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Common Rental Property Expenses & Which Ones Are Deductible

by Jeff Rohde, posted in Investment Strategy

Most real estate investors do a pretty good job of estimating the gross rental income a property can generate. Where many people make their mistake is my underestimating the true cost of owning and operating an investment property. 

In this article, we’ll explain how to accurately determine rental property expenses, list the common expenses of owning a rental property, and look at one of the best ways to track rental property expenses online for free.

 

How to Determine Rental Property Expenses

If you’re buying a rental property from an online marketplace such as Roofstock, you already have an accurate idea of what the rental property expenses were for the previous owner. 

But even with the seller’s profit and loss statement in hand, you should still analyze the property’s operating expenses. Look for costs that can be cut or potential maintenance expenses you may want to add to help increase the value of your investment.

Here are four ways you can accurately determine rental property expenses. It’s always a good idea to use more than one method to estimate expenses in order to get a balanced view of the actual ownership costs.

Profit & Loss Statement

The P&L – or profits and loss statement – is a financial report that lists income, expenses, and profit (or loss) from a rental property over a specific period of time. 

Even if your real estate business is brand new and you currently own just one rental property, consider using a free online software system such as Stessa to easily track property finances and performance. Information will be much more accurate, and you’ll receive tips on ways to increase your revenue that many investors may overlook.

When you review the P&L, look for expenses that are unclear or grouped together. Breaking costs out by vendor or purpose makes it much easier to discover areas where costs can be reduced, or where the current owner has been trying to cut corners.

Talk to Fellow Landlords

Visit today’s top real estate investor websites or sign-up for real estate investor blogs on Stessa, Roofstock, or BiggerPockets to begin learning about the rental property business from established and successful investors. 

Even though real estate investing is a very competitive business, the best rental property owners are usually more than willing to help a fellow investor out. By networking with fellow landlords you’ll be able to learn from people who have more experience, and avoid making potentially costly mistakes.

Speak with Local Property Managers

The secret to successfully investing in real estate remotely is to have a preferred property manager as part of your local real estate team. The best property management companies are always looking for new business and will go out of their way to set the right expectations with a prospective client. 

Property managers in the market you’re investing in will understand the actual costs of owning a rental property, because they’re already working with investors who own homes for rent similar to yours. Speaking with local property managers is also a good way to indirectly interview management companies so that you have someone in place the day you close escrow on your new rental property.

Use Real Estate Metrics

Rental property investors have over a dozen real estate metrics and formulas at their disposal to help analyze, monitor and estimate the potential value of income-producing real estate. 

For example, cap rate measures the return or profitability of similar homes in the same market or neighborhood. Another good real estate metric is the cash on cash calculation, which measures the amount of cash earned for each dollar that is invested. 

Generating real estate metrics for rental property you already own is easy to do online for free. Simply sign up for a free Stessa account, enter the property address, and connect the bank accounts you use for rental income and expenses. 

In only a few minutes, you’ll be able to run reports such as income statements, net cash flow, and capital expense reports in a single click, and export tax-ready financials to make tax time a breeze.

 

Common Rental Property Expense Deduction

Now that we know how to determine rental property expenses, let’s discuss what the most common rental property expense deductions are. 

Property Management

Property managers generally charge a fee of between 8% – 12% of the gross rental income collected each month. While that might seem like a lot of money, a good property management company can be worth its weight in gold. 

Rental property managers handle a multitude of daily details, including rent collection, responding to tenant requests, managing repairs and vendors, and ensuring that state landlord-tenant laws and Federal Fair Housing rules are followed.

Advertising & Marketing

Expenses for marketing a vacant property and screening for the best tenants are common rental property expense deductions. 

Many rental property listings websites such as Apartment Finder and Rent.com let landlords list and market vacant property to millions of potential tenants. Tenant screening websites including Cozy and RentPrep give landlords the option of paying for tenant screening or charging the cost of screening to the prospective tenant.

Leasing Commissions

Commissions paid to a real estate agent or property management company for finding a new tenant usually range from between one-half month and one month of the monthly rent. 

When it comes time for a tenant to renew, some property management companies collect a renewal fee equal to one-half month of rent, while others renew a lease with the current tenant at no charge.

Repairs & Maintenance

Common repair and maintenance expenses in a rental property are fully deductible and include costs such as landscaping, pest control, purchases for replacing light bulbs and air filters, seasonal HVAC inspections, painting and plastering, and fixing plumbing leaks or malfunctioning electrical outlets.

Utilities

In most single-family rental homes the tenant is responsible for setting up and paying for utilities. Investors who own multifamily property or short-term rentals may pay for and deduct the cost of utilities such as electric, internet, water, sewage, and trash.

Property Taxes

Property taxes are levied by the county assessor once a year and are often paid in semi-annual installments. 

If you have a loan on your rental property, be sure to review the year-end statement, because more often than not property taxes are included in the monthly mortgage payment.

Insurance

Insurance is another common rental property expense that is included in the monthly mortgage payment.

Real estate investors should talk to their insurance broker to make sure the current policy includes Landlord Insurance, which provides additional property and liability coverage for claims made by the tenant or guests.

Mortgage Interest

Most loans on residential rental property are fully amortized, which means the principal of the loan is paid down over the term of the loan through equal payments. Loan payments include P&I (principal and interest), and usually a pro-rata payment for property taxes and insurance. 

While the principal part of the P&I isn’t deductible, because it is a liability on the property balance sheet, the interest part of the loan payment is a fully deductible expense for owners of rental property.

Professional Fees

Common professional fees that are fully deductible for rental property owners include legal, accounting, and financial planning. Even though these expenses are deductible, no investor likes to pay more than he should. 

One way to keep accounting fees low is to visit the Stessa Tax Center and sign up for a personalized tax package.

Licenses & Permits

Many cities and states require a rental property owner to have a business permit and tax license for each rental property. If you hold your rental property under the name of an LLC, annual renewal fees collected by the state Corporation Commission are also a deductible expense.

HOA

If your rental property is located in a homeowners association, the monthly or quarterly fees paid to the HOA are a fully deductible expense. 

In most cases, special assessments from the HOA for capital improvements such as refinishing the community swimming pool or repaving the streets are normally not tax-deductible, but always check with your tax professional to be sure.

Capital Improvements

Capital improvements are items that increase the basis (or value) of a rental property, such as replacing appliances or carpeting or installing a new roof or HVAC unit. 

According to IRS Publication 527 must be depreciated over the life of the improvement, instead of being fully expensed during the year the improvement is made.

Depreciation

Depreciation is a non-cash expense rental property investors can use to reduce taxable net income. Property depreciation is based on the idea that rental property value is reduced over time due to wear and tear, and obsolescence. 

The IRS allows residential rental property investors to claim a depreciation expense of 3.636% of the property value each year over a period of 27.5 years, excluding the cost of the land or lot. For example, if a rental home cost $150,000 and the lot was valued at $15,000, the depreciation expense would be $4,909 each year ($150,000 – $15,000 lot value = $135,000 x .03636).

Travel

Auto expenses to travel to and from your rental property are fully deductible based on actual expenses such as gasoline and repairs, or the standard mileage rate of 56 cents per mile. Actual mileage must be logged and auto expenses must be tracked which is easy to do using a smartphone app such as Stessa’s mobile app

Long-distance travel expenses are generally deductible as long as the purpose of travel is mainly for business and expenses are ordinary and necessary. IRS Publication 463 provides real estate investors with additional guidance for travel expense deductions.

Pass-Through Tax Deduction

The pass-through tax deduction, also known as the qualified business income deduction (QBID) or section 199A deduction – is available to most rental property investors. 

Landlords may be able to deduct either 20% of their net rental income or 2.5% of the cost of the rental property, depending on their income level. The IRS has published basic questions and answers on the 20% deduction for pass-through businesses that you can find here.

 

IRS Rental Property Expense Tips

There’s no better source to go to for rental property expense tips than the IRS itself. Here are some tips about reporting taxes, keeping records, and information about rental property deductions:

  • Rental expenses that can be deducted on a tax return include mortgage interest, property tax, operating expenses, depreciation, and repairs.
  • Improvement costs paid for the betterment, restoration, or adaptation of the property to a new or different use must be recovered through depreciation.
  • Rental income and expenses are reported on Form 1040, Schedule E, Part I, and investors with more than three rental properties should attach as many Schedules E as needed.
  • Good records monitor the progress of a rental property, help to prepare financial statements, identify the source of receipts, keep track of deductible expenses, and most importantly, support income and expenses reported if the return is selected for audit.

 

How to Track Rental Property Expenses

Even if you have only one rental property, it’s never a good idea to try to track rental property expenses manually or by using a spreadsheet. 

That’s because it’s far too easy to overlook rental property expenses that you’re entitled to, or even worse accidentally double-book expenses and have your tax return pulled for an audit. Once you’re on the radar screen of the IRS it can be extremely difficult to get off of it.

The most successful investors use Stessa to simplify rental property finances with automated income and expense tracking, personalized reporting, and maximize potential profits through smart money management. 

Stessa is 100% free, with the goal of providing the real estate investor community powerful tools at the lowest possible cost.