Owning rental properties offers various tax benefits, including the ability to deduct mortgage interest on those properties. This deduction allows landlords to potentially reduce their taxable rental income by the amount of interest paid on the mortgage, potentially leading to significant tax savings. To qualify, the property must be rented out or available for rent, and you must keep detailed records of mortgage payments. Consulting with a tax professional can provide more guidance on maximizing this deduction and ensuring compliance with IRS regulations.
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Deducting Mortgage Interest on Rental Properties
When you own rental properties, you can deduct the interest paid on your mortgage from your rental income, potentially reducing your taxable income. This applies to mortgages on primary residences also used as rentals, mortgages on second homes that are rented out, and even home equity loans on rental properties if the funds are used for substantial property improvements.
How to Claim the Mortgage Interest Deduction
Claiming the mortgage interest deduction on rental properties can potentially significantly reduce your taxable income, but it requires careful documentation and adherence to IRS guidelines.
Here’s a step-by-step process to help you claim this deduction effectively:
- Confirm eligibility: Ensure the property is a rental property, meaning it is used to generate rental income. The mortgage must be a secured debt on this property.
- Keep thorough records: Maintain accurate records of all mortgage payments made throughout the year. This includes keeping mortgage statements and payment receipts.
- Confirm receipt of Form 1098: Your lender will typically provide a Form 1098 at the end of the year, which outlines the amount of mortgage interest paid. This form is necessary to report accurately the interest deduction.
- Complete schedule E: Report the mortgage interest paid on Schedule E (Form 1040), “Supplemental Income and Loss.” This form is used to report income or loss from rental real estate, royalties, partnerships, S corporations, estates, trusts and residual interests in REMICs.
- Record your deductible amount: Enter the total amount of interest paid during the tax year on Line 12 of Schedule E. Ensure that you are only deducting the interest portion of your mortgage payments, not the principal repayment, and only the portion that applies to the rental space if you also occupy the residence.
Other Rental Property Deductions
Owning rental properties comes with a range of other deductions that can potentially significantly lower taxable income. Beyond the mortgage interest deduction, landlords can benefit from several other tax breaks.
One of the most substantial deductions is depreciation. The IRS allows property owners to depreciate the value of their rental property over 27.5 years, accounting for wear and tear, while commercial properties depreciate over 39 years. This non-cash deduction may provide a considerable tax benefit annually.
Property taxes paid to local governments are deductible. This can be a significant deduction depending on the property’s location and the local tax rates.
Repairs and Maintenance
Costs associated with repairs and regular maintenance are fully deductible in the year they are incurred. This includes expenses for fixing leaks, painting and other minor repairs that keep the property in good condition.
Premiums paid for insurance coverage on rental properties are deductible. This includes fire, theft and flood insurance, as well as landlord liability insurance. The deduction applies to premiums for the year in which they are paid.
Utilities
If the property owner pays for utilities like electricity, gas, water or trash collection, these expenses are deductible. The costs must be directly related to the rental activity and paid by the owner.
Other Expenses
Fees paid to accountants, lawyers and other professionals for services related to the rental property are deductible. This ensures that the landlord can offset the cost of obtaining professional advice and services.
Expenses related to advertising the rental property, including online listings, newspaper ads and other promotional activities, are deductible. This helps landlords manage the costs of finding tenants.
Landlords can deduct travel expenses related to managing their rental properties. This includes trips to the property for inspections, maintenance or tenant meetings. If the property is out of state, these deductions may include airfare, car rentals and hotel stays.
What’s Not Deductible?
However, there are limitations on tax deductions and understanding them is key. Rental property owners cannot deduct the following:
- Improvements: Costs for improvements, such as adding a new roof or remodeling, must be capitalized and depreciated over time rather than fully deducted in the year they are incurred.
- Losses from vacant property: If a rental property is vacant and not actively being rented out, you can’t deduct the lost income from the vacancy, though you can deduct normal expenses of maintaining the property during the vacancy period as long as it’s held out for rent..
- Fines and penalties: Any fines or penalties paid to the government for violating laws, such as building code violations, are not deductible.
- Owner’s labor: The value of your own labor, if you perform work on the property, cannot be deducted. For instance, if you spend time painting the property or handling maintenance tasks, you cannot deduct a value for your labor.
- Loan principal payments: The principal portion of mortgage payments is not deductible. Only the interest portion can be deducted.
Bottom Line
Maximizing tax benefits from owning rental properties involves leveraging deductions such as mortgage interest, depreciation, property taxes and other related expenses. Properly documenting and understanding eligibility criteria for these deductions can potentially significantly reduce your taxable income, enhancing the potential growth of your investments.
Tips for Tax Deductions
- When you own a rental property, your taxes can get complex, fast. A financial advisor may be able to help. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve you financial goals, get started now.
- Make sure you’re deducting all allowable rental property expenses to cut down on your tax bill. Some expenses are easy to overlook, so check out these nine rental property tax deductions to ensure you haven’t missed them.
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