It's that time of year again! Small landlords across the country are preparing their income tax returns and filling out their Schedule Cs and Es. If you're in the same boat, here's a quick and dirty checklist of tax deductions for landlords you may be able to take. We're concentrating on deductions you can take in the current year, for the most part, or that will improve your cash flow in the next three or fewer years.
This is not an exhaustive list of tax deductions for landlords, and we're going to have to tackle some of these in greater detail in separate columns. However, these should get you started on digging out or reconstructing some records to hand over to your CPAs in time to file your returns.
Setting up a small business retirement plan: If you are operating a real estate business, or even if you have enough self-employment income to make it worthwhile, you can deduct any expenses incurred to set up an SEP IRA or a solo 401(k) for yourself—up to $500 per year for as many as 3 years.
Bookkeeping fees: Bear in mind you can deduct your investment property bookkeeping, not for personal bookkeeping.
Startup expenses for businesses: If your real estate activity qualifies as a business, you can deduct up to $5000 in the first year the expenses are incurred. You can deduct the remainder over the next 180 months, but the $5000 in accelerated deductions is designed to get businesses cash-flow positive that much sooner. List them as "startup costs" on your Schedule E.
Common startup expenses include signage, stationery, office supplies, office rent, office equipment rentals, starting up internet or phone service, insurance premiums (excluding title insurance), cost of recruiting and training employees, business permits and licenses, and lawyer and accountant fees (except fees paid to purchase an existing property).
Organization costs: Deduct costs to form a partnership, LLC, or corporation under IRC Section 248. You can deduct up to $5000 per year, and the rest over the first 180 months you are in business.
Attorney fees: For business only—personal attorney services are not deductible, so keep them separate.
Home office deduction: Available for those classified as a business, though not for those classified as investors. Adding this deduction makes mileage deductions much easier to qualify for.
Education and training: Deduct the costs of seminar and convention attendance; travel; and 50 percent of meals and entertainment expenses (for business owners, but not for passive investors).
Mileage: Deduct the mileage allowance from your home office to your property and back--every time you visit it. You can also deduct your mileage from your home office to business meetings with tenants, vendors, insurance agents, or real estate agents; the bank where you conduct your real estate banking transactions; the hardware store; the courthouse; travel to look at other rental properties for sale; etc. The standard mileage allowance for 2016 is 54 cents per mile, and it really adds up!
Deductible expenses you contracted for In 2016: Even if you didn't receive the goods or services or actually pay for them until 2017. If you use the accrual accounting method and paid with a credit card by year-end, you may be able to take the deduction in 2016 rather than 2017, even though you didn't pay off the credit card until this year. The same is true if you signed a contract for delivery prior to the end of the year but didn't take the delivery until the following year.
If it's a deductible expense, and you're on the accrual accounting method, you can take the tax deduction for the year in which you signed the contract, rather than the year in which you received the goods or services. For this reason, many businesses try to pre-pay things like attorney fees, accountant fees, office supplies, taxes, landscaping, consulting, and repair services immediately prior to year-end--to get the tax benefit now rather than having to wait until next year. Some restrictions apply.
Building components you replaced: Prior to 2014, if you replaced an entire component, you generally had to spread your deduction out over many years. A recent change to the tax rules allows landlords to take an immediate deduction for the value of building components that get replaced entirely, rather than having to continue to depreciate them over a period as long as 27.5 years from installation. (See Internal Revenue Bulletin 2013-43.)
De minimis safe harbor: Under IRS Regulation Section 1.263(a)-1(f), landlords can deduct a wide variety of low-cost personal property items used in their real estate enterprise--even if the item would normally be considered an improvement rather than a repair. In this context, the term 'personal property' refers to pretty much anything in the property that's not permanently attached to the dwelling. One common example: appliances. Most landlords can deduct such items, up to $2500 per item--up to a cap of 2 percent of the annual rental cost for the property. (While most other businesses could deduct similar expenses under Section 179, this section doesn't apply to 'personal property' rental residences.)
Cosmetic/curb appeal improvements: Sprucing up a home prior to renting? Painting the shutters? Mowing the lawn and generally making the place look pretty? That's usually deductible in the current year. Other examples include painting, fixing holes in the walls, power washing, and replacing damaged shingles or tiles. Deduct anything you spend on projects like this in the year in which the expenses were incurred. (See IRS Regs Sections 1.263(1)-3(j)(3).)
Money deducted From rent when a tenant performs a repair: Normally, this deduction is self-executing—if you don't list it as rental income in the first place, then you don't deduct against it.
Incidental materials and supplies: Keep a stash of lightbulbs on hand? Extra locks? Chlorine for the pool? These are incidental materials. Deduct them when you buy them, not when you use them. They qualify for 100 percent current year deductions.
Bonus depreciation: Even where you normally have to depreciate property over a number of years, you may be able to take "bonus depreciation" up to 50 percent of a new item's cost—in the first year you place it in service. This is true for tax years 2016 and 2017. If you're on the fence, you might want to pull the trigger on those expenses before year-end—because after January 1st, 2018, that allowable bonus depreciation is scheduled to fall to 40 percent, and then to 30 percent in 2019 (unless Congress intervenes).
You can take bonus depreciation on personal property only if it's new and has an expected useful life of less than 20 years. Bonus depreciation is not available for real estate property—only for personal property, though rules indicate that you can use it for depreciable land improvements like installing a hot tub or pool, landscaping, or paving a driveway. You can use bonus depreciation even after your de minimis safe harbor deductions are exhausted.
Accessibility expenses: Putting in a wheelchair ramp? Widening doorways to accommodate individuals with disabilities? You may qualify for up to $15,000 in current year deductions for making your property more accessible. Normally, you'd have to amortize these expenses over as long as 27.5 years, but that rule doesn't apply to accessibility projects. Anything above that gets added to the tax basis of the property and depreciated from there.
Green energy deductions: Have a property with four or more stories? You may qualify for up to $1.80 per square foot by upgrading interior lighting, your building envelope, or your HVAC and water heating systems. For details, see IRS Notice 2006-52. This break expired as of the end of December, but you can still claim the deduction for work that you did if it qualifies and meets the energy savings requirements. (For more information, see the Energy Tax Incentives Act.)
Software you own (buy a copy with a permanent license): It must be depreciated over 3 years. If you subscribe to a software service, you can deduct the entire subscription fee you pay each year.
Section 179 deductions: Yes, you read above that residential landlords can't use Section 179 for rental residences. However, there's an exception for landlords engaged primarily in short-term rentals, where the average tenant is staying 30 days or less. The rest of you, however, can use the Section 179 deduction for items not used within the dwellings, but within the office. This may be applied to things like office furniture and equipment, as well as computers and peripherals. The Section 179 deduction may also be used for cars and small trucks that you use within your business. The overall Section 179 deduction limit is $500,000 per year. Other limits apply as well, so work closely with your tax professional.
Mortgage interest & other loan interest: Deduct interest on credit cards used for goods and services that are used in the rental property itself, or to support the business. Note: Interest on late income tax is not deductible.
Reasonable compensation to employees' spouses and children (who may be in a lower tax bracket): In Eller v. Commissioner (1981), a landlord hired three children—ages 12, 11, and 7—to do minor tasks: Pool maintenance, yard work, delivering messages to tenants, answering phones, reading meters, and cleaning parking lots. He paid them a total of $17,800. The IRS challenged the arrangement, but the court allowed it, since the services the children were performing were essential services. However, the judge ruled that paying all three children the same wage was not reasonable, since the 7-year-old was not capable of doing the same work as the older children. Check with your state's laws regarding child labor before going overboard with this technique.
Gifts: Deduct up to $25 per tenant, vendor, or employee per year.
Bad debts: This excludes unpaid rent, which falls under different rules.
Advertising & marketing expenses: This includes printing and direct mail costs.
Insurance premiums: Many insurance policies you hold qualify for deductions. See the list below:
Tenant and employee background checks
Property management fees
Contributions to a 401(k) or SEP plan
Business credit card fees
AllPropertyManagement.com does not provide tax advice. The information in this column is for general information purposes only and is not intended to constitute individual tax advice. For information pertaining to your specific situation, you seek the services of a qualified tax professional.