From finding tenants to fixing toilets and potentially lied to on a regular basis, renting out a home is great, a lot of work and has the potential to become a full time job. Alternatively, you can hire a professional property manager and still use rental property expenses to offset rental income.
Writing off Rental Expenses
Most rental home expenses are tax deductible. Save receipts and any other documentation, and take the deductions on a Schedule E. (IRS Publication 527)
Figure you’ll spend 4-6 hours a week, including record keeping, fixing minor problems, cutting grass or shoveling snow and occasionally taking late night calls to change light bulbs-the American dream, right?
In general, you can claim the deductions for the year in which you pay for these common rental property expenses:
Cleaning and maintenance
Commissions paid to rental agents
Less obvious deductions include expenses to obtain a mortgage, and fees charged by an accountant to prepare your Schedule E. And don’t forget that rental homes can be a houseboat or trailer, as long as there are bedrooms, kitchens and bathrooms. The location of the rental home doesn’t matter, It can even be outside the United States.
Limits on Travel Expenses
You can deduct expenses related to traveling locally to a rental home for such activities as showing it, collecting rent, or doing maintenance. If you use your own car, you can claim the standard mileage rate, plus tolls and parking. For 2015, it’s 56 cents per mile.
Traveling outside your local area to a rental home is another matter. You can write off the expenses if the purpose of the trip is to collect rent or, in the words of the IRS, “manage, conserve, or maintain” the property. If you mix business with pleasure during the trip, you can only deduct the portion of expenses that directly relates to rental activities.
Repairs vs. Improvements
Another area that requires rental home owners to tread carefully is repairs vs. improvements. The tax code lets you write off repairs—any fixes that keep your property in working condition—immediately as you would other expenses. The costs of improvements that add value to a rental property or extend its life must instead be depreciated over several years. (More on depreciation below.)
Think of it this way: Simply replacing a broken window pane counts as a repair, but replacing all of the windows in your rental home counts as an improvement. Replacing a few shingles due to a roof leak is a repair; re-shingling the entire roof is an improvement. You get the picture.
Depreciation refers to the value of property that’s lost over time due to wear, tear, and obsolescence. In the case of improvements to a rental home, you can deduct a portion of that lost value every year over a set number of years. Carpeting and appliances in a rental home, for example, are usually depreciated over five years.
You can begin depreciating the value of the entire rental property as soon as the rental home is ready for tenants and you hold it out for rent, even if you don’t yet have any tenants. In general, you depreciate the value of the home itself (but not the portion of the cost attributable to land) over 27.5 years. You’ll have to stop depreciating once you recover your cost or you stop renting out the home, whichever comes first.
Depreciation is a valuable tax break, but the calculations can be tricky and the exceptions many. (Read IRS Publication 946, “How to Depreciate Property,” for additional information) If you prepare your own taxes, I’d recommend you consult a tax adviser.
Profits and Losses on Rental Homes
The rent you collect from your tenant every month counts as income. You offset that income, and lower your tax bill, by deducting the rental home expenses including depreciation. If, for example, you received $9,600 rent during the year and had expenses of $4,200, then your taxable rental income would be $5,400 ($9,600 in rent minus $4,200 in expenses).
You can even write off a net loss on a rental home as long as you meet income requirements, own at least 10% of the property, and actively participate in the rental of the home. Active participation in a rental is as simple as placing ads, setting rents, or screening prospective tenants.
If your modified adjusted gross income (same as adjusted gross income for most persons) is $100,000 or less, you can deduct up to $25,000 in rental losses. The deduction for losses gradually phases out between income of $100,000 and $150,000. You may be able to carry forward excess losses to future years.
Let’s say that for the year rental receipts are $12,000 and expenses total $15,000, resulting in a $3,000 loss. If your modified adjusted gross income is below $100,000, you can deduct the full $3,000 loss. If you’re in a 25% tax bracket, a $3,000 loss reduces your tax bill by $750, plus any applicable state income taxes.
And don’t forget, tax returns are due by April 15th unless you file for an extension.
Tired of dealing with tenants and keeping track of expenses? Contact Real Property Management today. Real Property Management is the nation’s leading property manager. For over 30 years, Real Property Management has developed intelligent solutions for thousands of individual property owners, investors, tenants and Realtors.