Whether you own a vacation home, an apartment building, or an office space, this tax guide will help you with many of the questions you may have.
Our rental property tax guide is split into 12 sections for your convenience. So whether you already own an rental business or are just starting, jump to the section you need help with.
- Tax Forms For Reporting Rental Activity
- Best Entity For Rental Property Ownership
- Selling & Reporting Your Rental
- Taxable Vacation Home Rental Income
- How To Deduct Startup Expenses
- Home Office Deductions
- Personal Car & Public Transport Travel Expenses
- Depreciation Expenses
- Tax Deductible Expenses
- Tax Deductible Rental Loss
- Non-deductible Expenses
- Tax Credits For Landlords
- LLCs For Real Estate Investments
1. Tax Forms for Reporting Rental Activity
As a rental property owner, accurately reporting your rental income and expenses on the proper tax forms is crucial. The forms required depend on how your rental business is legally structured – as an individual owner, partnership, corporation, or LLC. Here’s a comprehensive overview of the key tax forms for each ownership type:
Individual Rental Property Owners
If you own rental properties as an individual or jointly with a spouse, these are the forms you’ll use:
- Form 1040 – This is the annual individual income tax return all individuals must file. Your net rental income or loss will be reported on line 17.
- Schedule E – This supplemental form is used to report rental real estate income/expenses in detail. Part I is where you’ll list out each rental property’s income, expenses like mortgage interest, repairs, insurance, and depreciation.
- Form 4562 – Used to calculate the depreciation deduction you can take for your rental properties, which gets reported on Schedule E.
A few important points for individual filers:
- If jointly owning with someone other than a spouse, only report your share of income/expenses
- Allocate expenses between rental use and personal use if renting part of your residence
- You cannot use the simplified 1040A or 1040EZ forms for rental activity
Partnership or S Corporation Rental Owners
Rental income/expenses flow through to the partners/shareholders:
- Form 1065 (Partnerships) or 1120S (S Corps) – These report the entity’s total operations for the year.
- Form 8825 – Like Schedule E, but for partnership/S corp use. Report full rental income and expenses.
- Schedule K-1 – Shows each partner’s/shareholder’s allocable share of the net rental profit/loss to report on their individual 1040.
LLC Rental Property Owners
- Single-Member LLCs: Treated as an individual owner (see above forms)
- Multi-Member LLCs: Can choose to be taxed as a partnership or S corp (see above)
No matter your ownership structure, diligent recordkeeping of all rental income and expenses is vital for filing accurate tax returns. The right documentation ensures you receive all eligible deductions and avoid any underreporting issues.
As rental property tax specialists, we guide our clients through properly reporting their rental activity in full compliance with IRS rules based on their specific situation. Reach out to discuss the ideal approach for your rental business.
2. Choosing the Right Entity for your Rental Property
Picking the best structure for owning your rental property can be overwhelming. This guide explores the pros and cons of different entities, helping you make an informed decision.
Remember: Always consult a qualified professional like a lawyer or CPA before establishing an entity and transferring ownership.
Individual Ownership: Simple Structure but Risky
This is the most common option, where you own the property in your own name (or jointly with someone else). It’s straightforward, but exposes you to significant risk. If you face a lawsuit and lose, creditors could force the sale of your rental property to satisfy the debt.
Limited Liability: The Power of Entities
Legal entities like LLCs and Limited Liability Partnerships (LLPs) offer a key benefit: limited liability. Your personal assets are shielded from the debts and liabilities of the entity. This means that if someone sues the rental property itself, your personal home, car, or savings wouldn’t be at risk.
Let’s Break Down the Options:
- General Partnership: Simple to set up, but a major pitfall: all partners are personally liable for the partnership’s debts. Not recommended for rental properties.
- Limited Partnership: Offers some liability protection for limited partners, but they have no management rights. The general partner has full control and personal liability. Generally not ideal.
The Modern Choice: Limited Liability Company (LLC) or Limited Liability Partnership (LLP)
These are the most popular choices for rental properties. Both offer limited liability protection and are relatively simple to maintain compared to corporations. Here’s a quick comparison:
- LLC: A flexible and popular option. Requires minimal formalities to maintain limited liability protection.
- LLP: Similar to LLCs, but can be particularly useful if your rental property involves activities with potential professional liability (e.g., vacation rentals with recreational activities).
Corporations: Tread Carefully
While corporations offer limited liability, they come with complexities. Maintaining that protection requires strict formalities. Additionally, for rental properties, “C corporations” can lead to “double taxation,” where the corporation pays tax on income, and then you pay tax again on the dividends you receive.
The Takeaway:
- Individual ownership is simple but risky.
- Entities like LLCs and LLPs offer limited liability protection.
- LLCs and LLPs are generally simpler to maintain than corporations.
- Avoid “C corporations” for rental properties due to potential double taxation.
Make an informed decision! Consult with a qualified professional to determine the best entity structure for your specific situation and goals.
3. Selling & Reporting Your Rental Property
Thinking about selling your rental property? Be prepared for potential tax consequences! Here’s a concise breakdown:
Capital Gains Tax:
You may owe taxes on the profit (gain) you make from selling your property. This applies whether you held the property short-term (less than 1 year) or long-term (1 year or more). “Material participation” and “passive activity” rules exist, but typically don’t impact standard residential rentals. So let’s assume it is a normal sale, and not a casualty loss, theft or unusual event. Here are the two key points to remember:
- Taxable gain includes both the sale price and any depreciation you deducted over the years.
- Holding period determines whether you qualify for potentially lower long-term capital gains tax rates.
With that in mind, let’s dig into the forms.
IRS Forms for Business Property, Capital Gains and Assets
There are several forms that need to be involved in this transaction and they include:
- IRS form 1040 Schedule D capital Gains and Loss
- IRS form 4797 Sales of Business Property
- IRS form 8949 Sales and Other Dispositions of Capital Assets
All that said, the informational returns such as Form 1099 B, or 1099 S, usually for reporting a capital gain by the real estate reporting person.
Some of these forms may not be necessary depending upon the type of sale and the position the seller had in the property sold. With that said, we’ll keep it simple and focus on sales that are most common.
Let’s look at the first subject in which you are selling rental property that you have a personal use stake involved. You need to report the gain on a sale or exchange of this type of property on Form 8949 and 1040 Schedule D. Please note that losses on this type of sale are not deductible. Also if you had a loss and you received a 1099 S, report this on the 8949 and Schedule D even though it is not deductible.
Now let’s look at the “holding period” in which you will determine whether you have a Long term or Short term capital gain. The period of time less than 1 year is considered “short term” and any time after that is “long term”. Please note also that with Installment Sales the same applies if the payments are made within the current tax year then it is short term.
Reporting Gains and Losses for Depreciable Residential Rental Property on Form 8949:
| Holding Period | Outcome | Form 8949 Section | Notes |
|---|---|---|---|
| Less than 1 year | Gain | Part I | Short-term capital gain |
| Less than 1 year | Loss | Part I | Short-term capital loss |
| More than 1 year | Gain | Part II | Long-term capital gain |
| More than 1 year | Loss | Part II (if not subject to recapture) | Long-term capital loss |
| More than 1 year | Gain (subject to recapture) | Part III (1250) | Long-term capital gain with potential recapture of depreciation |
Lastly, there may be a “recapture” of depreciation, investment credits, rebates, and certain bonuses obtained in the purchase of the property. The nature of the sale will determine these factors.
For more detailed information, please review IRS Publication 527, 537, 544 and 550.
4. Taxable Vacation Home Rental Income
This particular article of the Property Rental Tax Guide focuses on the special rules involved when you use property both for personal and rental use. This may be either because you are renting out a room in the same house that you live in, or if you have a vacation home that you may personally use a few weeks out of the year and rent the rest of the time. If you do not use your rental property for personal purposes at all, this article is inapplicable to you.
Property rented for less than fifteen days
If you rented your property for less than fifteen days total during the year, you do not need to report any of your rental income. Treat the property as personal, and deduct all of your expenses as personal expenses, usually on Schedule A of Form 1040.
Renting a Vacation Home
Personal use test. The personal use test is a numeric calculation that measures the total number of days you used your rental property personally. Whether the personal use test is satisfied has a bearing on how you may deduct your rental expenses. To calculate the person use test, you must first figure the number of days in the year you actually rented the property for fair market value. Multiply that number by 10%. We will call the result the “total days rented,” or “TDR” for short. Next, figure out the number of days you used the rental property for personal use. We will call this “personal use days,” or “PUD” for short. See the chart below.
NOTE: “Personal use” includes use by you, any other owners of the property, and the families of all owners of the property, unless the family member is paying rent at fair market value.
| If TDR is… | and PUD is… | then the personal use test is… |
| over 14 | less than TDR | not satisfied |
| under 14 | less than 14 | not satisfied |
| over 14 | more than TDR | satisfied |
| under 14 | more than 14 | satisfied |
If test is satisfied. If the personal use test is satisfied, you may deduct your rental expenses only to the extent of your rental income. This means that you cannot have a net rental loss. Any excess expenses not deducted carry forward to future years and will be used if there is sufficient rental income in that year.
If test is not satisfied. If the personal use test is not satisfied, your rental expenses are not limited by your rental income. You may deduct all of your rental expenses and have a net rental loss. However, your rental loss deduction may still be limited by certain passive activity rules. See the article titled Tax Deductible Rental Losses, included in this Guide, for more information.
How to figure rental expenses. Expenses incurred regardless of personal or rental use (such as mortgage interest or real estate taxes) must be allocated between personal and rental use. Figure out the total number of personal use days. Then, figure out the total number of days you actually rented the property for fair market value. Then, divide rental days by the sum of personal days and rental days. The result will be your rental percentage. Multiply expenses by this percentage to arrive at the rental deductible portion.
Renting a Part of Your Home
If you rent a part of the home you live in, you must allocate your expenses between rental and personal. The IRS allows some flexibility with the method you use; just make sure it is consistent from year to year. One option is to divide the number of rooms you are renting with the total number of rooms in the home. Another is to divide the number of square feet you are renting by the total number of square feet in the home. The expenses allocable to the rental are deducted as rental expenses; the rest is deducted as a personal expense on Schedule A of Form 1040.
5. Deducting Startup Expenses From Rental Property
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.
6. Home Office Deductions
There are few tax deductions taken by business owners that are more feared than the dreaded home office deduction. Some tax experts are convinced that claiming this deduction increases the chances of an audit, while the IRS is adamant that this is not the case. Either way, if all the rules are followed, and records are properly documented, you should have nothing to fear.
Active owners of rental property may qualify for the home office deduction. The key to this deduction is the word active. The landlord must do more than just receive and deposit checks every month. You should regularly spend substantial time maintaining properties and preparing them for rent as well as seeking new tenants.
Once you have met this requirement you also have to meet the basic home office deduction thresholds. First of all, you have to use the home office exclusively for your rental business on a regular basis.
In addition, you must meet at least one of the following requirements:
1. Your home office is used as your principle place of business.
2. You have no other fixed location where you perform administrative and management activities.
3. You meet clients there.
4. You use a separate structure on your property for business.
After you have applied the threshold tests above and determined that the work area in your home does in fact qualify for the home office deduction, you need to look into what kind of expenses that can be written off.
There are direct and indirect types. Direct expenses only benefit the home office area of the home such as painting or cleaning. Indirect expenses benefit the entire home and must be apportioned out between the home office area and the rest of the house. Mortgage interest, insurance, property taxes and utilities are examples of indirect expenses. Square footage is the usual method of determining the proportion of the home office in relation to the entire house to come up with a percentage. A 2,000 square foot house with a 200 square foot home office area would mean 10% of the indirect expenses could be written off as part of the home office deduction. You can also depreciate the house structure (not the value of the land) in the same percentage over 40 years. However, this may complicate matters when the house is sold.
Since you don’t want any trouble if you do get audited, you should keep records to prove that you were entitled to take the deduction and that it has been accurately reported. You should document the home office space by a diagram and/or photograph that supports your square footage calculation. It is a good idea to use your home office address on business cards and other forms of communication and to have business mail delivered there. You should make an effort to meet clients at the home office and maintain a log to keep track of the client meetings and other time spent working there. Records to keep proving expenses include: property tax statements, utility bills, insurance premium notices, 1098 mortgage interest statements and receipts for any other home office expenses.
This topic can get quite complicated and the above is only intended to give you a basic understanding of the circumstances that would allow you to take advantage of the home office deduction.
7. Personal Car & Public Transport Travel Expenses
The special use of your personal automobile or other vehicles can be deducted as an expense based upon certain factors if they are ordinary and necessary. If you use your vehicle to maintain, collect income from residents, and manage your rental property you may be able to deduct these costs. Please note commuting is a personal expense and not allowed. Also, you cannot deduct the cost of travelling away from your home to improve the property. This is normally recovered under a cost recovery system such as depreciation.
There are 2 methods in which you can use to report these costs.
The first is Actual Expenses. Under this method you would record all of the costs related to your travel away from home in connection with the rental property. These expenses should be recorded and backed up with receipts in accordance with IRS Publication 463 Chapter 5.
Certain apps are available to help you track your miles however you still must have a tangible document to back up your deductions. You are required to report this either on your Schedule C or Schedule E with supporting schedules attached. If you have multiple properties, your expenses should be allocated to each property in which the costs are incurred. Remember to not include any personal use or any other use except that which is related to the property.
The second method is the Mileage method, under this method you want only use your actual mileage traveled to deduct. For example, if you traveled 1200 miles during 2020, you would use the current standard mileage rate of $0.555 per mile according to current tax rates.
Use of local transportation such as Zip Cars, Metro bus service, and auto rentals must have a direct correlation to the property and must have documentation to support this. If using public transportation, it is recommended that you have a separate fare card and a separate business account for rental cars to show that the use is solely business related.
For more information please refer to IRS Publication 527.
8. Depreciation Expenses
Understanding depreciation is crucial for any business owner. It’s a method to recover the cost of tangible assets over their useful life, reflecting the wear and tear they experience. Here’s a breakdown to simplify depreciation for you:
What is Depreciation?
Imagine buying expensive equipment for your business. Depreciation allows you to spread the cost of that equipment (its “basis”) over its usable lifespan, deducting a portion each year. This provides a more accurate picture of your business’s financial health.
Key Factors in Depreciation:
- Asset Class and Basis: Different assets have varying depreciation schedules based on their expected useful life. The asset’s “basis” is its original purchase price.
- Listed Property: Special rules apply to “listed property” like cars and computers. Consult a tax professional for specifics.
- Section 179 Expense Election: This allows you to deduct a portion of the asset’s cost in the year it’s placed in service.
Common Depreciation Method: MACRS
The Modified Accelerated Cost Recovery System (MACRS) is the most widely used method. It assigns assets to classes with specific recovery periods, determining the annual depreciation amount.
Example: Understanding Depreciation in Action
Let’s revisit the scenario you provided:
- Land ($750,000): Land is not depreciable as its value typically increases over time.
- Building ($500,000): The building qualifies for depreciation under MACRS based on its class life.
- Equipment ($75,000): This is also depreciable based on its class life and cost.
- Building Improvements ($7,500): These likely qualify for depreciation, but consult a tax professional regarding potential energy credit implications.
Additional Considerations:
- Dollar Limits: There may be limitations on the total depreciation amount for certain assets in a single year.
- Date Placed in Service: This typically refers to when the asset is operational, not necessarily the purchase date.
- Holding Period: The length of time you own the asset impacts depreciation calculations upon sale or disposal.
Resources for Further Exploration:
- IRS Publication 946: This IRS resource provides a comprehensive guide to depreciation.
- Tax Professional: Consulting a tax professional ensures you’re maximizing depreciation benefits and adhering to current regulations.
Remember: Depreciation plays a vital role in managing your business finances. By understanding the basics and consulting with a professional, you can ensure accurate tax reporting and optimize your deductions.
9. Tax Deductible Rental Property Expenses
There are 5 types of tax deductible rental property expenses. These are expenses you can deduct from your gross rental income in order to calculate your net rental income.
Part 1: Interest, Advertising, Professional Fees
Starting with interest, the main type of interest you deduct is mortgage interest. If you are renting the property as its own living unit, you can deduct all of the mortgage interest you paid on Schedule E.
On the other hand, if you’re renting a room in your home, or if it is a duplex and you’re occupying the other unit, you will need to prorate the mortgage expense.
Personal use mortgage interest always goes on Schedule A of your Form 1040. Additionally, if you own only a part interest in the rental, you must multiply the total amount of mortgage interest paid on the property by your ownership interest. Be aware however, that certain expenses you pay to obtain a mortgage (such as title/recording fees and commissions) are capitalized as part of your depreciable basis for the property, and are not expensed.
Other types of interest may also be deductible, if you incurred the interest solely for the benefit of the rental property. For example, if you took out a personal loan in order to replace carpeting, or fix the roof.
Next is advertising. Any fees you incur to promote your rental property, and list it on the open market, are deductible. For example, ads that you purchase in a local newspaper, or even Google ads you pay for, are deductible.
Finally, you can deduct professional fees you incur in connection to the rental. For example, if you paid a lawyer to draft a lease, or initiate court proceedings to evict a tenant, you can deduct these fees. Additionally, you can deduct fees you paid to an accountant/CPA for preparing the Schedule E of your tax return from the previous year.
Take care to prorate the total fee between the Schedule E and the rest of your return based on how much time it took. Any fees for preparing any part of the return other than Schedule E go on Schedule A as personal tax preparation expense.
Finally, if you pay any commissions or management fees to a professional realtor group, you may deduct those expenses as well.
Part 2: Insurance, Cleaning & Maintenance, Repairs
Now that you are engaged in renting your property out for income, it’s important you ensure certain fees and services are properly set up and recorded for tax purposes. Let’s discuss some of these expenses.
Starting with insurance. As with most premiums, this is usually prepaid in advance for a certain period of time.
An example would be if you purchased insurance for your property in March 2018 for $1,200. The coverage period is from April 2018 to March 31, 2019. Since the coverage period exceeds the current tax year, you must apportion the premiums applicable to this current year only and carry forward the balance for the next reporting period. In this example your allowed premium deduction would be $900; the nine months covered from April to Dec 2018 or $100 per month of qualified rental use.
Please note that some insurance carriers frequently bundle premium packages between personal and business customers for a discounted rate. You must ensure that you only allocate the portion which is applicable to your business rental property from this deduction. The personal and non-business use may be deductible on your personal income tax return.
Finally, title insurance is not applicable as an expense and must be included in the cost basis of the property.
Cleaning and maintenance can be thought of as the day-to-day maintenance of the property. This is an allowed expense provided it is only for common areas and daily cleanliness. These expenses are also limited to the days the rental days and not personal use days. In other words, if you’re living there and have it professionally cleaned, that doesn’t count.
Many property owners have contracts with local services to maintain the property on an ongoing basis to ensure your property is in working and usable order. This may include such services as window cleaning, dusting, appliance cleaning and upkeep. Any type of structural repairs and or changes must be allocated to the cost basis of the property.
Finally, let’s go over repairs. There may be appliance repairs, touch up painting, or a similar non-major renovation of the property structure. These costs which are ordinary and necessary are deductible in accordance with the rental period of time.
These costs are usually deductible against the income of the rental property. But, as always, you must not include those periods of personal use.
If you’re looking for more detailed recommendations, you can review the IRS Publication 527 for current regulations to get their exact stance on it.
Part 3: Supplies, Taxes, Utilities
As a Landlord, you may incur certain expenses during the course of business that may have an impact on your profitability. Among these are Supplies, Taxes, and Utilities. As with other business expenses, you must remove any personal use items as well as determine any periods of time in which the property was used for personal reasons. This is the case even if you are using 1040 Schedule C or Schedule E.
Starting with supplies, this expense can be very tricky and sometimes difficult to maintain, however if set up properly then there should be very few problems come tax season.
First, you need to determine what items would fall into this category. Anything that is used (or consumed) solely to maintain the rental place would be considered supplies.
Now I know what you’re thinking, wouldn’t that make supplies, expenses? They’re slightly different. Expenses are items that are in constant use or have a single-use — this sounds more complicated than it is. For instance, a trash can is a single and constant use (that’s an expense). Small appliances are single and constant use. In a different vein, food would be an expense as it’s a single-use. With me so far?
Supplies are items that you would purchase in bulk for the same purpose. The difference is supplies can be held in storage until consumed. For example, bulks of paper towels, toilet paper, pens, pencils, cleaning supplies (sprays, bleach, detergents), trash bags, etc.
It is very important to note that these items should be inventoried periodically to monitor costs as well as quantities on hand. Keeping a supplies and expenses chart of accounts ledge is the best way to handle this.
Next up, over the course of business there are many taxes you’ll have to pay directly related to the property. As with most jurisdictions, you may receive a separate bill for your property, business, and income taxes. If you operated a rental property in which this is not the case, then as we mentioned earlier you must allocate the percentage of personal use to business use.
This is common with a house in which a homeowner may have “residents” living in empty bedrooms and other spaces. This is a very important area since a miscalculation can cause large interest and penalties when discovered after a tax audit. It is recommended that on each tax bill make a copy of the original bill and on the copy write down the calculated amounts as back up for your records.
This can be somewhat complicated if you are using a Schedule E and have multiple properties and you receive a tax bill with no separation of address. Real Estate taxes are deducted as applicable to the property assessed and should not include the owner’s basis.
Meanwhile utilities, such as electricity, water, gas, communications, and security may be paid by the Landlord on a single bill. If you have multiple properties, sometimes separate bills are issued. However, if there is any personal use, you must allocate the portions for and report them on the appropriate tax schedules.
For further information please review IRS Publication 527.
Part 4: Landscaping & Hired Help
In order for your rental property to be attractive to prospective renter, it should be in good and presentable order. These expenses can be deducted against the income received from this property provided they meet the business use requirements. Let’s look at landscaping, hired help, and HOA fees.
Landscaping is pivotal and the seasonal maintenance of the property (such as grass trimming, floral arrangements, and other weather related tasks) can be applied to the rental income. In some of these services you may be required to pay for the cost of the plants, shrubs, etc. Most of these types of services are performed similar to your main home landscaping, however these costs are limited to only the portion of time in which the property is not personally used.
Next, hired help is also a tax deductible expense. These are services such as property security review and/or a concierge service for the local area.
This service should be set forth in an agreement between yourself and the parties involved. It can be expensed against the revenue of the property during allowed rental days. Please note that these services should not be used in return for rental use, otherwise it would be classified as personal use days since you had a material benefit from this.
Also note that these payments may need to be reported under a 1099 if they exceed the $600 threshold. Because of this when using hired help, it is usually best to use a service organization which would handle these requirements.
Part 5: HOAs
Finally, there’s HOA (Home Owners’ Association) fees that are deductible. Since these types of dues assessments are periodic, they can be used to offset the income from the rental property. Many of these associations perform services use as property maintenance, administration services, etc
Are HOA Fees Tax Deductible for Rental Properties?
Homeowners Association (HOA) fees are common expenses for rental property owners. As the article mentions, these fees help cover services like property maintenance, landscaping, security, garbage collection, and other administration costs.
But…
Are HOA fees considered tax deductible expenses for landlords?
Yes, HOA Fees are typically tax deductible.
In most cases, HOA fees paid for a rental property can be deducted as ordinary and necessary business expenses. This is because the fees are going towards services and upkeep necessary to maintain or repair the rental, make it suitable for occupancy, or manage the property.
However, like with all rental property expense deductions, the fees must properly prorated based on personal vs rental use days as outlined further below.
Partial Deductions if Mixed Personal and Rental Use
If the property owner uses the unit for personal purposes during the year in addition to renting it out, then the HOA fees deduction needs to reduced by the percentage of days allocated towards personal use.
For example, if the total HOA fees paid in a year were $1,200, but the owner stayed at the beach rental for 30 days out of 365, the deductible portion would be:
$1,200 x (365 – 30 Personal Use Days) / 365 Total Days = $1,100
So proper tracking and allocation between rental and non-rental use periods is key for maximizing deductions. An HOA fees deduction worksheet can help with the calculations.
Reporting HOA Fee Deductions
Deductible HOA expenses for rental properties are reported on Schedule E (Form 1040), line 20 under “Other” expenses. The IRS Pub 527 is also a helpful reference for reporting various rental property deductions like HOA fees.
Additional Common Rental Property Deductions
While HOA fees are deductible, other operating and maintenance costs for rentals also qualify such as:
- Advertising
- Property management fees
- Property taxes
- Insurance
- Mortgage interest
- Travel to the property
- Repairs and supplies
Tracking all of these deductible rental expenses accordingly can lead to substantial tax savings each year.
Note that HOA’s should not be duplicated in other areas such as landscaping and hired help. Using an HOA can be beneficial since most of the services needed to maintain your property can be a bundled service assessment fee.
For more information, please review IRS Publication 527 for current regulations. Also, included please review the worksheet which will assist in the
10. Tax Deductible Rental Loss
Understanding the passive loss rule, $25,000 dollar offset, real-estate professional exemption, & suspended passive losses deduction
One thing we learned about investing in real estate over the last few years is that it can be quite volatile at times and requires sufficient capital and planning to be successful. Rental properties are traditionally long-term investments and losses may occur during the holding period. Investors should make an effort to become familiar with the issues related to the deductibility of such losses.
The IRS passive loss rules dictate that passive losses from real estate can only be offset by passive income and can only be carried forward, not back. Generally, losses from real estate rental activities are considered passive unless you are a real estate professional. Even if you actively or materially participate in the management of the rental property any resulting losses would still be passive if you are not a real estate professional. Active participation and material participation are not the same.
Active participation is a less stringent standard and requires that you be involved in significant and bona-fide management decisions including tenant approval, rental terms and expenditures. To meet the material participation standard your management efforts must be on a substantial, continuous and regular basis and meet additional IRS requirements beginning with a minimum of 500 hours spent on rental activities.
There are exceptions to this rule. If you own at least 10% of a rental property and actively participate in its management then you may be able to deduct up to $25,000 of passive losses even if you don’t have any passive income. Under this rule you can offset passive income from the rental property with your non-passive income such as wages, interest and dividends etc. Since this is intended to be a break for smaller landlords the deduction amount gets reduced after your modified AGI exceeds $100,000. You lose one dollar of offset for every two dollars over MAGI which reduces the offset to zero when MAGI reaches $150,000. See Passive Loss Rules for Rental Property.
Real estate professionals are able to treat losses as non-passive and offset other income if they materially participate in the real estate management activities. This requirement applies to each rental property individually so some properties owned by a real estate professional could qualify while others do not.
To be considered a real estate professional you would need to spend more than 50 percent of your time and more than 750 hours annually on real estate activities. This standard must be met every year so one year you may qualify as a real estate professional and the next you don’t. See Professional Real Estate Rules for Rental Property.
Passive losses that cannot be offset because of a lack of passive income and don’t meet other deductibility requirements become deferred or “suspended” and are carried forward indefinitely until passive income becomes available or the entire rental property investment is sold.
Given the complexity of the rules regarding real estate rental properties and the usual long term holding periods you must maintain good records over the life of the investment and possibly long after it is sold if carry-forwards are involved. Obviously, this can get pretty onerous when you have multiple properties and your own personal involvement in each one can change from year to year which changes the tax treatment.
Aside from purchase cost information you need to keep receipts for all expenses related to your properties and keep track of rents received. Depreciation schedules should be kept for the property structures and any capital improvements. Be sure and keep a logbook to document your time spent on rental property to show active or material participation or that you are a real estate professional.
11. Non-deductible Rental Property Expenses
As a Landlord, there are many expenses you may incur related to your business activities. Most expenses, which are considered ordinary and necessary operating costs for the rental property, are deductible as a business expense. This includes costs like:
- Advertising for new tenants
- Commissions for finding tenants
- Travel to and from the rental property for maintenance/management purposes
- Property management fees
- Legal fees for evictions or other rental issues
- Utilities if paid by the landlord
- Property taxes
- Insurance
- Interest on mortgages used to buy/improve the property
- Repairs and routine maintenance like painting, carpet cleaning, landscaping, pest control etc.
However, there are also certain costs that are not allowed as tax deductions.
Non Tax Deductible Expenses
Any expense for personal use of the rental property is not an allowed deduction, although it may be deductible limited to your personal Adjusted Gross Income if you report it on your Schedule A.
For example, if you stay at the rental property for a weekend, rent equivalent for those days would not be deductible as a business expense. Similarly, if you allow a family member to use the property and they do not pay fair rent at market rates, then you cannot deduct that loss of rental income.
In order for rent to be valid and rental costs deductible, there must be an arms length rental agreement and rent payments at fair market value, even with relatives as tenants. If market rate rent is not received, then this lost income and associated time is not deductible against rental earnings.
Expenses for improvements and upgrades to the property also generally cannot be deducted and instead must be capitalized. This includes things like:
- Adding or renovating rooms
- Major renovations like kitchen or bathroom upgrades
- Installation of new doors, windows, siding etc.
- Upgrades like new appliances or fans
- Building upgrades like new flooring, countertops, cabinets etc.
These type of expenses appreciably extend the life of the property, increase its value, or adapt it to new uses. Therefore they cannot be immediately deducted but rather must be depreciated over time or added to the basis of the property when sold for tax purposes.
In contrast, normal wear and tear repairs can still be deducted as regular business expenses rather than capital improvements.
Some other specific non deductible costs:
- Security deposits – While costs like background checks to screen tenants can be deducted, security deposits themselves cannot. Rather, only the portion of deposits not returned to tenants upon move out is deductible.
- Barter services – If part of the rent is exchanged for services from the tenant, the value of those services is non deductible. It should be documented though to show the full market rent and portion being exchanged for services rather than paid in cash.
So in summary, operating expenses for managing the property can generally be deducted each year, while an allocable portion of personal use, lost rents from below market rates, improvements that extend the life of the property, and security deposits themselves are required to be capitalized or handled specially. Tracking these areas accordingly allows maximizing eligible business expense deductions each year.
For more information please review IRS Publication 527 and 946.
12. Understanding Tax Credits vs. Deductions
Before diving into specific credits, it’s essential to grasp the fundamental difference between a tax credit and a deduction. A tax credit directly reduces your tax liability, dollar-for-dollar. For instance, a $1,000 tax credit means you pay $1,000 less in taxes. Conversely, a deduction lowers your taxable income, which indirectly reduces your tax bill.
This article will explore two valuable tax credits that can significantly benefit small to medium-sized businesses: the Rehabilitation Tax Credit and the Low-Income Housing Tax Credit.
Rehabilitation Tax Credit
The Rehabilitation Tax Credit offers a substantial incentive for businesses that renovate historic buildings. This credit can be particularly advantageous for businesses looking to revitalize older properties.
Qualifying Properties
To be eligible for the Rehabilitation Tax Credit, a building must meet one of the following criteria:
- Certified Historic Structure: Listed on the National Register of Historic Places or located in a registered historic district.
- Substantially Rehabilitated: The rehabilitation costs exceed the greater of the building’s adjusted basis or $5,000. The building must have been placed in service before the rehabilitation and before 1936, and a certain percentage of its original structural framework must be preserved.
Credit Amount
The credit amount depends on the type of building:
- Certified Historic Structure: 20% of qualified rehabilitation expenditures.
- Non-Certified Historic Structure: 10% of qualified rehabilitation expenditures.
Low-Income Housing Tax Credit
The Low-Income Housing Tax Credit is designed to encourage the development of affordable housing. It provides tax credits to developers who build or rehabilitate rental housing for low-income families.
Eligibility Requirements
To qualify for the Low-Income Housing Tax Credit, a project must:
- Meet Occupancy Thresholds: Commit to either:
- 20% of units rented to households with incomes at or below 50% of area median income.
- 40% of units rented to households with incomes at or below 60% of area median income.
- Restrict Rents: Maintain rent restrictions for at least 30 years.
- Meet Other Requirements: Comply with additional IRS guidelines, such as income verification and tenant selection procedures.
Credit Amount
The credit amount is allocated by state agencies to developers through a competitive process. The specific credit amount varies depending on factors like the location of the project, the number of affordable units, and the level of income restriction.
Note: Due to the complexity of these tax credits, it’s strongly recommended to consult with a tax professional, such as a CPA or tax attorney, to determine your eligibility and maximize the benefits.
13. LLCs For Real Estate Investments
In general, you do not want your corporation to purchase real estate. If your company is a C corp, your company will pay tax when the building is sold. In order to get those profits in your hands, you have to pay yourself a dividend. This dividend is taxed again. So you are paying taxes twice on the gain from the building sale.
If the building generates a tax loss, which many buildings do because of depreciation, this tax loss will offset your corporate income. Corporate income, however, is sometimes taxed at lower rates than individual rates. Therefore, the tax benefit from the building would be less when held in a C corporation.
If the building generates a tax gain, this gain will be taxed as part of corporate profits and taxed again as a dividend when the cash is distributed to the owners. Often, real estate will generate more cash than taxable income. In C corporation form, getting that cash to the owners will involve extra income tax that would not be paid if held individually. The same principles apply to contributing your rental property to your corporation. You will be taxed twice when you finally sell the property. Any tax benefit provided by the property may be less when corporate rates are less. Taxable income from the property will be taxed twice.
The analysis is different if you have an S corporation rather than a C corporation. However, it is still not a good idea to own real estate in your S corporation. If you change your mind in the future and you want to pull your real estate out of the S corporation, you will immediately subject yourself to tax based on the fair market value of the property. For example, suppose you want to contribute the property to a partnership to develop the property or for other reasons. You will not be able to get the property out of the S Corporation without paying income tax.
Additionally, you may not want to subject such a large appreciating asset to potential liabilities that can arise in your corporation.
Buying the building personally is also not a good idea. Your personal assets would then be at risk to satisfy any potential liability that arises from operation of the building. For this reason, many people use a limited liability company to own real estate. You should still have liability insurance. Make sure to discuss liability issues with your attorney.
In addition to liability protection, a limited liability company (LLC) provides maximum flexibility and maximum tax savings for ownership of business or rental real estate.