My wife and I purchased an investment property 16 miles from our primary home in 2019. In 2020, we had to financially help my mom and moved her into the property. We no longer receive rental revenue for the property. What are we allowed to deduct from the property’s expenses (i.e. mortgage interest payments, property taxes, HOA fees, utilities, repairs, maintenance, etc.)
Single filers and those married filing jointly in most cases can deduct full interest on mortgages up to $750,000. This applies to any personal residence, be it your first or second. The previous limit was $1 million in mortgage debt, which still applies on home loans taken out before Dec. 16, 2017.
Previously, you could borrow against home equity and take a deduction on the interest regardless of whether the proceeds were used to pay off a credit card, take a vacation, or buy a second home. Now, you can deduct interest on home equity debt only if the funds were used “to buy, build, or substantially improve the taxpayer’s home that secures the loan.” In addition, as under the old rules, the loan must be secured by your primary or second home, and can’t exceed the cost of the home.
You can deduct property taxes on your second home and, for that matter, as many properties as you own. However, here too, the TCJA has brought changes that affect those deductions.
You can no longer deduct the entire amount of property taxes you paid on real estate you own. Now, the total of state and local taxes eligible for a deduction—including property and income taxes—is limited to $10,000 per tax return, or $5,000 if you're married and filing separately. Many people who buy a second home may already exceed that limit with their first home, and so will not see additional tax savings from their second home.
HOA and other expenses such as utilities and maintenance are not deductible unless you use a part of the property in a business, in which case you may be able to deduct a pro rata portion of maintenance expenses.
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My wife and I purchased an investment property 16 miles from our primary home in 2019.
Distance doesn't matter. Could have been 6000 miles from your primary residence.
In 2020, we had to financially help my mom and moved her into the property. We no longer receive rental revenue for the property.
So I am assuming the property was classified as residential rental real estate effective on the closing date of your purchase, and that you actually did have a renter in it in 2019 and for some part of 2020.
This means that one day after the last renter moved out in 2020, you converted the property to personal use. On that date, all depreciation stops. Additionally, all rental expense deductions incurred "BEFORE" that date are allowed SCH E deductions. All expenses incurred "AFTER" that date are NOT allowed rental expense deductions.
What are we allowed to deduct from the property’s expenses (i.e. mortgage interest payments, property taxes, HOA fees, utilities, repairs, maintenance, etc.)
Again, all rental expenses incurred BEFORE you converted it to personal use, are valid SCH E deductions.
- Assuming your HOA fees are paid monthly, you can deduct those fees for each month the property was classified as a rental. Even if you pay those fees yearly, divide the total by 12 and that's the amount you can deduct for each month the property was classified as a rental.
- Since I know utilities are paid monthly you can deduct on SCH E the utilities paid for each month the property was classified as a rental. Usually it's the renter that pays the utilities like water, electric, etc. But if you the landlord paid them with your own money, then you can claim/deduct them on SCH E.
- Repair expenses incurred are deductible, only if the expense was incurred while the property was classified as a rental. As an example, the last renter moved out on March 31st. On April 1st you go through the property to see what needs to be done for your mother to move in. You find you need to replace a broken door lock. The expense for this is "NOT" deductible because this expense is incurred "after" the last renter moved out, and your intentions are not to prepare the property for the next renter; your intentions are to prepare the property for personal use.
You also need to perform the standard maintenance of cutting the grass after that last renter moved out, and sometime before mom moves in. That expense is not a deductible rental expense.
- The property insurance also needs to be manually prorated by you. You can not claim the entire amount of insurance paid for 2020, since the property was not a rental for the entire year. Take the total amount of insurance you paid in 2020, divide it by 12 and that is the amount you can claim/deduct on the SCH E for each month the property was classified as a rental. The amount of insurance paid for the period of time it was not a rental is just flat out not deductible anywhere on any tax return.
- Property taxes *and* Mortgage interest are prorated also. The amount of each for the period of time the property was a rental is a deductible rental expense on SCH E. The amount of each for the period of time it was personal use is a SCH A itemized deduction subject to the SALT limits imposed by the tax law changes of 2018.
In a nutshell:
- Property taxes and Mortgage interest are split between SCH E for the period of time it was a rental, and SCH A for the period of time it was personal use.
- Homeowners insurance is prorated so you only claim the amount paid for the period of time it was a rental. Property insurance for the time it was personal use is just flat out not deductible anywhere on the tax return.
- All other expenses incurred before you converted the property to personal use are a SCH E deduction.
- All other expenses incurred "AFTER" you converted the property to personal use are just flat out not deductible anywhere on the tax return.
Property Improvements are their own category. (As opposed to maintenance/repair expenses).
- Property improvements incurred after your purchase of the property and before you converted it to personal use are entered in the Assets/Depreciation section of the program and depreciation starts on the "in service" date you enter for that property improvement. Depreciation stops on the date you indicate you converted that asset/improvement to personal use - typically the day after the last renter moved out.
- Property improvements incurred "AFTER" the last renter moved out are "NOT ENTERED" anywhere on the tax return, until the tax year you convert the property back to a rental or other business use, or in the year you sell the property. It *does* *not* *matter* in what tax year that property improvement was actually done either.
Here's a bit of guidance I usually provide to first time landlords. Most of it you probably already know or have figured out. But you'll find the definitions most helpful when it comes to clarity.
Rental Property Dates & Numbers That Matter.
Date of Conversion - If this was your primary residence or 2nd home before, then this date is the day AFTER you moved out, or the date you decided to lease the property – whichever is later.
In Service Date - This is the date a renter "could" have moved in. Usually, this date is the day you put the FOR RENT sign in the front yard.
Number of days Rented - the day count for this starts from the first day a renter "could" have moved in. That should be your "in service" date if you were asked for that. Vacant periods between renters count also PROVIDED you did not live in the house for one single day during said period of vacancy.
Days of Personal Use - This number will be a big fat ZERO. Read the screen. It's asking for the number of days you lived in the property AFTER you converted it to a rental. I seriously doubt (though it is possible) that you lived in the house (or space, if renting a part of your home) as your primary residence or 2nd home, after you converted it to a rental.
Business Use Percentage. 100%. I'll put that in words so there's no doubt I didn't make a typo here. One Hundred Percent. After you converted this property or space to rental use, it was one hundred percent business use. What you used it for prior to the date of conversion doesn't count.
RENTAL PROPERTY ASSETS, MAINTENANCE/CLEANING/REPAIRS DEFINED
Property improvements are expenses you incur that “better” the property. Basically, they retain or add value to the property. Expenses for this are entered in the Assets/Depreciation section and depreciated over time. Property improvements can be done at any time after your initial purchase of the property. It does not matter if it was your residence or a rental at the time of the improvement. It still adds value to the property.
To be classified as a property improvement, two criteria must be met:
1) The improvement must become "a material part of" the property. For example, remodeling the bathroom, new cabinets or appliances in the kitchen. New carpet. Replacing that old Central Air unit.
2) The improvement must retain or add "real" value to the property. In other words, when the property is appraised by a qualified, certified, licensed property appraiser, he will appraise it at a higher value, than he would have without the improvements.
There are rules that allow you to just flat-out expense and deduct some property improvements, if the total cost of the improvement was less than $2,500. It’s referred to as “safe harbor di-minimis” But depending on the specific situation, this may or may not be beneficial. Just be aware that not every property improvement that cost less than $2,500 qualifies for this. If this interest you, the rules can get complex. So a good place to start reading is on the IRS website at https://www.irs.gov/businesses/small-businesses-self-employed/tangible-property-final-regulations. The stuff on di-minimis starts about one page down.
Cleaning & Maintenance
Those expenses incurred to maintain the rental property and it's assets in the useable condition the property and/or asset was designed and intended for. Routine cleaning and maintenance expenses are only deductible if they are incurred while the property is classified as a rental. Cleaning and maintenance expenses incurred in the process of preparing the property for rent are not deductible.
Those expenses incurred to return the property or it's assets to the same useable condition they were in, prior to the event that caused the property or asset to be unusable. Repair expenses incurred are only deductible if incurred while the property is classified as a rental. Repair costs incurred in the process of preparing the property for rent are not deductible.
Additional clarifications: Painting a room does not qualify as a property improvement. While the paint does become “a material part of” the property, from the perspective of a property appraiser, it doesn’t add “real value” to the property.
However, when you do something like convert the garage into a 3rd bedroom for example, making a 2 bedroom house into a 3 bedroom house adds “real value”. Of course, when you convert the garage to a bedroom, you’re going to paint it. But you will include the cost of painting as a part of the property improvement – not an expense separate from it.