Discover the ins and outs of claiming rental property expenses for tax purposes. Learn about deductible expenses and essential record-keeping requirements.
In addition to a possible increase in value over time, owning rental property also offers a steady source of income. The benefits of owning and managing rental properties aren’t without their responsibilities, however. One of them is understanding the tax implications. Claimable property-related expenses are an important part of rental property taxation. From the many types of deductible expenses to the specific record-keeping requirements and the most typical mistakes to avoid, this article will cover it all when it comes to claiming your rental property expenses. Read on to find out more!
What Are Deductible Expenses?
Deductible expenses are expenses associated with owning and maintaining a rental property that can be subtracted from your rental income to calculate your taxable income. Any deductible expense falls into one of the two main categories: operating expenses or capital expenses.
Operating Expenses
These are the lifeblood of maintaining a rental property. These expenses are associated with the daily operation of the rental property and keeping it in good condition. Common operating expenses include mortgage interest, property taxes, insurance premiums, property management fees, repairs and maintenance, utilities (gas, water, and electricity), advertising and marketing, legal and professional fees, as well as HOA fees.
Mortgage interest and property taxes are the largest expenses for landlords. Property taxes are fully deductible as a business expense, and mortgage interest is often deductible for the part of the property that is rented out. Insurance premiums, including property damage and liability coverage, are deductible as well. Another typical expense for landlords is the cost of hiring a property management company to take care of routine tasks like screening tenants and collecting rent. Repair and maintenance costs – like fixing a leaking roof or broken appliance, are also deductible expenses that help maintain rental properties in good condition and attract renters.
Utilities, including gas, water, and electricity, are also deductible expenses, no matter if the landlord includes them in the rent or not. Expenses for advertising and marketing, such as posting ads on rental websites or printing fliers, are fully deductible as they are essential to attracting renters. Fees given to accountants or attorneys for services such as tax preparation or representation in eviction proceedings are also deductible. Lastly, landlords who own properties in managed communities can deduct homeowner association fees, if applicable.
Capital Expenses
Capital expenses are those related to improvements to the rental property that increase its worth or make it last longer. Capital expenses cannot be fully deducted in the year of incurrence, but they will have depreciation schedules and will be depreciated over time. Some examples of capital expenses include property improvements, major repairs, appliances and furniture, and landscaping and outdoor improvements.
How do these increase a property’s worth and lifespan? Well, property improvements, such as renovating a kitchen or adding a bathroom, increase the property’s rental value and attractiveness to tenants. Major repairs, such as replacing a roof or upgrading the HVAC system, are necessary to maintain the property’s structural integrity and habitability. Appliances and furniture, if provided by the landlord, are considered capital expenses if they have a useful life of more than one year and depreciate over time. Landscaping and outdoor improvements, such as installing a patio or planting trees, can enhance the property’s curb appeal and renter satisfaction.
Tips for Record-Keeping
To be sure that your rental income and expenses are reported appropriately on your tax return and can be supported in the event of an IRS audit, proper record-keeping is a must. Here are some things to keep in mind while keeping records:
First of all, open a separate bank account and credit card specifically for your rental property, to avoid mixing your personal and rental income and expenses. The process of record-keeping will be simplified, and reconciling transactions around tax time will be made simpler. Keep any paperwork pertaining to repairs, maintenance, upgrades, and professional services that are incurred for rental property. This includes receipts, invoices, and other relevant documents. Keep these records on hand in case an auditor wants to see proof of your expenses.
Keep a record of any received rental income, such as rent, security deposits, and any other payments. You can use a system or software to track your rental income and categorize it. If your rental property has any depreciable assets (such as buildings or appliances), it is important to keep a record of their cost basis, useful life, and depreciation schedules. You’ll need this information if you want to calculate depreciation expense and report it on your tax return. Remember that proper record-keeping is important for staying compliant with tax laws and regulations and ensuring accurate reports of rental income and expenses.
Mistakes to Avoid
You always need to stay in compliance with tax rules and regulations, so there are certain common mistakes to avoid when claiming rental property expenses, even if doing so might help you reduce your taxable income and tax liability:
- Personal use of rental property. You may not be able to deduct all of your rental property expenses if you use it for personal purposes like going on vacation or giving free stays to friends and family. For rental properties to be eligible for deductions, the IRS requires they be used primarily for producing income.
- Overstating expenses. In an effort to maximize your deductions, you may be tempted to overstate your expenses or claim personal expenses as rental property expenses. However, doing so can trigger an IRS audit and, if discovered, result in fines and penalties. You can only deduct costs that are directly related to the rental property and can be shown with proper documentation.
- Not depreciating assets. It is necessary to depreciate capital assets in your rental property, such as buildings and appliances, over their useful lives to represent the true decline in value over time. Not depreciating these assets can only lead to missed tax deductions and future tax consequences.
- Inadequate record-keeping. If you ever face an IRS audit, you won’t be able to support your rental property expenses without adequate record-keeping. It could be difficult to support your deductions if you don’t keep organized records of your income and expenses, and you will probably have your expenses rejected and end up owing more taxes.
In Conclusion
As a property owner, you can potentially minimize your taxable income and maximize your tax savings by claiming rental property expenses on your tax return. You will maximize your tax benefits while staying in compliance with the laws and regulations if you understand different types of deductible expenses, keep records properly, and avoid the usual mistakes. Always remember the importance of tax planning and compliance if you want to be successful in the long run as a rental property owner.
