The Internal Revenue Service (IRS) allows you to take tax deductions for any legitimate expense related to running a rental property. If you own rentals, you can claim expenses in 12 categories spanning everything from interest, to insurance, repairs, and depreciation. However, you must record them according to IRS guidelines.
Here are the 12 categories of rental property tax benefits and deductions:
1. Rental Property Depreciation
Depreciation is the process of treating the hypothetical wearing out of your building as if it were an expense. Even though you may not financially feel this wearing out, accounting principles allow you to take advantage of the eventual costs through depreciation.
Determining what the depreciation figure is, and keeping proper records over time is vital, and you should turn to your CPA or tax professional for assistance. Generally, you can depreciate your rental property value minus the cost of land evenly over 27.5 years, known as straight line depreciation.
Depreciation Example for Rental Property
We’re going to illustrate a straight line depreciation example that pertains to a rental property.
Let’s assume the following:
- The combined value of the land and the building is $300,000
- The land is valued at $150,000
- The depreciation time frame according to the IRS is 27.5 years
- The property is classified as a residential property (Some portions of commercial property improvements can be depreciated over 15 years)
To figure out the depreciation, you first subtract the land value from the combined value of the land and building. Then you divide the building value by 27.5 years to get the amount of yearly depreciation.
- $300,000 – $150,000 = $150,000
- $150,000/27.5 = $5,454.54 depreciation per year
5,454.54 is the annual amount you can deduct when filing your rental property taxes. You will do this each year to assess current home value and the associated annual depreciation.
“When you invest in a fixed asset like real estate, the IRS allows you to take a tax write-off for depreciation, or the expense you incur over time for the reduction in value due to wear and tear. The great thing about depreciation is that it is *not a cash expense*, and real estate historically appreciates, rather than depreciates, in value over time — meaning you benefit from the tax treatment but incur none of the assumed downside.”
– Aaron Lesher, CPA & Head of Customer Success, Hurdlr
2. Mortgage Interest Deduction & Other Forms of Interest
Interest on a rental property may take several forms: mortgage interest, points and loan origination fees, interest on credit lines and unsecured loans for the property, and in some cases interest from credit cards used for property-related expenses.
When you make a loan payment on your rental property, there are two components to that payment. There is the portion going to the principal and the portion paying back interest. You can see this by looking at your monthly statement. Unfortunately, you can’t deduct the principal portion of your payment. However, you can deduct the interest portion.
For example, let’s say you have a mortgage or other loan related to the property with a monthly payment of $1,000. Let’s assume $200 is applied to principal, meaning $800 is interest. Only the $800 is deductible as an expense. Multiply this interest by 12 and you find your annual interest deduction of $9,600.
Since the main loan(s) on a rental property are likely mortgages, this is the first interest figure to consider. You can also deduct points, etc. as a form of prepaid interest. Prior to the 2018 Tax Cuts and Jobs Act, you could deduct interest on home equity lines of credit (HELOC), but this is no longer tax deductible.
Points & Loan Origination Fees
When you obtained financing for your rental property, you probably paid loan origination fees and/or points. Both of those are deductible and can be treated as forms of interest. However, your down payment is not deductible.
Interest on Unsecured Loans for the Property
If you’ve obtained financing in the form of an unsecured loan, specifically used for a given property, that interest may also be deductible. For example, you might have gotten an unsecured loan for the replacement of a roof on a property; the interest on that may be deductible. Prior to the 2018 tax changes, interest on lines of credit was also deductible, but are no longer.
This is an area where you may want to engage the services of your accountant because deductibility for unsecured loans can be tricky – particularly if the proceeds were used on more than one property or certain amounts used personally. Accurate accounting is vital.
Interest on Credit Cards Used For The Property
You may have also used a credit card or fuel card for the property and incurred some interest. An example might be purchasing a refrigerator for a property from an appliance store on a credit card, but paying for it over several months, resulting in some interest charges. The interest stemming from that purchase would be deductible.
Similar to the situation with unsecured loans, involve your tax professional or CPA if you are trying to deduct credit card interest because it can be tough to properly account for.
If you want more information on business credit cards, how they work, and who they’re right for check out our guide on best small business credit cards of 2017.
3. Rental Property Taxes & Licensing Fees
Real estate investors receive rental property tax benefits and being able to deduct related expenses is definitely one of them. Property taxes, licensing fees, and occupancy taxes are three of the most common forms of taxation for rental property and they’re also deductible. You need to report expenses allocated for the rental property on a Schedule E.
We will now discuss property taxes, licensing fees and other rental property taxes:
Virtually every county or municipality in the country charges property taxes. In rural areas the amount may be small, perhaps only a few hundred dollars. In some markets property taxes can be quite high, sometimes 6 figures per year. Property taxes are one of the legitimate expenses related to a rental property, hence tax deductible.
You can find out your county’s tax rate by asking your local realtor or mortgage professional. You can also find it at your county’s Office of the Assessor or Recorder. Sometimes these offices have slightly different names but you can google your county and find property tax information on their site as well as a contact phone number. If you have a mortgage on the property, your lender will send you an escrow summary that shows property taxes paid as well.
Many states have licensing requirements for rental property. This refers to a license specifically for the property, not to be confused with a business license for your real estate business (but, which may be deductible in another way). If you’ve had to obtain or renew a landlord or similar license for the property, that cost is deductible.
Some municipalities require a vacation rental license for short term rentals, which typically cost around $1,200 the first year and around $600 the subsequent years, but depend on the area and the number of bedrooms the property has.
For additional information on short term rentals, check out our guide on how to buy a vacation rental property.
Some states charge occupancy taxes on rental amounts, very similar to sales tax. This is particularly the case in states where short-term rentals are common. Examples include Florida which charges a “tourist tax” for rentals less than 7 months and multiple areas throughout Arizona. If you are required to pay a tax on rental amounts, that figure can be written off. These taxes vary by state and sometimes vary by city, county or even municipality.
4. Rental Property Insurance
Any form of insurance is considered an expense, hence tax deductible for the rental building. This includes basic hazard insurance, and special perils insurance such as flood or hurricane coverage, as well as liability insurance.
Typical types of insurance needed for a rental property include:
- Liability insurance
- Hazard and fire insurance
- Sewer backup insurance which can be added to your hazard policy
- Flood insurance which covers water coming from any source outside the home and is required by most mortgage companies
- Loss of income insurance which can be added to your hazard policy and will cover you in the case of lost rental income
Insurance specifically for a rental property is generally 15 – 20% more than a policy for an owner occupied policy. The average annual premium on landlord insurance is about $986. This of course varies depending on the size, cost and location of the rental property. For more information, read our article on landlord insurance.
Deducting Umbrella Liability Policies for Rental Properties
If you have other forms of insurance such as a landlord liability policy or umbrella liability policy that covers multiple properties, you will want to seek the counsel of your tax professional or CPA to determine how it should be deducted. One option is to prorate the cost among each property; another possibility may be to deduct it from the overall business entity.
If you have to pay for any utilities – gas, electric, or water, they would be a deductible expense. If you pay for private trash removal and/or recycling service, those may be lumped in with utilities. In addition, if you pay for communication services such as Internet or cable/satellite TV for your rentals, those costs are also deductible as a utility expense.
Deductions for various common utilities can be claimed on:
- Heating bills
- Air conditioning
- Trash & Recycling
- Internet, T.V & Phone Services
“There are a couple of points worth noting regarding utilities. All of the utility expenses are deductible but the landlord must record a reimbursement, if any, from the tenant as income.”
– Brian J. Thompson, CPA & Real Estate Attorney, Brian Thompson Law
6. Maintenance & Repair
Costs to maintain, care for, and improve the property are deductible. However, there is a difference between how things like cleaning, maintenance, and repair are deducted versus how improvements are handled.
Cleaning, Maintenance, & Repair
These items are considered normal, ongoing items in the operating of the property. They are deductible as normal operating expenses. An example of maintenance might be replacing a few shingles lost to a storm. Normal wear and tear on a property can include replacing worn carpet or repainting rooms with faded paint from sunlight exposure.
Improvements are considered long-term benefits to the property and are depreciated over several years. Some items may be depreciated over 5 years, others as long as 27.5 years. Using the roof example from above, if it’s the entire roof being replaced, that’s considered a capital improvement and must be depreciated over 27.5 years.
Since the roof has been depreciated, you can’t expense the entire cost in 1 year. Instead you would spread the cost out over 27.5 years. So, if the roof was $15,000, you should deduct the same amount each year, according to the IRS, in the straight line depreciation method. This means you would deduct $545.45 each year for 27.5 years.
With improvements, it’s vital to involve your CPA or tax professional. It’s important to classify and compute things correctly, and the recordkeeping responsibility is rigorous.
7. Advertising & Marketing
There are 2 main sources of marketing deductions for a rental property. They include advertising to find tenants to rent the property and lease-up commissions to pay real estate professionals or property managers to rent out the property. Both of which can be tax deductible.
Any amount you expend to advertise your building, its availability for tenants, or for anything else related to the property (like trying to find an onsite manager or contractor) are all deductible as normal operating expenses. This includes fees or subscriptions for websites such as Zillow where you might list your property for rent.
Tenant Placement & Lease-Up Commissions
An often overlooked marketing expense is the commission paid to a real estate agent or property management firm to either secure a new tenant or renew their lease. Since this is often 1 month’s rent or more, it’s a significant expense well worth recording.
8. Homeowner Association (HOA) Fees
If your rental property is located in a community that charges any kind of homeowner association fees, condo fees, planned unit development (PUD) fees, etc., these are deductible expenses. HOA fees vary depending on the location, amenities included and size of the unit but the average HOA fees for a single family home are $200 – $300 per month.
9. Auto & Travel Expenses
Travel-related tax benefits for rental properties are generally categorized in 2 ways: automobile-related travel expenses and other travel-related expenses. You can deduct the necessary expenses of traveling as long as the trip’s primary purpose pertains to your rental property.
Business use of your car for your rental properties is deductible. If you have to drive to a property to show it, tackle repairs, or otherwise visit the property for a legitimate operational purpose, the mileage is deductible.
Auto expenses can be deducted one of 2 ways: the standard mileage method or the “actual” method. For 2017, the IRS set the rate at 53.5 cents per mile driven for business. The “actual” method uses the percentage of all the actual vehicle’s expenses used for business. Both require that you keep necessary records – date and business purpose of the drive, odometer readings before and after the business travel, and the mileage itself. To learn more details about the mileage deduction, read our in depth guide on standard mileage deduction.
There are also apps for smartphones that make keeping the records very easy and convenient. You don’t have to write it down or wait until you’re in front of your computer to record your mileage. Instead, you can download the app on your smartphone and keep track of your mileage on the go. To learn more about these convenient smartphone apps check out our guide on the best mileage tracking apps.
Additionally, you may have investment business mileage not attributable to individual properties, but to the business overall, that may also be deductible. Any business-related mileage (such as going to the office supply store or post office) is deductible if properly documented.
Other Travel Expenses
Aside from using your car, other travel expenses related to your rental property may be partially or totally deductible. For example, if you fly to a property in another state to clean out the building between tenants, that’s legitimately business-related. The airfare would be deductible as would hotel stays meals, rental cars, parking, and tolls.
However, only the business portion of the trip is deductible; you have to prorate that portion which is clearly business versus that which isn’t. In the above example, if you stayed a week, but only dealt with the property for 2 days, you can’t deduct all 7 days worth of meals or hotel costs.
To learn more about properly deducting travel related expenses check out our guide on deducting travel and entertainment expenses.
The supplies category is somewhat a miscellaneous one that can include anything from hardware to office supplies. Many supplies will be directly used on a given property and deductible to the property itself. An example might be driveway sealant, if the can was used on just the one property.
Other supplies might be applicable to several or all of your properties and deductible to the business as a whole. An example might be computer printer paper which can’t be allocated to a single property but is used for anything related to the business.
Typical supplies related to your rental property include:
- Printer ink, which can be expensive at an average of $13 per ounce
- Printer paper, folders, binders and receipt books to stay organized
- Maintenance supplies such as paint, spackle, primer, brushes etc
- Cleaning supplies such as buckets, mops, vacuums and cleaning solutions
- Building supplies like sheetrock, nuts and bolts, and plywood
- Hardware including locks and keys which can add up if you change them after each tenancy (locksmiths often charge upwards of $125 to change locks)
11. Property Management Costs
Property management comes in several forms. You may be handling it yourself, engaging a property management firm, or actually hiring a property manager. Each is handled differently from a tax standpoint. Property management fees generally range from 7 – 20% of the gross monthly rental income.
Tax Deductions If You Are Handling Property Management Yourself
Whether you can deduct any of your personal management depends on how you’ve structured your business. If your properties are owned by you personally (a sole proprietorship) it’s tricky to deduct the cost of your own management. However, it can be done, and the more you can substantiate your active management – like using tenant screening tools or property management software – the more likely you’ll be able to demonstrate your active engagement.
If you have an entity like an LLC or corporation, there may be the possibility of the company employing you as a property manager which means your salary will be a deductible expense.
Tax Deductions If You Engage a Property Management Firm
Fees that you pay to a property management firm for their services are deductible. Be aware, though, that things like commissions for tenant placement should be noted as marketing and not management.
Tax Deductions If You Hire a Property Manager
Real estate investors with large multi-unit properties or apartment buildings will often hire onsite property managers. Salaries and any benefits paid to these managers are fully deductible rental property expenses.
12. Legal & Professional Fees
If you use any professional services, perhaps for accounting or legal work, those are deductible expenses. Generally, these will be applied overall to your real estate investment business. However, if there is work clearly applicable to certain properties then the expenses are deductible for the properties themselves.
3 Types of Property Ownership that Affect Tax Benefits
The business structure you choose for your rental properties will affect what deductions you can take and how you approach them. These deductions vary whether you hold your properties as a
sole proprietorship, partnership, or corporate entity.
The 3 types of property ownership that affect tax benefits include:
- Sole Proprietorship
- Corporate Entity
In particular, there are tax deductions that are directly tied to the rental properties themselves (These are known as Schedule E deductions); there are others that can be attributed to an overall business that runs the investment business (known as Schedule C deductions). The type of business entity you select will govern, to a great degree, how much of the latter kind of deductions you can take.
Since the creation of the 2018 Tax Cuts & Job Act, each of the 3 entities is now entitled to a new pass through tax deduction as long as the rental activity qualifies as a business for tax purposes. You will be able to deduct 20% of your net rental income. Basically, you will pay taxes on 80% of your net rental income, instead of 100%. This can get complicated if you have employees or if your annual taxable income exceeds $415,000 for married couples filing jointly.
Tax Deductions for Rental Property – Beyond The Basics
In addition to the basic tax deductions for rental property, there are other tax issues worth noting. They are related to rental property losses, FICA or self employment tax, capital gains, and what’s known as depreciation recapture.
Properties showing a loss offer the most tax benefit, although you should be aware of two things. First, losses are limited to $25,000 in any year, although you can carry over any excess losses into future years. Second, any tax savings stemming from a rental or any other business loss only end up being a portion of what was expended. So, don’t go overboard with spending. Good financial management is the first rule.
FICA/Self Employment Tax Benefits
One of the biggest withholdings you have in your paycheck is that for social security, known as FICA; if you’re self employed, you know this as self employment tax. Depending on how your business entity is structured and what the financial situation of the properties looks like, you may be able to avoid paying some (or all) of the FICA or self employment tax.
Depending on the situation, that can save you from approximately 7.5% to nearly 15% of the profits derived from the properties. For more information on FICA check out our helpful FICA guide.
Capital Gains Taxes Versus Taxes on Ordinary Income
If you sell a property at a profit, chances are you will be taxed on that profit. If you sell after owning it for more than 1 year, it will most likely be capital gains tax, not ordinary income tax. However, if you sell the property within 1 year of purchasing it, you’re usually taxed at ordinary income tax rates.
Currently, capital gains tax rates run from 0% – 20%. That’s compared to income tax rates that range from 10% – 37%. So, it’s a substantial tax savings. For more information on taxes specific to flipping houses, read our guide on house flipping taxes.
Unfortunately, depreciation is a bit of a two-edged sword. At the outset of ownership, depreciation provided a tax benefit. However, when you sell, it creates a taxable amount through what’s called depreciation recapture. In short, a portion of the depreciation you’ve taken over the years will be taxed as part of the gain on the sale.
What’s important to note here is that most investors are not even aware of depreciation recapture, but it can wield a big tax bite upon sale. It’s one of the main reasons to have a tax advisor or CPA handle the tax strategy for your rental properties.
Special Tax Situations Involving Investment Property
There are many special-case tax situations worth learning about. While they may not end up being part of your investment landscape, knowing about them can give you access to even more rental property tax benefits.
Tax Deductions for Vacation Homes Used as Rental Property
If you have a second home or vacation property that you sometimes rent out, account for it as a rental property for the period of time you are leasing it. That means you may be able to write off things like advertising, rental commissions, part of the insurance, prorated repairs, etc.
That will help offset the income generated by the rents and might mean a fairly hefty tax deduction at the end of the year. Keep in mind that as of 2018, the maximum interest deduction limit on vacation homes and primary residences is $750,000. A vacation property is generally considered a rental property if it’s rented for more than 14 days a year. This is another area that can be tricky when calculating deductions, so it’s best to consult with your tax expert to receive the most rental property tax benefits.
Historic Tax Credits
If your property is a qualified historic property you might be entitled to take a historic tax credit. Historic tax credits are available at the federal level, and many states such as Ohio and Massachusetts also have programs. These may apply to both the building’s renovation and/or the operation of it as a rental.
Tax credits are a bit different than tax deductions. Whereas tax deductions come back to you as a portion of the effect of expenses, tax credits are dollar for dollar. In other words, spend $1 dollar on renovations, get $1 reduction in the taxes owed.
State or Local Tax Incentives
In addition to historic tax credits, your state or municipality may have economic development tax credits for buying, fixing up and operating property in lower-income areas like this example of Detroit. Governments use economic development tax credits to encourage people to purchase in these areas so they will eventually be improved.
“A big mistake is simply failing to keep good documents. It seems elementary, but the first thing we do when we onboard a client is train them on how to keep good records. We can give you all of the tax strategies in the world, but if you can’t maintain good records, our strategies will be pointless under an audit.”
– Brandon Hall, Founder & CEO, The Real Estate CPA
The Bottom Line – Rental Property Tax Benefits
Real estate investors have access to an abundance of rental property tax benefits. Depending on how you hold the properties, you may be able to deduct expenses directly related to running the properties along with deducting expenses related to the overall business entity. Tax laws for rental property are complex and it’s advisable to use a tax professional or CPA.