Tax Deductions For Income Property

Do you own income property? Or do you plan to take advantage of declining property values in the next year and want to buy an income property? If so, here’s a quick tax-season review of what you need to know.

Unlike the mortgage interest and property tax deductions you take on Schedule A for your primary residence, income property works differently. The deduction is calculated on Schedule E, and the formula is total income minus total expenses minus depreciation. Income is the rent eceived. Expenses include mortgage interest (but not principal), insurance and/or homeowner’s association dues for condos, management fees, maintenance fees and any other expenses associated with managing that property, right down to the cost of changing a light bulb or a shower curtain.

You also get to deduct depreciation. Your property’s value is based on the value of the structure itself and the land it sits on. Land doesn’t depreciate but the structure does, and the depreciation schedule for residential property is 27.5 years. In some U.S. markets, land is worth more than the structures that sit on the land. But for general estimating purposes, you can divide your structure-to-land value using a 70/30% ratio. So if your rental property is worth $625,000, the actual home itself would be worth $437,500, and if you divide that by 27.5, you get to depreciate $15,909 per year.

If you rented that property for $1500 per month ($18,000 per year) and your expenses ran about $5000 per year, your formula is $18,000 – $8000 – $15,909 = -$5909.

If that number is negative, you get to deduct it. If it’s positive you pay taxes on it. However, you only get to deduct the negative number if you make up to $150,000 per year. If you make more than that, the negative number accrues over the years and offsets any capital gains at the time of sale. So you still benefit, but not until later on.