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Tax Treatment of US Rental Properties

By: Elite Legacy Education, December 15, 2016

Tax Treatment of US Rental Properties

If you’ve decided to become a landlord in the US, you will definitely want to know how this additional source of income is taxed. Assuming that you have invested in the physical property itself (rather than a REIT), here’s what you can expect:

 

Rental Income

Rental income is treated in the same manner as personal income when it comes to taxes. Of course, you will pay tax on your income after expenditures, just as a business would. This means that you will not be paying tax on the full amount of rental income you collect each month. Wondering what you can deduct as expenses? These are discussed next.

 

Deductible Expenses

Monthly Depreciation. Each month, you are allowed to deduct an amount equal to the depreciated value of the property you have purchased. However, this is the value of the home and not the land. So, it will not be equal to the total amount that you paid for the property. You will need to decide how much the house itself is worth in relation to the entire property value. Otherwise, you will be deducting much more than you should be. Once you’ve done that, you can depreciate this value over a timeline of 27.5 years. Essentially, you deduct a monthly amount equal to the total value of the home itself divided by 27.5 years.

Interest on Mortgage Payments. Unfortunately, you do not get to deduct the entire mortgage payment amount. Technically, if you were to deduct your entire mortgage payment then you would end up deducting more than the amount you paid for the property in the first place. That said, you will want to consider the interest payment portion of your monthly (or sometimes biweekly) mortgage payments. The amount of interest is what you can deduct from your monthly rental income. This is because interest is technically the fee you pay to service the loan that helped you buy the home in the first place. Thus, you can deduct the expense accordingly.

Property Taxes. You are allowed to deduct any real estate or property taxes as they come due. Sometimes these are part of your mortgage payments so be sure to check for that and deduct any appropriate amounts.

Maintenance and Property Management Expenses. Any repairs to the property and the cost of required materials can be deducted as an expense. Even if you hire a property management team, these additional costs are considered deductible expenses.

Utility Costs. Costs for electricity, water and other utilities can also be deducted from the rental income. Typically, a portion of the rental income is meant to cover these expenses so you can deduct this accordingly.

Home Insurance Fees. If your rental property is insured (which it should be), then you can deduct these monthly payments as well.

Travel Expenses. Any money spent on gas or public transit related to this rental property can be deducted. This would include any situations where you must travel to the property for viewings or to meet with tenants.

Home Office Deductions. In some cases, if you have a room in your home that is designated specifically for the management of yourrentals, then you may be able to deduct some portion of the costs.

 

Of course, you must be able to provide proof of these expenses so be sure to keep your receipts. As you can see, you can deduct almost any expense that is related to the upkeep of your rental property.

 

Selling the Property.

Once you decide to sell the property, you will be taxed on any capital gains, as well as any amount of the home value that has already depreciated. By deducting an amount for depreciation on a monthly basis, it essentially acts as a tax shield since you are deferring these tax payments until a later date. However, you can avoid being taxed when selling the property if the funds are immediately invested into another property. This is called a tax-free exchange.

The bottom line is that you should do your research and make sure to deduct all of the expenses that you can. Why not maximize your savings on taxes?

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