As a property owner, you may be looking for ways to balance some of your real estate related income with deductions. How can you minimize the bite that taxes take out of your earnings? Consult your tax advisor to ensure that you are claiming all the deductions to which you are entitled. Here are some to look out for.
Interest Deductions. As with your personal residence, the interest on the mortgage for your investment properties is deductible, but it works differently and offers a greater advantage to the taxpayer. Using Schedule E (where you will also report your rental income), you can report interest payments without needing to itemize. Also, the investor taxpayer is not constrained by a $750,000 principal level cap. Finally, if you use a credit card or take out a non-mortgage loan to make repairs or improvements to your investment property, you can deduct the interest from those payments.
Maintenance and Repairs. You can deduct the cost of maintenance items, including gardening, pest service, utilities (if you pay them), and repairs like broken appliances and windows. If a repair crosses the line into a capital improvement (which substantially increases the property's fair market value), it is no longer deductible. Instead, it is added to the cost basis and depreciated.
Property administration. Expenses related to managing the property are deductible. These costs include the actual property manager if you hire one. It also encompasses advertising, legal fees, and insurance. If you travel to manage the property, those expenses are deductible.
Qualified Business Income. Also known as the pass-through tax deduction, this was established by the Tax Cuts and Jobs Act of 2017. It allows taxpayers who are actively involved in rental income management to deduct as much as 20% of a sole proprietorship, S-corporation, partnership, or LLC income.
Depreciation. Unlike other expenses, depreciation of property takes place over the life of the property. For a taxpayer to depreciate rental property, the following must be true:
- You own the property (you may have a mortgage or other obligation on the asset).
- You intend for the property to produce income.
- The property has a useful life span. You can depreciate a building but not land because land does not wear out.
- The life span is expected to be greater than one year. You may not acquire the asset (or put it into service) and dispose of it (or stop using it for business purposes) in the same year.
The IRS sets 27.5 years as the "useful life" of a rental property, so that is how long depreciation takes. Consult your tax accountant to ensure that you correctly determine the property's basis, but generally, it is the property cost and the expenses of the acquisition. Keep in mind that you can't depreciate the land, just the building, so you will need to separate the values of the two.
Capital Improvement Depreciation. Separately, the taxpayer can depreciate the amount spent on capital improvements to the rental property asset (such as a roof). The IRS designates the useful life of improvements as fifteen years, so the depreciation takes place over that period.