An Overview Of Deductions For Landlords
September 30, 2022
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What Are The Tax Deductions That Landlords Can Use?
You’re probably aware that operating expenses are deductible, but there are also many other valuable deductions, particularly for smaller landlords.
These deductions aren’t difficult to qualify for, especially if you keep accurate records.
Let’s look at the top deductions for landlords, from start-up and home office expenses to interest and insurance.
In 2018, a new income tax deduction went into effect under the Tax Cuts and Jobs Act. Most landlords qualify for this deduction, which may allow you to deduct up to 20% of your net rental income from your income taxes. This deduction will be around through 2025, as long as Congress doesn’t terminate it before then.
Learn more about pass-through deductions in our companion article.
Start-Up Expense Deduction
Repairs and operating expenses that happen before a building is placed in service can’t be used as standard deductions, but they do qualify for the start-up expense deduction.
Start-up expenses are costs you incur prior to your units being ready to rent. The start-up expense deduction allows you to deduct expenses up to $5,000 in the first year you’re in business. After the $5,000 maximum, you deduct the leftovers in equal installments over 15 years.
How Do You Qualify?
Before you can claim any start-up expense deductions, you must be classified as a business.
Here are examples of potential start-up expenses:
- Office supplies and equipment
- Minor repairs
- Investigative costs
- Insurance premiums
- Expense of finding and training employees
- Website-building costs
Below are items that aren’t deductible start-up expenses:
- Real property
- Travel expenses
- Interest and taxes
Home Office Deduction
The Home Office Deduction is another beneficial deduction for small landlords because most work out of a home office. This is particularly common for those who manage their properties remotely.
A “home office” can be located anywhere you live—an apartment, condo, boat, etc. It can be all or part of a spare room, den, workshop, or garage. It can even be inside a residential complex you own if you live in one of the units.
The Home Office Deduction allows you to deduct a portion of your home expenses as business expenses if you manage your rental business from home.
How Do You Qualify?
There are four criteria you must meet to use the Home Office Deduction.
- You must be classified as a business for tax purposes.
- You must use your home office specifically for rental activities.
- You must use your office on a regular basis.
- You must meet one of the following four requirements:
Deducting Home Office Expenses
To apply this deduction, you first need to know what type of expense you’re dealing with. There are two kinds of home office expenses: direct and indirect. Direct expenses only benefit your home office, such as paint, appliances, flooring, or paid cleaning. Indirect expenses aren’t limited to your home office; they benefit your entire home. Examples are rent, mortgage interest or property tax, utilities, insurance, maintenance, and security systems.
Direct expenses are typically completely deductible, unless they fall under permanent improvements. For example, if you built an additional room for your office, you must depreciate it.
Because indirect expenses benefit your entire home, they must be reduced with this in mind. The easiest method is to determine a percentage based on your home office’s square footage divided by your home’s total square footage. For instance, if you were to deduct the cost of heating and AC in your home office, you would calculate the square footage percentage and then multiply it by the total cost of heat/AC for your entire house.
One final caveat: The IRS enforces a profit limit for home office deductions. You can’t deduct more than your net profit from your rental business.
Car and Local Transportation Expenses
IRS auditors often keep a close eye on car and local transportation expenses. This extra scrutiny is because these expenses are easy to over-report, and many people don’t keep good records. So, if you decide to take this deduction, keep thorough records.
What Can You Deduct?
Local trips for your rental activities are the only expenses you can deduct under this expense category. You can deduct any business-related trips that don’t require you to stay overnight anywhere. Examples include trips to and from:
- Your rental property
- A prominent place of business (including your home office)
- Locations where you meet tenants, suppliers, vendors, maintenance workers, lawyers, etc.
- The garbage dump where you take trash from the rental property
- A local college where you take classes to receive education about landlord-related activities
- A store where you purchase materials and supplies specifically for real estate purposes
Do You Have a Home Office?
If you establish a home office that is your key place of business, you can deduct the cost of any trips you make from home to another location for your rental business. For example, you can deduct the cost of going from home to your rental property. A home office qualifies if it is where you take care of management or administrative tasks exclusively for your rental business.
If you don’t have a home office, you must follow the commuting rule. Commuting encompasses nondeductible personal expenses. This means that even if a trip has a business purpose, it’s still commuting and, therefore, not deductible. Once you arrive at your rental office, you can deduct trips to other rental-related locations, but it won’t apply to trips back home.
The Standard Mileage Rate
You have two options if you drive a van, SUV, or pickup truck for your rental business: You can use the standard mileage rate, or you can deduct precise expenses. You can use both methods the first year, but after that, you must select one method to use on your tax return.
The Standard Mileage Rate is the rate set by the IRS that allows you to deduct every mile driven related to your rental activity multiplied by the specific rate. So, what is the standard mileage rate for 2022? It’s now 62.5 cents per mile. The standard rate usually ends up being lower than if you go with the actual expense rate, but it’s much simpler.
The Standard Mileage Rate does come with requirements, though:
- You must use it in the first year you use the car for your rental business, or you can never use it. (That being said, you can go from the standard mileage rate to the expense rate. Thus, if you’re unsure which method to use, start with the standard rate.)
- It cannot be used if you have more than five cars simultaneously being used for rental activity.
It’s also worth mentioning that if you use the Standard Mileage Rate, you cannot deduct actual car operating expenses like maintenance and repairs. The IRS factors them into their rate.
Actual Expense Method
Using the actual expense method, you can deduct the specific costs to operate your car each year. These will most likely include:
- Gas and oil
- Repairs and maintenance
- Depreciation of your original vehicle and improvements
- Car repair tools
- License fees
- Parking fees for rental activity trips
- Registration fees
- Garage rent
- Tolls for rental activity trips
- Car washing
- Lease payments
- Interest on car loans
- Towing charges
- Auto club dues
You then add up all these costs and multiply the total by your business use percentage (divide business miles by total miles for the year). This is the reason it’s imperative that you precisely track miles and other expenses. You’ll also need to keep receipts for all vehicle-related expenses. This is why it’s the more arduous method.
One final note: You cannot deduct the cost of driving violations or parking tickets. Government fines are never deductible.
Like car and local transportation expenses, the IRS also pays close attention to overnight travel expenses. This is because it’s easy to run up personal expenses while you’re away from home for your business.
When it comes to taxes, a travel expense is any expense you incur while staying overnight outside your city for business purposes. There’s no specific distance you must travel to take this deduction, assuming you stay overnight somewhere outside your city limits. Expenses regarding travel within your city limits fall under local transportation expenses.
There are two types of travel expenses: transportation expenses and destination expenses.
Transportation expenses include plane/train fares, luggage shipping costs, half your meal expenses, and temporary lodging as you make your way to your intended destination. Destination expenses cover lodging, half your meal costs, transportation at the destination, laundry expenses, and fees for phone, internet, fax, and computer rental.
Entertainment expenses, on the other hand, are never deductible.
How Do You Qualify?
The IRS is stringent about deducting travel expenses.
Your expense must meet these requirements before it’s deductible:
- The expense is primarily for business activity.
- It’s ordinary and necessary.
- You are a current landlord with properties in service.
- Travel to view a property you later purchase is not deductible.
- Travel to perform an improvement is not deductible.
Deducting Travel Expenses
The way you deduct your travel expenses depends on how you spend your time on your trip.
Theoretically, a trip of entirely business activities (no personal time) is 100% deductible. But it’s unlikely that every expense is a business expense on a trip.
This doesn’t mean you have to account for every minute of every trip. That would be absurd. The IRS uses this rule to simplify things: If you spend over half of your trip on rental activities at your destination, you can deduct 100% of your transportation expenses. If you spend under half of your time on business, the trip is fully nondeductible.
Another way to think about the rule is that business days must outnumber personal days. A business “day” means you either:
- Spent more than four hours on business activities on that day
- Traveled over 100 miles away from your “tax home,” or primary place of business
- Spent more than four hours traveling to your business activities
- Drove at least 300 miles for your business (can be added up over several days)
- Spent over four hours on a combination of rental activities and travel
- Were prevented from working due to an accident, strike, etc.
Casualty Loss Deductions
A casualty is any damage or loss of property due to a sudden, unexpected occurrence. For example, property damage due to theft, vandalism, accidents, or natural disasters is considered a casualty loss.
Casualty loss expenses can be deducted if they meet certain criteria but understand that the IRS keeps a close eye on them.
How To Qualify
Property damage has to happen suddenly to qualify as a casualty loss. Losses due to your property’s gradual deterioration aren’t deductible. The casualty loss must be caused by an external force. That being said, routine wear and tear could build up to a sudden event.
For instance, the general deterioration of your property’s roofing is not deductible as a loss. However, if wind and rain damage the roof over time until it suddenly caves in during an especially fierce storm, you could make a case that the loss was a sudden casualty loss.
Interest payments are a common expense for landlords. For instance, you may have interest payments on a car loan, mortgage, business credit card, or government/personal loans you use for rental purposes.
For the most part, you can deduct any interest on money you borrow for your rental business as an operating expense. However, you must use the money you borrowed to deduct it. Putting cash in the bank is an investment and thus not deductible.
How To Qualify
For the most part, any interest related to your rental activity qualifies for this deduction. There are a few rules to adhere to, though.
These are the instances where the interest cannot be deducted:
- Interest on money you don’t owe. If you aren’t legally on the hook for over half of the debt, you can’t deduct its interest.
- Interest that you pay with money you got from the lender. You must wait to deduct the interest until you begin paying off that loan.
- Income tax interest. Your income tax amount is tied to your rental activity, but you cannot deduct interest on your personal tax return.
An important caveat is that you can only deduct interest, not principle (repayments on the borrowed sum). The principle is instead combined with the cost basis and depreciated.
Rental Loss Deductions
Rental losses are a different kind of federal tax deduction. A rental loss happens when all your deductions rise above the rent and other revenue you pull in from your properties. If you are like most new landlords and have a rental loss at the close of the year, you can use the IRS’s rental real estate loss allowance.
Passive Loss Rules
When it comes to rental loss deductions, you must follow the passive loss (PAL) rules. These rules are complicated and have multiple exemptions, so let’s look at them below.
The Passive Loss Rule states that you cannot deduct passive (or rental) losses from your active or portfolio income.
What does that mean exactly?
The three categories of income are active, passive, and portfolio. Active income/loss is your salary from your day job (as long as you have one) and any businesses you actively run outside of real estate. Passive income/loss is all the income from your rental properties and any businesses you don’t actively manage. Portfolio income/loss is your investment income, including interest and dividends.
Simply put, the PAL rules require money in the passive category to stay there. You can’t use losses in the passive category to counterbalance your active income, nor can you use active or portfolio losses to counterbalance your passive income.
At the end of the day, if you have a rental loss, you can only deduct it from other passive income.
Unfortunately, the PAL rules had unintended consequences for small landlords working diligently to improve their businesses.
Because most smaller rental businesses typically have losses for multiple years, Congress used exemptions to relax the PAL rules and help people who probably aren’t exploiting the rules anyways.
The $25,000 offset allows small landlords to deduct up to $25,000 of rental losses from non-passive income.
Your income must be below $100,000 and your losses under the $25,000 cap to qualify as a landlord. You must also actively contribute to your rental business and own at least 10% of the business.
Real Estate Profession Exemption
Congress also exempts real estate professionals from the PAL rules. Real estate professionals can view all their rental losses as active (instead of passive) and deduct them from other income.
This exemption has no max offset threshold or minimum income requirement, and most landlords have no problem qualifying.
Here are the official requirements for the real estate profession exemption:
- Participate in at least one real estate business.
- Participate in at least one of the tests below:
500-hour test – Participate in rental activities for 500 plus hours during the year.
Substantially all test – Participate in the activity substantially more than your staff.
101-hour test – Participate in the activity for over 100 hours and at least as much as everyone else.
- Spend over 750 hours each year working at your business.
- Spend over half your yearly work time at your business.
The last two requirements might be difficult to complete if you only have a few units or have stable tenants who don’t need constant maintenance support. Your best bet for passing these tests is if you’re a full-time landlord.
The Real Estate Profession Exemption isn’t optional, and you must determine if you qualify for it annually. It’s important to note, though, that this is more beneficial if you have substantial income from another job to deduct your losses from.
If you have a large amount of other passive income (from other business investments), you can’t use your rental losses to offset it.
This section will cover some additional expenses you can deduct as operating expenses. While meeting the criteria for an operating expense is a given, some categories have additional rules. We’ll go over them here.
Dues and Subscriptions
It’s common for landlords to belong to a professional or civic organization. For example, you might have membership in a real estate board, apartment association, or local chamber of commerce.
The dues and fees you pay to these organizations are completely deductible unless the organization’s purpose is to provide entertainment. That being said, if you use the word “dues,” you can count on an audit. The IRS will follow up if they see this word because dues to other social or business clubs aren’t deductible. Instead, go with the “fee” to avoid any hassle.
Your landlord education expenses are also deductible. For instance, if you attend a real estate seminar or convention, you can deduct the cost of your attendance.
There are a few additional rules to qualify for this deduction. First, you must prove that the educational expense maintains or improves your skills as a landlord, or that the education is required by law. This also applies to your employees—the cost of training your intern, for instance, is also deductible.
Second, you can’t deduct expenses if incurred before you’re in business (in which case, they would be start-up expenses).
Every so often, you may want to give a gift for business purposes. Gifts are fully deductible if they are under $25 per person annually. Gifts given to an organization have no maximum limit, assuming they’re reasonable.
Almost all insurance premiums related to your rental activity are fully deductible. For example, fire, flood, theft, and landlord liability insurance premiums are all deductible. You can even deduct homeowner’s insurance and part or all of your car insurance if you use your car for rental activity.
Legal and Professional Services
Any legal fees related to your rental property or business are deductible. This includes fees you pay to an attorney, lawyer, accountant, property manager, and investment adviser.
Be careful if you hire a friend or family member as a property manager. If the IRS thinks you’re doing them a favor by paying them excess, you might be audited and denied these deductions.
Meals and Entertainment
The IRS is extremely stringent about deducting meals and entertainment expenses. The Tax Cuts and Jobs Act limited many of the deductions under this group.
Entertainment expenses aren’t deductible even if they lead to business (e.g., a recreational tennis match leads to a discount on a contractor’s next job).
Most meal expenses, on the other hand, are at least partly deductible if they meet a few conditions. The meal must not be too lavish or excessive, the taxpayer (or employee) must be present, and the meal must be served to a business associate, such as a consultant or tenant.
Business-related meals are normally 50% deductible. However, in support of restaurants during the Covid-19 pandemic, Congress enacted a rule active through 2022 to allow meals from restaurants to be fully deductible.
Most taxes related to your rental business are fully deductible.
Real property, water, sewer, and other service taxes are deductible operating expenses. Taxes used to fund local improvements, though, aren’t deductible (think funds used for sidewalks, sewer lines, roads, etc.).
Also, special rules apply for employment taxes, and act as a tax break for accessibility charges. Look at the tax code for more information about either of these.
Assuming you’re not using accrual accounting (a rare type of accounting that’s not a great idea for most landlords), unpaid rent isn’t deductible.
Fortunately, if you must evict someone, you can fully deduct all the legal fees required for the process. This means you should remove bad tenants if they’re causing a lot of issues.
Understanding the various deductions is critical to your business. The more you know up front, the easier things will be when it comes time for taxes.
Deductions impact your profit margin, so you must take them seriously. You wouldn’t want to miss out on money due to a lack of awareness.