Top 10 Tax Write Offs for Rental Property: 2021 Deductions - Small Business Accounting & Finance Blog (2023)

Top tax write offs for rental property – let’s get into this.

Now, this post is focused purely on real estate. So we assume that you are either :

1. A current real estate investor, or
2. You are considering becoming a real estate investor.

By owning your own single-family property, or maybe getting to a real estate syndication and investing with a group of people.

So we personally love real estate. In fact, some of our team members are actually in a few real estate syndications and we have done taxes for hundreds of real estate investors.

Real estate can be a great way to build long-term wealth, earn additional income, and generate a tax shelter!

And because of that, in this post, we are going to break down the top tax write offs for rental property in 2021.

Keep reading!

Now before we get started, we just want to clarify that you may see us use tax deductions and tax write offs interchangeably in this post and others.

But, it’s basically the same thing. Tomat-o – toma-to, that’s it.

At the end of the day, what we’re trying to accomplish is to make sure that we are using all the legal ways to reduce our taxable income that we report to the IRS.

So when it comes to tax write offs for rental property, you need to know there is a difference between getting tax deductions as:

• an ACTIVE real estate investor, and
• a PASSIVE real estate investor

Because the IRS treats passive income and active income differently for tax purposes. Let’s dive a little deeper into this.

What is Passive Income From Real Estate?

In general, real estate investments are considered to be passive income because revenue is generated from the money you invested.

Usually how it works is, you go out and get a loan which you use your own money to put down a downpayment.

Then you use the loan money to get a rental property, and then that rental property pays you every month.

So basically, without money, you would likely not have the rental property, so it’s treated as passive EVEN if you actively are maintaining the property.

On the other hand, money that you trade your time for like a job is considered to be active income. So remember that because it’s all going to come full circle here soon.

What is Active Income From Real Estate?

So the IRS considers someone who works at least 750 hours per year in the real estate industry as an active real estate professional.

And we did the math, and 750 hours is about 20 weeks at 40 hours per week.

So basically, you need to work about half the year to be considered a real estate professional for tax purposes.

Also, if you are a full-time developer or a full-time real estate agent that is paid only on commission, then you are considered to qualify as a real estate professional.

So why is this important? Why would someone want to be active instead of passive?

Well, because these tax write offs for rental property that we’re going to share with you today have the potential to show a LOSS on your property allowing you to reduce your tax liability to zero.

And that is even if you had positive cash flow.

But here’s the catch.

Active vs Passive Income Tax Example

If you are getting passive income, then the passive loss you get from the tax write offs will only apply to your passive income.

For example, if you make $1000 of passive income and have a passive loss of $2000, then your net passive income will be zero.

And this is still great PLUS you can carry that passive loss into the next year.

However, if you are an active real estate professional then you can apply your active real estate income against your rental property loss.

So yes, real estate investors and professionals live the tax dream!

Now there is one exception though, which leads us to our first tax deduction for real estate investors.

Top 10 Tax Write Offs for Rental Property

Tax Write Off for Rental Property #1:Real estate by Income deduction

So, if you are making $100,0000 or less, you can write off up to $25,000 a year in passive rental real estate losses.

If your income is above $100,000, then the deductions go down by 50 cents for every dollar of income until it eventually phases out at the $150,000 income level.

And that’s enough to put you in a lower tax bracket, so it’s definitely huge tax savings there.

Tax Write Off for Rental Property #2: 1031 Exchange

Currently, the law allows investors to defer paying tax on real estate gains if they reinvest the proceeds of the property within 6 months of the sale.

So in theory, you can sell a real estate property at a gain, reinvest all the profits into a new home at a greater value, avoid paying any capital gains taxes…

…and when you die, pass the property onto your heirs, tax-free.

Now at the time of writing this post, there is a proposal coming out from the President to remove the 1031 exchange for people who have real estate profits of more than $500,000.

And, ensure the tax loophole will be closed by taxing capital gains on inherited assets as well.

So whether this proposal is approved or not is left to be seen.

But, if you want to learn about capital gains taxthen be sure to read our post about it.

Tax Write Off for Rental Property #3: Repairs

If you already know about this deduction then take a couple of minutes to read this.

In general, yes, you can write off things like fixing a garbage disposal, or patching holes in a wall.

But people often misclassify repair costs on their tax return which can be a serious red flag for the IRS if you ever go through an audit.

For example, if you buy a house for $100,000 and spend $30,000 to renovate the kitchen, you may not deduct the $30,000 that year.

That’s because the IRS will view that as a capital improvement- viewing that you bought that house at $130,000.

So a general rule of thumb, is that if you are paying a really high amount for a repair or maintenance, then make sure that it is not a capital improvement that improves the value of the house overall.

Because again, that can trigger an audit. Now, according to IRS publication 527, here are some things that should be capitalized:

• Bedroom additions
• Landscaping and sprinkler systems
• Storm windows
• New roofs
• Installed security systems
• Heating and A/C systems
• Water heaters
• Floorings
• Insulation

Tax Write Off for Rental Property #4: Legal Fees

We wanted to bring up legal fees early because one of the biggest reasons people hesitate with getting into real estate is the fear of the eviction process or someone suing them.

So if this is you, you should know that any legal fees that are associated with evictions, defending yourself, or even just writing up very strong lease agreements…

…all these expenses can be as a tax write off,

So at the very least, you can likely preserve your capital investment if you run into legal issues.

Tax Write Off for Rental Property #5: Depreciation

Now, most of our tax write offs require that you actively spend your money or cash flow from a property. But depreciation is different.

It’s one of the few deductions that can put you into a loss while keeping you in positive cash flow.

Usually, people think of their home as an investment that appreciates over time, but rental properties are more likely business assets, which depreciate over time.

And, most business assets eventually reach a point where the asset is no longer useful.

Because real estate investors need to continue to attract high-quality tenants and keep up with rental rates then they may need to improve certain aspects like the floors or paint, etc.

And because of that, you can take a depreciation deduction every year.

It’s important to note that you must have the property for at least a year to qualify for depreciation.

Now as a bonus tip, you need to know about depreciation recapture.

If you sell a property for more than the depreciated value, then the IRS may hand you a 25% recapture tax.

For example, if you bought a house for $100,000 and it appreciates to $150,000 then you may have to pay a 25% tax on that $50,000 gain.

Sometimes this tax can happen even if you don’t claim depreciation, so it’s best to take advantage of depreciation every single year that you can.

Tax Write Off for Rental Property #6: Mortgage Interest

Most people will have a loan that charges interest on their rental property.

And we’ve seen a lot of like real estate sheets analyzing cash flow, you should know that mortgage interest can be deducted 100% from rental income.

So basically, you are getting a loan for free as long as you put in a tenant who is able to pay you on time, every month.

Usually, around January or early February, you will get a form 1098 from your lender that shows exactly how much interest you paid.

You’ll just have to add that to Schedule E, which is for residential rental property owners.

Tax Write Off for Rental Property #7: Property Taxes

Now, this is one we have seen people frequently overlook when it comes to a deduction. We constantly have to remind people to give us their property tax payments for the last tax year.

And this tax write off actually applies to personal property, commercial property, and rental properties.

So this is one you need to remember to take every year of your own real estate.

Although, there is a limit on property tax deductions for personal use which is up to $10,000 if married filing jointly.

This limit does not apply to business activities like a rental property.

Tax Write Off for Rental Property #8: Wages for Employees and Independent Contractors

If you hire a property manager or a maintenance man, you can deduct their wages on your Schedule E. This would also apply to other independent contractors like:

• electricians
• lawn care company
• carpenters

Of course, if you are building a big real estate company, then you can deduct the wages of asset managers or real estate agents as well.

Tax Write Off for Rental Property #9: Home Office Deduction

If you have a space in your home where you conduct rental business (which we assume everyone does) then you definitely need to take the home office deduction.

Now we won’t dive too deep into this because we recently wrote a whole post dedicated to the home office deduction which you can read next.

The quick breakdown is to:

1. Calculate your office space square footage divided by the square footage of your entire house.

2. Use the prescribed rate multiplied by the allowable square footage used in the home. For 2020, the prescribed rate is $5 per square foot with a maximum of 300 square feet.

For example, if your home office measures 150 square feet, your deduction would be $750.

And remember, the space MUST be used for rental or other related business activities.

Tax Write Off for Rental Property #10: Capital Gains Exclusion

The last write off we want to touch on is the capital gains tax exclusion.

Some of you may know that the capital gain tax rate is going up for people that make more than 1 million dollars a year.

And this is like .03% of the population, so the capital gains exclusion will still apply to mostly everyone.

Basically, as long as you live in your house for 2 of the last 5 years, you can sell your primary residence up to $250,000 more (if you are single) than what you bought it for.

And if you are married, you can sell your primary residence up to $500,000 more than what you bought it for

Tax-free. That is, more specifically, capital gains tax free.

So if you’re one of those people who are into house hacking or house flipping yourself then this would be a great approach and strategy to build your wealth with real estate.

And if you need help with your real estate tax planning, then don’t hesitate to contact us today and let our tax experts help you.