If you’re asking yourself whether real estate is a good investment choice or not, you first need to understand the tax benefits of investing in real estate.
Many real estate investors are motivated to answer “yes” because of the potential tax deductions. However, there’s a couple of things you need to know about investment property tax deductions before investing money in a rental property.
This blog covers all you need to know about investment property tax deductions and will help you figure out how to make money in real estate. To achieve optimal return on your investment property, you should factor in the effects of the following investment property tax deductions in your investment property analysis.
Related: The Right Way to Do Taxes as a Real Estate Investor
Rental Property Depreciation
Depreciation is one of the most obvious investment property tax deductions. Knowing how to depreciate your assets properly and claim the proper depreciation on your rental property is key for a real estate investor. Depreciation of your investment property can go on for a number of decades. The concept behind depreciation is that the value of your asset (in this case the investment property) is bound to decrease over the years because of wear and tear. You can treat this as an expense and deduct it from your taxes. Depreciation is known as a wealth builder because even though it’s treated as a rental expense, it isn’t a ‘cash expense’. The value of investment properties is known to appreciate over time instead of depreciate. So, you’re benefiting from the investment property tax deductions without actually incurring any of the assumed downside.
Interest Deduction
Whether it’s interest on mortgages or other loans, interest is one of the main investment property tax deductions that you can use as a write-off to offset the income coming in from your rental properties. So, if you have a mortgage on the rental property, the loan interest will probably be your single largest deductible expense. An important thing to note for all real estate investors or anyone considering the real estate business is that a new law was passed. Under this new tax reform, as of January 2018, real estate investors can no longer deduct interest on home equity lines of credit.
Related: How the 2018 Tax Reform Affects Real Estate Investors
Property Tax
Every county in the country charges property taxes. The amount differs depending on the location of your property and the value of the property. If you invested in a rural area, the property tax is probably much smaller than when investing in real estate in a huge city. The property tax in a housing market can range from a couple hundred dollars to six figures. Since this is such a legitimate expense of owning an investment property, it is tax deductible.
Related: The Best States With No Property Tax for Real Estate Investing
Repairs
Any effort to maintain the current condition of the asset is a repair, the asset here being the investment property. But according to the IRS, you can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep your property in a good operating condition. As a real estate investor, you need to clarify between a repair and an improvement. Do not make the mistake of writing off an improvement as a repair. If you are adding a new item or upgrading a current item, this translates to improving the investment property. You are adding value to the property. That is considered an improvement and cannot be a part of your investment property tax deductions. The most common repairs are:
- Fixture repairs: fixing a broken part of an appliance or furniture (microwaves, beds, doorknobs, cabinets, fridge, etc.)
- Air conditioning repairs
- Plumbing repairs
- Painting
- Technical repairs (faulty wiring)
Office
If you’re renting out a space as your office or working from a home office, you can deduct the costs of doing so. These costs can include: renting out a commercial office space, ink and paper, printer, phone bill, legal forms, pens, etc. However, in order for this to be counted as part of the legitimate investment property tax deductions, you can only include expenses incurred related to your investment properties. The IRS often flags deductions made on home office tax deductions. To avoid this keep, records for the time you use that office for business purposes and remove any personal use.
Insurance
Any insurance you’re buying for your investment property is tax deductible: homeowners insurance, mortgage insurance premiums, fire/damage/liability insurance, flood insurance, and more. The insurance policy you purchase can be considered an expense if you purchased it because of the investment property.
Rental Income
Your rental income is considered taxable in the year you receive it, not when it was due or earned. This is why you need to include advance payments as income. So, for example, if you rent out an apartment as an income property for $800 a month and require new tenants to pay the first and last months’ rent when they sign the lease, you need to include $1,600 as rental income for that year even if the last month of rent is several years in the future.
If your tenant paid for any expenses related to your rental property, then this is included within the rental income. For example, if a tenant paid $50 to repair the fridge, that amount is deducted from that month’s rent payment. You can then deduct the cost of the fridge repair as a rental expense.
Utilities and Maintenance
You are eligible to deduct the cost of any rental property utilities, such as: electricity, gas, water and sewage, trash and recycling, and any other utilities you pay for. If a tenant pays for any utility bills, you need to first deduct that amount from their monthly payment and can then treat it as an expense.
Maintenance is often confused for repairs, but it isn’t. Maintenance costs are more day to day things that people expect to be done. Examples of maintenance costs are: landscaping, janitorial items, lights bulbs, pool cleaning, pest control, etc.
Travel
Many real estate investors don’t live close to their investment properties. It can be quite costly reaching those properties. Whether it’s local travel or international, you can still include these costs in your investment property tax deductions.
Capital Gains
The definition of a real estate investor is: an entity (individual or legal organization) that purchases a property with the intent of holding the property and producing a capital gain. Capital gain here is referring to the money received after selling a personal or investment property. Even in selling your investment property there are tax benefits! This is a taxed gain, and calculating capital gains tax for a personal property and an investment property differs. Its calculation is the difference between the basis price and the net sales price. Depreciation plays a major role in the definition of the basis price. Selling an investment property can recapture that property’s assets. This could result in larger capital gains.
To Sum It All Up
Is real estate a good investment? Yes! The investment property tax deductions are numerous and very beneficial for a real estate investor. Having knowledge of the tax law and knowing how to apply the many long term and short term rental tax deductions to your property are key for your real estate career.
Mashvisor can help real estate investors optimize their rental income strategy and learn how to invest money in real estate. Also learn how to manage all the potential expenses of the rental property by using the rental property calculator. Our rental property calculator can calculate all the different expenses that go into owning an investment property, telling you exactly what can be included in your investment property tax deductions!
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