By David J. Hawks | David J. Hawks
Rental properties can be a great investment. They can also provide helpful tax benefits. To maximize the tax benefits of a rental property, it is essential to know which expenses are deductible. The short answer is that most expenses related to a rental property are deductible, but this article will help to clear up any confusion.
Rental properties, if owned individually or through a single-member LLC are reported on Schedule E of Form 1040. If owned by a partnership or S corporation, rental properties are reported on Form 8825 of the business tax return. If you are unsure what types of rental expenses are deductible on a tax return, a review of these forms is a good place to start. Below is the list of expense categories on the tax forms.
- Auto and travel
- Cleaning and maintenance
- Legal and other professional fees
- Interest expense
- Wages and salaries
Most of these deductions are self-explanatory so I will address a few that may be less clear. First, auto and travel expenses. When it comes to vehicle expenses, keeping track of mileage is a must. Vehicles used part of the time for business and part of the time for personal uses are considered listed property. The listed property is reported on Part V of Form 4562, and you are required to list the total miles driven, commuting miles, and business miles. To determine total miles, you should get in the habit of recording your odometer on January 1st of every year. Make it part of your New Year’s celebration. Commuting miles are miles driven to and from your home to your regular place of business. If you work out of your home and drive to your rental property, these are considered business miles. In addition, miles driven to Home Depot for rental supplies are also business miles. To track your business miles, you can use helpful apps, or you can go old school and keep a written log in your vehicle.
An overlooked deduction may be legal and other professional fees. In 2018, the itemized deduction for tax preparation fees went away. However, the cost of filing Schedule E or Form 8825 is still deductible as a professional fee. Make sure you, or your tax preparer, are not forgetting to include these tax preparation fees related to the rental property as a deduction.
Repairs expense can be a point of confusion for some. Generally, repairs are deducted in the year the expense is incurred. However, if the repair is a betterment, improvement, restoration, or adaptation as defined by the IRS, you may have to capitalize on the repair and depreciate it over the appropriate useful life. Improvements that are a structural part of a residential building have a 27.5-year life, whereas carpet and fixtures have a 5 or 7-year life. There is a de minimis safe harbor election that can be claimed on the tax return that allows you to deduct items with a cost of less than $2,500. As an example, if you purchase a refrigerator that costs less than $2,500, claim the de minimis safe harbor election and include the cost of the refrigerator as an expense, not as a depreciable asset.
You may have heard that rental buildings are depreciable, whereas land is not. When you purchase a rental property, make sure you are not depreciating the entire cost of the property. An exception is a condominium, where you own the building and not the land. The cost of the condo would be fully depreciable. You can determine the value of the building versus the value of the land by looking at your property tax records.
If a rental expense does not fit into the categories already listed on Schedule E or Form 8825, the expense can be included as an “other” expense. These expenses can include HOA fees, cell phone expenses, and any other expenses related to the upkeep of the rental property. You are also allowed to claim a home office deduction on Form 8829 if you use an office in your home to manage the rental property. See the instructions for Form 8829 if you have any doubt whether your home office qualifies for the deduction.
Generally, rental properties are considered passive activities and may be subject to the passive activity rules. Under the passive activity rules, you can deduct up to $25,000 in passive losses against your ordinary income (W-2 wages) if your modified adjusted gross income (MAGI) is $100,000 or less. This deduction phases out $1 for every $2 of MAGI above $100,000 until $150,000 when it is completely phased out. These limits apply to both those filing single or married filing jointly. So, if your MAGI is higher than $150,000, do not be surprised when your rental losses do not reduce your taxable income. The losses will be carried forward until you can offset them with passive income, or until you sell the property.
If you meet the requirements of a “real estate professional,” you are allowed to use passive losses against your ordinary income. To be a real estate professional, you must provide more than one-half of your total personal services in real property trades or businesses in which you materially participate and perform more than 750 hours of services during the tax year in real property trades or businesses. Ideally, you should prepare contemporaneous time logs that detail the services rendered.
If you are new to investing or are a seasoned pro who has been renting real estate for many years, two keys to maximizing your rental real estate deductions are being educated about tax laws and keeping good records. Being aware of the deductions available to you will help you maintain appropriate records and be ready come tax time.
If you need the help of a CPA who understands real estate taxation, you can call me at (480) 626-5557 or email me at email@example.com.
by David J. Hawks, CPA, EA