If you are looking for a stable monthly income, investing in rental properties is a good choice. However, renting out property can come with various expenses, from hiring a management company to handling repairs, which can add up to a significant amount of money.
Nevertheless, many of these expenses are tax-deductible. Understanding the deductible costs will help you maximize the benefits from your rental property.
Most property owners are required to pay property taxes, which can amount to thousands of dollars depending on the location. These state and local property taxes are deductible.
The Internal Revenue Service (IRS) sets a limit of $10,000 for total deductions, so any tax payments exceeding this limit cannot be deducted.
Some states or local governments impose fees for short-term rentals, known as occupancy taxes, similar to sales taxes. However, these fees are also deductible.
Additionally, other expenses that can be deducted include sales tax on items related to your rental business, as well as payroll taxes or social security taxes for employees.
You can deduct mortgage interest but not the portion of the repayment used to pay off the loan principal. Only the interest portion is deductible.
Interest expenses will be listed on the lender’s monthly statement. Multiply the monthly interest by 12 to calculate the total annual interest.
Wear and tear on a rental property, known as depreciation, is inevitable. Once your property is ready for rent, even if there are no tenants yet, you can start claiming property depreciation.
Depreciation can be claimed over the expected useful life of the property but must be spread out over multiple years. For example, depreciation is taken at the same rate of 3.636% annually for property.
If the property is rented out for less than a year, the depreciation rate for that year will be lower based on when the property was available for rent. For instance, a property rented out starting in May will have a 2.273% depreciation rate, while one put into use in December will have a 0.152% depreciation rate.
The structure of a house depreciates, but the land does not, as the value of the land remains constant.
Although maintenance and improvements may seem similar, they differ significantly in terms of taxation.
Maintenance involves tasks that maintain the current condition of the property, while improvements increase the property’s value or extend its life. For example, tasks such as repairing faucets, patching roof leaks, fixing air conditioning, and repairing appliances fall under maintenance.
Tasks that increase the original value of the property, like adding a room, replacing the roof, installing a new air conditioning system, or fitting new windows, fall under improvements.
Understanding this difference is crucial as the tax deductions for maintenance and improvements vary.
Maintenance costs can be deducted in the current year, directly reducing taxable income.
Improvement costs must be depreciated over a longer period for tax purposes. For residential properties, this period is usually 27.5 years.
If you cover all utility expenses rather than having tenants pay for them, these costs are deductible. This includes costs for internet, cable TV, or satellite TV. If tenants later reimburse you for these costs, you can still deduct them, but you need to count the reimbursement as income.
Lenders typically require property insurance even if you fully own the rental property. Property and liability insurance expenses are necessary and deductible. If you provide health insurance for employees, this cost is also deductible.
If the insurance doesn’t cover certain losses like hurricanes, floods, earthquakes, or theft, you can deduct your losses. If the insurance only covers a portion of the loss, you can deduct the unpaid portion but not the already compensated part.
If your rental property is located far from your primary residence or you have multiple rental properties, you can deduct transportation expenses. Costs for showing your rental property, collecting rent, or maintaining and repairing the property are all deductible.
You can deduct actual expenses or the standard mileage rate. The standard mileage rate for 2024 is $0.67 per mile. Whichever method you use, make sure to keep detailed records.
If you hire a property management company, that cost is deductible. Legal fees, accounting fees, investment advisory fees, and any other professional service expenses related to the rental property activities are also deductible.
Many rental property owners equip their properties with personal property such as appliances, computers, or gardening equipment. The costs of these personal properties can be deducted within a year, with a maximum of $2,000.
Rental property owners can deduct home office expenses from taxable income. This deduction applies not only to a home office but also to any workspace or workshop used for your rental business.
Before investing in rental properties, understanding the tax rules for renting out properties is crucial. Utilizing various tax deductions can maximize your investment returns. Keep all invoices related to your rental property expenses and consult with an accountant to ensure you claim all available deductions and optimize your investment returns.