Are You A Real Estate Investor? Don't Forget These Essential Tax Deductions

The only thing in life that's certain besides death and a sudden craving for pizza at 3 a.m. is taxes. But did you know that owning real estate can come with some sweet tax benefits? Being a property owner doesn't just mean dealing with leaky roofs and unruly tenants — it can also mean saving some serious cash come tax season. Property owners can benefit from deductions on mortgage interest payments, taxes related to improvements and repairs and in some cases, the ability to deduct state and local taxes. Read on to learn more about the tax benefits associated with owning real estate. 

Deductible Expenses

Real estate investors have a wide range of deductible expenses, allowing them to minimize their tax burden significantly. These can include:

Mortgage Loan Interest Payments

When you purchase a rental property, you are essentially investing in a business. As such, you can deduct the mortgage interest paid on the property as a business expense on your tax return. This is done by filling out Schedule E when filing your taxes. Say you purchased a rental property for $500,000 and financed it with a mortgage loan for $350,000. The total interest paid for the first year of the loan comes to $15,000. If you earn $50,000 in income from renting the property in that same year, you may take a deduction of $15,000 for the mortgage interest, which will reduce your taxable rental income to $35,000. 

Your lender will provide a Form 1098 annually, which will show how much money was paid in mortgage interest during that year. 

Property Taxes

Property taxes are based on the assessed value of your property and vary from area to area. Your tax rate may be determined as a percentage of this assessed value, or as a flat fee for certain types of properties. In addition, local governments may charge special assessments for additional services such as sewer or water upgrades.

To deduct property taxes, you must itemize them on your income tax return. When you fill out Schedule A (Form 1040), you will need to enter the total amount paid in property taxes during the year next to the Real Estate Taxes area on the form. This amount can come from any combination of personal and rental properties, so long as all are reported accurately. When itemizing deductions, it’s important to note that property taxes are generally deductible only if they were imposed on you as an owner and not passed through from tenants as part of their rent payments. 

Insurance

Insurance is deemed a necessary expense to protect your investment. You may be able to deduct the cost of landlord insurance from your taxes. This sort of insurance typically covers damage to the property, a liability that may occur on the premises and lost income resulting from extended vacancies.

 If you own a commercial building or other business-related real estate, you may be eligible to deduct the cost of commercial property insurance. This type of coverage often provides protection against physical damage caused by natural disasters, disturbances such as vandalism or theft and civil liability claims resulting from injuries suffered by visitors. 

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Any insurance premiums that are paid by your tenants or reimbursed to you by your tenants must be excluded from your deduction. Only the portion of the insurance premiums you pay out of pocket can be claimed as a deductible business expense.

Repairs

You can deduct repairs and expenses that you make to your properties on your taxes. Common deductions include the cost of materials and labor for necessary maintenance and repairs. These include costs associated with:

• Painting
• Carpentry
• Masonry work
• Roofing repair or replacement
• Landscaping
• Plumbing
• Window and door repair or replacement
• Heating ventilation and air conditioning (HVAC) repair or replacement 
• Any other costs associated with keeping the property in good condition

You can also deduct any costs associated with tenant improvements such as carpeting or appliances. 

Travel 

Real estate investors can claim a deduction for their travel expenses related to investment activities, so long as the costs are necessary and ordinary. These may include plane tickets, hotel accommodations, meals and other incidental costs associated with traveling away from home for business. To be eligible for the deduction, the primary purpose of the trip must be related to real estate investments such as visiting a rental property, meeting with tenants or contractors or attending an industry conference or seminar.

Keep accurate records of all your traveling expenses to support deductions when filing taxes. This should include dated receipts and documentation that verifies the business-related purpose of the trip. The IRS may require detailed information to substantiate deductions and any additional proof could significantly reduce tax liabilities in the event of an audit.

Depreciation

Depreciation is an accounting method that allows real estate investors to deduct the cost of the property over its useful life. The IRS considers real estate to be a depreciating asset because it has a limited lifespan and will eventually lose value over time. Real estate investors can claim a portion of the property's value each year as a tax deduction.

The amount of depreciation that can be claimed each year is determined by the property's cost basis (the purchase price plus any improvements) and its useful life. The useful life is determined by the IRS based on the property type and is typically 27.5 years for residential rental property and 39 years for commercial property.

Utilities

Generally, you can deduct the utility costs associated with operating a rental property, such as water, electricity and gas. Depending on the specific type of utility being used, deductions may vary.

For example, when it comes to electricity and gas bills for rental properties, investors are typically allowed to deduct 100% of the cost of these expenses as long as they are used for business purposes. But if only part of the utility is being used for business purposes (such as the lighting in common areas), an investor can only deduct a portion of the cost related to that use. If utilities are being used exclusively for personal reasons, such as heating or cooling a residential unit, investors would not be able to take this deduction at all.

Along with electricity and gas bills, you may be able to deduct water bills from your taxes. Although water is considered a necessary utility for most rental properties — especially those with multiple units — deductions for water usage will depend largely on how much it is being used and what it’s being used for. 

If you own a single-family home that has one unified bill covering both business-related activities, such as sprinkler maintenance, and personal ones, such as bathroom usage, then you would only be allowed to deduct a portion of the total cost corresponding to its business-related uses. 

Generally, when the water bill is separate and in the tenant’s name, you’re unable to claim the deduction if the tenant pays. 

If you have a vacant property, you can deduct the cost of water you pay until the unit is rented.

Advertising

Advertising expenses are typically defined as any costs incurred for services or products that help promote a business. When it comes to real estate investing, this could include anything from listing fees to billboard advertisements. 

To take advantage of these deductions, you must have the necessary documentation to prove that these expenses were related to your business activities. This includes receipts, invoices and other evidence of payment for the advertisement itself. 

The IRS also requires that all advertising costs be reasonable in comparison with industry standards and within accepted parameters for what is considered necessary for your business activities. For example, if you ran a radio ad campaign throughout your city but only had five properties listed in one neighborhood, this would not meet the criteria of necessary advertising expenses because it doesn't make sense compared to industry standards and expectations when it comes to marketing campaigns within specific geographic areas. 

Home Office Expenses

To be eligible for this deduction, your home office must be used as your primary place of business or where you meet with clients or customers.

There are two methods for calculating the home office deduction: the simplified method and the regular method. With the simplified method, you can claim a deduction of $5 per square foot of your home office space, up to a maximum of 300 square feet. With the regular method, you calculate your actual expenses for your home office, such as mortgage interest, property taxes, utilities, repairs and maintenance and depreciation, and then allocate those expenses based on the percentage of your home that is used for business purposes.

To qualify for the home office deduction, you must meet the following requirements:

1. The home office must be used exclusively and regularly for business purposes.
2. The home office must be the principal place of business for your real estate investment business or a place where you regularly meet with clients or customers.
3. The home office must be a separate and identifiable space in your home, used solely for business purposes.
4. The home office must not be used for any personal purposes, such as watching TV or conducting household activities.

Professional Services

Professional expenses include fees paid to attorneys, accountants, real estate agents, property managers and other professionals who provide services to help you manage and grow your real estate investment business.

To be eligible, the professional services must be directly related to your real estate investment business. If you hire an attorney to draft a lease agreement or a property manager to manage your rental properties, these expenses would be deductible.

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