As a rental property owner, you are likely already aware of the many financial benefits of owning income-producing real estate. However, were you aware that there are also significant tax breaks available to those who own a property and rent it out?
The IRS considers rental income to be taxable income, which means you must pay taxes on the cash you earn from renting out your property. However, you may be able to offset some of this tax burden by deducting the costs of owning and operating your rental property.
Let’s get into more detail about the most common tax deductions for rental property owners.
What Are the Various Expenses That Rental Property Owners Deduct?
The following are the most common deductions for rental property owners:
- Mortgage interest deduction
- Rental property depreciation
- Repairs and improvements
- Property taxes
- Travel expenses
1. Mortgage Interest Deduction
Most homeowners utilize a mortgage to buy their own house, and the same is true for rental properties. Loan interest is the most deductible expense for landlords who have a mortgage. Moreover, the portion of your mortgage payment that pays down the principal loan amount is not deductible. Instead, the deduction is limited to contributions made toward interest charges. These components will be listed separately on your monthly account and, therefore, easily accessible. Simply divide the monthly sum by 12 to calculate the total annual interest.
This is frequently one of the most considerable tax benefits available to landlords on their rental properties. Generally, your lender will send you a Form 1098 at the beginning of the year detailing the overall amount of interest you paid in the previous tax year.
2. Rental Property Depreciation
Another significant tax deduction for rental property owners is depreciation. Depreciation enables you to reduce your taxable income by recognizing the wear and tear of your property over time. The IRS considers most residential rental properties to have a useful life of 27.5 years, meaning you can deduct a portion of your rental income each year for almost three decades!
To calculate your depreciation deduction, you will need to determine the cost basis of your property. The cost basis is equal to the purchase price of your property, plus any capital improvements made, minus any previous depreciation deductions claimed. Once you have determined the cost basis, you can divide that number by 27.5 to calculate the annual deduction amount.
For example, let’s say you paid $200,000 for your rental property, plus an additional $10,000 in capital improvements. Assuming you have not previously claimed any depreciation on the property, your cost basis would be $210,000. Dividing this number by 27.5 gives us an annual deduction of $7,636.
But it’s important to remember that you cannot begin claiming depreciation deductions until your property is “placed in service,” meaning it is ready and available for rent.
3. Repairs and Improvements
Another common deduction for rental property owners is any money spent on repairs or improvements to the property. These expenses must be necessary to keep the property in good condition and fit for rental purposes. For example, if you need to buy a replacement for a broken window or repair a hole in the roof, these are deductible expenses.
It’s important to note that any expenses incurred to increase the value of your property are not considered deductible. For example, if you install a new pool or make other major renovations, these improvements must be depreciated over time rather than deducted in the year they were made.
4. Property Taxes
Property taxes are collected by almost every state and local government. They might range from a few hundred dollars to hundreds of thousands of dollars, depending on the location of your rental property. Check your escrow summary or contact your tax professional to find out the exact tax rate in your area.
It is important to mention that regardless of the amount paid, the IRS limits the amount of property taxes that can be deducted each year to $10,000 ($5,000 for married taxpayers filing separate forms). For example, if your property tax bill is $12,000 per year, you will only be able to deduct $10,000 of that on your taxes.
5. Travel Expenses
Landlords can deduct the majority of their rental business travel from their taxes. If you go to your rental building to deal with a tenant complaint or to the hardware store to buy a part for a repair, you can deduct your travel expenses. However, you cannot deduct the cost of travel to upgrade your rental property; these expenses must be added to the tax basis of the property and depreciated over a long period.
Travel expenses can be deducted in two ways:
- The standard mileage deduction (check the IRS website for current rates).
- The actual expenses incurred (gasoline, repairs, tolls, and parking.)
These methods require that you keep detailed records of your travel itinerary and expenses. The IRS recommends using a mileage tracking app or GPS device to document the miles driven for business purposes.
Where Should I File My Rental Income for Tax Deductions?
Schedule E of your Form 1040 should include all rental income and expenses. Use this form to disclose any additional income or losses incurred from business activities such as rentals. You must submit a separate Schedule E for each property you own.
Be sure to report all sources of rental income on Schedule E, even if the property is owned jointly with another person. The IRS requires that each owner file a separate Schedule E for their portion of the rental income and expenses.
For example, if you and two other people own a rental property with a total annual rental income of $30,000, each person would report $10,000 on Schedule E.
How Should Rental Property Owners Deduct Expenses?
As a landlord, you can deduct various expenses related to your rental property. These deductions can help reduce the amount of taxes you owe each year.
To calculate your deductions, you will first need to determine your gross rental income. This is the total amount of rent you collected from your tenants during the year. Once you have your gross rental income, you can begin to deduct your expenses.
Let say:
Your gross rental income is $20,000
Your expenses are:
—Property taxes: $1,500
—Mortgage interest: $600
—Repairs and maintenance: $2,500
—Travel: $1,000
—Depreciation: $2,000
In this case, your total deductions would be $7,600. This would leave you with a taxable rental income of $12,400 ($20,000 – $7,600).
Once you have determined your taxable rental income, you can use the tax rates from Schedule E to determine the amount of taxes you owe.
For example, let’s say you are in the 25% tax bracket. This means that you would owe $3,100 in taxes on your $12,400 of taxable rental income ($12,400 x 25% = $3,100).
Remember, these are just examples. It would be best to consult with a tax professional to determine the deductions you can claim for your specific situation.
Is Rental Income Taxed the Same as Regular Income?
Maybe. If you rent out your property for 14 days or less during the year, you do not have to report the rental income on your taxes. This is because the IRS considers this income to be “passive” and does not tax it at the higher rates typically applied to earned income.
However, if you rent out your property for more than 14 days during the year, the rental income is considered “active” and is subject to the same taxes as your regular income. This means that the amount of taxes you owe will depend on your tax bracket.