If you're a new landlord -- or planning to become one -- you've probably asked yourself, "How is rental income taxed?" The short answer for most landlords is on your personal tax return, like everything else.
Becoming a landlord is a business where tax law is concerned, and that opens up an entire world of deductions that can reduce your taxable income. To ensure your tax planning is on-point, keep clear and thorough records of every cent you spend or receive as a result of your property management activities, and then make sure you're applying every possible deduction when you file.
Different tax authorities usually let you deduct the amount you paid to other authorities. For example, the federal government always allows deductions for state taxes, and most states reciprocate in kind for federal taxes.
Other commonly deductible taxes include local taxes, Social Security and other employer taxes, and a portion of your personal vehicle if you use it for your landlord duties.
Interest and Premiums
Mortgage interest is likely to be your single largest expense as a landlord, but, fortunately, it can also be one of your largest rental property tax deductions. Consider a landlord who bought a home for $550,000 and then took out a 30-year mortgage at 4 percent. That's more than $13,000 in interest that can be deducted each year.
Any other interest charged as a result of a rental expense can also be deducted, including credit cards and non-mortgage loans. Additionally, don't neglect to deduct the premiums you pay for every type of insurance covering your rental properties.
Advertising, Professional Fees and Employees
Anytime you pay another person to handle something related to your rental, that expense is usually deductible. Typical examples include marketers, rental brokers, maintenance and repair personnel, lawyers, accountants and even the kid who mows your lawns.
Office, Travel and Entertainment
Don't forget that many expenses not tied to the property itself can still reduce your rental property taxes, as long as they're relevant to the business of being a landlord.
For example, if you maintain a home office that conforms to the IRS rules, you can deduct relevant expenses on your tax return. Similarly, travel and entertainment expenses related to your rental activities can also be deducted, though you need to keep pristine records explaining what portion of the expenses was directly tied to business concerns.
Repairs, Maintenance and Utilities
Costs for all repairs and maintenance on your rental property are deductible as long as they abide by these general guidelines:
The repair or maintenance must not meaningfully increase the value of the property.
The benefits of the repair or maintenance must be short term.
If the expense doesn't fit those categories, it probably counts as an improvement instead.
Improvements and Depreciation
Anything that increases the value of your rental property, especially over the long term, usually counts as an improvement, meaning you can't claim the entire cost in one year. Instead, the expense is capitalized and depreciated, and you spread the deduction across multiple years.
Generally, small improvements such as replacing carpeting or buying new appliances are depreciated over a period of five or fewer years. Larger depreciations, such as those applied to the cost of buying the rental property (minus land value), are usually stretched out over 20 years or more.
Entire books can (and have) been written about the complexities of improvements and property depreciation, so you usually need to consult a tax professional to be certain how they apply to you.
Don't Pay Unnecessary Taxes
While sorting out the capital gains tax on rental property can be complex, most tax issues are fairly straightforward. Whether you're dealing with a property tax refund, property tax deduction, or are simply calculating how a new fridge impacts your return, comprehensive paperwork and good records help ensure your landlord tax bill is as low as possible.
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