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Rental Accounting

A Breakdown of your Schedule E Expense Categories

If you own real estate as an investment you will need to report your income for each individual investment property at the end of the tax year. You will likely do this on a Schedule E form, which is part of the IRS form 1040 that deals with supplemental income and losses.

While the Schedule E is also used for other passive income such as royalties. In this article, we are going to take a look at the Schedule E from a real estate investors point of view and what each of the Schedule E categories mean.

To make filing your Schedule E as easy as possible, Landlord Studio has created default expense categories that align with the Schedule E form as well as creating a Schedule E report. This allows you to instantly generate a report with all the data entered over the tax year and simply copy across the information when filing your end of year taxes.

IRS Schedule E Form 1040
schedule e form 2020
Landlord Studio’s Schedule E Report
schedule e landlord studio

Part 1 of the Schedule E form

– calculating your total taxable income for your rentals

Part 1 of the Schedule E form is where you figure out the taxable profit (or loss) from your rental business for that year.

In the top section fill out the property detail information, including address, type of property, and how many days it was rented over the period and how many days it was used for personal use.

There is also a box that you can tick labelled “QJV”, which stands for qualified joint venture. This is a special status box for those people that own the investment property(s) jointly with a spouse. You cannot check the box if you this a joint venture with anyone other than your spouse.

Next you will list the total rental income for the period following by your expenses broken down by category.

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A Breakdown of the Schedule E Expense Categories

There are 15 expense categories on the Schedule E form. Some of these are fairly self-explanatory such as advertising expenses. However, others require a little more explanation. Below we go through each of the categories to make sure you’re using them correctly.

Advertising

When searching for new tenants you will likely need to take actions to market your property. Any out of pocket expenses for the purpose of advertising your property are deductible business expenses. These expenses include things like newspaper ads, yard signs, online listing costs, online ads, website expenses etc.

Auto and travel

Travel can make up a large deductible expense as you will likely need to travel between properties for business purposes – such as routine inspections or showing a listing. Auto and travel expenses include things like vehicle mileage (the Internal Revenue Service allows a deduction of $0.575 per mile in 2020), airfare, and half of the meals you purchase while traveling.

If your rental properties are local, this isn’t likely to be a major expense, but if you own faraway vacation rentals, it could add up to a substantial deduction.

If you do deduct any travel expenses make sure to keep careful records, such as a mileage log, with the details and purpose of the travel as the IRS often chooses to closely scrutinize this expense, especially if it’s substantial.

Cleaning and maintenance

Cleaning and any routine maintenance costs that you pay for on your rental property can be deducted. Examples of expenses that fit within this category include gardening or lawn care, pest control, snow removal, pressure washing of the building exterior etc. This includes the cost of labor as well as any supplies that were necessarily bought for this purpose.

Commissions

Commissions are generally considered a business expense. As such they are normally deductible. If at any point in time you pay a commission to someone this can be expensed here. This might include a commission for someone to find you a tenant to fill a vacancy for example.

However, this does not include any commissions you might have paid to a real estate agent when buying a property.

Insurance

Maintaining an insurance policy on your rental property is just good business. As such there are very few real estate investors that don’t have at least one policy per property. You may also have additional insurance policies for things like flood protection if the property is in a flood zone.

Regardless of the type or number of policies you have, insurance premiums are deductible as a rental property business expense.

Legal and other professional fees

Legal and professional fees aren’t just for worst case scenarios such as managing an eviction. There are various other more standard reasons you might employ a lawyer or professional service to help deal with your investment property. A few examples include, hiring a lawyer to oversee paperwork such as new lease documents, any fees you might have paid to get your taxes prepared, your CPA costs, and if you use a property management software like Landlord Studio, these fees can be deducted here too.

These are all considered operating expenses, and should be deducted as such. You cannot, however, deduct legal fees used to defend the title of your property or recover and improve property.

Management fees

Property management fees are generally between 8%-12% of your monthly rent income. Thankfully, if you do hire a property management service, their fees are generally deductible.

Mortgage interest

Leveraging through loans to invest in property is a tried and tested way to build wealth through real estate. The mortgage that you take out will likely make up a large expenditure for your business.

For investment properties any investment property owner can use their mortgage interest as a business expense on IRS Schedule E.

It’s important to note it is only the interest which is deductible, not the actual mortgage payment itself. So, when recording your expenses it’s a good idea to track the interest separately.

Other interest

You can also deduct the interest from other loans. This includes interest on credit cards as well. As long as the expenses were incurred in actions taken to make improvements or repairs to the property.

Additionally, you can deduct interest from loans from non-bank lenders. Generally speaking, if you have interest on a loan but don’t receive a Form 1098 mortgage interest statement you can report this interest as a deductible expense under this category.

Repairs

The cost of making repairs to a property is deductible under this section. Examples of repairs might be repairing broken plumbing, fixing a broken cupboard door,  etc.

 

It’s important to note that you can’t deduct the cost of any improvements made to the property. Improvements might be anything from a loft conversion or new conservatory, to replacing (rather than repairing) kitchen appliances, etc. Instead, capital improvements need to be added to your cost basis and depreciated.

There are some grey areas when it comes to determining what is a repair and what is an improvement so it’s worth discussing this with your CPA to make sure you categorize these expenses properly.

A good rule of thumb is that a repair is necessary to keep the property in good working order but doesn’t really increase its market value, while a capital improvement is a modification that adds significantly to the fair market value of the property.

It’s also worth pointing out that all deductible rental property expenses (repairs and otherwise) must be ordinary and necessary. If you needed to spend $100 to repair the tap on the kitchen sink but instead you spend $500 replacing the sink it might not qualify as a deductible expense.

Supplies

This is a pretty broad category. It normally refers to any office equipment you might have purchased to help you manage your property or any other supplies that are to be used exclusively for your rental properties.

An example of this could be notepads, or if you self-manage you might purchase a toolset for use in the properties maintenance.

Taxes

Any property taxes that you might pay to your local government can be recorded under this section of the Schedule E form as a deductible expense. You can also deduct any taxes or fees associated with being allowed to rent out the property, such as local licencing fees or occupancy taxes.

Utilities

All landlords handle utilities differently. Some will pass the expenses on to their tenants, some will simply have their tenants set up their own connections or move the bills into their name when they move in. However, if you choose to cover things like gas electric, water, heating, AC, or internet for your tenants you can deduct these as utility expenses.

If your tenant agrees to reimburse you at a later date you can continue to file it as a deduction, but you would need to then record the reimbursement as income.

Depreciation expense or depletion

Properties (not the land itself) are seen as assets with a value that reduces over the period of your ownership due to wear and tear. As such they can be depreciated over 27.5 years and deducted against your taxes.

You can start claiming depreciation as soon as your property is ready for rent – this generally means when you start advertising for your tenants. It is important to make sure you claim the maximum amount of depreciation you are entitled to because the IRS will reclaim some of the depreciated value through a process called depreciation recapture when you eventually sell the property.

You can also depreciate the value of equipment used in the management of the property or improvements made to the property.

Other (list)

If there are any further expenses you have that are related to the owning, maintaining or management of the property you can list them under the Other section.

If you aren’t 100% sure something is deductible, it’s wise to seek help from a qualified tax professional.

IRS tax filing

Final Words

Schedule E is part of Form 1040. It is used to report the income and loss of supplemental income sources. This is income not earned through active business activity such as your regular employment.

Supplemental income is considered passive income, such as collecting rent. Of course, as a landlord, you know that rental income is anything but passive. However, passive is how the IRS sees it.

To ensure you file an accurate tax return at the end of the year and maximize your potential deductions whilst remaining above any scrutiny from the IRS, you need to ensure you keep meticulous records of your income and expenses alongside any documents of proof. This is where Landlord Studio comes in.

Easily track income and expenses on any device at any time, generate professional reports instantly, quickly and easily digitize receipts, and store documents on our secure cloud server.

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Ben Luxon

Ben is an author and real estate enthusiast. His interest in all things entrepreneurial has led him to work with real estate professionals all over the world, distilling their knowledge into articles and Ebooks.

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