What are the tax benefits of rental properties?

What are the tax benefits of owing rental properties?

Homeowner Tax Concept

Last updated on May 1, 2022

For many of those just getting their feet wet in the world of real estate investing, tax considerations are not always top of mind amongst the numerous benefits of acquiring rentals. Don't forget that tax impacts can have a significant effect on your financials. Here are some items to consider that will factor into your decision of entering the real estate investing space:

Tax Consideration 1: Depreciation

Contrary to the trend of property values appreciating over time, the concept of rental property depreciation might come across as nonsensical. However, when it comes to tax purposes, think of your rental as a business asset in the same class as a piece of equipment that can wear out over time. The IRS will allow you to depreciate your rental over a period of 27.5 years in order to account for the wear and tear the dwelling unit of your rental. Generally, the depreciation period begins once the rental is ready for tenancy.

Keep in mind that in the case of single-family homes, the lot value isn't able to be depreciated as land does not wear out like dwellings do. There are some other intricacies to this so please consult a qualified tax expert for more information on your exact situation.

In addition to wear and tear of the dwelling, the appliances within the rental are also able to be depreciated over a period of 5 years. Again, this period of time generally begins once the appliance is in use under tenancy within the rental. Of course, for specifics and a more complete breakdown of what applies to you, please refer to a tax specialist.

Tax Consideration 2: Mortgage Interest

Payments made by you towards your rental mortgage interest are fully tax deductible since they are classified as a business expense. Make sure that you understand that only the portion of your mortgage payments that go towards paying down interest can be deducted. Money that goes towards the principal of the mortgage loan is not tax deductible.

Tax Consideration 3: Property Taxes

In addition to mortgage interest payments, the property taxes you pay for your rental properties are also tax-deductible. Property taxes will vary depending on the location and the size of the property as well as which state the property is in, but this amount can usually be deducted.

Property taxes for rental properties differ from those on primary residences since rentals can be classified as businesses, and therefore property taxes on rentals can be classified as ordinary operating costs for the business.

Tax Consideration 4: Repairs

Money spent towards conducting necessary repairs for your rental property can be tax deductible. This depends on the nature of the work done as well as the timeframe of the work. In simple terms, qualifying expenses not incurred within the same year as you acquired the rental can be deducted.

For example, if you acquire a new rental property and then immediately pay for a new roof to be installed, the money towards the new roof will most likely not be considered a tax deductible expense - it will be considered a capital improvement instead according to the applicable IRS guidelines on rental properties. Items such as new roofs, security systems, HVAC systems, sprinkler systems, water heaters, new flooring, and new insulation are generally to be capital improvements instead of deductible repair expenses.

However, if you acquire a rental property, and then in the following calendar year you put money towards repairing a hole in the wall, you're able to claim the cost of that repair as tax deductible for that calendar year.

Tax Consideration 5: Miscellaneous Expenses

There are a few other items you may be able to to include on your tax return in addition to the above. These may include the following expenses:

1. Transportation expenses incurred during activities related to rent collection, managing, or maintaining your rental properties. For example, if you need to drive an hour to help your tenant fix a leak, then you may be able to deduct the cost of that trip.

2. Insurance premiums and costs for your rental properties;

3. Utility costs paid by you for your rentals;

4. Advertising expenses incurred by you associated with your rentals;

5. Costs associated with continuing education about real estate. For example, any costs incurred by membership to a real estate or the cost of subscribing to real estate magazines may be tax deductible.

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