By Wallace Gibson, CPM, GRI
Millions of rental property owners pay more state and federal taxes on their rental income than they should. Why? Many fail to take advantage of ALL of the tax deductions available to them because they do not know and can not get good counsel on this issue. Millions of rental property owners fail to take advantage of all the tax deductions available to them and they miss one of the JOY$ of owning rental property. Often, these benefits make the difference between losing money and earning a profit on a rental property.
Here are the top ten tax deductions for owners of small residential rental property:
1. Interest. The landlord’s single biggest tax deduction is interest. Common examples of interest that can be deducted are mortgage interest payments on loans used to acquire or improve rental property and interest on credit cards for goods or services used in a rental activity.
2. Depreciation. The actual cost of the IMPROVEMENT of the house, apartment building, or other rental property is not fully deductible in the year in which you pay for it. Instead, investment owners get back the cost of real estate through depreciation. This involves deducting a portion of the cost of the IMPROVEMENT over several years.
3. Repairs. The cost of repairs to rental property (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.
4. Local Travel. Landlords are entitled to a tax deduction whenever they drive anywhere for their rental activity. For example, when you drive to your rental building to deal with a tenant complaint or go to the hardware store to purchase a part for a repair, you can deduct your travel expenses.
5. Long Distance Travel. If you travel overnight for your rental activity, you can deduct your airfare, hotel bills, meals, and other expenses. If you plan your trip carefully, you can even mix landlord business with pleasure and still take a deduction.
However, IRS auditors closely scrutinize deductions for overnight travel — and many taxpayers get caught claiming these deductions without proper records to back them up. To stay within the law (and avoid unwanted attention from the IRS), you need to properly document your long distance travel expenses.
6. Home Office. Provided they meet certain minimal requirements, landlords may deduct their home office expenses from their taxable income. This deduction applies not only to space devoted to office work, but also to a workshop or any other home workspace you use for your rental business. This is true whether you own your home or apartment or are a renter.
For the ins and outs on taking the home office deduction, see Home Business Tax Deductions or Every Landlord’s Tax Deduction Guide, both by Stephen Fishman (Nolo).
7. Employees and Independent Contractors. Whenever you hire anyone to perform services for your rental activity, you can deduct their wages as a rental business expense. This is so whether the worker is an employee (for example, a resident manager) or an independent contractor (for example, a repair person). Be sure to get their taxpayer ID and provide them with a 1099 if appropriate.
8. Casualty and Theft Losses. If your rental property is damaged or destroyed from a sudden event like a fire or flood, you may be able to obtain a tax deduction for all or part of your loss. These types of losses are calledcasualty losses. You usually won’t be able to deduct the entire cost of property damaged or destroyed by a casualty. How much you may deduct depends on how much of your property was destroyed and whether the loss was covered by insurance.
9. Insurance. You can deduct your insurance premiums for your rental activity. This includes fire, theft, and flood insurance for rental property, as well as landlord liability insurance. And if you have employees, you can deduct the cost of their health and workers’ compensation insurance.
10. Legal and Professional Services. Finally, you can deduct fees that you pay to attorneys, accountants, property management companies, real estate investment advisors, and other professionals. You can deduct these fees asoperating expenses as long as the fees are paid for work related to your rental activity.
DID YOU KNOW? Landlords can greatly increase the depreciation deductions they receive the first few years they own rental property by using segmented depreciation. Careful planning can permit you to deduct, in a single year, the cost of improvements to rental property that you would otherwise have to deduct over 27.5 years.
Most small landlords can deduct up to $25,000 in rental property losses each year. A special tax rule permits some landlords to deduct 100% of their rental property losses every year, no matter how much.
People who rent property to their family or friends can lose virtually all of their tax deductions if this is not done properly.