Top 6 Tax Benefits of Owning a Rental Property
- Mar 20, 2023
- 5 min read
A 2022 Bankrate survey shows that real estate continues to be America’s favorite long-term investment option. Stocks were close behind in second, and cash investments came in third.
It’s no surprise why real estate investing is so popular. Aside from its lower volatility compared to stocks and excellent ability to generate passive income, there are many tax benefits of owning a rental property.
In fact, the Internal Revenue Service (IRS) has a long list of rental property tax deductions that investors can apply to their gross income.
So, what are the tax benefits of owning a rental property? Below you’ll learn about the six best perks you can take advantage of during tax time if you’re a rental property owner.
1. Deductions on Your Mortgage Interest
The first benefit to know about is the interest deduction.
The IRS considers mortgage interest like paying interest on a business credit card. Therefore, mortgage interest on a rental property, like credit card interest, is a business expense and, thus, tax deductible.
Your lender will send you Form 1098 to show the interest you paid for the year. Then, when you file your tax return, you will include this form with your Schedule E (Form 1040).
2. Deduct Operating Expenses
In most cases, IRS tax law states that you can deduct operating expenses from your rental income. Some deductible expenses include:
- Advertising and marketing costs
- Leasing commissions
- Liability insurance premiums
- Maintenance and repairs
- Pest control
- Professional services, such as a CPA or real estate lawyer
- Property management fees
- Property taxes or real estate taxes
- Utilities paid by the landlord
However, operating expenses are not a standard deduction. This means you will need to list all your expenses on your Schedule E. Keep all receipts from these expenses to help track spending and manage cash flow.
Being a landlord is challenging work. Many real estate investors don’t want to deal with the hassle, especially those who own multiple properties. This is where property management services come in.
A property management company deals with all landlord duties, such as:
- Collecting rent
- Finding and screening new tenants
- Handling maintenance and repairs
- Managing taxes
The best part about this? The use of a professional property management service is entirely tax deductible! This means you can still generate a healthy income while putting in minimal effort in handling the day-to-day duties.
It’s true that real estate typically appreciates with time, meaning it becomes more valuable. Yet, since rental properties are business assets, the IRS allows you to depreciate them. Depreciation is the reduction in value of an asset over time due to normal wear and tear. The depreciation period for rental properties is usually 27.5 years.
However, the depreciation deduction only allows real estate investors to depreciate the costs of the home and related items, not the land. Examples of things to include are:
- Carpeting or flooring
- New HVAC system
- New roof
To apply this deduction, you want to work with a tax professional. Different items have different depreciation periods, making the calculation difficult.
4. Deduct Owner Expenses
While we already discussed deducing operating expenses, there are more owner expenses you can deduct, too. Some examples include:
- Continuing education
- Home office
For example, if you subscribe to a real estate investing group or take real estate classes online, you can deduct these expenses from your gross income.
Some rental owners apply the standard home office deduction to a portion of the residence if they use it exclusively for business purposes. The deduction is $5 per square foot, with a maximum of 300 square feet.
While the IRS allows you to deduct some travel expenses, there are restrictions. For instance, the expenses must be ordinary and necessary for your real estate business. You cannot deduct everyday commuting expenses.
5. Pass-Through Deduction
This may be one of the lesser-known tax benefits of an investment property. Thanks to the 2017 JOBS Act, those who qualify for the pass-through income deduction can deduct up to 20% of their net business income from their tax bill.
To qualify, you must have the following:
- A pass-through business, such as a partnership, LLC, S-corp, or sole proprietorship
- A qualified business income (QBI)
QBI is the net income or profit your pass-through business earns. It doesn’t include income from:
- Capital gains
Thus, it’s wise to establish an LLC for your rental business and become self-employed once and for all! You can use this deduction to write off a significant amount on your personal tax return.
6. You Can Defer Capital Gains
Perhaps the best tax break for real estate investors is the 1031 exchange. This tax break allows you to defer capital gains tax. All you need to do is buy a similar property for the same purpose. In this case, that means buying another rental property.
Why is this one of a rental property’s most significant tax benefits? Because the short-term capital gains tax rate is the same as your ordinary income tax bracket. If you sell your property within one year of buying it, you’ll face a stiff tax bill.
On the other hand, the long-term rate is between 0% and 20%. So taxpayers generally want to avoid capital gains tax when possible to lessen their tax burden. Additionally, you can do 1031 exchanges indefinitely – so this tax rule significantly reduces your taxable income.
Further, if your spouse or children eventually inherit the property, the IRS will eliminate any outstanding capital gains tax and depreciation recapture tax liability. The depreciation recapture tax can be up to 25% in addition to the capital gains tax!
Importantly, if you want to buy an investment property through a 1031 exchange, it’s best to work with a tax professional. The paperwork can be complex, and any mistake will result in you needing to pay taxes on capital gains and depreciation recapture.
Take Advantage of the Tax Benefits of Owning a Rental Property
It’s clear there are numerous tax benefits to owning a rental property. These six tips are just a start – there are many more!
Whether you’re a homeowner looking to get into rental real estate or a seasoned real estate investor, a property management company in your corner can help maximize your returns.
So find a property manager in your area today with the help of All County Property Management! We’re a nationwide, premier property management partner focused on helping owners make their rental properties more profitable.
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