Rental Property Tax Deductions: The Definitive Guide - Stessa (2024)

If you’re like most real estate investors, tax season likely produces sweaty palms, an intimidating “to do” list, and an overwhelming sense of dread. The good news? It doesn’t have to—especially if you go digital with your paperwork and files, do a little upfront prep work starting earlier in the year, and self-educate on the “best practices” for tax strategy for rental property owners (which is why you’re here).

For this article, we partnered with a certified public accountant firm that specializes in real estate investment, The Real Estate CPA, to provide you an overview of the rental property tax deductions available for your rental income. You’ll learn valuable tax strategies you can implement now to minimize your upcoming tax bill—and maximize your annual revenue, making tax season actually enjoyable. After all, who doesn’t like found money?

For more detailed information, our official 2023 Stessa Tax Guide offers a more precise and nuanced understanding of the tax filing process so you can become more confident year after year—especially if you plan on doing most of the tax prep work yourself.

Obviously, there are many different tax scenarios you can explore depending on your specific rental property portfolio, and we decided to outline all of them (thank us later). We recommend reviewing all the Rental Property Tax Deduction Topics listed below with your CPA, who may be able to advise additional actions you can take to further reduce your tax liability. We also recommend the official guidance provided by the IRS, if you’re DIYing your taxes this year.

Rental Property Tax Deductions Topics

1. Rental Property Accounting Basics
2. 9 Common Landlord Tax Deductions
3. Business Travel Expenses for Rental Owners
4. Pass-Through Deductions and Casualty Losses
5. Rental Property Depreciation Overview
6. Capital Improvements vs. Repairs and Maintenance Expenses
7. Passive Activity Limits and Passive Losses
8. Capital Gains, Depreciation Recapture, and 1031 Exchange Rules
9. Short-Term Rentals and Related Taxes

First things first. An effective tax strategy and planning process starts with understanding that—when you file your income tax returns each year—you’re simply reporting the results (income, losses, etc.) of your activities from the prior year.

Once the year ends, while there are a few things that can be done, most of your results are already set in stone and you will pay tax based on those results.

That means you need to be taking a proactive approach to tax strategy and planning by implementing strategies and taking the right actions throughout the year so you’ll end up with favorable results come tax filing season.

There’s no better time than right now to learn which strategies matter.

Rental Property Accounting Basics

Before we get too granular into rental property tax deductions, let’s cover some of the basic real estate accounting best practices and tax strategies that have served rental property owners well for decades.

Recordkeeping

While it isn’t necessarily a tax strategy, the importance of keeping organized, detailed, and up-to-date records for your rental income and expenses cannot be understated. Doing so will allow you to see how much income your rentals are bringing in at any given time and to project future income and expenses.

This is key in determining the amount of estimated tax payments you’ll need to make, the tax bracket you’ll be in, and what tax strategies make sense for you.

Luckily you have this guide and Stessa to help keep your accounting records up to date. Below are the most common tax deductible expenses you’ll want to track in your accounting software throughout the year:

• Advertising/Marketing
• Leasing Commissions
• Professional Fees (Legal, Accounting, etc.)
• Interest (Mortgage & Other)
• Taxes (Property & Other)
• Depreciation
• Business Mileage
• Education & Training
• Bank Fees
• Employees and Independent Contractors

Here is a handy interactive map of property taxes by US state and county from SparkRental:

Here are additional deductions real estate investors with rentals may be able to take as well:

• Repairs and Maintenance
• Insurance
• Property Management Fees
• Supplies
• Utilities (Oil, Gas, Electric, Water, Phone, etc.)
• Home Office Expenses
• Travel Expenses
• Snow Removal, Landscaping, Pest Control, etc.
• HOA Fees
• Business Meals (50% deductible)

HELOC Interest Changes

The Tax Cuts & Jobs Act no longer allows you to deduct interest from a home equity line of credit (HELOC), unless it was used to acquire a residence or substantially improve a residence.

However, if you use a HELOC to fund your rental business, the interest will be tax deductible, if you elect to treat the debt secured by your residence as not secured by your residence.

That may sound confusing. But it makes perfect sense to the IRS because the interest tracing rules allow you to deduct interest if used for business purposes.

Establishing a Home Office

As a rental property owner, you can dedicate a room, or a portion of a room, to a home office. This dedicated space also grants you a home office deduction.

Having a home office also allows you to deduct local transportation expenses. Without a home office, a trip from your home to the business site will be considered a personal expense. With the home office, the same trip will be considered a business expense.

Requirements and Best Practices for Home Offices

Per the IRS’s Internal Revenue Code (IRC) § 280A, a home office must be used:

1. regularly and exclusively as the principal place of business; and
2. regularly and exclusively as a place to meet or deal with patients, clients, or customers in the normal course or trade of business.

If you work off-site, which is often the case for real estate investors, you can still deduct the home office if it is the location you handle your administrative work (for example, bookkeeping and rental property accounting).

IRS Rev. Proc. 2013-13 allows for a “safe harbor” deduction for anyone with an established home office. The deduction is $5 per sq. ft. of the home office annually.

Alternatively, you can use the actual expense method that allows you to deduct a portion of your actual home expenses. To calculate this:

• Divide the square footage of your home office by the total square footage of your home to determine the ratio.
• Then multiply the ratio by the total amount of expenses that relate to your entire home, to arrive at the deductible amount for your home office.

For example, if your home office is 100 square feet and your entire home is 1,000 square feet, then you can deduct 10% (100/1,000) of the expenses that relate to your entire home.

If you plan to use the actual expense method, you’ll want to track all expenses related to your entire home, including but not limited to:

• Utilities (Oil, Gas, Electric, Water, Phone, etc.)
• Homeowner’s Insurance
• Landscaping
• Office Furniture
• Mortgage Interest (Not Principal)
• Internet
• Office Supplies

Note that any expenses related solely to your home office (such as an office chair) will be 100% deductible if you use the actual expense method.

In order to substantiate a home office, you’ll want to put together a small folder including the following:

• A statement as to what you use your home office for
• A floor plan showing where the home office is located in your home
• Pictures of your home office

Rental Property Business Entity Options

As a rental property owner, you’ll most likely use a business entity to hold your investments.

This is done largely for asset protection purposes rather than tax purposes as most are considered “pass-through” entities that don’t pay tax at the entity level. Instead, the income/losses flow through to your personal tax return (Form 1040) and are taxed based on your personal circ*mstances.

Before we jump into the most common entities that real estate investors use, it is important to note that you should almost never put rental real estate in an S or C Corporation. These corporate entities are taxed at the entity level and often incur negative tax consequences when assets are transferred out of the entity for estate planning or other reasons.

Single Member LLC (SMLLC)

An SMLLC is the most common type of entity for individual real estate investors. SMLLCs are separate from the owner for legal purposes, but disregarded for tax purposes. This means that the rental activity in the SMLLC is reported directly on your Schedule E as if you owned the property directly under your name.

When using an SMLLC, treat it like a real business complete with business bank accounts, credit cards, etc. separate from your personal accounts.

Multi-Member LLC (MMLLC)

Investors often use an MMLLC when multiple individuals invest in rental real estate together. MMLLCs are generally taxed as partnerships, and you’ll receive your portion of the reported income or losses on a Schedule K-1. The K-1 amounts are then reported on your personal income tax returns (Form 1040), and you’ll pay tax based on your personal circ*mstances.

Like an SMLLC, establish business bank accounts, credit cards, etc. for an MMLLC. Also, prior to starting the MMLLC, you’ll want to discuss profit/loss splits, capital contributions, and how to handle unreimbursed partnership expenses with your partners.

Be sure to document the details of your MMLLC carefully in the operating agreement. It is also wise to consult an attorney with real estate experience when setting an entity up.

The Importance of Date Placed In Service

When you first purchase a rental property, it will be considered “placed in service” on day one if there’s an existing tenant in the property. If there’s no existing tenant, then the property is assumed to be not yet in service.

To place a property into service, you must meet two requirements:

1. the property must be ready for use; and
2. the property must be available for use.

Generally, your rental is ready for use when the city or locality of your rental property will conservatively issue a Certificate of Occupancy. The rental property is considered available for use once it’s advertised for rent.

Rental property investors will often purchase a property vacant and in need of significant renovations before it’s ready to rent. Any renovation costs incurred before you place the property in service must be capitalized and depreciated, generally over 5, 7, 15, or 27.5 years (5, 7, and 15-year property is eligible for 100% first-year depreciation), regardless of whether or not they are actual capital improvements or simply repair and maintenance business expenses.

The key point here is that costs that are capitalized and then depreciated are recovered over several years and then are subject to depreciation recapture (a 25% tax when you sell the property). Regular repair and maintenance expenses are fully deductible business expenses in the year incurred and are not subject to depreciation recapture.

Successfully manage this distinction from a tax perspective by completing the minimum amount of work necessary to get the property ready for lease, then immediately advertise it for rent.

As mentioned above, the definition of ready for lease will be determined by the building codes in your locality, but is typically when sheetrock is on the walls and the flooring is finished. In other words, if the property is habitable and no longer dangerous and someone could live there, it’s probably also ready for lease.

Once the property is in service you can finish the renovation and deduct some of the costs as repair and maintenance expenses in the current year. Other start-up costs such as appliances, which are normally considered capital improvements, become deductible in the current year under the de minimis safe harbor provision of the tax code.

Note that some renovation costs will always be considered capital improvements regardless of whether or not a property has already been placed in service (for example, replacing the entire roof).

Examples of renovation items you want to complete before you place the property in service:

• fixing structural issues (for example, cracks in the foundation)
• replacing an entire roof, floor, bathroom, kitchen, or plumbing system
• adding a deck or new HVAC system

Examples of renovation items you want to do after you place the property in service include:

• painting
• installing appliances
• replacing a doorknob or window
• repairing an existing plumbing system
• other minor repairs

As a best practice, you’ll want to get in the habit of itemizing your invoices so that you, or your bookkeeper, can more easily categorize these items as repair and maintenance business expenses or capital improvements. Itemized invoices are also helpful in determining whether expenses might qualify under one of the safe harbors or for 100% bonus depreciation. Your tax professional will thank you for it.

Check out more topics on rental property tax deductions:

• 9 Common Landlord Tax Deductions
• Business Travel Expenses for Rental Owners
• Pass-Through Deductions and Casualty Losses
• Rental Property Depreciation Overview
• Capital Improvements vs. Repairs and Maintenance Expenses
• Passive Activity Limits and Passive Losses
• Capital Gains, Depreciation Recapture, and 1031 Exchange Rules
• Short-Term Rentals and Related Taxes

While reasonable efforts were taken to furnish accurate and up-to-date information, we do not warrant that the information contained in and made available through this guide is 100% accurate, complete, and error-free. We assume no liability or responsibility for any errors or omissions in this guide.