About Income Property Tax Deduction
Thanks to the phenomenon of flipping (purchasing houses with the idea of selling them for a profit), some people became accidental landlords when they weren't able to sell the property without incurring a loss. The good news is that more deductions and tax strategies are available for rental real estate than almost any other investment. The key is to know what deductions you're entitled to take and to keep very detailed records.
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The Facts
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Income property is any property owned by an individual or corporation in which a tenant is allowed to use or occupy the dwelling and/or land in exchange for money. When you are the owner of rental property, you're required to report all money received as rent on your annual federal tax return. This includes any amount received for occupation or use, any expenses a tenant pays for improvements or the fair market value of any property or services received in lieu of rent. From this amount, you can begin to make your deductions.
Rental Expenses
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The four primary deductions you can claim with rental property are maintenance and property taxes, insurance and mortgage interest. This includes repairs, upkeep to the dwelling and cleaning. Other deductions include advertising, commissions paid to rental agents, legal fees, travel expenses, utilities you paid, and the portion of tax preparation paid to file Schedule E, Part 1, which is a form filed with your personal income taxes that lists all rental income and rental expenses.
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Depreciation
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The IRS refers to depreciation as an annual allowance for wear and tear. It is based on three factors: the fair market value at the time the property is acquired for rental, or changed to a rental if you were previously living in it yourself; the amount of time over which the IRS allows you to spread out this deduction, typically its useful lifespan, which is 27 ½ years for residential and 39 years for commercial; and the depreciation method.
The method used most often in these cases is straight-line depreciation, which basically means subtracting the land value from the purchase price of the property, then dividing by the useful life span. To calculate and report this amount, use IRS form 4562.
In some cases, such as apartments, townhouses and condominiums, depreciation is figured based on the amount of stock you have in the corporation that owns the entire complex. It's important to note that certain payments made to capital improvements are not deductible (see Resources).
Considerations
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If the rental property in question is part of your vacation home, the expense and deductions must be divided between personal use and rental. If a rental property is also considered a personal dwelling, you cannot claim more deductions than income (a loss) for this property. The IRS considers the property a personal dwelling if you live in the home 14 days or more in a year or at least 10 percent of the number of days you rented it to others. More information regarding this is available in IRS Tax Topic 415.
If you are a partial owner of a rental property, deductions must be made based on the percent of ownership. Some states also have specific rules for property rented for short periods of time. In this case, they may be applicable to tourist and sales taxes.
Warning
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Security deposits collected should not be included as income. If you keep any part of it, that amount should be reported.
If the property is vacant between tenants, a loss of rental income cannot be claimed as an expense. Payments toward the principal amount of the mortgage also cannot be claimed. This amount must be depreciated instead. Even if you don't write off depreciation, the IRS automatically assumes that you do, which means that when you sell the property, you will have to recapture this amount. Consult a tax professional for specific information regarding your property.
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