Generating income and increasing owner equity over the long term are not the only ways investors hope to profit by owning a rental property. Investing in rental properties provides numerous tax benefits compared to many other income producing assets.
Let’s take a look at 5 tax benefits and deductions for rental property that every real estate investor should know.
1. Operating expenses are deductible
Operating expenses for managing and maintaining a rental property are tax deductible. As the IRS explains, ordinary and necessary expenses may include:
- Advertising costs
- Leasing commissions
- Property management fees
- Repairs and maintenance
- Supplies
- Landscaping
- Pest control
- Property taxes
- Landlord liability insurance
- Utilities paid directly by the landlord
- Professional service fees, such as an accountant or real estate attorney
Note that you may not deduct capital expenditures, which are treated differently for tax purposes. For example, if you replace a roof or make other large capital investments, these cannot be claimed as deductions. Instead, these will be depreciated over time, according to depreciation schedules prescribed by the IRS.
2. Mortgage interest is deductible
Mortgage interest paid on a loan used to purchase a rental property is fully tax deductible. Interest paid on a credit card balance and reasonable interest paid to a member of an LLC who loans a company money are two other examples of tax-deductible interest expense.
Investors who use a credit card to purchase major items, such as appliances or fixtures, may wish to obtain a business credit card to help keep business expenses separate from personal expenses.
3. You get a depreciation deduction
Another tax benefit of owning rental property is the depreciation expense.
The IRS allows real estate investors to depreciate rental property over a period of 27.5 years to recover the cost of wear and tear. Because land does not wear out, only the cost of the home plus other items that increase the cost basis such as a new roof, appliances, or carpeting may be depreciated.
4. Owner expenses are also deductible
Even when a real estate investor hires a local property manager to take care of the tenant and home, there may still be expenses an owner can deduct to reduce taxable income:
Continuing education
Money spent on dues to belong to a real estate investing club, subscriptions to real estate or business periodicals, and tuition paid for continuing education can normally be deducted from income generated from a rental property business.
Travel
Rental property owners can generally deduct travel expenses, such as airfare and lodging, provided they meet the following criteria described in IRS Publication 463:
- Travel must be mainly for business and have a clear business purpose
- Majority of the time must be spent on business activities and not leisure activities
- Travel expenses must be ordinary and necessary for the real estate business but not be overdone, such as staying an reasonably-priced hotel versus a five-star resort
Owners may also be able to deduct auto expenses related to traveling to the rental property.
The standard mileage deduction is the simplest way to deduct business-related travel expenses, with a rate of 56 cents per mile (for 2021). Another way of deducting auto expenses is by keeping track of actual itemized expenses such as gas, insurance, and car payments and deducting the pro rata share used for business at the end of the year.
Home office
Rental property owners may also be able to deduct for the home office use of a portion of a residence, provided the portion is used exclusively and on a regular basis for business purposes.
With the simplified option for home office deduction, the IRS allows taxpayers to claim a standard deduction of $5 per square foot, up to a maximum of 300 square feet.
5. You avoid FICA taxes
Taxpayers who are self-employed are normally required to pay the employer and employee portion of Social Security and Medicare taxes, also known as FICA or payroll tax. Fortunately, income from a rental property is usually not classified as earned income, which means the income is not subject to FICA tax.
Disclaimer
The information contained within this article is provided for informational purposes only and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional accountant.
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Any U.S. federal tax advice contained in this website is not intended to be used for the purpose of avoiding penalties under U.S. federal tax law.