I’m a landlord, so I can vouch that there are certain tax advantages to investment property. But it can be a bit complicated. Here’s one question that isn’t as straightforward as it sounds: Is investment property tax deductible?
You can’t write off the purchase price of your property on next year’s taxes. What you can do is depreciate the costs of the property over a span of 27.5 years, so that’s why I say the question of whether investment property is tax deductible isn’t a simple yes/no question.
Depreciating investment property over 27.5 years
Tax laws permit you to deduct 1/27.5 of the purchase cost of the property on your taxes. So while it’s not a straight tax deduction, you do get a deduction from owning the property. That means if you buy a house for $100,000, you can write off $3,636 for the next 27 years, and I guess $1,818 the last year. I can’t speak from experience on how they handle that last half-year, as I haven’t owned any investment property for 27.5 years yet.
If you follow the one-percent rule, that means you’re charging $1,000 a month for rent, and therefore collecting $12,000 in income. The depreciation comes very close to covering your self-employment tax. Theoretically, the self-employment tax works out to about 30 percent, which would be $3,600.
But since it’s depreciation, there’s a catch that other deductions don’t get. So that’s why I say it almost offsets self employment tax in spite of the $36 profit. Sometimes a $36 profit isn’t a $36 profit.
Depreciation = trading one kind of tax for another
The catch when you depreciate a property is that, for tax purposes, if you ever go to sell the property, you owe capital gains taxes on whatever depreciation you’ve taken. So if you buy a property for $100,000, hold it for 27.5 years, then sell it, you owe capital gains taxes on the entirety of the sale price. This tends to be 15 or 20 percent, so it’s lower than self employment tax, but when real estate books call landlording rent-free income, they’re oversimplifying it.
A landlord can reset the clock by selling a property, then using the proceeds to buy another property within 12 months. The books make it sound like that’s as easy as buying a box of cereal. It’s not. It works best if you know other landlords, they have properties on a depreciation schedule similar to yours, and the property values are very similar. Then you can sell the properties to each other and honor each other’s leases. That’s the ideal situation. I know from experience that tenants tend to get spooked when their landlords sell and they leave.
Certain huckster authors definitely exaggerate the tax advantages of real estate. And the tax advantage often has a hidden cost when you go to cash it in. It’s something to keep in mind. Your tax deductible investment property can turn into a bit of a liability if you’re not careful.
Deducting repairs related to investment property
There’s another complication when it comes to tax deductions for repairs or improvements on investment property. Maintaining the property is a business expense, so it’s deductible, right? Repairs are, but when something crosses a certain dollar threshold, it becomes an improvement. Improvements go on the depreciation schedule.
You’ll need to discuss the threshold with a CPA, as I’m not a tax professional. I simply tell him what I spend on my property each year and what it was for, and he figures out what goes where. When I replace an air conditioner or a furnace, it falls in the improvement category, not the repair category. The same goes for other major expenses like replacing a roof, a hot water heater, a plumbing stack, or electrical box. Replacing the garbage disposal, microwave, or even the dishwasher generally falls into the repair category.
Needless to say, if you’re going to get into real estate, don’t do your own taxes. You’re going to need a CPA’s help to do it right.
Hidden tax deductions related to investment property
There are some deductions related to investment property that are easy to forget. When you drive to the hardware store to get supplies to do a repair, it’s not just the supplies that are deductible. Your mileage to the hardware store, to the rental property, and back home is deductible. Be sure to keep written record of that mileage, including the date and purpose of the trip, start mileage and end mileage. Any other trip related to your property management also is deductible. That means trips to the realtor’s office, to your property manager’s office, any trips to your properties, and any trips related to properties you’re considering buying.
How big of a difference it makes is an open question, but you don’t want to forget it. Some years I forget just how many trips I made to my vacant property, and how many miles I racked up driving there to get it ready.
So is investment property tax deductible?
That’s why I say it’s complicated when someone asks me if investment property is tax deductible. It’s not like writing off the annual fees related to my certifications for my day job. I’ll be writing off part of the roof I bought last year for the next two decades, for example.
I’m not complaining, and I’m not saying other people shouldn’t get into real estate. I am saying it may be a bit more complicated than the books you’ve read have suggested. And you’ll definitely need a CPA. My CPA has me fairly well trained at this point, but for many years, he was finding deductions I never would have thought of on my own. Some years I come close to getting it right on my own, but he’s there to catch it when the rules change. Which they do sometimes.