Last week, I answered a question from a reader who is renting out a single family home (his former primary residence) that is too big for him. He is now renting a different property and had some questions about whether the income from the rental property could be deducted somehow from the rent he is paying on his rental home.
In the column, I wrote that you cannot write off the income from the rental property against the rent paid to another landlord for a primary residence. Those are separate transactions.
I then wrote that the rent you receive from the rental property can be offset by the expenses of owning the investment property. “For example, let’s assume your mortgage on the investment property is $1,000, and your maintenance and upkeep and taxes are an additional $500 per month. The costs of the property are $1,500 per month. If you are receiving $2,000 in income per month from the property, you can offset all but $500. That’s $6,000 in income you’ll have to report to the IRS.”
I received dozens of emails from astute readers who rightly noted that you cannot offset mortgage payments if they include mortgage and principal payments.
As Phil Bertolo, a certified public accountant (CPA) based in Florham Park, NJ, put it: “A couple of my clients have contacted me about your most recent Q&A Real Estate Matters question regarding deductible expenses when renting investment property. Your answer says the owner of the property may offset their mortgage payments and overhead expenses against the rental income. People take things literally and as it reads, they believe the payment, including the principal is deductible instead of just the mortgage interest.”
But, it is not. Only the mortgage interest part of the payment is deductible.
In other words, if your rental property mortgage payment is interest only (as mine are), then you can write off the entire payment. If your payment consists of principal and interest, you can only write off the portion that is the interest payment.
According to the IRS, the expenses of renting your property, including maintenance, insurance, taxes, and interest can be deducted in the year that the expenses are incurred.
But you may also be able to deduct the following: Advertising, cleaning and maintenance, commissions, depreciation (which you’ll have to recapture when you sell the property), insurance, mortgage interest, legal fees, local transportation expenses, management fees, other types of interest, points (a point is one percent of the loan amount), rental payments, repairs, tax return preparation fees, real estate property taxes (excluding the portion that is “local property benefit,” which may be added to your cost basis), travel expenses, and utilities.
Let’s say that there are some expenses that your tenant pays you on his or her behalf. If, for example, you pay heat and your tenant pays you to pay the energy bill, the amount you’re paid is rental income. However, because you are including this amount in income, the IRS says you can also deduct the expenses if they are deductible rental expenses.
Finally, if you’re paid a year’s worth of rent up front (which is very common for tenants from foreign countries that may not have any sort of verifiable credit history), the IRS requires you to declare that rental income entirely in the year in which you receive it. Likewise, if you have a tenant who pays you to cancel a rental agreement, you must declare that entire payment as rental income in the year you received it, and not spread out over the course of what would have been the original lease term.
One last note: Income, expenses and depreciation on rental and investment properties can be tricky and complicated to calculate correctly. There are certain rules for real estate professionals (who claim that profession on their IRS tax return) and for others who invest in real estate on the site.
These designations may limit the amount of losses you can take in any given year. Given that rental and investment properties may also allow you to take depreciation, you should talk to an accountant or your tax preparer to determine those deductions and the amount of depreciation you might be entitled to and what your limitations might be with the investment.
For more details and additional information on what deductions you can take on rental property, download a free copy of IRS Publication 527 “Residential Rental Property” at IRS.gov.