Rental properties come with a slew of valuable tax benefits. But only to the extent that you understand what they are and how to use them!
Deni and Brian break down the most commonly used rental property tax deductions, to help you reduce your tax burden and improve your returns!
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Deni Supplee:
Hello everyone, and welcome to Spark Rentals weekly podcasts and Facebook live. If you are joining us or please let us know in the chat where you’re coming from and because that’s what we’re going to go over today. I jumped ahead of myself because I just want to remind you last week we talked about renting to family or friends. We got some interesting comments on that. There’s a definite for or against there. And today we are going to go over our landlord tax deductions and let you know what are these things that you should be keeping track of so that you’re maximizing your deductions. So, you’re lowering your tax amount you’d have to pay.
Brian Davis:
And in doing so, raising your returns and the more you can lower your expenses, your taxes, the higher your returns.
Deni Supplee:
Absolutely. So in speaking of these things Brian, start us off and tell us a little bit of some of the typical tax deductions.
Brian Davis:
Sure. There are dozens of these and we’re not going to go through every single one today, but we will go through some of the most common ones, starting with everyone’s favorite mortgage interests. So before we even actually jump into this, I just want to point out that these tax deductions for landlords, these are what they call above-the-line deductions. You do not have to itemize your personal deductions in order to take advantage of these, these come off of your rental income. So this all happens on a separate schedule on your tax return, and then the bottom line, your net rental income, after all of these deductions is what appears on your personal tax return. You do not have to itemize their deductions and we’re going to probably repeat that like three times throughout this broadcast because it’s important and that is unlike with homeowners trying to take the mortgage interest deduction. Landlords do not have to itemize.
Landlords can itemize mortgage interest every year and of course in the year that they take out a loan, they can also deduct mortgage fees, lender fees at the settlement table points, junk fees, like admin fee, processing fee, that kind of stuff. All that’s deductible. You can also deduct for depreciation, which is something that gets very confusing very quickly for a lot of real estate investors and many landlords actually don’t even understand depreciation. So we have a whole article on it that includes a free depreciation calculator. I’m going to put a link in the comments to that. By the way, Trent says: “depreciation, here’s how this works in a nutshell, when you buy a rental property, there are two things of value that come with that, you’ve got the land and you have the building itself. So, the improvements on that land”.
Now, land does not decline in value over time, it doesn’t rust or crumble or fall apart, but the building does. The IRS lets you do a process called depreciation for the building portion of the property and when you buy a property, there’s on the tax assessment, it will be a land assessment and a building assessment. The building’s value you can deduct, you can spread that deduction for the entire building value out over the first 27 and a half years that you own the property. And for each year after that first year you take 127th and a half of that building value.
Deni Supplee:
It was bad enough, they use 27, but they had to throw a half in there to really confuse you.
Brian Davis:
Seriously, that’s how depreciation works, the value of the building when you buy it, you can deduct that, but you have to spread the deduction over the next 27 and a 1/2 years. Now added to that are many of the closing costs that you incurred at the settlement table when you bought the property, those get added to your cost basis and you can depreciate those as well. And if you make any capital improvements, that extended the life of the building, for example, putting on a new roof that also gets added to your cost basis and you can add that to your depreciable amount each year as well. Additionally, each year you can deduct 127th and a half of the building value, most of the closing costs, any capital improvements. So and again, we put a link in the comments there to anyone that wants to read up on depreciation and see exactly how it works and use a free depreciation calculator.
Speaking of capital improvements and repairs, you can deduct for maintenance and some repairs. The difference between repairs and maintenance versus capital improvements are that repairs and maintenance are not things that extend the life of the building and now that gets to be a blurry line very quickly. But to give you a quick example, if little Tanya from next door throws a baseball through the window and breaks it, you replace that window, that’s a repair, you can deduct that cost. If you go out and replace all of the windows in the property with like super high energy efficiency, double paned windows, that’s a capital improvement. A quick example of making the repairs on the one side, which are deductible versus capital improvements that have to be depreciated over 27 and a half years. Moving on property taxes, also deductible, because otherwise, you have to pay taxes twice. You have to pay taxes on your tax bill, which is just crazy. Same thing for landlord insurance, you can deduct the cost of your premium from landlord insurance as well. You can also deduct the premium for rent default insurance, which Deni and I talked about quite a bit.
Deni Supplee:
Which even gives more reason to have something like that.
Brian Davis:
Yes, and it’s not expensive. It’s a few hundred bucks a year and if your tenant stops paying the rent, the insurance kicks in and pays it for you, which is awesome. Obviously I can speak that as a landlord. Legal and professional fees, for example, property management, accountant fees, bookkeeper fees, all of those are deductible for landlords. Travel expenses are deductible for landlords, but that’s one that a lot of people get in trouble with because it’s a bit of an audit trigger. If you try to claim too much in travel deductions, that’s a good way for the IRS to flag your return and come after you with an audit and say, well, let’s see all of your receipts and your records to prove that you were actually traveling for real estate investing and for your rental properties.
Deni Supplee:
The IRS want logs. They don’t want just it was 15 miles from here to there, they want dates too from mileage.
Brian Davis:
Exactly. And another one that is also an audit trigger is meals, but you can, it is legal. Landlords and real estate investors can deduct for meal costs while they’re traveling to visit properties that they already own and that’s a really important distinction. You can’t write off meals when you’re traveling to scout for prospective rental properties. The IRS will not let you do that and again, if you get too crazy with the meal deductions, the meal cost deductions expect a not-so-friendly letter from the IRS.
Deni Supplee:
Yes. If you’re going to McDonald’s on your way home from your rental property, which is two miles from your house, that could be a problem.
Brian Davis:
Exactly. A third one is also, it can be an IRS audit trigger, but it is legitimate a deduction for landlords and real estate investors is a home office, which, the tax law change from a couple of years ago, the tax cuts and jobs act of 2017, which we’ll talk about more in a minute, just as a very quick overview, but that no longer allows W2 employees to claim the home office deduction, but self-employed people can still claim the home office deduction and real estate investors and landlords are self-employed. You can take the home office deduction. But again, you have to be really careful with it. Don’t try to pull one over on the IRS here. The room that you claim as a home office, it cannot be used for anything other than work. You cannot have a spare bed in there used for like guests when they come and stay with you, can’t have any of that. Your home office must be only used for, and again, this is only available to self-employed people.
Deni Supplee:
Right, it must be dedicated space.
Brian Davis:
Dedicated space exactly. And of course you can also deduct for the costs of people who work for you. Whether that’s employees, whether that’s contractors, anyone you pay to help you with your real estate investments or your rental properties, the costs you can pay that person is deductible. Even for a virtual assistant. If you have a virtual assistant help you, those costs are deductible as well.
Deni Supplee:
And a cleaning person for your office, if you truly have somebody that does that.
Brian Davis:
Right or if you manage like vacation rentals, you have some 3B properties and you send any cleaning crew in between guests staying there, those costs are deductible as well, that’s another example. Deni, did I miss any deductions that you want to include here?
Deni Supplee:
I think we got them.
Deni Supplee:
It’s really important, we got to put the disclaimer here. We are not accountants, nor am I a financial professional, that’s just not what we are. If you have several properties, please talk to a financial professional and accountant and a good accountant who knows real estate. I’ve gotten messed up by using an accountant who didn’t know real estate.
Brian Davis:
All accountants are not created equal. We included a link in the comments to our very comprehensive guide to the many tax deductions for rental properties. We don’t have time to go through all of them today, but check out that list. If you have any questions about them or tax deductions. And let’s do a very quick run through Deni of some of the most tax changes that have gone into effect within the last few years. Just as a quick overview for anyone who has been under a rock for the last couple of years with their tax returns.
Deni Supplee:
Just some quick, there are still seven tax rates from 10 to 37%, but the income tax ranges did shift a bit. Our standard deductions rose from 200 to 400. So it makes it now 12,400 for single and 24,800 for married and 18,650 for a head of household. So those are a little different.
Brian Davis:
The standard deduction went way higher a few years ago which is both a good and a bad thing. But they are basically, they’re discouraging people from itemizing their deductions, which for the average person is probably a good thing. Keeps your tax return a lot simpler and it makes the IRS’s job simpler. So the standard deduction is now much higher at 12,400 for single people, 24,800 for married couples filing jointly. So yeah, much higher.
Deni Supplee:
Another good change is when you’re itemizing charitable donations, they are now hundred percent deductible of your adjusted gross. That means the whole amount can be deductible.
Deni Supplee:
By the way, that won’t work if you’re filing standard. Also, medical costs have gone up to seven and a half percent of what may also be deducted, which is an increase.
Brian Davis:
Well, right. So did your medical costs have to be at least seven and a half percent of your adjusted gross income in order for you to deduct those now, if you’re self-employed, you can deduct your medical expenses as a business expense, right?
Deni Supplee:
I don’t know if it’s considered a business expense, but it is; oh, well it is a business expense if you have like an LLC and your LLC is paying the premiums, yes. But if you’re paying for it personally, it’s a little different.
Brian Davis:
Okay. Once again, we are not CPAs.
Deni Supplee:
Exactly, this is changing daily. I have a friend of mine that’s an accountant and we’re in March and she just had to take a class on how to handle some of these new changes. So it’s changing constantly. Like for instance, the stimulus check that’s coming out, if you file your tax return last year and it was less, it is better for that return to be used. But if you already filed your 2020, and it’s more, they’re going to go by that. So if you want more money or any of the money, you have to be careful with all that stuff and this just was released. I mean, you have to really keep your eye on things.
Brian Davis:
Yeah, and that’s a great point. Deni, are there any other COVID or pandemic-related tax issues that the landlords and real estate investors in particular should be aware of?
Deni Supplee:
Well, there are quite a few people that have losses, rental losses because of the eviction moratorium. They are considered passive and I didn’t even realize this, there’s a five-year, this is like the 27 and a half, but it’s a five-year carry back privilege. So you can stretch that loss out if it doesn’t meet the maximum, if it over goes the maximum. That is good, carry it forward if you can.
Brian Davis:
To offset your income next year.
Deni Supplee:
Exactly. Which is good because the years that you hopefully don’t need it, in the future going forward. There’s a lot of people that got hit hard with this pandemic.
Brian Davis:
No question and any other COVID related tips, tax tips for landlords?
Deni Supplee: I can’t think of anything, don’t forget to include anything that you had to do to make common areas COVID friendly or protected anything like that. A lot of people won’t even think about installing those sanitize stations as anything, and they are. Make sure you keep track of all those things as well. Talk to your accountant and keep an eye on what’s going on out there. Because I have a feeling, things are going to change because of the moratoriums and they’re stretching them and there’s gotta be some relief for the landlords that are there. There are landlords that are hurting big time because of this.
Brian Davis:
Well, landlords are unfortunately not a very politically powerful or protected group and they’re much maligned. But at least we have some good tax lessons. We talked about is common tax deductions for real estate investors and landlords. There is mortgage interest and fees, depreciation, maintenance and repairs, property taxes, landlord insurance, rent default insurance, legal and professional fees, such as property management fees or accounting fees, realtor fees, travel specifically for real estate investments, meals while you’re traveling for real estate investing, your home office and of course, any employees or contractors that have done work for you. Any last thoughts Deni before we call this episode complete?
Deni Supplee:
I don’t think so. I think that covers it. Remember to make sure that you’re keeping your eye on the news and other good resources, there’s so much out there, you don’t even know what’s true and what’s not and then check with a good financial person because that’s important.
Brian Davis:
Absolutely. Well, thanks guys. We will see you next Tuesday.
Deni Supplee:
Because it’s super complicated.
Brian Davis:
So, we’ll see you next Tuesday at 2:00 PM Eastern, 11:00 AM Pacific and let us know what you want us to talk about. This is just as much about you guys as it is about us. So, let us know your, your request, your thoughts, any questions you have about real estate investing, land lording and we will see you next Tuesday.
Deni Supplee:
Have a great day.
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