Investing in real estate or rental properties offers both tax incentives and favorable tax rules that are not available in other types of investments. As with most of the tax code, filing and taking full advantage of these tax breaks can be a bit challenging. Here are the top 10 tax deductions for the upcoming 2016 filing season as well as a breakdown of the tax forms required.
Top 10 tax deductions for rental properties
1. Mortgage Interest
Whether a homeowner is a property manager or resident, mortgage interest is likely to be the largest deductible expense. Landlords can deduct interest on mortgage loans used to purchase or repair a property, and even credit card interest if the expense is for goods and services related to the property upkeep or maintenance.
2. Real Estate Taxes
Real estate taxes are often paid through the mortgage company and are delivered to the owner on the Form 1098. There are also tax deductions available for permit fees, personal property taxes, and wage taxes that all relate to the property.
3. Passive Losses or Passive Activity Losses (PAL)
Most properties provide passive losses early in their investment as the cost of acquisition, setup, and repairs often outweigh the income. While these losses are deductible, passive income from other sources or properties needs to be considered. Landlords should consult a tax advisor when determining the PAL impact for tax filings.
Landlords can deduct the cost of any utilities that are not paid by the tenants. These deductions include gas, heating oil, electricity, water, and trash removal.
All insurance premiums that relate to the business of running or owning the property are deductible. General liability and personal umbrella insurance can be costly for a rental property, so this is a good way to recoup a portion of that expense.
Any work that extends the life of a property or increases its value is an eligible deduction, but the expense must be depreciated over multiple years. A general rule of thumb states that any expense that exceeds one hundred dollars is deductible.
The total cost of a rental property is not fully deductible in the year in which it was purchased. Landlords get to deduct a portion of the cost spread out over several years.
8. Association Fees
Homeowners’ association, resort or condo fees are fully tax deductible.
9. Traveling and Mileage
Property managers and landlords are entitled to deduct travel expenses if they drive while performing the rental activity. There are two options:
• Deduct the actual or realized traveling expenses (upkeep, gas, repairs, etc.)
• Or use the IRS’ standard mileage rate. Using the standard mileage rate has some restrictions and limitations so; it’s advised that property managers consult a tax specialist
10. Legal and Professional Fees
Any fees paid to an attorney, property manager, or tax accountant are fully deductible as long as they relate directly to the rental property.
Filing Landlord Taxes
The ownership structure of the property drives the tax forms to be used when filing.
• Individuals should file IRS Schedule E to report income and expenses associated with landlord taxes.
• Properties owned by more than one individual also use Schedule E and identify the appropriate owner percentage when declaring the income and expenses.
• Individuals who own properties through some form of business entity must file IRS Form 8825.
• Partnerships and Limited Partnerships must file using Form 1065. The partnership must also provide partners with a separate IRS Schedule K-1 listing the partner’s share of ownership of the income and expenses.
• S Corporations owning real estate property file returns with IRS Form 1120S.
Limited Liability Companies (LLC’s) are a sole proprietorship for tax reporting and must report income and deductions on Schedule E of the partners’ individual tax forms.
Considering the complexity, multiple deductions, and various tax forms, a property manager or landlord would do well to consult a professional, keeping in mind that the fees associated with the consultation would be tax deductible.