Top 10 Tax Deductions for Your Real Estate Investment Rental Property
When the housing bubble burst, I realized I was faced with an opportunity to purchase some investment properties at fire-sale prices—although I knew I couldn’t offload them in that particular market right away. Other investors thought I was nutty because they were pulling away from real estate altogether. But, sometimes buying and renovating a property to hold until the market tides change in your favor makes sense. Holding properties doesn’t necessarily need to be a financial drain for your real estate portfolio. In fact, there are numerous tax benefits for landlords who, as the IRS would say, choose to put their property “into service.”
Riding Market Lows With Tax Deductions for Your Rental Investment
Understanding tax deductions for your rental property can be complicated. For instance, you are only allowed to take advantage of certain deductions while your property is either being offered for rent or it is rented out. Real estate investors who find fixer upper homes for sale to rehab can generally only take advantage of certain deductions when the house is rent-ready. With that in mind, let me walk you through some of the ways that investors may leverage tax deductions to defray the cost of holding an investment property as a rental business.
1. Interest on lines of credit
This category of deductions is usually the biggest win for landlords. Deducting interest is not just for mortgage loans to purchase a property; there are other interest payments involved in operating a rental and these can usually be written off as deductions too. Generally, you have the ability to itemize any interest paid on personal loans, institutional loans, and credit cards for property improvements or other rental-related expenses. Remember, though, that you currently cannot deduct any of the principal on those lines of credit!
Contrary to popular misconception, in tax terms, depreciation does not refer to a decrease in the value of your investment property, Rather, it describes how the IRS allocates your cost basis over the life of the property. How much you can deduct is determined by three factors: 1) your cost basis for acquiring the property, including taxes and fees; 2) the allowed recovery period; and 3) the depreciation method that’s employed. Your tax professional can help you determine the appropriate deductions for your unique situation.
Unless you have unusual circumstances, most investors will use the Modified Accelerated Cost Recovery System (MACRS). Using this method, landlords can depreciate their asset classes at varying rates.
Here’s my caveat: If you begin to rent out a property and then stop within the same year, you will not be eligible for claiming depreciation that year.”
Depreciation Rates for Different Asset Classes
|Asset Class||Recovery Period|
|Buildings & Structures||27.5 Years|
|Fences, Landscaping, & Driveways||15 Years|
|Otherwise Unspecified Property Class||7 Years|
|Appliances & Furniture||5 Years|
In simplified terms, your annual depreciation deduction for each asset class is currently calculated by dividing the cost basis of each asset class by the allowed recovery period.
Cost Basis / Recovery Period = Annual Deduction
So, for instance, if your cost basis for the land and structures on the rental property is $175,000, then you will be able to deduct $6,364 each year for depreciation. Please check all deductions and calculations with your financial advisor or attorney.
175,000 / 27.5 = 6,364
The IRS provides a form to guide you through making these calculations for each asset class. Deducting depreciation costs can be valuable as it lets you spread the property’s purchase cost over time and this decreases tax obligations.
3) Private Mortgage Insurance (PMI) premiums
Unlike the premiums on your private residence, you may be able deduct the cost of homeowner’s insurance for a rental. Here’s the catch though: You can only deduct the amount applied toward insurance during that tax year. In other words, even if you paid more than a year in advance for property insurance, you can only deduct one year’s worth of costs. The rest will typically roll over into the next tax year.
Of note, the PMI deduction expired as of December 31, 2016 but it may be reinstated for the next tax season.
4) Local taxes
It might seem straightforward, but this deduction can be a bit tricky. In most cases, property owners can deduct the amount that you pay toward local taxes, with the exception of taxes for local benefits that increase the value of your property. Local benefit taxes may include charges for installing new sidewalks or a new sewer system.
5) Professional fees or commissions
This is a broad category of deductions that can be leveraged to offset the costs associated with hiring professionals ranging from a resident manager or property management company to an eviction attorney or accountant.
6) Cost of ordinary repairs
It’s important to understand that for tax purposes, repairs are typically handled in a manner that’s different from home improvements. Repairs, such as painting or fixing the hot water heater, just keep the property in good condition. These can be deducted in the tax year that they were completed. Home improvements—like installing a swimming pool—increase the value of the property.
TIP: The costs of repairs are deductible, but currently only a percentage of improvement costs are eligible for write-offs. Improvement costs must be capitalized and depreciated over multiple years. You can often benefit from taking photos of any major repairs to prove that you did not substantially increase the value of the property and keep a copy of all invoices for your records.
One tax-saving I’ve learned along the way is to repair, not replace. You see, I can deduct the whole cost of a repairing a roof as many times as needed. But, replacing the roof is considered an improvement for tax purposes so I could only recover the costs by deducting the depreciation value over 27.5 years.”
7) Cleaning and maintenance
Some of the expenses associated with your rental can be written off as a deduction, including fees associated with trash removal services, pest control, supplies, yard care, and cleaning services. In addition, you can usually itemize equipment rentals—such as the rental of carpet cleaning equipment—that are necessary to maintain the house.
8) Water and utilities
If you are in the rental business, the IRS says that water and utilities are ordinary operating expenses that can potentially be deducted. This is a great deduction to leverage if your tenants are not responsible for paying the utilities themselves.
9) Travel expenses
Local transportation costs to collect rent or manage your rental property represent another potential tax deduction. But it’s important to note that you cannot write-off the cost of commuting from your home to the rental property unless your home office is your primary place of business.
It goes without saying that your rental may be vacant at times when you’re in the process of seeking new tenants. Whether a property management company does the advertising, screening, and vetting or you opt to tend to this in-house, any related expenses can be considered deductible. It might not add up to much compared to your other expenses, but every little bit counts!
If you make passive income from real estate, you must keep good records in order to maximize your rental property’s tax deductions. In the event that the IRS questions your write-offs, your records will prove your case, while ensuring that you remain out of hot water. Please consult your tax professional to help guide you to determine which tax deductions you may be eligible to claim.
Position Yourself to Maximize Investment Opportunities
Investing in real estate doesn’t have to be overly risky, despite market ebb and flow. You just need a solid strategy. I was effectively able to continue investing in real estate throughout the collapse of the housing bubble. I purchased houses from distressed homeowners who called my HomeVestors® franchise after seeing that memorable “We Buy Ugly Houses” national marketing. The homeowners needed a way to escape an “ugly” situation, so I paid rock bottom prices knowing that there may be a long-term opportunity if I simply maintained the properties as rentals until the market saw a turn-around. Of course, consulting with my financial advisor, I was able to take advantage of all of the available tax deductions for my HomeVestors business, which helped position my business to be even more competitive.
If you are interested in learning more about the HomeVestors franchise opportunity, please get in touch today!