Debt, taxes, laundry, the dishes — these are things we all have to deal with at some point, whether we want to or not. Tackling the laundry or dishes is a pretty straightforward task that can be quickly started and completed with minimal repercussions or meaning.
But managing taxes and debt? Well, that’s downright confusing.
You’ve got good debt and bad debt, tax deductions and taxable income. Boxes to check and line sums to add up. Individual tax reports are complicated enough, but as a landlord, you have to factor in additional components, like rental income.
Navigating the IRS and tax responsibility portion of your rental property doesn’t have to be difficult. It all starts by knowing a few basic details related to debt, along with some qualifying intel about rental property tax deductions. If you’re already well-versed with good and bad debt, skip ahead to the “nine ways to offset bad debt with rental property tax deduction” section of this post.
For real estate investors or property owners, bad debt is best summarized as “the amount of unpaid rental income that is determined to be uncollectible. The term bad debt is often referred to or used interchangeably with ‘credit loss’ or ‘collection loss.’”
Bad debt often occurs when:
External factors (such as loss of rent) prevent you from making payments on debts.
Additional sums of money are needed to finance and pay off your current debts (i.e., using a loan to pay off another loan).
Real estate investments that depreciate unexpectedly and permanently.
For instance, here are some examples of bad debt:
Unnecessary renovations — Say you took out a line of credit or borrowed money for a superfluous or extravagant cosmetic construction project.
Uncollectible rental income or loss of rent — Unfortunately, you can’t deduct uncollected rent from your taxes. You’re still on the hook for paying your debts, regardless of whether or not your renters paid you.
Relative to real estate investing, good debt generates income — “the ideal debt will finance a good or service that will enable you to: refund the amount borrowed (the asset acquired must therefore retain value), pay back the interest on the debt (it must also generate income), generate an income that will enable you to become wealthier (otherwise the operation would be neutral).”
Examples of good debt for landlords might look like:
Consumer loan for your business — For real estate investors, the key to a “good deb” consumer loan is ensuring that the monetary return is higher than the interest rate.
Real estate investment credit — According to Florian Monkham of the Forbes Biz Council, “real estate, on average, tends to increase in value over the long term. Whether the property is owned directly or via an SCPI, a private investment company, it can be a win-win situation if the net rents offset the loan rate. The leverage effect, which consists of developing your assets thanks to borrowed money without a personal contribution, then comes into full play and allows the capital to grow. It is a matter of budgetary balance: you must calibrate the financing so that refunding the loan remains bearable and doesn’t overstress you. You must never sacrifice your leeway. In this case, consumer credit can be considered good debt.”
As a rental property owner and manager, you should be aware of your rights and your responsibilities related to rental income. You’re legally responsible for paying taxes on your rental income, but that doesn’t mean you have to shoulder the entire financial burden — that’s where tax deductions come into play.
Rental tax deductions are only part of the solution to a much larger problem for today’s landlords.
From shelter-in-place requirements to mask mandates and loss of rent, we’re all vaguely familiar with the various degrees to which the pandemic has touched our lives — and bad debt is only the tip of the iceberg. When used properly, tax deductions are powerful tools and especially advantageous to real estate investors or property owners with bad debt.
Let’s dive into rental property tax deductions.
Utilities — Believe it or not, paying for utilities at your rental property (on behalf of the renter) qualifies as a tax deduction. Think water, electricity, gas, and trash or snow removal. And no, if you shovel your property’s sidewalk, that does not mean you can pay yourself out and write it off simultaneously.
Basic repairs and operational expenses — Basic repairs and operational expenses are sort of similar to utilities. According to the IRS, you can “deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities, and insurance. You can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep your property in good operating condition.”
Tenant screening — If you front money for tenant screening, be it a background check or anything else of the sort, you can deduct it from your taxes.
Mortgage interest — This only applies to rental properties with mortgage insurance on FHA or conventional loans.
Property tax — Property taxes: You either don’t care for them, or you hate them. But did you know that you can deduct property tax from your rental property income? Pretty exciting stuff.
Depreciation — This is an important one to know because it’s connected (albeit tangentially) to home improvement. Per the IRS website, “You may not deduct the cost of improvements. A rental property is improved only if the amounts paid are for a betterment or restoration or adaptation to a new or different use. See the Tangible Property Regulations - Frequently Asked Questions for more information about improvements. The cost of improvements is recovered through depreciation. You can recover some or all of your improvements by using Form 4562 to report depreciation beginning in the year your rental property is first placed in service, and beginning in any year you make an improvement or add furnishings. Only a percentage of these expenses are deductible in the year they are incurred.”
Property management, marketing, accounting, or legal fees — Property management fees and accounting and legal fees can be written off since they typically contribute to the overall functionality of your property. Marketing and advertising can be a little murky, so double-check with an accountant to see if you qualify. Alternatively, you could look to social media to do things both cheaply and effectively.
Home office or HQ — Writing off expenses for your home office or HQ is a bit tricky. If your office is based out of your home, you’ll need to be a registered business owner to write it off. And unfortunately, if you don’t have a designated space for your office (inside your home), then you leave yourself pretty vulnerable to the IRS auditing you.
Transportation expenses — Transportation expenses are a bit of a grey area for rental property tax deduction. We wouldn’t recommend leaning too heavily on this expense, but it’s something to consider.
Accountant — Tempting as it might be to file your taxes, we strongly recommend working with a licensed professional who has experience dealing with real estate investments. A good accountant goes a long way. They’ll be able to tell you what’s truly a deductible expense and what’s not.
Investment or financial consultant — You may want to work with a financial consultant if you’re planning on making a sizeable first-time purchase or looking to expand your current portfolio with another investment property.
You — Naturally, you’re a crucial player in this adventure! You’re the person with the properties in hand. Or you will be if you’re making a first-time purchase.
Records — When it comes to the IRS, you have-to-must-need-to back up all claims you make about tax deductions. You’ll want to keep a record of anything and everything related to expenses, utilities, property management fees, and more. It couldn’t hurt to employ a property management system to help keep you organized with renter-related repairs or whatnot.
IRS — Speaking of the IRS, the organization has a wealth of information on the core website. It couldn’t hurt to take a look and do a little light research for yourself.
Having bad debt doesn’t make you a bad business owner. And while debt certainly isn’t ideal or desirable, it’s sometimes par for the course when learning the ins and outs of rental property management — but that doesn’t mean it should be a mainstay in your business plan either. The key is knowing how to overcome bad debt.
Unfortunately, sometimes, life has other plans. For real estate owners, large and small, present-day events, like the pandemic and eviction moratorium, have wreaked havoc on financial business health. Rental tax deductions play a small part in the larger strategy for real estate owners — so what’s a property owner to do now that the eviction moratorium’s lifted? Learn more about what the end of the eviction moratorium means for property owners, and how to take action (without alienating your renters).