9.2 Checklist of Rental Deductions

The expenses in this section are deductible from rental income on Schedule E of Form 1040 in determining your profit.

Real estate taxes.

However, special assessments for paving, sewer systems, or other local improvements are not deductible; they are added to the cost of the land. See 16.4 through 16.7 for real estate tax deductions.

Construction period interest and taxes.

These expenses generally have to be capitalized and depreciated (16.4).

Depreciation of a rental building.

You may start claiming depreciation in the month the building is ready for tenants. For example, you bought a house in May 2012 and spent June and July making repairs. The house was ready to rent in August and you began advertising for tenants. On your 2012 return you begin depreciation as of August, even if a tenant did not move in until September or some later month. The month the building is ready for tenants is the month that determines the first-year depreciation write-off under the mid-month convention. See 9.5 for the monthly depreciation rates for residential rental property. Rates for nonresidential buildings are at 42.13.

Court Decision

Co-Tenant’s Deduction for Real Estate Taxes

The Tax Court may allow a co-tenant to deduct more than his or her proportionate share of real estate taxes. According to the court, the deduction test for real estate taxes is whether the payment satisfies a personal liability or protects a beneficial interest in the property. In the case of co-tenants, nonpayment of taxes by the other co-tenants could result in the property being lost or foreclosed. To prevent this, a co-tenant who pays the tax is protecting his or her beneficial interest and, therefore, is entitled to deduct the payment of the full tax, provided the payment is from his or her own funds. In several cases, the Tax Court limited the taxpayer’s deduction to his or her proportionate share, despite payment of the entire amount of taxes, because the taxpayer could not prove that the payment came from his own separate funds.

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Depreciation for furniture and appliances.

Furniture, carpeting, and appliances such as stoves and refrigerators used in residential rental property are considered five-year property for MACRS depreciation purposes. Furniture used in office buildings is considered seven-year property. See 42.5 for MACRS rates.

Management expenses, such as a fee paid to a company for collecting the rent.

Maintenance expenses, such as heating, repairs, lighting, water, electricity, gas, telephone, coal, and other service costs (9.3).

Salaries and wages, paid to superintendents, janitors, elevator operators, and service and maintenance personnel.

Traveling expenses to look after the properties.

If you travel “away from home” to inspect or repair rental property, be prepared to show that this was the primary purpose of your trip, rather than vacationing or other personal purposes. Otherwise, the IRS may disallow deductions for round-trip travel costs.

Legal expenses for dispossessing tenants.

But expenses of long-term leases are capital expenditures deductible over the term of the lease.

Interest on mortgages and other indebtedness.

But deductible interest does not include expenses paid to obtain a mortgage such as mortgage commissions and abstract or recording fees. Such costs are capital expenses that can be amortized over the life of the mortgage. For a mortgage obtained in 2012, amortization is claimed on Form 4562 (Depreciation and Amortization) and amortization for expenses of pre-2012 mortgages is claimed on Schedule E as an “Other expense.”

Commissions paid to collect rentals.

But commissions paid to secure long-term rentals must be deducted over the life of the lease. Commissions paid to acquire the property are capitalized as an addition to basis.

Premiums for fire, liability, and plate glass insurance.

If payment is made in one year for insurance covering a period longer than one year, you amortize and deduct the premium over the life of the policy, even though you are on a cash basis.

Tax return preparation.

You may deduct as a rental expense the part of a tax preparation fee allocable to Part 1 of Schedule E (income or loss from rentals or royalties). You may also deduct, as a rental expense, a fee paid to a tax consultant to resolve a tax underpayment related to your rental activities.

Charging below fair market rent.

If you rent your property to a friend or relative for less than the fair rental value, you may deduct expenses and depreciation only to the extent of the rental income (9.8).

Co-tenants.

One of two tenants-in-common may deduct only half of the maintenance expenses even if he or she pays the entire bill. A tenant-in-common who pays all of the expenses of the common property is entitled to reimbursement from the other co-tenant, so one-half of the bill is not his or her ordinary and necessary expense. Each co-tenant owns a separate property interest in the common property that produces separate income for each. Each tenant’s deductible expense is that portion of the entire expense that each separate interest bears to the whole, and no more.

Costs of cancelling lease.

A landlord may pay a tenant to cancel an unfavorable lease. The way the landlord treats the payment depends on the reason for the cancellation. If the purpose of the cancellation is to enable the landlord to construct a new building in place of the old, the cancellation payment is added to the basis of the new building. If the purpose is to sell the property, the payment is added to the cost of the property. If the landlord wants the premises for his or her own use, the payment is deducted over the remaining term of the old lease. If the landlord gets a new tenant to replace the old one, the cancellation payment is also generally deductible over the remaining term of the old lease.