Rental Expenses

Being a landlord is much more complex than buying a property and renting it to tenants. Many landlords and real estate investors underestimate their rental property expenses and fail to record them properly, which takes away from both your profit and your tax deductions. It’s important to set aside money in your budget for both expected and unexpected rental expenses. Here, we’ll take some time to discuss some expenses to look out for and how they play into your rental income taxes.

What is a Rental Expense?

According to the IRS, rental expenses are classified as any expenses spent on your for-profit rental business—such as utilities, transportation, maintenance, and more. By keeping detailed records of your rental expenses, they can become significant tax deductions for you. Reporting these expenses will reduce the amount of your rental income that’s taxed later, which means more money in your wallet.

The IRS classifies types of deductions differently, so it’s important to understand these differences before you report them.

Kinds of Rental Expenses

Operating Expenses

Operating expenses are associated with the ongoing, day-to-day expenses that all landlords have for their rental properties. Most of your expenses will qualify as rental property operating expenses—which are fully deductible the year that they are incurred.

For your operating expenses to be deductible, they need to be all of the following:

• Ordinary and necessary – Operating expenses must be typical property-related expenses that helps your rental business in some way.
• e.g., Insurance, supplies, advertising, etc.
• Current – Operating expenses must benefit your business for less than a year (they become used up, obsolete, etc. within a year).
• e.g., Isolated roof repairs, preventative maintenance, etc.
• Directly related to rental activity – They cannot be something bought for personal use.
• e.g., Car for business-use only, etc.
• Reasonable in amount – Most expenses are reasonable unless there is a significantly cheaper way to receive the same result.
• e.g., Unnecessarily expensive services, etc.

Operating expenses include the following:

• Advertising & marketing – Online listing syndication sites, paid advertisements, etc.
• Tenant screening services – Credit, criminal, and eviction checks, etc.
• Property taxes – Taxes paid for your rental property
• Insurance – Premiums paid for landlord insurance
• Utilities – If tenants cover some of their utilities, you can only deduct what you pay for
• Property management fees – Staff members, accountants, property managers, etc.
• Repairs & maintenance – Pest control, landscaping, snow removal, etc. Anything classified as improvements to the property does not count
• Homeowners Association dues – Any dues required for your property’s HOA membership
• Travel expenses – Business car, gas, etc.
• Tenant turnover costs – Cleaning, new keys, etc.

Start-Up Expenses

Start-up expenses are incurred before your units are ready to rent (up to $5,000 in the first year you’re in business, then what’s left in equal installments for the following 15 years). They aren’t deducted like operating expenses, but they do need to meet the same criteria—ordinary and necessary, current, rental-related, and reasonable in amount. Additionally, to qualify for start-up expense deductions, your rental activities must first be classified as a business.

Some examples of start-up expenses include:

• Office supplies
• Minor repairs
• Employee search and training
• License and permit fees
• Insurance premiums
• Website-building costs
• Advertising

Start-up expenses are NOT:

• Improvements
• Travel expenses
• Interest and taxes
• Real property
• Research and experimental costs
• A mortgage payment

Capital Expenses

Capital expenses, sometimes confused with operating expenses, are long-term investments made to improve/increase the value of a rental property. Some landlords may confuse repairs (which are operating expenses) with improvements and renovations, which are capital expenditures. It’s important to note that repairs, such as fixing a leak, are necessary to the property’s functionality, whereas improvements, such as updating appliances, are not.

Capital expenses do not qualify for same-year deduction, but they do depreciate, which means you can deduct a portion of the cost each year as its value and lifespan decrease. For property to qualify for depreciation, it must:

• Be property you own
• Be used in your business
• Have a determinable useful life
• Be expected to last more than one year

Pass-Through Tax Deductions

Pass-through tax deductions allow you to deduct up to 20% of your net rental income from income tax, which effectively lowers your income tax rate on this income by 20%. To qualify for pass-through tax deductions, you must:

• Be qualified as a business, not an investment or a non-profit
• Be a self-rental (meaning the taxpayer rents the property to their business)
• Meet the requirements of the safe harbor
• Have a qualified business income (QBI)

The majority of landlords running a rental business for profit will qualify for pass-through tax deductions, but if you’re unsure, make sure to do further research, or to reach out to a tax professional.

How to Report Rental Expenses

In order to take full advantage of these deductions, you’ll need to have very organized and thorough documentation of your rental expenses. When it comes time to file your taxes, you’ll need to fill out a Schedule E form with all your income and expenses accrued through your rental business.

The Schedule E form is broken down into 15 expense categories, such as advertising, insurance, etc. You’ll need to report your passive income (income made from your rental business), as well as your rental expenses listed above, to receive the lowest possible taxable rental income. The more meticulous you are about your documentation, the lower your taxable rental income—meaning you get to keep more of it.

Managing it All

Managing rental expenses may not be as easy as it seems, but that by no means makes it impossible. You may be wondering how you can keep your head straight while managing all these expenses and deductibles. Luckily, you do have options that can help estimate rental property expenses.

Some landlords use a rental property expenses spreadsheet to help them stay on top of their expenses. These spreadsheets allow you to list each property, its income, and all of its associated expenses in one place. This way, you can keep a close eye on your profit, as well as any potential trends. You can find many beginner templates available online.

Another great option is rental property accounting software. With these platforms, you can track similar data, except your information will be in secure cloud-based software that you can access from anywhere. Many accounting software platforms, like LedgRE, are highly customizable, allowing you to track your income, expenses, and cash flow for your rental property business in a way that makes sense to you.

Conclusion

With so many moving parts, staying organized is key to your success as a landlord. There are many expenses you can plan for, but when in doubt, it’s best to have savings for some worst-case scenarios as well. We hope that you have a better idea of what some typical rental property expenses are and that you feel better prepared to take them on.