The billionaires of the world are not doctors or lawyers, they’re entrepreneurs. Specifically, they are people who started their own businesses, whether those businesses are online, brick and mortar, or real estate empires.
Starting and owning a business provides a long list of tax advantages, and real estate investments provide all the usual tax advantages plus some extras unique to real property. Every expense associated with rental properties – plus some just-on-paper expenses – are tax deductible.
However, tax laws change fast and that means it is imperative for all those who invest in real estate must educate themselves. So, before you jump into the rental property deductions checklist, make sure you’re up to speed on how the new tax law affects landlords’ tax returns.
The changes in the Tax Cuts and Jobs Act of 2017 (TCJA) impacted homeowners, real estate investors and landlords alike. Here’s an outline of what you need to know as a real estate owner, and when in doubt, hire a professional who knows accounting with a real estate investing focus. Ideally one who invests in real estate themselves.
Changes to the Home Mortgage Deduction in 2017
Home mortgage interest remains deductible up to $1,000,000, for loans that settled before December 15, 2017.
Home mortgage debt incurred after December 15, 2017 is only deductible up to $750,000. Mortgage interest on rental property loans is unaffected by the TCJA.
Another change worth mentioning is the tax deduction is no longer available on HELOC’s (Home Equity Line Of Credit) in tax year 2019.
Keep in mind that interest on HELOCs for rental properties remains deductible for landlords.
Lower Income Tax Rates
From 2018 through 2025, rental property investors will benefit from generally lower income tax rates and other favorable changes to the tax brackets. The TCJA retains seven tax rate brackets, although six of the brackets’ rates are lower than before.
Here are the updated regular income rates for tax year 2019 (due in April 2020 or October 2020 with an extension):
|Tax Rate||Single||Married Filing Jointly||Head of Household|
|10%||$0 – $9,700||$0 – $19,400||$0 – $13,850|
|12%||$9,701 – $39,475||$19,401 – $78,950||$13,851 – $52,850|
|22%||$39,476 – $84,200||$78,951 – $168,400||$52,851 – $84,200|
|24%||$84,201 – $160,725||$168,401 – $321,450||$84,201 – $160,700|
|32%||$160,726 – $204,100||$321,451 – $408,200||$160,701 – $204,100|
|35%||$204,101 – $510,300||$408,201 – $612,350||$204,101 – $510,300|
|37%||$510,301 and up||$612,351 and up||$510,301 and up|
Keep in mind that you pay separate tax rates for each “segment” of income. For example, a single taxpayer with an adjusted gross income of $50,000 would pay the following taxes:
$970 on their first $9,700 of income (10%)
$3,573 on the next $29,775 of income (12%)
$2,315.50 on the next $10,525 of income (22%)
Total Taxes: $6,858.50 Effective Tax Rate: 13.72%
Long-Term Capital Gains Tax Brackets
The TCJA retains the existing tax rates for long-term capital gains.
Remember, short-term capital gains – earnings on investments held for less than one year, such as flipped homes – are taxed as regular income. But the IRS charges less for long-term capital gains: earnings from investments held for at least one year.
Roughly speaking, taxpayers pay 0% on long-term capital gains if their income falls in the 10% or 12% income tax brackets. If they earn enough to pay taxes at the 22% tax rate, they have to start paying taxes on long-term capital gains.
Here’s how the tax brackets look for long-term capital gains for tax year 2019 (due in April 2020):
|Capital Gains Tax Rate||Single||Married Filing Jointly||Head of Household|
|0%||$0 – $39,375||$0 – $78,750||$0 – $52,750|
|15%||$39,376 – $434,550||$78,751 – $488,850||$52,751 – $461,700|
|20%||$434,551 and up||$488,851 and up||$461,701 and up|
No Self-Employment Taxes for Landlords
In many ways, landlords get the best of both worlds: the tax benefits of owning a business, without the downside of self-employment taxes.
Real estate flippers can sometimes fall under the “dealer” category, and find themselves subject to double FICA taxes. FICA taxes fund Social Security and Medicare, and cost both employees and employers 7.65% of all income paid. Self-employed people end up having to pay both sides of FICA taxes, at 15.3% of total income.
But the Tax Cuts and Jobs Act of 2017 ended up leaving landlords and their rental income free from any FICA taxes.
New Passive Income Loss Rule
If you have losses from “passive activities” such as owning rental properties, typically you can only deduct those losses to offset other passive income sources, such as other rental properties. For example, if you earn $10,000 from one rental property and have an $8,000 loss on another, you can offset your $10,000 income with the $8,000 loss, for a net taxable rental income of $2,000.
But if you have a net loss, that can’t be used as a deduction against your active income from your 9-5 job. You can carry it forward however, to offset future passive income earnings and rents.
Here’s how the TCJA changes matters: there’s a new $250,000 cap for single filers, $500,000 cap for married filers, for passive losses. Any passive losses that you’re allowed, in excess of those caps, must be carried forward to the next tax year.
It won’t affect most landlords, but it’s something to be aware of.
20 Tax Deductions for Landlords
Here are 20 rental property expenses you can deduct on your tax return, to keep more of your money in your pocket where it belongs. It’s not 100% exhaustive, as there are a few obscure tax deductions that only apply to a few landlords, but think of this as a rental property deductions checklist for the average landlord.
IMPORTANT: These rental property tax deductions are “above the line” deductions, meaning they come directly off your taxable income for rental properties. That means you can deduct these expenses, and still take the standard deduction.
1. Losses from Theft or Casualty
The TCJA suspended the itemized deduction for personal casualty and theft losses for 2018 through 2025. Before 2018 deductions of this kind were permitted when they exceeded $100.
But landlords can still deduct losses from theft or damage to their rental properties, as business expenses.
2. Property Depreciation:
This is a handy “paper expense.” Much of the cost of buying your property can be written off as a tax deduction, although it must be spread over 27.5 years (don’t ask me where that number came from). Buildings lose value as they age (at least theoretically), so the IRS lets you deduct 1/27.5th of the property’s cost each year.
Major property upgrades and “capital improvements” must be depreciated as well, rather than deducted in the year you make them. For example, a new roof is a capital improvement that must be depreciated, rather than deducted all at once.
But the patching of a roof leak? That’s a repair.
3. Repairs & Maintenance
Basic repairs and maintenance such as new paint and new carpets are deductible for your rental properties. That’s not the case for your primary residence, in which repairs are not deductible.
Remember, if it’s a large improvement or replacement (like the roof example), it may count as a “capital improvement,” in which case you’ll have to spread the deduction over multiple years, in the form of depreciation.
The line isn’t always crystal clear however, like the roof example above. Here’s an example of how it gets blurry: if you replace all your windows to modernize and improve your energy efficiency, it’s a capital improvement. If a baseball goes through one window, which you replace, it’s a repair. But what if you replaced a few windows last year, but not all?
Talk to an accountant, and build a defensible argument for any repairs you deduct.
4. Segmented Depreciation
Some improvements, such as landscaping and “personal property” inside the rental/investment property (e.g. refrigerators) can be depreciated faster than the building itself. It’s more paperwork, to segment the depreciation of certain improvements as separate from the building’s depreciation, but it means a lower tax bill right now, not in the far distant, unknowable future.
Do you pay for gas, heating, trash removal, sewer or any other utility for your rental? Be sure to deduct these costs when you file your tax return.
Take heed however, these if your tenant reimburses you for a utility, that would be considered income. So you have to declare both the income and the expense, even though they offset each other.
6. Home Office
This is a popular deduction, but it’s also one you need to be careful about, as it can trigger audits. You have to set aside a percentage of your home for only doing work/business/real estate investing-related activities, and that percentage of your housing bill can be deducted. And 2020 may see this deduction scrutinized even more.
One new downer: no more home office deduction for those who work for others in the comfort of their home. But as a real estate investor, you’re a business owner, so you can still claim it if you sue the space exclusively for “business.”
Make sure and talk to an accountant about this, and keep the percentage realistic.
7. Real Estate-Related Travel
Another popular-but-dangerous deduction, you can deduct travel expenses if your travel was for your real estate investing business… and you can prove it. Many people get cute with this one, and when they go on vacation they’ll go see one or two “potential investment” properties and then write the entire trip off as a business expense.
Whenever you plan on deducting travel expenses, put together as much documentation as you possibly can so that you can make a strong case that it was an actual business trip. For example, meet with a real estate agent in the area, and keep all of your email correspondence with them. Keep all listing information and investment calculations for any properties you visit. Track your mileage for all driving done to and from rental properties.
8. Closing Costs
Many closing costs are tax deductible, and others can be depreciated over time as part of your acquisition cost. Use an accountant with a deep knowledge of real estate investments, and send them the settlement statement (previously called a HUD-1, now known as a CD or closing document) for each property you bought last year.
9. Mortgage Insurance (PMI/MIP)
No one likes mortgage insurance (other than banks). But at least you can deduct the cost from your taxable rental property income.
While you’re at it, check to see if any of your mortgage balances have fallen below 80% of their respective property values. If so, and if you financed it with a conventional mortgage, you can apply to have PMI removed from the loan, and potentially save yourself hundreds of dollars per month.
The same goes for your home, not just your rental properties!
10. Property Management Fees
Paid a property manager to handle the headaches and field those dreaded 3 AM phone calls from tenants? You can write off their management fees, including monthly percentage fees, new tenant placement fees, and any other fees the manager slaps you with.
If you’re still on the fence about hiring one, here’s what you should know about whether to hire a property manager.
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11. Rental Property Insurance & Rent Default Insurance
Like homeowner’s insurance for your primary residence, your landlord insurance premium for each property is also tax deductible.
You can also deduct the cost of rent default insurance policies for each property. Not familiar with rent default insurance? If the tenant stops paying the rent, the insurance company pays it until you go through the eviction process and sign a lease agreement with a new tenant. It protects you against tenants failing to pay rent, so you never go without rental cash flow.
They’re not very expensive either, usually ranging between $250-400 per year. Try Rent Rescue, we’ve vetted them as a reputable and easy insurance provider to work with.
12. Mortgage Interest
All interest you pay to your mortgage lender on rental property loans remains tax deductible. As mentioned above, it’s an “above the line” deduction that simply comes off of your taxable rental property income.
But for your primary residence, the IRS limits the deductibility of mortgage interest only up to $750,000 of home mortgage debt for tax year 2019.
13. Accounting, Legal & Other Professional Fees
All professional fees associated with your rental properties are tax deductible. Bookkeeping, accounting, attorney, real estate agent and any other fees you pay out for professional services can be deducted from your taxable income. Don’t forget the cost of any bookkeeping or landlord software (ahem!) you use.
One wrinkle introduced by the TCJA however is that personal tax preparation expenses are no longer deductible from 2018 onward. But business accounting – such as for your real estate LLC or S-corp – is still deductible as a rental business expense for landlords. Talk to your accountant about shifting as many of your tax preparation expenses as possible to the “business” side of the books!
14. Tenant Screening
If you paid for tenant credit reports, criminal background checks, identity verifications, eviction history reports, employment and income verification or housing history verification, those fees are deductible.
Even better, have the applicant pay directly for tenant screening report costs. Which, I might add, our landlord software allows you to do!
15. Legal Forms
Bought a state-specific lease agreement this year? Eviction notices? Property management contracts? The cost of legal forms is also deductible.
16. Property Taxes
Under the Tax Cuts and Jobs Act, landlords can still deduct rental property taxes as an expense.
But it’s a little more complicated for homeowners, and even though this is a list of landlord tax deductions, let’s take a moment to review the changes for homeowners, shall we?
For tax year 2019, you can no longer deduct for state and local taxes in excess of $10,000. These state taxes include things like: state and local income tax, sales taxes, personal property tax, and… homeowner property taxes.
What does this mean for high-tax states like New York, New Jersey or Connecticut? Well, it could mean that more people may relocate to lower-tax states like Florida, and may even spark lower property values in states such as New Jersey. Only time will tell.
17. Phones, Tablets, Computers, Phone Service, Internet
Bought a new phone this year? Maybe a new laptop or tablet? If you use it for work, you can probably persuade your accountant (and the IRS) that the costs should be deducted from your taxable income.
Likewise, for internet bills, phone service charges and the like, with the caveat that you need to be able to document that it was for business purposes. Printer toner, computer paper, pens, and the like; keep those receipts.
18. Rental Property Licensing & Registration Fees
Licensing and registration fees are sometimes a local requirement for rental properties. For instance, in the city of Philadelphia, a rental license fee is required along with an inspection of the property.
So, if you’ve had to purchase or renew a landlord or rental license for the property, that cost is deductible.
Furthermore, some localities will require a vacation rental license for short term rentals such as seasonal, AirBnB and the like. These licensing costs are deductible as well.
19. Occupancy Tax
There are states that assess an occupancy tax on collected rental amounts, comparable to paying sales tax. This is more of a common practice in states where short-term rentals are common. Florida, Arizona and New Jersey are examples of states that charge an occupancy or tourist tax.
If you own rental property in an area that charges an occupancy-like tax, then the amount is tax deductible. Remember, however, that the tax will not only differ from state to state but also from local jurisdictions like cities and counties.
20. Business Entity Pass-Through Deduction
There are significant changes in 2018 tax regulations on how legal entities (e.g. LLCs) and pass-throughs and the like are going to be treated. Sole Proprietorship, Partnership, and Corporate Entities are now entitled to a “pass-through” deduction as long as the rental activities meet the requirements for business tax purposes.
The short version is that landlords can deduct 20% of their rental business income from their taxable business income amount. For example, if you own a rental property that netted you $10,000 last year, the pass-through deduction reduces your taxable rental business income from $10,000 to $8,000. Pretty sweet, eh?
There are restrictions, of course. The deduction phases out for single tax payers with adjusted gross incomes over $157,500, and married taxpayers earning over $315,000. Although under some conditions, higher-earning landlords can still take advantage of the pass-through deduction – definitely discuss with your accountant.
One more reason, beyond asset protection, to own rental properties under a legal entity!
It’s hard to get ahead if 50% of your income is going to taxes (which it probably is, if you add up everything you pay in sales tax, property tax, federal income tax, state income tax, local income tax and FICA taxes). But by being savvier with your documentation and deductions, landlords and real estate investors can pay less in taxes than other people, and truly realize the advantages of entrepreneurship.
Remember to always document every expense you plan to deduct. That means keeping receipts, invoices and bills throughout the year as expenses pop up; to help with this, keep a separate checking account for your real estate expenses if you don’t already. Never swipe that debit card or write a check from that account without first getting documentation!
We will continue updating and expanding this article content as the upcoming tax changes continue. (If you want to be notified of future webinars by email, sign up for our mailing list – you even get access to our free mini-course on buying 2-4 multifamily rentals!)
Feel free to pass this rental property deductions checklist on to other landlords, to make sure they’re taking advantage of all tax deductions available for landlords!
How aggressive do you get with your travel deductions and home office deduction? Do you leave your mortgages in place just for the interest deduction? Spill the beans!