1. Mortgage interest
Mortgage interest for a loan on a rental property is a common tax deduction. Points and other loan origination fees are also deductible, but they might have to be taken over a period of time according to IRS rules rather than all at once at the time the loan was issued.
2. Tenant acquisition expenses
Expenses related to acquiring tenants are also deductible. This category can include items such as the cost of advertising, commissions paid to listing agents, and cleaning. Any utility expenses the landlord must pay between tenants are also included. Similarly, if the rent includes any utilities such as heat, hot water, sewage, or trash collection, those expenses are an available deduction for the landlord.
3. General business & property management expenses
Fees and expenses related to running the business are another category. These can include transportation necessary to maintain the property or collect rents; legal fees; the usual office supplies and expenses; and insurance. Note that insurance premiums can be deducted only for the year of coverage: any advance premium payments must be divvied up over the period of coverage for the purpose of the tax deduction. If the owner uses a property management firm, any related fees are an allowable expense, as are any state or local taxes.
4. Depreciation
Depreciation is an important deduction that is easy to overlook as it's not available for a person's primary residence. It is considered a capital expense based on the acquisition cost of the income-producing property. The calculations start with the date the property is available for rent. Depreciation deductions must be taken over the expected life of the property. The IRS provides extensive guidelines on what costs should be included in the depreciable amount and how to calculate the annual deduction amount.
Note that the cost of land alone cannot be depreciated as it is considered to not wear out. Certain improvements to the land related to making it ready for business use can be depreciated but should be evaluated carefully to ensure they meet IRS requirements.
5. Repairs
It is important to differentiate between deductible expenses and expenditures that are considered capital expenses that are part of the owner's basis in the property. For example, repairs that keep the property in good operating condition without adding much to its value or lifespan are deductible operating expenses. But improvements are considered capital expenses that add to the value of the property.
Repairs can include tasks such as fixing a broken window, repairing a leaky faucet, or giving the interior a new paint job. Improvements are capital expenses that must be depreciated over a period of time and include things such as adding a deck, upgrading the wiring, remodeling the kitchen, or adding a fence. The line between repairs and improvements is not always clear - repairing the furnace is a repair but replacing it generally an improvement - but the IRS does provide examples and scenarios to help.
Good records are key for all expenses for both annual tax filings and in the event of a future sale of the property. It can be challenging to work through all the available provisions of the tax code. When in doubt, it is always best to retain the services of a tax professional.
Roger D. Eagleton is a real estate investor and co-founder of Five Star Property Management, a San Francisco-based property management company specializing in residential property management.
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