Per the IRS, certain rental expenses are tax-deductible while others are not. Find details about rental expenses and federal taxes below.

Typical deductible rental expenses include amounts paid for advertising; janitorial/maintenance and gardening services; utilities; fire, earthquake, flood and liability insurance; taxes; management fees and commissions for collecting rent payments; travel and transportation expenses. An allocable portion of tax preparation fees paid is also deductible.

A taxpayer may deduct, as home mortgage interest, interest he paid on a mortgage on real estate of which he is the legal or equitable owner, even though he is not directly liable on the debt secured by the mortgage. (Reg. § 1.163-1(b)) 

Mortgage interest paid on rental property is deductible. However, if the loan on a rental property is refinanced for more than the outstanding balance, the portion of the interest allocable to loan proceeds that are not related to rental use are not deductible as a rental expense. And when a personal residence is converted to rental property, the interest on the converted home’s acquisition debt continues to be deductible as a rental expense but the interest on any equity debt is not deductible.

If a taxpayer refinances their first mortgage loan on their principal residence and uses the proceeds to buy a rental property, the interest can’t be divided between Schedule A and Schedule E. Instead, if the taxpayer gets a separate loan secured by the principal residence and uses the funds to buy the rental property, the taxpayer could make the election to treat the loan as not secured by the principal residence. By tracing the use of the proceeds the taxpayer would be allowed to deduct the interest paid as a rental expense.

The TCJA added a provision that limits the deduction for business interest to 30% of the taxpayer’s “adjusted taxable income,” (ATI) effective in 2018, with an exception for “small businesses” with average gross receipts of $25 million or less (inflation-adjusted to $26 million in 2019 – 2021, $27 million in 2022). Mortgage interest may be subject to this limitation if the rental activity is determined to be a “trade or business.”

A provision in the CARES Act generally allows businesses to elect to increase the interest limitation from 30% of ATI to 50% of ATI for 2019 and 2020 and allows businesses to elect to use 2019 ATI in calculating their 2020 limitation. 

Whether an expense is a capital improvement, or a repair has long been an arguable issue between the IRS and taxpayers. The IRS issued temporary regulations, that were to be effective January 1, 2012, but delayed to January 1, 2014, providing guidance with respect to whether costs to acquire, produce or improve tangible property should be currently deductible as repairs (or as materials or supplies) or capitalized. IRS finalized these regulations in 2013. Under these regulations, a qualifying taxpayer may, on an annual basis, elect a safe harbor provision to currently deduct improvements made to an eligible building property that would otherwise have to be capitalized. 

While quite complex, the final regs comprehensively restate many long-established concepts about which costs must be capitalized in connection with the acquisition or production of real or personal property.

Generally, a taxpayer must capitalize amounts paid to acquire or produce a unit of real or personal property, including leasehold improvement property, land and land improvements, buildings, machinery and equipment, and furniture fixtures. Amounts paid to acquire or produce a unit of real or personal property include the invoice price and transaction costs (discussed below). Costs for work performed before the date that the unit of property is placed in service by the taxpayer must be capitalized. (Reg. § 1.263(a)-2(d)(1))

Amounts paid to facilitate the acquisition (or production) of real or personal property—i.e., paid in the process of investigating or otherwise pursuing the acquisition—must be capitalized and included in the basis of property acquired or produced. (Reg. § 1.263(a)-2(f)(3)(i)) Whether an amount is paid in the process of investigating or otherwise pursuing an acquisition is based on all of the facts and circumstances. The fact that the amount would (or would not) have been paid “but for” the acquisition is relevant but not determinative. (Reg. § 1.263(a)-2(f)(2)(i)) An amount is paid in the process of investigating or otherwise pursuing the acquisition of real or personal property if the amount is inherently facilitative. The amounts paid for the following are considered inherently facilitative:

Costs relating to the process of determining whether to acquire real property and which real property to acquire generally aren't facilitative expenses (and therefore may be currently deductible), unless they are “inherently facilitative” expenses (e.g., the cost of an engineering study or a broker's fee). (Reg. § 1.263(a)-2(f)(ii) and (iii))

The final regulations clarify the meaning of finders' fees and brokers' commissions and provide a definition of contingency fees. The final regulations provide that for purposes of §1.263(a)-2, a contingency fee is an amount paid that is contingent on the successful closing of the acquisition of real or personal property. The final regulations also clarify that contingency fees facilitate the acquisition of the property ultimately acquired and are not allocable to real or personal property not acquired. Therefore, if a real estate broker's commission is contingent on the successful closing of the acquisition of real property, the amount paid as the broker's commission inherently facilitates the acquisition of the property acquired and, therefore, must be capitalized as part of the basis of such property. However, no portion of the broker's contingency fee is allocable to real property that the taxpayer did not acquire. In addition, the final regulations retain the rule that inherently facilitative amounts allocable to real or personal property are capital expenditures related to such property, even if such property is not eventually acquired or produced.

IRS has privately ruled that the business cost a taxpayer incurred on a project to remove mold from a building it owned and leased out was deductible as an ordinary and necessary expense under Code Sec. 162. (PLR 200607003) Note: Presumably the mold removal would have had to be capitalized if it was done as part of an overall rehabilitation or renovation plan.

Generally, repairs are deductible as an ordinary and necessary trade or business expense under Code Sec. 162 if they merely keep the property in an ordinary, efficient operating condition. But expenses must be capitalized if they're needed to place the property in an ordinarily efficient operating condition (as in the case of expenses to remedy a condition that existed when the property was acquired), or if they add to the property's value, substantially prolong its useful life, or adapt it to a new or different use.

A frequent question is whether repainting is an expense or capital improvement. The IRS Q&A provides excellent guidance as reproduced below:

https://www.irs.gov/faqs/sale-or-trade-of-business-depreciation-rentals/depreciation-recapture/depreciation-recapture-4

Repainting the exterior of your rental property: