We outline everuthing your need to know about rental property expenses and how to track them so you can maximize your tax deductions for a more profitable real estate business.
Whilst many real estate investors excel in projecting a property's potential gross rental income they fall short when it comes to predicting the rental property expenses. Underestimating these expenses is a common pitfall new investors make and it’s a calculation that can seriously impact the success of a venture.
This article explores several methods real estate investors can use to predict rental property expenses, typical costs associated with property ownership, and how you can leverage these expenses to reduce your tax liability. Plus, we’ll explore the best tools and strategies for tracking rental property expenses.
When purchasing a rental property, you will typically get some insights into the previous owner's rental property expenses through the previous owner’s profit and loss statement. While this data can be used as an estimate expenses going forward, it’s still recommended that you undertake a thorough analysis of the property's operational expenses.
This will allow you to identify areas for cost reduction and assess potential maintenance expenses that could enhance the investment's value. It might also highlight areas of investment or maintenance the previous owner has avoided and allow you to predict potential larger one-off costs.
Below we outline four methods to calculate rental property expenses. It’s always advisable to get as much data as possible by employing multiple approaches.
The profit and loss statement (P&L) is a financial document that details a rental property's income, expenses, and overall profit or loss within a specified timeframe.
Even if you're new to the real estate business and own just one rental property, consider utilizing a free online financial management tool like Landlord Studio to monitor your rental finances and performance. This ensures you maintain accurate, up-to-date data and can draw real-time insights for informed decision-making.
When examining the P&L, focus on rental property expenses that lack clarity or are grouped together. Breaking down costs based on vendors or purposes will help in identifying areas where expenses can be reduced or where the current owner might have attempted to economize.
Explore the leading real estate investor websites and subscribe to real estate investor blogs, YouTube channels, and podcasts hosted on platforms like Landlord Studio or BiggerPockets. These resources serve as an entry point to grasp insights into the rental property industry from accomplished and thriving investors.
Despite the competitive nature of real estate investing, seasoned rental property owners often extend a helping hand to fellow investors. Networking with landlords enables you to gather wisdom from those with greater experience, steering clear of potentially expensive pitfalls while learning valuable lessons.
Property managers and real estate agents operating within your investment market possess in-depth knowledge about the genuine expenses tied to owning rental properties. Their existing collaborations with investors who own similar rental homes ensure a nuanced understanding of the costs involved.
Engaging in conversations with local property managers is especially important if you are investing from out of state or otherwise won’t be able to visit your property regularly.
There are numerous metrics that real estate investors use to analyze, monitor, and estimate the potential value of income-generating real estate. For example:
Using these real estate metrics for your existing rental properties can be done online at no cost.
The easiest and most accurate way is to create a free Landlord Studio account, input the property address and link your rental property bank accounts. Within minutes, you can reconcile up to two years of income and expense transactions and begin generating reports such as income statements, cash flow analyses, and capital expense reports.
Expenses incurred when marketing vacant properties and screening tenants are deductible. Platforms like Apartment Finder and Zillow facilitate property listings and you can easily collect, prescreen, and run comprehensive tenant screening reports on applications through the Landlord Studio app.
Commissions paid to agents for finding tenants or for lease renewals are common. The range varies from half a month to a full month's rent.
Property maintenance and repairs encompass a wide range of costs including landscaping, cleaning, pest control, repairs, painting, HVAC maintenance, and plumbing fixes.
While investors generally let their tenants typically cover these expenses in single-family homes owners of multifamily or short-term rentals may choose to cover the utilities themselves and then recoup the costs from the tenants through increased rents. These costs can be deducted.
Every state has property taxes, however, they are much higher in some places than others. Research the local and state laws to make sure you have an accurate estimate of the expected property taxes for a property. Property taxes are usually paid semi-annually or may be included in mortgage payments and can contribute to deductions.
Landlord insurance is generally legally required for your rental properties. It covers property damage and liability claims by tenants or guests.
The interest on your mortgage loan (not the loan principal) is a deductible expense and can make a huge difference when it comes to operating a profitable rental portfolio.
Professional fees are fully deductible. This category of expenses includes legal, accounting, and financial planning expenses.
Business permits, tax licenses, and LLC renewal fees are deductible expenses for property owners.
Homeowners association fees (HOA fees) can be fully deductible. However, special assessments for major improvements may not be.
Landlords can deduct travel expenses including mileage at the standard mileage rate, transport costs such as flights, and up to 50% of food and other necessary expenses for business trips. It’s important that all travel expenses are carefully recorded along with the purpose of travel as these deduction claims are often closely scrutinized by the IRS.
Most rental property investors qualify for the pass-through tax deduction, allowing a deduction of 20% of net rental income or 2.5% of the property's cost, depending on income level.
The IRS has published basic questions and answers on the 20% deduction for pass-through businesses that you can find here.
One of the biggest tax advantages for real estate investors is depreciation. The depreciation rules allow you to deduct the vale of the building (excluding the value of the land) over what the IRS deems its useful life. For residential rentals, this is 27.5 years, and for commercial and short-term rentals this is over 39 years.
On top of the depreciation of the property itself, you can also depreciate and upgrades that increase the property value. This can add up to a significant tax saving if done right. However, these need to be treated differently from regular deductible expenses. Whilst investors can claim these expenses back, they will need to depreciate the capital improvement over what the IRS deems it’s 'useful life’.
In some circumstances, it may also be beneficial to undergo a cost segregation study. This allows you to split out the value of non-permanent fixtures and depreciate them individually according to their useful life span. This is one way investors can maximize depreciation in the early years of owning a property which may help increase cashflow.
Cost segregations and depreciation schedules can quickly become complex and a cost segregation study may not be suitable for every situation. As such it is advisable to consult with a qualified financial advisor or CPA.
Not all rental property expenses can be deducted at the end of the year. While rental property owners can deduct numerous expenses related to managing and maintaining their properties, certain costs typically aren't deductible:
Here are key insights regarding tax reporting, record-keeping, and details on rental property deductions:
Even when managing just a single rental property, relying on manual tracking or spreadsheets for rental property expenses can lead to missed expenses and errors. The risk of overlooking eligible expenses or unintentionally duplicating entries heightens the chances of triggering an IRS audit.
The most accomplished investors use property accounting software like Landlord Studio to streamline their rental property finance management. With automated income and expense tracking, customized reporting, and a range of powerful financial reports you will have all the tools and data you need to make informed decisions, increase your ROI, and maximize tax deductions without drawing the attention of the IRS.