Rental income comprises all the payments you receive from other people occupying your property. As the owner, you’re responsible for the federal taxes on that income.
However, you’re also entitled to some deductions to lower your tax responsibility. Ideally, you have to report your tax returns, and expenses can be deducted from the income.
Rental property is considered an investment in real estate, attracting tax deductions by balancing profits and losses. For example, consider the gross income when calculating the taxes payable and then subtract all the deductibles, such as expenses. You can then determine the taxes owed from the profits.
Obviously, who doesn’t want to pay lower taxes? The thing is that it’s possible so long as you follow legitimate protocols.
With that said, here are four ways rental property owners can lower their taxes.
1. Depreciate The Property
As the rental property owner, you can depreciate it by claiming that a part of the property is a tax-deductible expense for a given period. Making a depreciation claim significantly cuts the taxes you owe each year.
You’ll first have to determine the cost basis to depreciate the rental property. Start by learning the original cost of the property and then including the cost of all the improvements and renovations made.
After that, you’ll have to calculate the depreciation you intend to claim. The Internal Revenue Service (IRS) permits rental property owners to depreciate their property for a given period. For example, it can go up to 27.5 years for residential properties and 39 for commercial ones.
To calculate the depreciation, divide the property’s cost basis by the years in the depreciation period. Then, you can file your depreciation claim during tax returns by filling out Form 4562 and attaching the tax returns.
Just note that depreciating the property can impact your basis in the property, especially if you decide to sell it in the future. It’s because the calculation of capital gains tax would be affected. Therefore, ensure that you consult a tax expert first before making any changes to your property taxes.
2. Deduct Mortgage Interest
You can reduce your taxable income on a rental property by deducting the interest paid on the mortgage. This is because the interest can be considered a rental expense.
To claim a mortgage interest deduction, first, determine the eligible mortgage interest by considering the loan taken to buy or make improvements to your property.
Once you have that down, calculate the deduction. Consider only the interest amount paid during a specific tax year. You can request your mortgage lender to provide you with the statement to check this amount.
The final step is to claim the deduction. Fill out Schedule E and attach the tax returns.
While mortgage interest deduction can help cut your tax liability, there’s a limit on how low it can go. Speak to a tax professional about limit regulations on mortgage interest deductions, as some of these can get complex depending on where you live.
3. Claim Expenses Deduction
Another way that you can lower taxes on your rental property is by claiming an expense deduction. These can be used to counterbalance the rental income from the property, thus reducing your taxable income.
Some valid deductible expenses include:
- Advertising and marketing costs
- Repairs and renovations
- Cleaning and maintenance costs
- Insurance costs
- Property management costs
- Legal and professional fees incurred from the property
- Utility charges and other services for the property
When creating a list of the expenses incurred in a property, you must ensure that they’re reasonable and necessary to its operations. In addition, the costs must be directly incurred to be considered deductible. If you’re renovating, ensure that you save all the receipts from the expenses to provide an accurate representation.
4. Claim Insurance Premium Deduction
If you have an insurance premium on your rental property, you can tag it as an expense when claiming tax deductions. Ideally, a rental property owner must have insurance coverage that protects their investment. Therefore, the premium can be classified as an ordinary and necessary expense.
Deducting an insurance premium is simple. For example, if your rental income is USD$9,000 and you have an insurance premium worth USD$1,000, the calculations for taxable income would subtract the cost of insurance premiums to end up with USD$8,000.
Lower Your Payments The Smart Way
As a rental property owner, you can significantly lower your taxes by claiming several deductions. However, you must be ready to prove that the deductions are reasonable, necessary, and directly related to the rental property. So, having impeccable records of all expenses and claimed deductibles is crucial. It’d also help to hire a tax expert to handle your taxes and advise on all the deductibles.