Investing in Rental Property

Real Estate Taxes

Rental Property Tax Deductions

Knowledge about real estate taxes will help you save a lot of money on your rental property investments. There are hundreds of rental property tax deductions available to you as a business owner.

Tax law favors investors over employees and you need to have a cursory knowledge of what paperwork to save and data to keep track of. Owning rental property puts you at a slightly higher risk of a tax audit, so it's important to do your homework here.

I've used TurboTax for many years to do my taxes. Whether you use a computer software program or hire a professional, the hardest part about doing taxes is the preparation of all of the data. The software is designed to walk you through every rental property tax deduction possible.

Even if you chose to have a professional prepare your taxes, I think that at least once you should use this type of software so that you learn something about real estate taxes.

Opening a separate checking account is a critical first step to show the IRS that this is a business and not a hobby. Mixing money between personal and business checking accounts is not a good idea and would be a huge problem to explain if you were to be audited.

Here's a lengthy list of rental property tax deductions to keep track of. See IRS Publication 527 for more details.

  1. Rental income - one reason why your risk of an audit is higher is that many people pay cash and the IRS will look to see if you are hiding money.

    • Keep track of rent credits separately if you give these to tenants. This is reported when the tenant leaves or when they buy the property.
  2. Capital investment in rental properties.

    • Track all closing costs - some can be expensed, others depreciated

    • Each time you make a capital improvement to the property it needs to be recorded

    • Equipment you buy for your business - computers, tools, etc.

  3. property taxes

  4. mortgage interest and interest on business loans

  5. insurance

  6. advertising

  7. mileage - keep a mileage log

    • it may be better for you to track actual vehicle expenses

  8. Home office - direct and indirect expenses

    • office supplies, copying costs and postage

    • insurance - homeowners and business

    • utilities - phone, Internet, voice mail, heating, water, electric

    • home repairs

    • property taxes and insurance for your home

  9. legal expenses

  10. tax preparation fees

  11. repairs to your rental property

    • The IRS is a stickler about repairs. If your cost is too high they might try to get you to depreciate the repair as a capital improvement.

  12. cleaning and maintenance
  13. utility costs

  14. rental equipment

  15. any educational materials or seminars you spend money on

I've been audited by the IRS twice in the past 16 years. Both times the first level auditor tried to adjust something to my detriment and both times I appealed to a second level auditor who overturned the first level audit finding. If you have your records organized it's not that bad.

You should also be aware that if you do not actively manage your properties, your tax deductions will be limited by your rental income. Even if you do manage the properties there is a $25,000 limit on real estate tax losses, unless you or your spouse is a full time investor.

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