Maintaining an investment property comes with a range of costs. However, there are many deductions available to help landlords enhance their return on investment, some of which can significantly alter the profitability of a property.
The Internal Revenue Service (IRS) states that investors can claim tax deductions for all property costs required to run a rental business, so long as they count as ordinary and necessary for running the business. Expenses cannot be for personal use. To report rental real estate costs, investors create a Schedule E form for each tax year
Common landlord-specific tax deductions
While investors can claim a wide range of potential deductions, the most common include:
The costs for necessary and reasonable repairs, such as fixing locks or addressing faulty wiring, are fully deductible in a single tax year. However, you must ensure your repair is not a capital expenditure. To avoid making it a CapEx item, mend broken fixtures or installments rather than replace them.
2. Travel expenses
You can claim back the costs of all travel related to your rental business, such as visiting properties. Depending on your preferences, you can work out your tax benefits using the IRS’s standard mileage rates or deduct your actual expenses, as long as you can back them up with receipts.
3. Independent contractors and employees
Many landlords hire contractors and employees to carry out necessary services related to their property business, such as repairs or handling tenant communications. If you’re enlisting the help of independent contractors, you must remember to file an IRS Form 1099-MISC for payments over $600, as this will ensure you’re eligible for tax deductions.
4. Insurance costs
Landlords are eligible to deduct the many premiums they pay to insure their properties, such as fire, flood, and landlord liability insurance. You may also deduct insurance costs associated with hiring employees, such as health insurance.
5. Home office space
If you require a home office space to conduct work related to your rental properties, you may deduct operational expenses, such as utility bills, rent, and insurance. However, you must regularly and exclusively use the office as your principal place of business.
6. Advertising costs
You may deduct the costs of advertising your property. However, you must ensure such claims are separate from other turnover costs, such as cleaning and repairs.
7. Utility bills
You may claim expenses if you’re responsible for covering the cost of utilities at your rental properties. This rule still applies while your property is vacant.
8. Tax advice services
You may deduct the costs of hiring bookkeepers or tax professionals. However, you must not deduct capital expenses such as legal fees, title insurance, and closing costs, as these are incorporated into your property's basis and factored into depreciation.
9. Homeowners’ association costs
If your investment property is part of a homeowners’ association (HOA), you may deduct 100% of its monthly or quarterly fees. Please note, however, that special capital improvements, such as enhancing a community park or repaving the sidewalks, are not usually tax-deductible.
10. Pass-through tax deductions
You may be able to claim money back through the IRS’s pass-through tax deduction. Depending on your income stream, you may be able to deduct 20% of your net rental income or 2.5% of the property cost.
Deprecation refers to a property’s loss of value over time due to wear and tear. It allows landlords to reduce their taxable income, details of which are explained below.
Finally, and perhaps most importantly, investors can deduct mortgage interest costs on loans used to acquire their rental properties. Again, we explore this vital deduction in more detail below.
How does Depreciation work?
Maintaining a property for several years inevitably means landlords encounter upkeep issues such as wear and tear. Fortunately, it is possible to claim expenses related to this kind of depreciation. You can depreciate any instalment or structure used for rental purposes, such as apartments, mobile homes, parking lots, swimming pools and smaller fixtures such as doors, windows, electrical wiring, and heating systems.
As the IRS explains in Publication 946, investment properties can depreciate by 3.636% over a period of 27.5 years, while small items such as appliances can depreciate over five years. You can deduct an equal amount of the property cost (typically not including land) every year, apart from the first and final years. For example, you can deduct 1/27th of a residential building’s depreciable basis each year.
Investors can also use “bonus depreciation” rules to immediately deduct 100% of the depreciation costs of an item in the first year. Though, consult an accountant if you’re looking to use this rule as it’s subject to phase-out. In 2023, the bonus depreciation percentage will fall to 80%, eventually reaching 20% in 2026. By 2027, bonus depreciation will no longer exist. If you want to make the most of this benefit while it’s available, take note of the following rules:
- You can’t convert property once used for personal purposes and claim bonus depreciation
- Currently, there are no limits as to how much you can claim in bonus depreciation deductions every year
- Bonus depreciation is optional, but it applies automatically unless you explicitly opt-out
How does the Mortgage Interest Deduction work?
As you may know, homeowners can save money on their mortgage interest payments through the Home Mortgage Interest Deduction (HMID), allowing them to claim back the interest on the first $750,000 of a mortgage principal. While the HMID does not apply to landlords, you can deduct mortgage interest through a Schedule E, as it is considered a business expense. If you’re wondering how it works, here are a few key details:
- You can deduct all interest paid on a rental-related mortgage unless you occupy part of the property, or it wasn’t available for rent for the whole tax year. In such cases, you can work out the portion of the interest that covers the year or rental space and make proportional reductions. It is also worth noting you can only deduct interest in the tax year it was applied (rather than the year it was paid).
- You can deduct expenses related to all types of home loans, including Federal Housing Administration (FHA) loans and non-conforming home loans.
- You cannot use Schedule E deductions for vacation homes. If you occasionally use the property as an Airbnb, you may make proportional deductions. If you rent it out for six weeks a year, for example, you can deduct around 11.5% of the mortgage interest.
The bottom line
If you want to maximize the return on investment of a rental property, you must claim all relevant tax deductions. While there are many rules and regulations to consider, accounting and banking technologies will help speed up the process. With Nophin, you can automate many administrative jobs associated with claiming tax relief, such as categorizing expenses on your Schedule E. To find out more, browse our website or sign up for free.