Smart Tax Strategies for Rental Property Owners: Avoid Costly Mistakes

Tax season can be challenging for rental property owners, but understanding key tax strategies can help avoid mistakes and maximize deductions. Here are important tax considerations for rental property income and expenses:

Rental Income Basics

Rental income includes all payments received for property use. This may include:

• Advance Rent: Any payment received before the period it covers.
• Lease Cancellation Payments: Compensation from a tenant for terminating a lease early.
• Expenses Paid by Tenants: This amount is considered rental income if a tenant covers maintenance or repairs. For example, if a tenant pays for a furnace repair and deducts it from rent, it must be reported as income, with the repair cost then deducted as an expense.
• Property or Services Received: The fair market value (FMV) of services or goods received instead of rent. For example, if a tenant paints the property in place of two months’ rent, the FMV of the work must be reported as income, with the same amount deducted as an expense.

Security Deposits

Security deposits are not included in rental income if they are refundable. However, if any portion is kept due to lease violations, that portion must be reported as income. Deposits used as final rent payments should be included in rental income in the year received.

For further guidance, visit the IRS Real Estate Tax Center.

Deductible Expenses

For an expense to be deductible, it must be both ordinary and necessary. Common deductible expenses include:

• Insurance Premiums: Premiums covering 12 months or less are deductible in the year paid. Premiums paid for over 12 months must be allocated over the applicable period.
• Local Transportation: Costs related to managing rental properties are deductible. Owners can deduct either actual expenses or use the standard mileage rate (70.0¢ per mile for 2025). Commuting expenses are not deductible.
• Travel Expenses: When traveling away from home for property management purposes, expenses for transportation and lodging may be deductible.
• Repairs: Costs to maintain the property in its current condition, such as fixing a broken window or plumbing issue, are deductible in the year incurred.

Repairs vs. Improvements

Understanding the difference between repairs and improvements is essential for tax purposes:

• Repairs keep a property in good condition and can be deducted immediately. Examples include fixing leaks or patching walls.
• Improvements add value, extend the property’s life, or adapt it for a new use. Examples include adding a new roof, expanding a room, or installing new flooring. These costs must be capitalized and depreciated over time.

More details are available in the IRS Tax Tips for Real Estate.

Personal Use Considerations

Expenses must be allocated accordingly if a rental property is also used for personal purposes. For example, if a rental unit is 10% of a home’s total space, only 10% of the home’s expenses can be applied to rental deductions. Property rented for fewer than 14 days per year does not require income reporting, and expenses cannot be deducted.

Vacant Property Expenses

Expenses for a rental property are deductible even if the property is temporarily vacant as long as it remains available for rent.

Common Tax Mistakes to Avoid

• Misclassifying repairs vs. improvements affects deductibility.
• Failing to maintain detailed records of income and expenses. Itemized invoices should clearly separate repairs from improvements.
• Incorrectly allocating expenses when part of a property is used for personal purposes.
• Misunderstanding the treatment of security deposits.
• Neglecting to depreciate improvements correctly.
• Overlooking deductions for vacant properties.
• Incorrectly reporting insurance premiums paid in advance.
• Missing deductions for properties available for rent but not yet occupied.

Practical Examples

• Phil owns a home with 1,800 square feet and rents out a room measuring 180 square feet. He can allocate 10% of his home’s expenses to the rental.
• Ashlyn replaces a small section of her rental property’s damaged roof. This is classified as a repair and can be deducted immediately. If she replaces the entire roof, it must be capitalized and depreciated.
• Nina uses a truck for her contracting business. Routine maintenance, like oil changes, is deductible, but adding a hydraulic lift is considered an improvement and must be depreciated.
• Penny owns an office building with 24 windows. Replacing eight damaged windows is a deductible repair, but replacing 16 windows is an improvement that must be capitalized.

For expert assistance, a real estate tax accountant can help investors understand tax rules and maximize deductions.