The Mortgage Interest Deduction for a Rental Property
Letting the IRS Help You in Your Real Estate Investing Business
If you came to this article in a search, it is part of our Rental Property Investment Analysis. Start there to walk through a detailed analysis of a sample property.
In our Rental Property Income Series, we're looking at the ways in which a rental fourplex can return cash and tax advantages to the owner. These include:
- Rental income after direct expenses, insurance & property taxes.
- Depreciation deduction to offset taxes on the rental income.
We will talk about the mortgage interest deduction in this article. Using our example property purchased for $325,000 with a $260,000 loan, our mortgage interest is approximately $16,814 the first year of the loan. Looking back at our rental cash flow and depreciation calculation, we're sitting on a potential tax liability on $25,999.
$25,999 - $16,814 = $9185
This is far from a bad thing, as we've seen that we are pocketing $15,192 in cash, realizing property appreciation and only paying taxes on $9185. Remember that other articles in this series are discussing depreciation and other income items and deductions. In the case of this mortgage interest deduction, the IRS is helping you to keep this property while it appreciates in value, as well as enjoying a positive cash flow with less tax liability at this time.
Other Rental Property Tax Advantages
All of your business expenses:
If you run ads for tenants, you can deduct it. If you pay for hosting or for a website for your properties, you can deduct it. Maintenance, regular repairs (not major stuff that must be depreciated) and expenses between tenants, like painting, are all deductible.
If you hire professional management companies or pay an attorney and accountant for services related to your properties, it's deductible as well.
If you keep track, you can even deduct mileage expenses driving to check on your properties.
This is a really good one, as you're getting to deduct an expense when you haven't really spent any money! Check with your accountant, but in most cases the IRS will let you depreciate the value of a structure, not the land, over 27.5 years if it's a rental property.
So, let's say you own a rental home that you bought for $187,000. The land is valued at $37,000, so your structure is worth $150,000. Divide that by 27.5 to get $5,455. You can deduct that as depreciation expense each year of ownership. Of course, no gift from Uncle Sam comes without a glitch. Some or all of your depreciation may be subject to recapture if you sell the property at a profit. Consult an accountant for details.
The 1031 Tax Deferred Exchange
This is one you definitely don't get with stocks. When you sell your stock shares at a profit, you owe the current rate of capital gains taxes for the year of the sale. It's the same for most other investment property, but not for real estate investments.
The rules are complicated, so you'll need an accountant and/or a 1031 Exchange company to explain them for your situation.
In a really simple overview, if you roll all of the profit of the sale of a rental property into another property, you will not have to pay capital gains on that profit, instead passing them forward in time until final sale.
Even better, you can retire like a king and take it with you! Well, not technically. If you leave your property to your heirs, they will inherit it at the "stepped-up" value. This means that it will be inherited at the value at your death, and all of the capital gains will disappear for tax purposes! In the meantime you've enjoyed your retirement on the cash flow.
So, get out and buy a rental home!