The Ultimate Guide to Rental Property Tax Benefits

Investing in income properties is a great path to financial independence. It’s a form of passive income — after the initial legwork. First, you’ll need to do some research on the rental and real estate market in your area to find the right property at the right price and lock the best investment interest rate. Once you own the property, you’ll probably need to complete some renovations and put effort into finding the right tenant. But once you do, you’ll be earning rental income, with the added bonus that your property will appreciate over time.

Investment real estate has historically offered a good return on your investment, but the coronavirus pandemic has thrown a wrench into rental income. Mortgage interest rates are at an all-time low, but unemployment reached an all-time high in 2020. Many Americans are struggling, with states enacting eviction moratoriums that prevent landlords from evicting tenants who can’t pay rent because of COVID-19. This puts all the financial pressure on a real estate investor, who must continue to pay a mortgage, taxes and other related property expenses, with potentially no income from a tenant.

Some states, such as California, are calling for an extension of eviction moratoriums into 2021. If you own investment property and rely on rental income or vacation rental income as an Airbnb host, finding ways to recoup some of the lost income could bring you relief. With tax season approaching, knowing what tax benefits are available in the form of credits, deductions and write-offs could, at the very least, save you money on your upcoming tax bill.  

COVID-19 tax implications for rental property owners

The federal Tax Cuts and Jobs Act (TCJA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act ushers in some changes rental property owners can take advantage of. Here’s a closer look at what you can expect when filing 2020 rental property taxes.

Write-offs

There are no changes to the types of write-offs you can take on your rental properties. You can still deduct interest, property taxes and improvement expenses.

Depreciation

One of the biggest write-offs for property investors is depreciation. You can depreciate a commercial property over 39 years and a residential property over 27.5 years. If you’re a commercial property rental owner, you can now depreciate the property faster through a TCJA provision in the CARES Act. 

The provision allows owners to write off the entire cost of interior improvements made to a commercial building (QIP) in the year it was placed in service, as long as it was between 2018 and 2022. Some QIP include:

• Alarms/security systems
• Fire prevention systems
• Furniture

This could provide an added tax break for commercial property owners, but the provision has some limits. Interior structural work, square-foot expansion or adding or upgrading elevators or escalators are not qualified interior improvements. 

Passive activity loss (PAL)

If your rental property operated at a loss in 2020, a passive activity loss may be possible. PAL deductions are limited and complex — consult with a tax professional that specializes in real estate about your options. PAL is only available in excess of other passive income or if you sell the property. 

In other words, if you have other forms of passive income that are making a profit, such as additional rental properties, you may be able to take advantage of PAL. There’s a caveat — PAL isn’t an immediate option. You cannot deduct excess losses in the year they occurred. You’ll have to carry it forward as a net operating loss (NOL) in future returns. 

Changes to NOL

Even if you qualify for passive activity losses, the loss threshold is typically high. The excess loss you carry forward must be higher than $250,000 for a single filer or $500,000 for a married couple who files jointly. Fortunately, the CARES Act suspended the excess loss disallowance threshold for the tax years of 2018 to 2020. Smaller real estate investors with a single property or those who have losses less than the threshold can now carry them forward as an NOL. 

According to Sharon Winsmith of Winsmith Tax, “You may be able to deduct up to $25,000 of the excess losses if your modified adjusted gross income is $100,000 or less for the 2020 tax year. The deduction is subject to a phaseout if your modified adjusted gross income is above $100,000 and is not available for real estate owners who have income above $150,000.” 

In addition, you can now carry back an NOL for five years for the 2018 to 2020 tax years. Using this strategy, you may be able to get back some of the federal income tax you paid in previous years.

Winsmith warns property investors to be strategic regarding deductions, write-offs and losses. “The large depreciation deductions and other expenses associated with renting and maintaining the property reduce the rental income earned, but the net losses from rental properties may exclude property owners from being classified as active real estate professionals. If you have excess losses, you should reach out to a tax professional to see if you have other forms of passive income which could be offset by those losses.”

Tax benefits available for rental property owners

Some of the changes to write-offs and deductions through the CARES acts are complex. Consulting with a tax professional is your best bet to explore your options. However, there are other tax benefits that are simpler to understand and utilize. Whether you lease your property to a tenant or rent a room or vacation property as an Airbnb host, you have several tax deductions available. They include:

Mortgage interest

If you have a mortgage on the property you’re renting, a sizable amount of your monthly payment goes to interest charges. You can deduct the interest portion of your mortgage interest after calculating the amount found in past mortgage statements. Say you pay $1,233 per month, your statement will show the date the payment was received, $533 went towards your principal balance and $700 went to interest. You can write off the $700 in interest on your taxes.

Standard operating expenses

Expenses necessary to operate your rental business are typically tax-deductible. Some of the most common deductions include:

• Business license or other licensing and permit fees
• Hosting fees or commissions (Airbnb and vacation rentals)
• Insurance premiums
• Legal fees
• Maintenance and cleaning fees
• Marketing fees
• Office rental
• Office supplies
• Payroll
• Professional fees (accounting, realtor and property management)
• Repairs
• Travel fees to commute to properties
• Utilities paid by the owner

Real estate taxes

All states charge some form of real estate tax. You may even pay city and local taxes, as well. All the real estate taxes for your property are also tax-deductible. And if you host your home (or a room) as a vacation rental, the occupancy taxes you pay can also be exempt. 

Married business partners

If your rental property business is robust enough to support you and your spouse, it may be worth putting your spouse on the payroll. Winsmith explains, “It may surprise a lot of rental property owners to know that they or their spouse can actually make more money if one of them quits their regular job and fully manages the properties to qualify as an active real estate professional when the impact of taxes are taken into account across all sources of income.”

How to calculate your taxable rental income

One of the most important aspects of whether your rental property business will be in the red or the black depends on the rental income you charge and the associated tax liability. Here’s how you can calculate it:

1. Add up the rental income you receive (or plan on receiving) for a year.
2. Add up all the annual tax-deductible expenses you have. Refer to the list above for guidance.
3. Subtract the annual expenses from the annual rental income. You hopefully have a positive number.
4. Divide the cost of the property by 27 for residential and 39 for commercial to find the annual depreciation deduction you can take.
5. Subtract the amount from your profit (or loss) after expenses.
6. The total will be a rough estimate of your annual taxable income.

Based on the amount of taxable income, your 2020 filing year tax rate may vary as follows:

COVID-19 resources for rental property owners

In addition to tax write-offs and deductions, there are other resources available that could help you weather this unprecedented time.

Forbearance letter generator

You may be able to get some relief from your mortgage payments by requesting forbearance at this time. A forbearance pushes back your monthly payments. Most lenders are offering borrowers some form of forbearance. In most cases, you’ll need to write a hardship letter. You can use a template to generate a forbearance letter. 

National Multihousing Council (NMHC) 

The NMHC provides many resources for property owners. Some of the topics available in the knowledge base include COVID-related news and updates, rent trackers, webinars and tools useful when communicating with renters.

 SBA disaster assistance

The Small Business Administration provides disaster assistance loans that can be used for working capital and to pay for business-related expenses.

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