If you are considering moving and wondering whether you should rent or sell your existing house, you may want to consider some of the tax breaks associated with renting out your home.
When done well, you can save quite a bit on your taxes by owning a rental house. However, before you assume you will save money on rental properties, take some time to understand what tax breaks are allowed.
Deducting One-Year Expenses
Many of the costs of owning a rental house are considered one-year expenses. For example, the cost of landscaping and gardening, general cleaning and maintenance, and even your annual HOA fees, can all be deducted in the year that they are spent. To deduct these expenses, you will record them, along with the rent you collect, on a Schedule E form.
Understanding Depreciation
Rental property depreciation is one of the biggest expenses you can claim, and also one of the harder to understand. Improvements on your property, like adding a new kitchen or putting in new carpeting, have value past the year in which they are added. So, you have to capitalize and depreciate these losses. This means you only claim a portion of the cost each year of its expected life.
Here's an example: If you add $5,000 worth of carpeting to your rental house, and the carpeting has an expected useful life of 10 years, you can deduct 1/10 of the cost of the carpeting each year for those 10 years.
Now, the $500 for your carpeting for the next 10 years may not seem like much of a deduction, but you also get to claim rental property depreciation for the purchase cost of the house. According to the IRS, the structure of the house is a depreciable asset.
How does this work? First, divide the purchase cost between the land and the structure, as the land is not a rental property depreciation option. Then, when you know the value of the property's structure and any improvements you've made to the property, you can claim for that amount.
How Much Can You Deduct
If you have a house that is worth $150,000, and the land it sits on is worth $25,000, you can deduct a rental property depreciation amount for the $125,000 value of the structure. The IRS allows a 27.5 year useful life for residential real estate. Dividing the $125,000 amount by 27.5 gives you a depreciation expense every year of $4,545.
That is a substantial deduction, and one that makes renting out your house a potentially lucrative move. However, it's very easy to mess up this deduction, which is why you may want to consider hiring a tax professional for the first year you have a rental house. By using the rental property depreciation properly, you can save substantially on your taxes every single year, all just because you own and maintain a rental property.
For more information on the tax benefits of renting a home, consult the IRS website by clicking here.
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Yaffe Real Estate does not advise on any personal income tax requirements or issues. Use of any information from this site or any other website referred to is for general information only and does not represent personal tax advice either express or implied. You are encouraged to seek professional tax advice for personal income tax questions and assistance.
