Tax deductions are one of the most effective tools used by real estate investors in general, and rental properties owners in particular, in order to reduce their expenses and earn more profit from their real estate investments.
But what are tax deductions? What role do they play in calculating your rental property expenses? And how can you use tax deductions to earn more money and pay fewer expenses on your real estate investment?
Let’s find out.
What Are Tax Deductions?
Tax deductions refer to the reduction of taxable income as a result of a portion of the income being spent on business expenses, or expenses that incur for the purpose of producing additional income. While tax deductions and exemptions are similar in that they reduce taxable income, they are different from tax credit which directly reduces taxes.
It is crucial for any real estate investor who owns an income property to have full understanding of tax deductions, as it is a tool that can help real estate investors to greatly reduce the amount of taxes that they pay on their rental income based on a number of expenses that they’ve paid towards sustaining, running, and improving their business. This includes owners of Airbnb investment properties.
Related: Everything Real Estate Investors Should Know About Tax Season
Calculating Your Airbnb Expenses
In order for any real estate investor who owns an Airbnb investment property to plan his/her investment and manage his/her finances, it is important to always calculate the expenses that incur on an investment property in order to accurately predict the income that the rental property will be earning in the short and long term.
Naturally, when calculating the expenses of running your rental property, you will also have to include the amount of income taxes that you will be paying on your rental income. However, this tax amount will be reduced by the other expenses on the list, which mainly includes the expenses of running your investment property.
This is where things get a bit tricky, and this is where many real estate investors fail to calculate the accurate values of their expenses.
Why Are Tax Deductions Important?
It is important to take into account the tax deductions that apply to your expenses when trying to calculate them, as it would give you a more accurate estimation of the expenses as well as the profits that your rental property will be earning, in addition to giving you a better idea of how to manage your finances and reduce your expenses in order to make more money.
When it’s time to pay taxes, many real estate investors are surprised by the large chunk of money that is being taxed on their rental income, and without having a solid plan and record-keeping of your receipts and expenses, it might not be possible to avoid paying these taxes, which will greatly reduce your income.
What Tax Deductions Apply to Your Airbnb Property?
So, now that you know how important it is to accurately calculate your expenses taking into account the taxes and tax deductions, it’s time for you to learn what expenses can be counted towards tax deductions in order for you to reduce your income tax and increase your profits effectively.
Related: All You Need to Know About Rental Income Tax
Property Maintenance and Repairs
One the major expenses for any investment property involves the costs of repairs and maintaining the rental property to keep it in a hospitable condition. Airbnb rentals in particular usually have high maintenance costs due to the regular tenant turnover, and their expenses occur often whenever a tenant moves out of the rental property.
A large portion of your maintenance and repair expenses is actually tax deductible. This includes the costs of replacing broken windows or locks, supplying new furnishing and fixtures, purchasing cleaning supplies, laundry costs, and a number of other expenses that are directly related to the maintenance of your income property.
Agent Fees and Services
This includes any service that you use in order to facilitate your rental business, such as hiring an intermediary to collect the rent for you.
Additionally, and more importantly, service fees that are paid to Airbnb in order to list your rental property (which is typically 3% of your investment property’s total reservation) can also be included in your short term rental tax deductions.
Utility Costs
This includes water, electricity, Wi-Fi, and gas bills. Any utility costs that occur on your rental property, and as long as your lease agreement does not oblige your tenant to pay these bills, can be tax deductible.
Local Service Costs
This includes any local services that maintain the environment of your Airbnb rental property in a good condition such as trash collection, snow plowing, pool cleaning, and gardening. These costs are all tax deductible.
Marketing and Advertising
Expenses that go towards advertising and market your rental listing and enhancing its publicity are all tax deductible.
Insurance
One of the best costs to take advantage of in tax deductions is insurance costs. Many real estate investors don’t realize this, but any insurance premiums that you pay to get your rental property insured can be added to tax deductions, greatly reducing the expense of insuring the investment property.
Mortgage
Although considered common knowledge, one cannot make a list of tax deductions on any real estate property without including the fact that interest rates on mortgages are in fact tax deductible.
Renting Out a Part of Your Property
As a final note, it is important to mention that if you intend to rent out a part of the real estate property that you’re using as your primary residence, then your tax deductions are calculated differently from the case in which you were to rent out the entire property.
If you’re living in the same property you’re renting out, then you would have to calculate the expenses based on the portion of the property that you’re renting out. For example, if you’re renting out a section of the house that makes up 30% of the total living space, only 30% of the expenses that apply to the entire house can be tax deducted, such as water and electricity bills, unless you have a system that separates the expenses that apply to your part of the property from the part that you’re renting out.
Related: The Best States With No Property Tax for Real Estate Investing
Bottom Line
Airbnb investment properties are becoming more and more popular as they allow for much higher nightly rates, and in many cases result in higher profits and total rental income. However, it is usually more challenging to calculate the income and expenses on an Airbnb rental property due to the different laws and regulations, especially taxes, that apply to them. In order to reduce these expenses and finance your property more effectively, you as a real estate investor need to learn about tax deductions and be aware of the expenses that you can use to reduce the income tax that applies to your investment property.
Are you interested in purchasing an Airbnb investment property? Or are you more interested in traditional rental properties? Either way, you can use Mashvisor to find the best properties for your real estate investment, furnished with investment property analysis and real estate stats to help you determine the most profitable rental property for your type of investment.