Tax Deductions in Real Estate Rentals

deductions in rental real estateRich people love to rave about how they were able to reduce their tax burden. How about paying 15% in effective taxes on a $1,000,000 income? In the United States, laws favor those who are small business owners. In the previous post, I discussed fundamental ways that one makes money from rental real estate. Here I will go over some of the more common ways to reduce your tax burden as a landlord in the real estate business.

Why are tax deductions important?

Running a real estate business is not easy. You are basically taking out a loan to purchase an expense property to generate cash flow while hoping that the property appreciates over time. This is by no means passive—things break, renters can be deadbeat, your property can go unrented—in essence, in real estate you are hoping to generate a stream of growth on the money that you locked down. Can you get 4% growth? How about 7%, 9%, or more? Whatever you do in real estate, make sure you end up with more money that you started, beat inflation, and get a tolerable return for the effort you put in.

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Fortunately the U.S. tax system allows you to offset your paper gains with many of the expenses of running a business. If you do venture into the real estate business, make sure you are taking advantage of what is available to you.

Common deductions that you can tax in your rental real estate business.

  1. Mortgage interest is deductible. Most landlords will obtain bank loans to finance the purchase of a rental property. The interest on the mortgage paid every year can be deducted from the business earnings to reduce your tax burden. Uncle Sam is effectively reducing your marginal income tax if you spent that amount of money on interest payment on a loan!
  2. Depreciation of real property — Depreciation is a complex subject that is beyond the scope of this generalized overview. However, depreciation should be construed as MONEY IN YOUR POCKET. Commercial real estate is treated differently than residential property. In the broadest sense, real estate for tax purposes loses value over time. The amount lost can be used to reduce your tax burden. For instance, residential real estate can be depreciated over 27.5 years. This amount only includes the building structure, and not the land. So if you purchase a home for $500,000, with the land accounting for $150,000 of the purchase price, you can divide up the remaining $350,000 cost of the home to depreciate over the next 27.5 years. Yes, this seems like a long time, but the amount becomes quite substantial over time, especially if you can keep generating rental income in your property.
  3. Repairs — Things break. Fortunately if a critical component of your rental property needs to be repaired, you can use that to offset income. There is a fine line in this perk. If the roof needs to be replaced, the fan on the AC air handler breaks, or the garage door needs to be patched, these costs can be deducted from your income. The rules are quirky too. If you pay the HVAC person to clean your AC fan for $50 because it wasn’t working well, you can deduct the cost of your repair. If you do it yourself, you cannot.
  4. Personal property — Items such as carpets, furniture, and appliances used in a rental property can also be depreciated as personal property. This means that the cost of this type of item can be depreciated over 5-7 years instead of the 27.5 years for the building itself.
  5. Insurance — You can essentially deduct any insurance you pay for your rental property from your income. This includes fire, theft, landlord liability insurance…etc. Not bad!

There are plenty of other nuances in the U.S. tax system that allows real estate investors to maximize their options for reducing income tax. You can’t do this with other types of investments.

The caveat of tax deductions for high income earners.

Remember, you are a highly paid professional. Maybe even a neurosurgeon. Maybe you are a horrible businessman (or woman) with no ideal how to operate a real estate business. You still forge ahead and buy real estate to rent out to your unsuspecting neurosurgery residents (they are locked into your rental for at least six years!) You lose money in the process. Can you deduct your losses from your professional income as a surgeon?

Unfortunately not.

The tax system does forgive lower income folks with rental property. (lower income is obviously a relative term) If you earn less than $100,000 a year from your current job, you are allowed to offset up to $25,000 in rental business losses from your earned income! This deduction benefit phases out until an earned income of $150,000, where you don’t qualify at all. The neurosurgeon earning $600,000 of annual income will not receive any remorse from Uncle Sam.

What deduction benefits of real estate ownership do you like the most? Which other ones do you use?


Note: I am not a licensed tax expert, accountant, or financial or business advisor. All information contained in this post and this website are solely opinions of the author. We are not responsible for any damages incurred from information contained on this website.


(Photo courtesy of Flickr)

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