You can deduct expenses from rental properties before the property is rented. Preparation counts.
How do I amortize startup costs with my rental?
Amortizing startup costs refers to spreading the deduction of certain expenses over a period of time rather than claiming them all in one year. This applies to expenses incurred before your rental property starts generating income.
Here’s a breakdown of eligible expenses:
- Legal and accounting fees that are associated with acquiring the property or setting up the rental business.
- Inspection and appraisal fees that are paid before purchasing the property.
- Marketing and advertising costs to find your first tenant.
- Loan origination fees paid when getting a mortgage for the property.
Startup expenses are not the same type of expenses as those allowed under the deduction under section 195 of the Internal Revenue Code. Under that section, startup expenditures in an active trade (or business) are deductible, up to $5,000, with the balance amortizable over fifteen years.
However, section 195 isn’t applicable to a rental property because renting is considered a passive activity rather than active trade or business. See the article titled Tax Deductible Rental Losses (included in this Guide) for more on passive activity rules.
Rental activity begins when you make the property available for rent and place it on the market, not when you have actually rented it.
When is the amortization period and what are the benefits?
When it comes to owning a rental property, startup costs incurred before your first tenant arrives can’t be deducted all at once. Instead, the IRS requires you to amortize them, meaning you spread the deduction over a period of time. The minimum amortization period is 180 months (15 years), but you have the flexibility to choose a longer timeframe if it suits your tax situation.
This amortization offers several benefits. By splitting the deduction across multiple years, you lower your taxable income in each year, potentially leading to reduced tax liability. This also helps with cash flow, avoiding a large upfront expense and letting you claim tax benefits gradually.
Expenses to Obtain Mortgage
Mortgage commissions, abstract fees, and recording fees are all capitalized and become part of your basis in the property. This means that you must depreciate these expenses, rather than expensing them all at once. See the article titled Depreciation Expenses for Rental Property included in this Guide, for more on depreciation.
What are Points?
Points are charges paid by a borrower to take out a loan or a mortgage. These charges may also be called loan origination fees, maximum loan charges, or premium charges. Points are essentially prepaid interest. Thus, they are deductible as interest, but you cannot deduct the full amount at once. Rather, you must amortize the points over the life of the loan. Figuring out the amount of points to amortize per year is a complicated process beyond the scope of this article. Consult a tax professional.
Improvements vs. Repairs
You must capitalize and depreciate all improvements you make to the property prior to putting it on the market. Improvements are those that prolong the use of the property or materially add to the property’s market value. On the other hand, you may freely deduct all repair expenses.
If you’ve made any repairs to the house before you offered it as a rental, then these expenses must be capitalized. A repair maintains your property in good working condition without adding to its value or prolonging its use. See the series of articles about deductions and depreciation, included in this Guide, for more information.