Rental Income and Taxes: A Comprehensive Deduction Guide

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Brendan Tuytel

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December 21, 2023

This article is Tax Professional approved

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As of 2019, renters made up about 36% of the population. This demand is mostly served by individual investors and the number has ticked up since 2008.

With it becoming more common for someone to own a rental property or be part of a small rental business, you may be new to rental real estate and the rules and regulations surrounding them.

To help you navigate the ins and outs of rental property taxes, we've compiled a list of the most common rental property tax deductions you should know.

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What’s included in “rental income”?

For rental property owners, the most commonly known form of rental income is rent payments: the gross income received as payments for the use or occupation of the property.

However, there are additional sources of income associated with rentals that get grouped under rental income.

Expenses paid by tenants are an example of this. If a tenant pays out of pocket for a repair, the rental property owner must record that amount as rental income. However, they also get to claim the expense on their tax return.

Other examples of rental income include:

  • Advance rent (payments received before the period covered)
  • Security deposits used as a final payment of rent (i.e. not to be returned to the client)
  • Payment received from a tenant to cancel a lease
  • Goods or services received in lieu of a rent payment
  • Payments received in a lease with option to buy agreement

Top rental property tax deductions

Property repairs and improvements

Not every expense associated with maintaining the property is tax deductible. Whether it is or isn’t depends on whether it’s considered a repair or an improvement.

The rule of thumb used by the IRS is whether the cost is to keep the property operational or adds value.

Fixing a toilet because it’s no longer flushing is repair. Redoing the bathroom because it makes the property more desirable is an improvement.

Repairs are immediately tax deductible in the tax year they occur.

Improvements are not immediately tax deductible. Instead, they must be depreciated over the life of the property.

What’s better for your taxes, a repair or an improvement? The complicated answer is it depends. Repairs maximize your deductions in the current tax year. Making repairs before they require a full renovation means you’re consistently minimizing your tax bill in the present.

Rental property depreciation

Depreciation spreads the cost of the property and any long-term improvements over the property’s lifetime. 

For residential rental property placed in service after 1986, the IRS determined the “useful life” to be 27.5 years. The cost of the property and other costs to be depreciated are to be spread over this timeframe.

A depreciation schedule is needed to determine what you can claim as a depreciation expense in a given tax year. It takes information about the price of the asset, date of purchase, expected useful life, depreciation method, and salvage value to determine what the depreciation expense would be.

It’s best to work with an accountant to figure out the depreciation schedule of your property and help you figure out the deductible amount.

Property taxes

On personal tax returns, the amount of property taxes you can claim as a deduction is capped at a total of $10,000 ($5,000 if married and filing separately).

If the property is used for business activity, like a rental, you are eligible to deduct the full amount. However, this depends on you having “active participation” in the rental property business.

If your involvement is not considered “active participation,” you are still limited to the $10,000 cap.

Mortgage interest costs

If you have an ongoing mortgage you’re making payments on, you’re eligible to claim a portion of them as a deductible expense.

Your mortgage payments are broken out into two portions. The principal amount is what reduces the balance owed while the interest amount is the cost of borrowing.

Only the interest amount is a deductible expense.

The mortgage lender must send you IRS Form 1098 which shows the amount of interest you paid throughout the year.

Any costs or fees involved with obtaining a mortgage are not deductible expenses.

Utilities

Any utilities paid by the landlord are tax deductible, even if they’re reimbursed.

Say the water bill is $100. If the tenant doesn’t foot the bill, you simply record $100 as a tax deductible utilities expense.

If the tenant does reimburse you, you record the transaction twice: once as $100 as rental income and again as a tax deductible utilities expense.

For utilities to be eligible as a tax deductible expense, the account must be in the landlord’s name. If the account is under the tenant’s name, it’s no longer eligible.

Insurance premiums

Often, property owners have home insurance plans to protect their asset.

Insurance premiums that cover the property in the tax year are tax deductible. If you prepay any premiums beyond the year, they must be claimed on next year’s tax return.

For example, if you pay for a year’s worth of insurance covering January through December, you can claim the whole amount on that year’s tax return. But if it started in February and ran through January of the next year, only 11 months of the amount would be eligible.

Home office expenses

To qualify for home office deductions, some conditions must be met. Consider working with a tax professional to guarantee you qualify.

A workspace in your home qualifies if you have active participation in the rental, the space is used for work purposes only and regularly, and it’s your primary workspace.

If you have a space that qualifies, you can deduct a portion of your personal home expenses as operating expenses. Examples include mortgage interest, insurance, utilities, and repairs. 

To find your deduction amount, there’s two approaches you can take. Both require you to know the square footage of your home office space.

The simplified method means taking a standardized deduction of $5 per square foot of the workspace. This is capped at $1,500.

The regular method requires you to calculate the percentage of your home the workspace takes up. Divide the square footage of your workspace by the total square footage of your home to find the percentage you use. This is the percentage of the eligible expenses you can claim as a tax deduction.

Travel expenses

Travel expenses refer to expenses related to the cost of travel to collect rent or maintain the rental property.

If you’re traveling to the property for a non-business reason, it’s no longer considered a tax deductible business expense. Similarly, if you are traveling for the purpose of improvements, like making renovations, those travel costs are considered part of the improvement costs.

For example, if you drive over to the property to pick up a rent check, that’s a travel expense. But if you’re driving over to build a new patio, that’s now considered part of the improvement expenses.

Advertising expenses

Any paid listings or postings to promote your property are considered an advertising expense, which are tax deductible.

Professional services

Having a team of professionals gives you the peace of mind that all the t’s are crossed, i’s are dotted, and rules are followed. Plus, they’re a deductible expense.

Professional services include accountants, lawyers, property managers, and bookkeeping (like Bench).

Only the portion that applies to the rental activity can be claimed. For example, if you have a lawyer write up the rental agreement and your will in the year, be sure to only include the billable hours that apply to the rental.

Reporting rental income and deductions

Rental income and rental property tax deductions are typically reported on your personal tax return.

You must fill out Schedule E and attach it to your Form 1040 come tax filing. Schedule E is where you report rental income and tax deductible expenses associated with the rental property.

A Schedule E allows you to report income and deductions for up to three rental properties. If you have more than three, complete as many Schedule E forms as needed to list them all.

Remember to keep receipts to back up all expenses (though some expenses don't require receipts).

As always, a tax professional helps you track and deduct expenses related to the property as well as stay on top of any changes in tax law that impact you. Consider working with one for your first tax filing with a rental property to get started on the right foot.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. Bench assumes no liability for actions taken in reliance upon the information contained herein.
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