While owning rental real estate can be a great way to build wealth, it most certainly comes with its fair share of expenses.
Taxes are one of those expenses.
For every dollar you earn, you’ve got to give a few cents - or maybe more than a few cents - back to Uncle Sam.
No one can escape it.
Well, you can try, but that’s called tax evasion - a federal offense - so I wouldn’t recommend it.
Even though the IRS invokes fairly negative feelings by taxpayers, it isn’t all bad. In fact, the IRS offers rental property owners a hefty amount of tax breaks.
You just have to know where to look.
Unfortunately, the IRS isn’t going to provide you with a neatly, bulleted list of deductions and I doubt you’ll want to scan over the 73,000+ pages in the U.S. Tax Code to find them, so I thought I would highlight a few.
What qualifies as an expense?
First, we need to define what is considered an expense. For real estate purposes, there are two separate categories: Current and Capital Expenses.
- Current Expenses: These are typically one-off items that keep the property in good working condition and habitable, or help you operate your rental business.
These expenses can be deducted in the same year they were incurred. Example of these expenses could be repairing a plumbing leak, basic landscaping, pest control, etc.
To qualify as a Current Expense, it must be:
- Ordinary and necessary
- Directly related to rental activity
- Reasonable amount (If you claim you’ve paid $300 for a new shower rod, you run the risk of getting audited.)
- Capital Expenses: Anything that increases the value of the property or extends its life is considered a Capital Expense or improvement.
These expenses must be depreciated over multiple years and include things like a new roof, new HVAC, etc.
A general rule of thumb is anything that costs a couple of thousand dollars or more to replace should probably be deducted as a Capital Expense. Your tax advisor can help you determine the best way to go about deducting both types of expenses.
Top 11 Tax Deductions for Indianapolis Landlords
Before claiming any tax deductions, make sure you have sufficient records to back them up.
The IRS will scrutinize these claims and you need to be prepared should you get audited.
Failure to produce thorough records of deductions will result in you having to pay the full amount of the expense, plus interest.
If you employ a Property Management company, they should be able to produce all maintenance and repair receipts as well as tax statements for you.
Interest-For most Landlords, interest is often the single biggest deductible expense.
Common examples include:
- Mortgage interest payments on loans used to acquire or improve rental property
- Interest on credit cards for goods or services used in a rental activity
- Interest on any personal loans used for items related to rental activity
Landlord Note: According to Nolo, starting in 2018, the Tax Cuts and Jobs Act limited the interest deduction for landlords who earn more than $25 million from their rentals. However, such landlords can avoid this limit by agreeing to depreciate their rental property over 30 years instead of 27.5 years.
- Home Office and Operating Expenses -
While being a Landlord is somewhat nontraditional, if you self-manage especially, you most likely need a space where you can conduct business.
If you use a dedicated room for activities related to your rental properties, then you can claim some of your home’s expenses as a deduction.
However, these deductions are commonly the most flagged by the IRS because many individuals take advantage, so keep detailed records of your home office expenses.
You can claim things like ink and printer paper, pens, phone service, rental software (like Propertyware), rent paid for office space, and square footage of home office.
Repairs -Repairs are defined as "any effort to maintain the current condition of a property or asset."
Rental property repairs can end up costing you thousands of dollars over a 12-month span.
Thankfully, these expenses (provided the repairs are ordinary, necessary, and reasonable in amount) are fully deductible in the year in which they are incurred.
Good examples of deductible repairs include repainting, fixing gutters or floors, fixing leaks, plastering, and replacing broken windows.
Maintenance -For tax write-off purposes, maintenance and repairs are not the same thing, but they are equally deductible. The reality is that, oftentimes, Property Managers will lump "Maintenance & Repairs" together.
However, repairs are expenses related to fixing things and maintenance expenses...aren’t.
Maintenance issues would include things like lawn mowing, HOA fees, pest control, replacing HVAC filters, smoke detector batteries, etc.
You’re not necessarily “fixing” anything, just keeping it maintained.
Travel -There can be a great deal of back and forth travel involved when you own rental properties.
For local Landlords, you can either deduct the actual expenses of your vehicle, or you can use the standard mileage rate.
For you out-of-staters, you can deduct all of your travel expenses when it directly relates to rental activity including airfare, hotel, and meals.
This is another deduction that the IRS will scrutinize very closely, so be sure to properly document your long distance travel.
Utilities -For single family rentals, it’s pretty common to have the Tenants put all utilities in their name.
However, when your properties are vacant, you can write off any utility bill that you have to cover while you’re trying to place another Tenant.
You can deduct electricity, water, sewer, gas, trash, and recycling services.
Insurance -As a Landlord, it’s very important to have proper insurance in place to protect you and your assets.
If you have to have it, you might as well get a tax perk out of it!
You can claim all business related insurance premiums on your taxes which include:
- Homeowners insurance (Rental Dwelling Policy)
- Mortgage insurance
- Fire/Damage/Liability insurance
- Flood insurance
- Theft insurance
- Workers Comp insurance
- General liability insurance
- Personal Umbrella insurance
Employees and Independent Contractors -If you hire someone to perform any type of services for your rental property, you can deduct their wage as a business expense.
Whether you hire a Leasing Agent to show your rentals, or a plumber to unclog a toilet, you can claim the amount you pay them on your taxes.
Pass-Through Tax Deduction -While not technically a rental property deduction, it’s still one you should be aware of. Starting this year, most Landlords will qualify for this deduction established by the Tax Cuts and Jobs Act.
Depending on your income, you may be able to deduct either up to 20% of your net rental income, OR, 2.5% of the initial cost of your rental property plus 25% of the amount you pay any employees.
Property Management Fees -If you decide you want to hire a Property Management company, you can deduct the expense associated with employing them.
This goes for:
- Property Management companies
- Individual Property Managers
- On-Site Managers
Self-managing is tough, and Property Management companies can offer tremendous value to Landlords. If it’s something you’ve even just considered, then I encourage you to do some research to find a quality company to speak with here in Indianapolis.
Legal and Professional Fees -Unless you happen to know everything about everything, at some point, you’re going to need to hire a pro to help you out.
If you need a legal help, you can deduct lawyer fees.
If you need tax help, you can deduct accountant fees or software fees such as TurboTax.
If you have to evict a Tenant, you can expense all reasonable court and filing fees.
As you can see, there are tremendous tax benefits to owning rental real estate and you absolutely need to be taking advantage of them.
If you're honest and meticulous in documenting your expenses, next tax season could be just a little less painful.