Can I Deduct Remodeling Expenses for Rental Property? Exploring Tax Benefits and Guidelines

As a rental property owner, you poured money into upgrading and renovating your units. Wouldn't it be nice to recover some of those expensive remodel costs when tax season rolls around? The good news is that you may be able to deduct certain improvements as rental expenses.

But how much can you write off? Can you deduct that full kitchen remodel or just the appliance upgrades? What about that new bathroom or flooring? The IRS has strict rules around deducting rental property repairs and renovations. Decode those guidelines correctly on your tax return, and you could see substantial savings.

In this article, we'll explain exactly which remodeling projects you can and can't deduct on a rental property. You'll learn key record-keeping tips to substantiate both large and small renovation expenses. We'll also cover main rental property costs that landlords can and cannot deduct.

So read on to uncover how much you can potentially deduct from major upgrades to your rental units. With the right strategy, you can offset remodel costs while keeping the IRS happy!

Can you deduct renovation costs on rental property?

The short answer is yes, you can deduct renovation costs on your rental property, but you must depreciate major improvements over time rather than deducting them all at once. The reason is that the IRS makes a distinction between major and minor renovations:

• Major renovations: These renovations are considered capital improvements, such as upgrading the property, expanding its usability, extending its lifespan, or significantly increasing its value. Examples include adding new rooms, finishing a basement, or upgrading major systems like HVAC.
• You depreciate these capital improvement costs over 27.5 years for residential rentals and 39 years for commercial property. Each year, you'll deduct a portion of the depreciation.
• Minor: These are smaller renovations like simpler repairs and maintenance that don't drastically improve the property. These include fixing a roof leak, painting walls, repairing appliances, or replacing flooring. You can usually deduct the total costs of these minor renovations in the year they happen.

Check out IRS Publication 527 for more details, and keep track of your capital improvements separately from regular expenses.

Common rental property tax deductions

Besides remodeling expenses, what else can rental property owners deduct? Let's look at the expenses that can lower your tax bill by reducing your taxable rental income. Common deductions for landlords include:

Advertising

You can deduct the costs associated with advertising your rental property to attract new tenants. This includes any money spent on newspaper ads, real estate listing sites, and even signage or flyers.

Casualty losses 

You can deduct the loss on your tax return if your property is damaged or destroyed by something unexpected, like a natural disaster or fire. However, you can only deduct losses that insurance does not cover.

Home office

If you use part of your home exclusively for managing your rental property, you can deduct a portion of your home office expenses. There are two methods you can use for this expense:

• Percentage: Use this approach to deduce a share of all home expenses based on office square footage percentage.
• Simplified: With this method, you can deduct $5 per square foot of home office space, up to 300 square feet.

Insurance

The money you spend on insurance to protect your rental property is deductible as an operating expense. This includes insurance premiums for policies that safeguard against liability risks, loss of rental income, or property damage.

Management fees

If you hire a company to manage your property, you can deduct the fees you pay them from your taxes. These fees include screening tenants, collecting rent, arranging repairs, and handling the finances. You can also deduct expenses for finding new tenants, like placement fees.

Mortgage interest deduction

You can deduct mortgage interest payments on loans you used to buy or improve your rental property. This covers purchase loans, refinances, and home equity lines of credit if you used the funds for expenses related to your rental.

The deduction applies to interest on mortgage debt of up to $750,000 across all your rentals. You may not be able to deduct the interest for debt that is above this limit.

Professional fees

Fees paid to professionals concerning your rental property are deductible business expenses. These can include fees paid to lawyers or tax preparers.

Some common professional fees that landlords incur and can deduct include:

• Annual tax preparation fees.
• Legal fees for tenant disputes or evictions.
• Property appraisal fees for financing purposes.
• Inspection fees when purchasing the property or turning over tenants.
• Ongoing accounting fees for property management.

Property taxes

You can deduct all property taxes imposed on your rental property by local and state governments. This includes taxes from the county, city, school district, or any other entity taxing the property. You might pay these costs directly or through your mortgage lender's escrow account.  Either way, you can deduct property taxes.

Repairs

You can deduct the costs for maintenance and repairs to keep your rental property in good working condition. These expenses cover routine fixes and maintenance tasks that do not materially add value to the property. Examples include patching holes, fixing leaks, repairing broken windows, and addressing wear and tear issues.

Supplies and equipment

Buying supplies and equipment for maintaining or fixing your rental property is deductible in the year of purchase. This includes cleaning supplies, tools, small appliances, hardware, and landscaping tools. However, be sure to check with an accountant if you buy larger equipment that can be considered a capital expense and depreciated over time.

Utilities

Do you cover utility costs for your rental property that benefit your tenants, such as electricity, gas, water, sewer, garbage collection, cable, or internet for shared areas? You can deduct these expenses from your rental income. Note that the bills need to be in your name to qualify.

Travel

You can deduct travel expenses for overseeing your rental property. This includes vehicle mileage, airfare, lodging, and 50% of meals.

Be aware that only trips directly related to managing your rental property qualify for deductions here. Examples are travel costs for:

• Visiting the rental property.
• Meeting with tenants or contractors.
• Showing the unit to prospective renters.

Non-deductible rental property expenses

There are certain costs that the IRS doesn't allow as rental property deductions. Knowing these non-deductible expenses can help you avoid future headaches and audit troubles:

Personal use

The expenses for any part of the rental property you use personally for vacations or residential purposes are not tax deductible, as the IRS sees this as personal use.  

For instance, if you use your beach condo for two weeks each year for your own family trips, you can't deduct expenses like utilities, maintenance, or HOA fees for those two weeks. You'll need to divide your rental property expenses based on the days you used it personally versus days rented out.

Travel not related to your rental property

You cannot deduct personal travel expenses, even if combined with business travel.

For example, suppose you travel to your rental beach house. Your trip is for two reasons: a vacation and to conduct rental business activities. These activities could include meeting with contractors for property renovations.

In such a case, you can only deduct the portion of your travel expenses directly related to the business aspect of your trip. You cannot deduct the full cost of the flight or other expenses unless the trip is solely for business-related purposes.

Fines and penalties

You can't deduct fines or late fees on bills, mortgages, or other invoices tied to the rental property. Even if these expenses are related to the property, the IRS doesn't allow you to deduct fines and penalties as legitimate rental expenses.

Land depreciation

You cannot depreciate the land your property is on.  For tax purposes, you'll need to separate the value of the land from the building and any upgrades.  You'll be able to depreciate the building and upgrades, not the land.

How to claim rental property tax deductions

Claiming tax deductions on your rental property can significantly reduce your tax liability. Here's how to verify you're making the most of your available deductions:

• Keep records: Use digital tools or software designed for rental management, like Azibo, to track your expenses and income throughout the year. This approach simplifies the tax filing process and makes sure you're ready in case of an audit. Keep all receipts, invoices, and bank statements related to your rental activity organized and accessible.
• Use Schedule E: Schedule E helps you report all the money you make and spend on your rental property. Your rental property's final profit or loss goes onto your main tax form, the 1040.
• Report your expenses: When it's tax time, add up all the costs related to your rental property and put them in the right spots on Schedule E. Make sure you only include things directly related to your rental, not personal expenses.
• Apply depreciation: You must depreciate major improvements like renovations and the property itself over its useful life. Begin depreciation in the year your property is available for rent and continue annually.
• Calculate your profit or loss: After you've added up your income and expenses, figure out whether you made a profit or had a loss on Schedule E. If you lost money, you might be able to use it to lower your taxes on other sources of income, but this depends on certain IRS rules.
• Seek professional help if unsure: Organizing all your deductions requires effort, but it can help you save a lot on taxes. If you're not sure what to do, it's a good idea to talk to a tax expert for advice.

Accounting software for rental property owners

Keeping thorough records of your business finances is key as a rental property owner. It helps back up your expenses, squeeze out every last deduction, and steer clear of IRS headaches. However, doing it all by hand or trying to shoehorn Excel into managing rental finances can be a giant pain.

Specialized accounting software like Azibo can be a total game-changer for landlords. This rental property management software does all the heavy lifting for you when it comes to tracking income, expenses, deductions, and everything in between. Here's how Azibo can help your rental business:

• Expense tracking: Azibo's accounting software allows for the categorization of every expense related to your rental property, aligning with IRS deductible expense categories. This functionality helps you capture every potential deduction and organize them in a manner that simplifies tax filing.
• Depreciation schedules: One of the more complex aspects of rental property deductions is accurately calculating depreciation on the property and improvements. Azibo can assist in tracking the cost basis of your property and calculating depreciation over the appropriate lifespan, helping you maximize this deduction.
• Real-time financial overview: By maintaining up-to-date records of income and expenses, Azibo provides real-time financial insights. This helps in managing the property's profitability and making decisions that could impact tax liabilities, such as the timing of repairs or improvements.
• Tax preparation efficiency: When it's time to file taxes, Azibo can generate comprehensive reports detailing deductible expenses and rental income. This streamlines the preparation of Schedule E and other relevant tax forms, reducing the likelihood of errors.

IRS forms for reporting rental income and deductions

Report all income and expenses from your rental property on IRS Schedule E and file it with your Form 1040 personal tax return. Here's all the potential IRS forms you might use to report your rental property information:

• Schedule E: This is where you report your rental income and expenses. Put your rental income on line 3 and claim deductions for mortgage interest, repairs, and utilities on lines 8-20.
• Form 4562: If you claim depreciation for your rental property, fill out Form 4562 and enter the amount on line 18 of Schedule E.
• Schedule C: If you're using a part of your home to manage your rental property and want to claim a home office deduction, use Schedule C to determine the percentage of your home used for business. Then, carry that over to line 19 on Schedule E.
• Schedule SE: The IRS considers most rental income as self-employment income. Use Schedule SE to determine how much self-employment tax you owe on your rental earnings. Put the deduction for self-employment tax on line 27 of Schedule E.
• Form 1040: Whatever profit or loss you get from Schedule E goes onto line 17 of your Form 1040 tax return. If you have a loss, it might help offset other income you have, but there are some rules and limits to watch out for.

Can you write off renovations on a rental property?

Renovating your rental property can pay off twice: first, by attracting higher rents and greater demand, and second, by unlocking tax deductions that put cash back in your pocket. As we've covered, you can write off both minor repairs and major improvements over time.

But to tap into these savings, you need solid record keeping and an understanding of what the IRS does (and doesn’t) allow. Consider leveraging rental management software like Azibo to effortlessly track income and expenses, saving you time while positioning your taxes for success.

At the end of the day, being a successful landlord is just as much about mastering your tax strategy as your tenant strategy. So, do your homework on the deduction details, commit to record keeping, and let the tax savings from smart renovations start flowing in!

Can you write off renovations on a rental property? FAQs

Are bathroom renovations tax deductible?

Yes, bathroom renovations on rental properties are tax deductible, but you can't deduct them all at once. The IRS requires depreciating them over the property's useful life.

Can you write off painting a rental property?

Yes, you can deduct the costs of painting your rental property as a maintenance expense in the year it is completed.

Can renovations be depreciated?

Yes, if renovations improve the property, you can depreciate the cost over the property's useful life.