Can you deduct rental expenses when you have no rental income?

It is a common question for property owners whether rental expenses can be deducted even when no rental income is generated. This situation frequently arises for various reasons, from initial vacancy to periods between tenants or during property improvements. Understanding the specific tax rules governing these scenarios is important for property owners to navigate their financial obligations accurately.

Understanding Rental Expense Deductibility

For an expense to be deductible, the rental activity must be engaged in with the intent to make a profit, even if a property does not generate income in a particular tax year. The IRS allows for the deduction of ordinary and necessary expenses incurred in a rental activity. An ordinary expense is common and accepted in the rental business, while a necessary expense is appropriate for the activity.

A “rental activity” for tax purposes involves receiving payments for the use or occupation of property. Common deductible expenses include mortgage interest, property taxes, insurance premiums, utilities, and repairs. Depreciation, which accounts for the wear and tear of the property over time, is also a significant deduction. Other deductible costs include advertising, property management fees, and legal and professional fees.

Applying Passive Activity Loss Limitations

While expenses can be deductible, rental activities are classified as “passive activities” under Internal Revenue Code Section 469. This classification means that losses from these activities, when expenses exceed income, can only be deducted against passive income sources. Passive income includes earnings from other rental properties or certain partnerships where there is no material participation.

If passive losses exceed passive income, the disallowed losses are carried forward indefinitely. These losses can be used to offset passive income in future tax years. They can also be deducted in full when the entire rental activity is disposed of in a taxable transaction.

There is an exception for active participation in rental real estate, allowing individuals to deduct up to $25,000 of passive losses against non-passive income. This allowance begins to phase out for taxpayers with a modified adjusted gross income (MAGI) exceeding $100,000 and is completely phased out at $150,000 MAGI. Another exception involves qualifying as a “real estate professional.” This classification requires more than half of personal services to be in real property trades or businesses, with over 750 hours spent annually. If this status is met, rental activities are not automatically considered passive, and losses may be used to offset other income.

Addressing Special Rental Situations

Several common scenarios involve incurring rental expenses without immediate income. For new rental properties, expenses incurred before the property is “placed in service” (available for rent) are not deductible as current expenses. Once the property is ready and held out for rent, expenses become deductible. Costs like repairs or advertising to prepare the property can be capitalized and depreciated or deducted once it is placed in service.

Expenses on a vacant rental property remain deductible as long as the property is genuinely held out for rent and a profit motive exists. This includes ongoing costs such as mortgage interest, property taxes, insurance, repairs, maintenance, and depreciation. Continued efforts to rent the property, such as advertising and showing it, help demonstrate the profit motive.

For properties used for both personal and rental purposes, tax rules govern the deductibility of expenses. Expenses must be allocated between personal and rental use, based on the number of days the property is rented at fair market value versus days of personal use. If personal use exceeds certain thresholds, deductions might be limited to the amount of rental income generated. These thresholds include using the property for personal purposes for more than 14 days or more than 10% of the total days rented at fair rental value, whichever is greater.

Essential Record Keeping for Rental Properties

Record keeping is important for all rental property owners, especially when claiming deductions without current income. Property owners must maintain records to substantiate all claimed deductions and to track passive activity loss carryforwards. These records support tax positions, particularly in the event of an audit.

Key records to keep include income statements, receipts for all expenses, bank statements, and lease agreements. Documentation for repairs, maintenance, and improvements, along with depreciation schedules, are also necessary. Receipts should detail the payee, amount paid, transaction date, and a description of the service or item. Records should be kept for at least three years after the tax return due date or filing date, though some, like those for improvements, should be retained for the property’s entire holding period plus several years after disposition. Organizing records digitally or physically in a structured manner can simplify tax preparation and compliance.