Landlords need to be knowledgeable about a range of topics: advertising, managing, law, finances, and more.
Taxes are an especially critical part of the job that many landlords feel unprepared to tackle. What are the most important things to know about rental taxes? Why should you learn about taxes?
By researching and understanding taxes, you can take advantage of tax deductions, which can save you hundreds of dollars each year. If you’re looking to maximize your rental income and profits, you must understand tax deductions.
Among the most common of these are rental property operating expenses. Operating expenses are the ongoing, everyday expenses required to keep your rentals functioning. These expenses are fully deductible from your taxable income.
So, what is included in operating expenses for rental property?
Let’s dive into rental tax basics and discuss a few examples of operating expenses you can deduct.
1. Repairs
Repairs are a classic example of an operating expense. For tax purposes, a repair is any upkeep that meets the criteria for an operating expense and restores your property to its original, working condition.
As a reminder, the criteria for an operating expense are:
- Ordinary and necessary
- Current (expires within one year)
- Rental-related
- Reasonable in amount
A repair that meets these four criteria may be deducted like all operating expenses. The important caution here is that the repair shouldn’t improve the property beyond its original state. If the repair adds value or otherwise improves the property, it is no longer a repair—it’s an improvement.
Improvements are depreciated instead of deducted, a key distinction all landlords should know.
An example of a repair would be replacing shingles on a roof that had been lost during a storm. The expense is an ordinary one for property owners, current (as shingles tend to need replacing occasionally), directly related to your rentals, and reasonable in amount. You aren’t replacing the entire roof, which would constitute an improvement. You’re only restoring the roof to its condition before the storm. Therefore, your shingle replacement is fully deductible as an operating expense.
2. Advertising Fees
Another example of an operating expense is advertising fees.
If you’re actively renting out your properties, you’ve probably listed them online to attract new tenants and fill your vacancies. Paid advertisement and marketing fees are deductible, once again, if they meet the four criteria for an operating expense.
Here’s an example: Let’s say you have two vacant units you’re looking to fill. You list them on Zillow and Apartments.com—and because you’re want the rental income as soon as possible, you decide to pay for priority positions on these sites.
Your fees are an ordinary expense and necessary to fill your units. They’re also current (you only want to pay the premium for a few weeks) and directly benefit your rental business. Finally, the fees you’re paying are reasonable and industry-standard, so you meet the final criterium as well.
Therefore, the cost to list your properties on a paid site, even while optional, is a deductible operating expense.
3. Insurance
As a landlord, you probably pay a premium for landlord insurance. Landlord insurance typically covers property damages, lost rent due to damage, and legal liability costs.
Insurance fees are one of the most common rental operating expenses. Almost all landlord insurance premiums are fully deductible, including those for fires, floods, theft, and liabilities.
You can also deduct homeowner’s insurance and a portion of your car insurance if you use your vehicle for rental activities.
4. Property Management Fees
Do you pay a resident manager, property management company, or software company for your management needs? If so, you can deduct the costs of these services as operating expenses, too.
Management fees easily meet all four criteria for an operating expense, and thus are always fully deductible. Unlike other deductions—such as travel, transportation, meal, or gift expenses—management fees are unlikely to be highly scrutinized by the IRS.
You can even deduct your property management software fees. This could be a monthly charge to access the software platform or one for access to specific features on the software.
Conclusion
Understanding operating expenses and their relationship to your taxes is crucial for your rental business. Without knowledge of the criteria or examples of operating expenses, you could land yourself with an IRS audit or simply miss out on many of the great deductions available to help you save money.