Real estate investments definitely add complexity to your tax returns, but any savvy investor knows that tax season also means the ability to cash in on breaks and benefits you can earn through investment properties. As a landlord, you know that the IRS requires you to report all rental income. You probably also know that the IRS taxes real estate portfolios in two different ways: income tax (profits made as rental income) and capital gains tax (net profits made from selling properties). Read on to learn about the tax deductions landlords may take advantage of in 2020.
What is Considered Rental Income?
The IRS defines rental income as payments you receive for the occupation or use of your property. Rental income isn’t subject to FICA taxes, as wages are. But it is taxable, so you must declare it on your tax return and pay income tax on it. You must report rental income for all your properties. Typically, your gross income includes the entire amount you receive from rent, minus allowable deductibles.
What Is considered tax-deductible?
As a landlord, your property is your business. In 2017, the IRS added a Qualified Business Income (QBI) deduction made especially for real estate investors. The deduction allows “eligible taxpayers to deduct up to 20 percent of their qualified business income (QBI), plus 20 percent of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income”.
If you receive rental income from a residential property, you can deduct certain rental expenses when you file your tax return. Which rental expenses are tax-deductible? Allowed deductions may include mortgage loan interest, depreciation, insurance, maintenance and repair costs, office expenses, and travel costs.
Mortgage Loan Interest
If you’re like many landlords, you may have taken out a mortgage loan to purchase your investment property. Good news: You can deduct the interest paid on the loan. This may even be your biggest deductible expense. Keep in mind that you can’t deduct what you pay toward the principal. Rather, this deductive applies to the payments you make toward interest.
Monthly statements from your lender will list interest payments separately. Simply multiply these by 12 to find the total for the year. You may be able to deduct the origination fees and points used when you purchased (or refinanced) the property. These can be difficult to determine, so work with a tax professional to be sure you use the deduction appropriately.
Depreciation can be complex. But in general terms, wear and tear, also known as depreciation, reflects how assets naturally decrease in value over time due to regular use or uncontrollable outside forces. Once your property is available for rent, you may claim depreciation. This applies even if you don’t have any tenants! This rental property tax deduction can be taken over the property’s expected life, but you must spread it out year by year. The IRS provides guidelines on how to properly depreciate a property.
Lenders often require landlords to have insurance before they’ll secure a mortgage. Because insurance is considered a regular — and necessary — rental property expense, you can deduct it from your taxes. You may also be able to deduct certain losses. Damage and expenses related to hurricane damage, flooding, earthquake, and theft may be deductible.
Maintenance, Repairs, and Utilities
Some home improvements fall under depreciation, but you may deduct certain repairs and maintenance costs separately. How do you tell the difference?
If an expense makes your property more rentable but doesn’t add significant value, it’s likely deductible. Examples may include a fresh coat of paint, landscaping costs, or cleaning furnace filters. As for utilities, if you pay them for the tenant, they’re also deductible.
Office Space and Travel
Whether you work in a commercial space or have a home office, you can deduct your office expenses. Include square footage, equipment such as computers and printers, office supplies, phone lines, and the other expenses associated with running a business.
Do you travel to multiple properties to conduct business? You may be able to deduct your transportation expenses. (Note: Your normal commute does not count.)
Prepare your financing for your next flip
Rental properties can be a great investment. Make sure you’re optimizing your return on investment by taking full advantage of tax breaks. When you’re ready to expand your investment portfolio, let the Sherman Bridge team help you fund your next project. While a break on taxes can be a huge financial relief, you may not have enough on hand for your next project or simply want to use your return for something other than real estate. Sherman Bridge can help. We offer low rates and fast approvals on a variety of hard money loans built with investors like you in mind.