One aspect of being a real estate investor is to figure out how to operate within the framework of the law while seeking as many tax breaks as possible. For instance, investors can claim the depreciation (the gradual loss of value over time due to natural wear and tear) of a property on their taxes, which can offset some of the profits generated by the property. While there are multiple tax breaks and tax deferral options available to real estate investors, there are still questions that surround the legality of taking advantage of some of these breaks. For instance, investors often wonder if they can claim the interest owed on their investment properties in the same way that they claim interest on the mortgage associated with their primary residence. The answer to that question will come as a great comfort to real estate investors who want to use every allowable tax break to their advantage.
Can I claim Interest on an Investment Property?
If you have invested in a piece of real estate that generates income, there are some costs associated with the property that you can claim as deductions on your taxes. These deductions include depreciation in the property’s value, operating expenses, property taxes, and even the interest that is owed on a mortgage that was obtained to purchase the property. In addition to interest on a mortgage, there may be other types of interest that a real estate investor can claim in order to help minimize his or her tax liability.
Mortgage interest only applies to investors who have obtained a mortgage to purchase an investment property. If you purchased an income generating property with cash, there won’t be an option for you to claim mortgage interest. However, for mortgage-backed properties, the annual interest paid to the mortgage provider can be claimed as a tax deduction.
However, it’s important to note that even if you used cash to purchase an investment property, you may still obtain a mortgage to perform any necessary improvements on the property. In that situation, you are still able to claim the interest that you pay on that mortgage.
Additionally, real estate investors can claim the interest owed on any personal loans that they obtain if the funds are used to improve the property or perform any other action that results in income generation. Finally, if an investor uses a credit card to pay for goods or services related to the rental property, the interest owed to the credit card company is tax deductible.
How Do You Report Rental Income and Expenses?
As is always the case, the Federal Tax Code requires that anyone who earns income in the United States files a Federal Income Tax Return annually. For real estate investors, certain forms are required to report both the income generated and the expenses accrued.
According to the IRS website, real estate investors should use Form 1040 or 1040 SR, Schedule E, Part I to list their total income and expenses associated with real estate investments over the course of the previous tax year.
As always, you are encouraged to work with a tax professional when preparing your annual tax return. It’s imperative that you maintain good records throughout the year, not only so you don’t fail to report any earned income from the previous tax year, but also so you’re able to claim as many deductions as possible. Knowing how to use legal tax benefits to your favor may be the difference in finding success as a real estate investor and failing.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. The income stream and depreciation schedule for any investment property may affect the property owner’s income bracket and/or tax status. An unfavorable tax ruling may cancel deferral of capital gains and result in immediate tax liabilities. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. Cash flow or income are not guaranteed.
