Here are some of the most common rental property tax deductions as well as some more advanced tax rules landlords should be aware of.
10 Common Rental Property Tax Deductions
First, here’s an overview of ten of the most common tax write offs that rental property owners use.
Bad Debt Expense
Many landlords have been asking about an unpaid rent tax deduction. There is no direct deduction if your tenant stops paying rent.
If you use the accrual method of accounting, you can write off unpaid rent as a bad debt expense. Since you report rental income as it’s due, the bad debt expense reverses the income you never received, so you don’t pay taxes on it.
If you use the cash method of accounting, you don’t need to take a deduction because you never reported rental income you didn’t receive.
Mortgage interest is one of the largest expenses for most landlords. That makes sense since your mortgage payments often make up the bulk of what you charge in rent.
Most landlords can deduct their mortgage expenses in full. Unlike the personal mortgage interest deduction, there is no cap on the mortgage amount when claiming a business interest deduction as a rental property owner.
Your mortgage lender should give you a breakdown of your interest, principal, and other charges in each mortgage payment.
If you have a very high net worth or income, consult with your tax advisor as there are planning moves you need to make to deduct all of your mortgage interest. (While there’s no cap on the mortgage amount, you may run into limits on your interest expenses in relation to your income.)
Property taxes are also generally tax-deductible as a business expense for landlords.
Similar to mortgage interest, there is no cap on the property tax deduction for landlords as there is for personal property taxes deducted through the state and local tax deduction.
In addition, you can usually deduct both ad valorem and non-ad valorem taxes.
Ad valorem is something like a 1% tax on your property value. Non-ad valorem is something like a $150 annual charge to each property owner in the area for fire services.
Other taxes may also be deductible depending on how you pay them.
For example, if you have to pay a separate rental property tax or sales tax, that might count as a rental property expense.
If you pay a state income tax on your rental income on your personal tax return, that usually won’t qualify for rental property deductions. It would usually count for your personal itemized deductions.
Most landlords have routine operating expenses like a subscription to a rent collection service, property management fees, lawn care services, and other ongoing expenses.
The expenses might be to maintain your property or to make it easier to manage your business. They can be expenses that you pay directly or that you hire independent contractors for.
As a general rule, you can deduct your actual expenses in full unless you also use the property for personal reasons. Then you may need to prorate your expenses.
One thing to note is that you generally can’t take a deduction for your own time. For example, even if you’re a licensed plumber that charges $100 per hour, you can’t deduct $100 per hour spent on your own plumbing work.
When you buy a new rental property, you can’t write off the cost you paid for it. Instead, you have to take a depreciation expense over time.
Depreciation also applies to large expenses like installing a new air conditioner or replacing your roof. The IRS has rules for the depreciation timelines for different items. The rules usually match the expected lifespan of the item.
See below for more on when and how to use depreciation deductions to reduce your rental income.
If something breaks, you can deduct the cost to fix it. For example, if the AC goes out in your rental property, you can deduct what the HVAC company charges you to fix it.
If you do repairs yourself, you can only deduct the cost of parts. You can’t take a deduction for your time or labor.
If a repair for a major item turns into a replacement, you can deduct the service call and repair attempts. If the costs for the replacement item and installation are high enough, you’ll usually need to depreciate them over time.
There are two types of travel expenses landlords can take.
- If you own a property outside of your home area, you can deduct the cost of traveling there to manage your property. For example, say you moved to a new state and rented out your old house. You need to travel to it to do work in between tenants. You can deduct the costs of that business trip.
- You can also deduct trips inside of your local area when you’re driving between your rental properties, between your rental property and your business location, or between your rental property and shopping trips for your rental property. You generally can’t deduct trips starting or ending at your house since those are considered your commute.
If you have car expenses, read up on the standard mileage deduction vs. actual expenses method to learn how to claim them.
You might need to hire a lawyer to draft a lease or evict a tenant. While personal legal fees are usually not deductible, attorney fees related to your real estate business are generally deductible as business expenses.
If you pay a rental listing service or buy an ad in a newspaper, those are generally deductible marketing expenses. You can deduct the cost of all of your ads, not just the service that found you your new tenant.
Hiring a real estate agent to list your rental property will usually fit in here.
Insurance is another important rental business expense that can be considered an operating expense. It deserves special mention because you need to ensure you have the right insurance.
Landlords will generally need a landlord’s or business policy rather than a standard home insurance policy.
Qualified Business Income Deduction for Rental Property Owners
Unlike other rental property tax deductions that you take on Schedule C or Schedule E, the Qualified Business Deduction is a separate deduction that you take on your personal tax return. The deduction is normally worth 20% of your business net profit.
The QBI Deduction or Section 199A Deduction generally only applies when you’re operating your rental properties as a “rental real estate enterprise.” That’s fancy IRS language for you’re operating your rental property as an active trade or business rather than a passive investment.
The IRS has a special safe harbor rule where rental property owners can automatically qualify for the Qualified Business Income Deduction. See IRS Revenue Procedure 2019-38.
Safe harbor rules create black and white requirements where there would otherwise be gray areas. So when you follow a safe harbor rule, you don’t have to worry about the IRS challenging you on that tax position.
The safe harbor rule for the Qualified Business Income deduction requires you to meet all of the following requirements.
- Keep separate books and records for each rental real estate enterprise. Your enterprise could be one or more rental properties. Multiple properties generally don’t require separate enterprises if they’re similar and you’re running them together.
- Perform 250 hours of rental services each year for at least three out of the last five years. If your enterprise has been in existence for less than four years, you must perform at least 250 hours of services each year.
- Keep time reports, logs, or similar documents showing:
- The hours of all services performed
- A description of the services performed
- The dates the services were performed
- Who performed the services
- Attach a statement to your tax return each year you use the safe harbor
If you don’t meet all of the safe harbor requirements, it’s still possible to qualify for the QBI deduction. Since you’d be getting into a gray area with a higher risk of an IRS audit, you should talk to your tax advisor.
Some properties are generally excluded from the safe harbor rule even if you meet the requirements. These generally include:
- Triple-net leases (tenant pays taxes, fees, and insurance premiums on top of rent)
- Properties you use as a residence
- Properties where you engage in certain other activities that don’t qualify for the QBI deduction (for example, renting to your own law firm)
The IRS generally allows rental services to be performed by an owner, employee, or independent contractor. This will usually include hiring property management companies.
So hiring someone doesn’t automatically mean that you have a passive investment or don’t meet the hours requirements.
Qualifying services typically include:
- Collecting Rent
- Providing services to tenants
- Spending time renting the property (showings and marketing)
Qualifying services usually don’t include:
- Acquiring a rental property
- Getting financing for a rental property
- Reviewing financial statements or reports
- Travel time to the property (even when performing rental services)
So what’s the catch? Doesn’t everyone qualify?
The 250 hours will be the biggest hurdle. That’s 20.83 hours per month or over 2.5 full working days.
If you have a single residential rental property or even a small portfolio of properties with long-term tenants, you’ll often fall well short of the hours requirement.
One trick you can use to hit the minimum hours is to provide additional services such as lawn mowing, pool cleaning, snow shoveling, etc. instead of using your lease to pass those responsibilities on to your tenants.
And again, not hitting the minimum hours doesn’t mean you lose the QBI deduction. It just means you don’t get the automatic safe harbor rule.
So, for example, if you’re providing 10 hours of services per month but only have a small duplex, you might qualify as a rental business. Ask your accountant about your specific situation.
If you scrolled past the intro to deductible expenses for a rental property, depreciation requires you to deduct large expenses over time rather than all at once.
Given the choice, most taxpayers prefer to immediately claim deductible expenses in full in order to get the lowest possible taxable income this year.
When business expenses provide a long-term benefit, the IRS prefers that you spread out your tax deduction over time to bring more taxes in now.
Just like the matching principle in financial accounting, the IRS believes that depreciating expenses related to your rental property better matches the rental income you receive as a result of those expenses.
Depreciation Safe Harbor Rules
Just like the Qualified Business Income Deduction, the rental property depreciation rules have safe harbor provisions. You can use these rules to get more tax benefits now by taking an immediate full deduction rather than using depreciation to deduct expenses.
De Minimis Safe Harbor Rule
Under the de minimis safe harbor rule, most rental property owners can take an immediate tax deduction for expenses up to $2,500.
That increases to $5,000 for a very small number of rental property owners that have to file reports with the Securities and Exchange Commission or that have to have their financial statements audited by a CPA.
De minimis is a Latin term that means too small to matter.
The IRS doesn’t want to deal with extra paperwork for small expenses that don’t give much of a deduction in the big picture of things. It also makes things easier for landlords.
The $2,500 or $5,000 limit usually applies to each individual item.
So if you buy $6,000 worth of new appliances for a rental unit but no individual appliance is worth more than $1,000, you can deduct $6,000 now. You don’t have to use depreciation.
If an individual item is over $2,500 or $5,000, you may or may not need to depreciate it. Depreciation usually applies to capital improvements or assets you will continue to use at a rental property or in running your rental business.
Routine Maintenance Safe Harbor Rule
You generally don’t have to use depreciation for routine maintenance items regardless of how much you have to pay.
Maintenance generally includes the following.
- Inspections and testing
- Replacing worn or damaged parts with comparable components
There are some exceptions, though.
First, replacement parts generally need to be things that you can reasonably expect to replace within 10 years. For parts that normally last longer than ten years, you’ll usually need to use depreciation even if it’s a like-for-like switch.
Second, you can’t use the routine maintenance rule for betterments or restorations. These are generally things that would increase your property value rather than just getting something working again.
Safe Harbor for Small Taxpayers
If you’re a small landlord that files your tax return using Schedule E, you may be eligible to deduct all of your business expenses including repairs, maintenance, improvements, and other costs.
The main thing that you wouldn’t be able to deduct is your initial investment in a rental property.
For this rule, small means all of the following:
- Less than $1 million in unadjusted basis. This will often be your initial investment in the rental property, but if you’re close to the line, talk to your accountant.
- Less than $10,000 in annual expenses for repairs, maintenance, and improvements. Alternatively, ask your accountant about increasing the limit to 2% of your building’s unadjusted basis.
- Have gross income less than $10 million per year for each of the previous three years
Section 179 Depreciation
The Section 179 depreciation deduction rule is similar to the safe harbor for small taxpayers except it’s for an active trade or business. A rental property owner that files a Schedule C and qualifies for the QBI deduction can fit in here.
If you’re not a corporation, it’s really difficult to qualify for Section 179. In addition, you’ll usually be covered by the de minimis and routine maintenance safe harbor rules.
I put Section 179 in here for completeness and for something to ask your accountant about if the other safe harbors don’t cover your full expenses. Ideally, this is something to ask about before you acquire a rental property or sign a lease.
The IRS has standard depreciation timelines for most items.
The depreciation period is 27.5 years for residential rental properties and 39 years for commercial rental properties. You can only depreciate the value of the building.
Let’s say you bought a commercial rental property for $500,000. The land is worth $110,000, and the building is worth $390,000. You would divide the value of the building by 39 years. Your depreciation deduction is $10,000 per year.
Here are some other common expenses related to rental income and the standard depreciation timeline.
- Appliances: 5 years
- Carpets: 5 years
- Furniture used in residential rental property: 5 years
- Office furniture and fixtures: 7 years
- Improvements to land (shrubs, sidewalks, driveways): 15 years
Note: Some permanent fixtures, such as central air conditioning, may count as an improvement to the building itself. That means they may get depreciated according to the building timelines rather than the timelines for individual items.
For the full list, see IRS Publication 946. The default rule for non-specified items is seven years.
Common Landlord Situations and Tax Differences
While many people think of a rental business as signing tenants to long-term leases, there are other common types of rental arrangements.
Short-term rental tax deductions will usually work the same way as any other rental property. The main difference with short-term rental tax treatment is in income taxes and sales taxes.
Many states charge additional taxes for short-term rentals. In addition, because short-term rentals take more work, they’re more likely to count as active income rather than passive income.
Renting a Room
Since renting out a room counts as taxable income, it’s only fair that your expenses are tax-deductible.
Direct expenses like background check fees, furnishing the room, or touching it up between tenants are usually deductible in full.
More involved work, such as installing new flooring or windows or doing a full renovation can get trickier.
You may need to use depreciation for larger expenses instead of deducting them all at once. Some projects may also count as improving your full home instead of counting 100% towards your rental business deductions.
To learn more, see Home Improvement Tax Deductions or talk to your tax advisor.
A timeshare that you’re using as a rental property will usually qualify for rental property tax deductions. It’s similar to buying a rental property that you fully own.
If you use a timeshare as a vacation home and only rent it out sometimes, talk to a tax professional as the rules can get a little tricky.
If your timeshare qualifies as a personal property, you may be able to deduct your mortgage interest and property taxes as itemized deductions.