Rental property taxes come with several rules and procedures that landlords must follow. The good news is that some of these, in the form of deductions, can be immensely beneficial.
Among the most advantageous deductions for landlords are rental property operating expenses. These are the ongoing, everyday expenses that landlords typically have, and they’re deductible for the year in which they’re incurred. Examples include repairs, maintenance management, advertising fees, utilities, etc.
Before you start deducting expenses, it’s important to know what is included in operating expenses for rental property. The IRS defines an operating expense using the following four criteria:
- Ordinary and necessary
- Directly related to your rental activity
- Reasonable amount
This article will go over the specifics of each of these criteria to determine what qualifies as an operating expense for taxes.
Ordinary and Necessary
The IRS doesn’t require that rental operating expenses be purely essential. They must be “appropriate” and “helpful” for your rental business.
Some common examples as listed in the IRS Schedule E are as follows:
- Advertising your units online or in papers
- Auto and travel
- Cleaning and maintenance
- Commissions paid to rental brokers
- Insurance (property and commercial general liability insurance, and a portion of automotive insurance if you use your car for your business)
- Legal and other professional fees (such as accounting fees)
- Management fees (for a hired person or property management software)
- Mortgage interest paid to banks or other financial institutions
- Other interest (such as interest on a credit card used for business)
This is more of a guide than a definitive list. As long as the expense serves a business purpose and isn’t absurd, it’ll most likely qualify.
A current expense is one whose contribution lasts less than a year. If it takes more than a year for the expense to be used up or become obsolete, it doesn’t qualify. For example, cleaning fees, maintenance, and isolated repairs count as current expenses because their benefits won’t be tangible after a year.
However, purchasing a piece of equipment to use on your rentals, such as a power washer or lawn mower, wouldn’t count as an operating expense because this expense is made to last you several years. This kind of expense is a capital expense and cannot be deducted as a rental operating expense.
Directly Related to Your Rental Activity
All expenses must relate directly to your business. Any expense made for personal use cannot be deducted.
For example, if you rent an office to conduct your rental business operations, you can deduct the price of rent for the office as an operating expense. But if you use the office for multiple businesses, and only half the time spent in the office goes toward your rental business, you can only deduct 50% of the price of rent.
It’s important to know that the IRS is stringent about how travel, food, and gifts qualify as deductions.
Although there’s technically no dollar amount limit, the IRS will reject claims that are too large. If you spend a lot of money on an expense when there’s a more economical way to get the same outcome, that would be considered an unreasonable amount.
In certain instances, the IRS does limit the specific amount you can deduct:
- Business meals (typically 50% deductible, but 100% deductible from restaurants from 2021 to 2022)
- Travel expenses (depends on how far the trip is and how much time was spent on business while gone)
- Business gifts ($25 maximum deduction per individual each year)
- The home office deduction (restricted to the profit from your business)
It’s also worth noting that the IRS looks out for deductions for unreasonably large salaries.
What Isn’t Deductible?
Beyond the restrictions highlighted above, there are other restrictions for what can be deducted. The following expenses do NOT qualify as rental operating expenses:
- Business-related entertainment expenses
- Fines and penalties for breaking a law
- Licensing fees
- Lobbying expenses and political contributions
- Federal income taxes paid on your rental income
Deductions for rental property operating expenses can save you a lot of money come tax season. With that being said, it’s essential to know how to navigate operating expenses and understand what qualifies and what doesn’t.