
- Loses its value over time
Some items may be put on a 27 ½ year schedule and some on a 5-7 year schedule. The improvements (building) is depreciated over 27 ½ years. Other things such as appliances and carpets are put on a 5-7 year schedule. This can significantly increase After Tax Cash Flow (ATCF) on your rental property. Consult with your accountant to determine appropriate valuations and schedules.
3. Passive Rental Losses
If you are considered “actively involved” in your rental property business, you can deduct up to $25,000 in passive rental losses if you make less than $100,000 a year. In fact, a special tax rule now permits that some landlords can deduct 100% of their rental property losses every year , no matter how much. To clarify, in order to be considered actively involved, a landlord may be participating in tenant screening, management decisions, property marketing to name a few.
Landlords are able to deduct the cost of property repairs incurred in a given tax year. Repairs are considered to be work that is necessary to keep a property in “good working condition”, and do not add significant value to a home. The IRS distinguishes between “improvements” (value add) and “repairs”. Improvements are not considered a deductible expense, but can be added to the depreciation schedule. Consult with your accountant to determine the appropriate schedule.
5. Travel Expenses
Landlords qualify for a tax deduction when they travel anywhere for their rental activity. E.g. drive to to rental property to deal with tenant complaint, or visit local supplies store to get materials to repair the property. If you drive a car in the course of rental business activities you have two deduction options.
- Deduct direct expenses (gas, maintenance, repairs) or
- Standard mileage rate (56.5 cents per mile for 2013)
If you don’t have your own vehicle you are able to deduct public transportation costs.
You can also deduct fees related to the insurance premiums for your business activity. This includes fire, theft, and flood insurance for the rental property. Premiums associated with landlord liability insurance is also deductible. Landlords may also deduct premiums for employee health, accident, causality, theft, flood, fire, liability, and vehicle insurance.
Landlords can deduct property taxes, real estate taxes and sales tax associated with business related items that are not considered depreciable for the year.
Planning becomes extremely important because owners must recoup depreciation loss when they sell the property. For example, if you purchase a rental property for 300,000 and you depreciate the value of that property by $50,000 over 10 years and sell it on the eleventh year for 350,000, you will have to pay capital gains not only on the $50,000 increase, you will also have to pay for an additional $50,000 in gains to recoup the $50,000 in depreciation. The total tax exposure will be $100,000. There are several options such as a 1031 exchange in order to postpone this. Making a plan and including your accountant is imperative for success in rental property investments.
Bonus Tip: Landlords can significantly increase the depreciation deductions they realize in the first few years of business by implementing segmented insurance.
By Robbie Richards.