What Can You Write Off on Rental Property?

Owning a rental property is treated as operating a business for tax purposes. This framework allows property owners to subtract certain costs from their rental income, which can lower the overall amount of income subject to tax. The expenses that qualify for this treatment are those considered both ordinary and necessary for the management and maintenance of the rental property. The purpose of these write-offs is to ensure that taxes are paid on the net profit from the rental activity, not on the gross rents collected.

Commonly Deductible Operating Expenses

A wide array of operating expenses can be deducted from rental income, provided they are ordinary and necessary for the business of renting property. These are current costs that do not have to be capitalized. Some of the most common deductions include:

• Mortgage interest paid on the loan used to acquire the rental property, which is reported on Form 1098.
• State and local property taxes assessed on the rental building.
• Insurance premiums for policies related to the rental activity, such as fire, theft, and landlord liability insurance.
• Management fees paid to a property management company to handle tenant screening, rent collection, and maintenance.
• The costs associated with finding tenants, such as placing advertisements.
• Utilities that the property owner pays for, like water, sewer, gas, or electricity.
• Professional fees paid to accountants for bookkeeping or tax preparation, as well as legal fees for services like drafting leases.
• The cost of supplies needed to manage and maintain the property, such as cleaning materials or light bulbs.
• Costs of making repairs to the property to keep it in a good, serviceable condition.

Distinguishing Between Repairs and Improvements

The Internal Revenue Service (IRS) distinguishes between repairs and improvements, which dictates their tax treatment. A repair is an expense that keeps the property in its current operating condition but does not add to its value or prolong its life. Examples include fixing a leaky faucet or patching a wall, and these costs can be fully deducted in the year they are paid.

In contrast, an improvement is an expenditure that betters, adapts, or restores the property. These actions add to the property’s value, extend its useful life, or prepare it for a new use, such as remodeling a kitchen or replacing a roof. These costs cannot be deducted in a single year.

The cost of an improvement must be capitalized, meaning the expense is added to the property’s cost basis. The owner then recovers the cost over time through depreciation. Misclassifying an improvement as a repair can lead to tax issues if discovered during an audit.

Understanding Rental Property Depreciation

Depreciation is a non-cash tax deduction that allows a property owner to recover the cost of an income-producing asset over its useful life. It accounts for the gradual wear and tear or obsolescence of the property. You can begin to depreciate a rental property when it is placed in service, meaning it is ready and available for rent.

To calculate depreciation, you must first determine the property’s cost basis. The basis is the amount you paid for the property, including certain settlement fees and closing costs. You cannot depreciate the value of the land, so the purchase price must be allocated between the building and the land. Only the basis attributable to the building and subsequent capital improvements is depreciable.

Residential rental property is depreciated using the Modified Accelerated Cost Recovery System (MACRS). The recovery period for residential rental structures is 27.5 years, and the straight-line method of depreciation is required. This means the cost basis of the building is spread evenly over this period. For example, if the depreciable basis of a rental house is $275,000, the annual depreciation deduction would be $10,000, claimed on Form 4562, Depreciation and Amortization.

Special Rules and Deduction Limitations

Certain rules can limit the total amount of write-offs a rental property owner can claim. The Passive Activity Loss (PAL) rules generally consider rental real estate a passive activity. This means losses from the rental typically cannot be used to offset non-passive income, such as wages from a job. Disallowed passive losses are not permanently lost and are carried forward to future years to offset passive income.

A special allowance permits individuals who actively participate in their rental real estate activities to deduct up to $25,000 in rental losses against their non-passive income. To qualify for active participation, a taxpayer must be involved in management decisions, such as approving tenants or deciding on rental terms. This $25,000 allowance begins to phase out once the taxpayer’s modified adjusted gross income (MAGI) exceeds $100,000 and is eliminated when MAGI reaches $150,000.

Another set of limitations, the “vacation home rules,” applies if you use the rental property for personal purposes. If your personal use of the property exceeds the greater of 14 days or 10% of the total days it was rented to others at a fair market rate, your deductions are limited. In this scenario, you must allocate expenses between personal and rental use, and the deductible rental expenses cannot exceed the gross rental income for the year.

Required Documentation and Reporting

To claim any deductions, property owners must maintain records that substantiate all income and expenses. This documentation is required to support the figures reported on a tax return. Essential records include bank statements, receipts for materials, paid invoices from contractors, and closing statements from the property’s purchase to establish its basis. For travel expenses related to managing the property, a detailed mileage log is necessary.

The financial activity of a rental property is reported to the IRS on Schedule E (Form 1040), Supplemental Income and Loss, which is an attachment to your personal tax return. On Schedule E, you list the total rental income received and then itemize your expenses into categories such as advertising, insurance, mortgage interest, taxes, and repairs. The form also has a specific line for the previously calculated depreciation deduction.