By Jason Watson, CPA
Posted Sunday, March 22, 2026

Every so often we get this question: “Can I buy a car just for my rentals?” Ok,, that’s a lie. It’s not every so often- more like every day. The question is a good one for sure. The answer is more elusive.

The short answer is maybe. The long answer is Yes, with excellent documentation and a decent dose of risk tolerance.

Ordinary, Necessary, and Documented

As this chapter starts off, under IRC Section 162, business expenses including rental property expenses must be both ordinary (common and accepted in your line of work) and necessary (appropriate and helpful). The U.S. Supreme Court said it best in Welch v. Helvering, 290 U.S. 111 (1933): what’s “ordinary” depends on “life in all its fullness.” In other words, context matters, even in 1933.

Beyond ordinary and necessary, automobiles also get special scrutiny under IRC Section 274(d) because they’re “listed property.” The IRS assumes personal temptation is high on an automobile that can double for a grocery or kid mobile (shocker, right?). You must maintain contemporaneous records that include mileage logs (dates, odometer readings, trip purposes), and service records (maintenance, Jiffy Lube, etc.) to corroborate your amazing mileage log. The Cohan rule (estimating expenses when records are lost) doesn’t apply here. No log, no tax deduction.

In other words, you can’t rock up to the IRS and say, “I don’t need to track miles. They are all business miles for my rental properties.” Well, you can say that, but you still need adequate records or other sufficient evidence. IRC Section 274(d) reads in part-

(d) Substantiation required
No deduction or credit shall be allowed—
(1) under section 162 or 212 for any traveling expense (including meals and lodging while away from home),
(2) for any expense for gifts, or
(3) with respect to any listed property (as defined in section 280F(d)(4)), unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement

In other words, do you need a mileage log if you claim the automobile is 100% for the rentals? Not necessarily (but it certainly helps). You just need adequate records or sufficient evidence to support the 100% rental use claim.

Some automobiles are designated nonpersonal by design. Treasury Regulations Section 1.274-5(k)(2)(ii) has a big list, and here are some of the highlights-

(C) Any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds.
(H) Delivery trucks with seating only for the driver, or only for the driver plus a folding jump seat.
(I) Dump trucks (including garbage trucks).
(J) Flatbed trucks.
(L) Passenger buses used as such with a capacity of at least 20 passengers.
(M) Qualified moving vans (as defined in paragraph (k)(4) of this section).

So, a general pickup truck or cargo van is not automatically considered nonpersonal, and as such you need to support your claim as we mentioned above.

Luxury Automobile Or Practical Tool

This is where white starts to turn gray (and possibly on your way to turning charcoal). Could a $100,000 SUV used only to haul linens and touch-up paint be “ordinary and necessary”? Possibly. Could a $150,000 SUV pass the same sniff test? Unlikely. A $250,000 supercar? While it certainly goes fast, it is a no go in the eyes of reasonableness.

Granted, there’s no IRS spreadsheet that says “ordinary stops at $97,500,” but examiners look at scale. Scale is another way of saying reasonableness. Two short-term rentals generating $60,000 a year in net income probably don’t need a six-figure truck to operate. The IRS might argue that a less expensive vehicle would be equally “appropriate and helpful.” Then again, the IRS can’t tell definitively how to spend your money on your business, but they can certainly make you jump through hoops (and likely make you wish you hadn’t tried).

Still, “scale” isn’t defined in the tax code. In Henry v. Commissioner, 36 T.C. 879 (1961), the Tax Court denied yacht expenses because they were “excessive in relation to the taxpayer’s trade or business,” yet it acknowledged that “what is ordinary depends upon the scope and nature of the enterprise.” Said differently, the IRS can raise an eyebrow and perhaps both of them, but there’s no bright-line rule. Most real estate investors and rental property owners can accept the risk- if documentation is bulletproof and the business purpose legitimate, it’s defensible even if it feels extravagant.

What if the rental property is a short-term rental with lots of turnover all year? What if your rental property is an 8-unit mini apartment building? What if you purchased four rental properties in one year that needed a lot of minor repairs? Or a major renovation? There are a zillion different combinations or examples to brighten your day and buttress your tax position on why a $100,000 truck is necessary.

This is the “long answer is maybe, with excellent documentation and a decent dose of risk tolerance” part we spoke about just a bit ago.

Automobile Depreciation Limits Still Apply

Even if you clear the IRC Section 162 hurdle, IRC Section 280F limits depreciation for passenger automobiles. Each year, the IRS publishes maximum allowable depreciation which is $20,800 first year for the 2026 tax year. Automobiles with a gross vehicle weight over 6,000 pounds such as large SUVs and heavy pickups can escape those caps and may qualify for Section 179 expensing or 100% bonus depreciation, or a combination.

So a $100,000 heavy SUV might see a full tax deduction, while a $60,000 small sedan crawls through limited annual depreciation.

Don’t forget that under IRC Section 168(k) (accelerated depreciation) and IRC Section 280F(b)(3) (listed property limitations), you can only claim bonus depreciation or Section 179 expensing if the business use exceeds 50% of total use in the year the automobile is placed in service. While we are on the topic, should business use drop to 50% or below, you must recapture depreciation or the Section 179 benefit as if you depreciated it using normal depreciation (listed property, such as automobiles, have a clawback similar to Section 179).

Automobile Losses Might Be Limited

All this works only if you are able to deduct your rental property losses through real estate professional status (REPS) or short-term rental loophole or you have other passive income to slap against it. In other words, if you increase rental losses with automobile expenses and depreciation, and those rental losses are limited by passive activity loss limits, then why bother? Sure, you’ll eventually get the tax deduction but it might take several years (or you sell the rental property).

Sidebar: Keep in mind that automobiles depreciate in value. As such, to buy one just for the tax deduction might be fool’s gold. Sure, time value of money can play into this just as much as the vanity of having your real estate operations own an automobile to tell your buddies about. A $100,000 SUV that is worth $65,000 3-4 years later, and that you only use or mostly use to conduct rental business might not make a lot of sense.

In Summary

Two questions to reflect upon-

1. Was the automobile truly necessary for the rental activity? (needs and wants occupy the same brain space, right?)
2. Is the cost proportionate to the business’s size and operations? (absolutely, without a doubt, Yes Yes)

These questions don’t have right answers. As we said before, it is very subjective. If your answers sound like “yes, I needed reliable transport for linens, supplies, and maintenance, and I have logs for every mile,” you have a reasonable case. If your answers sound like “damn it Jim, I am a landlord not a real estate mogul, but to keep up appearances I wanted something nice for the occasional Home Depot run,” you might want to cuff yourself to the desk and wait for the warrant. Ok, that was a bit much.

Some more reflection-

• If you want to claim 100% rental property use for the automobile, you don’t need a mileage log as we stated above. But you will need to support your tax position with a contemporaneous record such as a log, diary, trip sheet or electronic recording (such as MileIQ or similar phone app).
• Ideally for 100% rental property use, you have an LLC or some other entity that owns the rental properties also own the automobile. This just adds to your claim. If you have several rental properties all owned separately by LLCs with a real estate holding company owning the subsidiary LLCs, then the holding company should title the automobile.
• If you want to claim less than 100% rental property use, then a formal mileage log plus third-party corroboration is necessary.

See our automobile deductions in rentals section for other information.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

Should you pay Johnny or Suzie to paint a wall? Or build out your social media platforms? Mow the lawn with scissors? Perhaps. While most parents can’t get their children to clean a counter or put away dishes, putting them to work on the rental properties might be a good option.

This section is long and nuanced, so buckle up for your safety. Here we go.

Tax Advantages

There are some tax benefits to paying your children- for example, you can pay your child $15,700 in wages since the standard deduction is also $15,700 (for the 2026 tax year) and they will not have any taxable income. You can still claim them as a dependent too (see below). From there, they can also gift this money back to you, save for a house down payment, or help pay for groceries.

Some kidding aside, for you to give your child $15,700 to save for college or pay for college, it requires $20,700 or more in parental income because of just your federal income taxes. Simply take $15,700 and divide it by 76% for the 24% marginal tax bracket. At 35% marginal tax bracket, it takes $24,150 in parental income to give your children $15,700 and we haven’t even considered your portion of Social Security and Medicare, nor state income taxes.

For grins, taking $15,700 and dividing by 55% which represents 45% in a truckload of taxes equals $28,550. As such, there are some real tax advantages to employing your children to work on your rental property.

There are three basic ways to compensate them for their amazing talents and impeccable work product. In descending order of elegance, you can-

• Create a property management company.
• Process payroll through an S corporation if you already have that deployed.
• Consider them a contractor, and issue a 1099-NEC.

Your children are going to take your money anyways- might as well make it tax-advantaged, right?

Sidebar: We recently came across this phrase, and thought it was lovely- Either you fly first class, or your children will.

Getting Money Out Of The Rentals

As mentioned in our sections on retirement planning in a later chapter, net rental income (profits) is not subject to Social Security and Medicare taxes unless you are operating a hotel or providing substantial personal services. This might not seem like a big deal, but when we consider payroll taxes later, you might be creating additional taxes unnecessarily (keep reading).

The next hurdle is how to get the money out of the rental property itself. What can be done? Two options in reference to paying your children to work on the rental properties-

• Create a property management company, or
• Pay them directly from the rental property checking account, either processing payroll or paying them as a contractor (both of these options have problems as we will discuss).

The next hurdle is that your child or children must be doing actual work at a compensation rate that is reasonable. $100 an hour to pick up pine needles might be excessive.

Create A Property Management Company

This is the most elegant option since you can a) scale this arrangement across multiple rental properties, and b) use the same arrangement to fund additional retirement accounts for you and your children such as a 401k plan.

How does this work? You would charge your rental properties a management fee that is usual and customary. 5-10% for long-term rentals, and perhaps 20-40% for short-term rentals. This is paid like any other management fee where money is paid from the rental property checking account to your management company checking account.

Sidebar: You can be a rockstar, and act like a real property manager and collect the rents directly, take your commission or fee, and transfer the remainder to the rental property checking account to pay remaining bills such as mortgage loan payments, property taxes, and typical expenses.

The management company could also provide direct chargeable services such as advertising, picking up pine needles, licking stamps and other cleaning and maintenance services. From there, payroll accounts are set up and payroll is processed with paystubs, W-2s, etc. Yeah, real payroll. One children, a gaggle of children. One employee, or a SWAT team. Proper payroll processing is the same.

For single-member limited liability companies (LLCs) or sole proprietors, if your child is under the age of 18, the business does not have to pay typical employment taxes such as Social Security and Medicare. You can also avoid unemployment taxes until the child turns 21. But for S Corps and C Corps, Social Security and Medicare taxes are paid regardless of age (we discuss this again later).

This is akin to the family management LLC concept that we discuss in our tax reduction strategies article. You can read it here-

Learn more in our tax reduction strategies guide

Property Management Problems

However, the property management option quickly creates two potential problems-

• Depending on your state and regulated industry rules, you might have to register your management company. This might be extreme, right? You could also consider the payments from the rental properties to your basic LLC as consulting fees, cleaning services or contract maintenance and repair expenses, and not property management as a workaround.
• You might easily run into a situation where your property management fee or services fee creates a rental loss. However, that loss might be limited based on passive activity loss limits (see our section on page 104). Sure, you can reduce this with the wage expenses from paying your children and Yes, your passive activity losses will eventually offset future rental profits or release upon sale, but be aware of the corner you might be painting yourself into. And if Johnny or Suzie is being paid to paint, then this becomes a bit ironic.

Payroll Processing Problems

There are four problems with processing payroll-

• The cost of processing payroll can be $800 to $1,200 annually depending on the payroll processor such as Gusto, ADP, Paychex, Intuit, etc. This might go away if you already process payroll through an existing business (we talk about S corporations in a bit).
• If your child or children are 18 years or older, Social Security and Medicare taxes must be paid at 15.3% of the wages paid.
• Payroll is another headache to add to your already long list of headaches. The IRS is fairly chill, but states can be a big pain in the butt. Texas, piece of cake. Ohio? Complete nightmare with local cities and school district taxes. Check out your own paystub and see what nutty taxes are being withheld by your employer- that is a decent barometer of what you’ll need to handle for paying your children to dust the end tables and replace lightbulbs.
• Where do you put the payroll processing system? If you don’t do the property management, family management LLC or contractor / consulting idea above, then you typically will process payroll from the rental property itself. This doesn’t scale since payroll accounts are tied to an Employer Identification Number (EIN). One rental, one LLC, one EIN. Sure, one rental property could lend your child to another rental property (employee leasing) but that is unnecessarily messy. Alternatively, one LLC can own several rental properties but most real estate investors like compartmentalization if they can.

Tax Savings Of Employing Your Children

The juice must be worth the squeeze, right? The tax arbitrage is real as we discussed above, but the math comes from the difference between the parent’s tax rate and the “costs” of processing payroll including payroll taxes such as Social Security and Medicare.

One child earning $7,000 might not be worth the effort whereas $15,700, which is the standard deduction for the 2026 tax year, might be. Consider the following table-

As you can see, employing your 19-year-old college student when you are in the 24% marginal tax bracket, might not be worth the effort. The $566 bolded above might not push your needle or blow your hair back. Two kids, ages 15 and 17, might make the effort worthwhile especially if you are in the 24% marginal tax bracket or higher.

There are also some parental pleasures beyond the dollars and cents such as having your children contribute to a Roth IRA at an early age. Imagine your 15-year-old contributing $7,000 annually to a Roth IRA. When they are 25 years old, they would have $70,000 in contribution basis to be used for a home purchase. Or they could let it ride for another 40 years and have a healthy nest egg towards retirement.

The Equal And Opposite Reaction

There are several things at play when considering employing your children with your rental properties. First, and as mentioned earlier, your children must actually work, and this is the biggest bone of contention with the IRS. Consider that a $30 an hour job would need 500 hours or about 10 per week to achieve $15,000 in wages. So, get that squared away and be reasonable.

Also, the pay must be consistent, and the pay must be usual and customary to what you pay others for similar work. Basically, you need to treat them like any other employee or service provider to avoid trouble. Lastly, you need to keep detailed records such as timecards and job descriptions (of course you do!). This must be perceived as an arms-length relationship.

Another issue to consider is support and claiming them as a dependent. If your child is going to college and you are paying them to work at the family business or on the rental property, for you to claim them as a dependent you must provide over half of the their support. This includes the amounts spent to provide food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities.

This creates an interesting conundrum. If your child earns $30,000 working for the parents, but socks all the money away into savings while you continue to pay over half of the support such as rent, food and education, you can still claim them as a dependent. Nice, right?

Many states also have labor laws that dictate the age your child can work, even if employed by the parents. For example, Indiana allows a 14-year-old to work with a permit. Minors under 14 may work as newspaper carrier, golf caddy, domestic service worker in a private residence (sounds like chores) or farm laborer. Minors under 12 in Indiana can only be farm laborers. Again, in Indiana, there is no need for a work permit if the work is outside school hours of 7:30AM to 3:30PM. We bring these examples to light so you understand and check your state or local laws about hiring your kids.

WCG CPAs & Advisors will not process payroll for any child under the age of 12 unless there are special circumstances. For example, we have a client who has twin 9-year-old daughters who do quite well recording Tik Tok videos. We continue to be amazed at how people make money, and what the public is willing to pay for the efforts. But we digress.

Education Credits

You can also create some tax due to take advantage of the American Opportunity Tax Credit (AOTC). Huh? You, the parents, make too much money and cannot take advantage of the AOTC education credit. But Johnny or Suzie, with a little bit of tax due on their 1040 tax return from a $30,000 salary (for example), can get all the tax back as a credit plus the refundable portion.

There are some things to navigate through such as claiming them as a dependent, the work needed for a $30,000 salary, etc. but it is something to consider.

Add Your Children To Your S Corporation

Do you already have a business taxed as an S Corp and process shareholder payroll? Perhaps you have employees too. You might be able to create a business need for your rental properties to pay a consulting fee or pay for other services to your S corporation, and then process payroll for your children.

However, there are some pitfalls. If you are paying them through an S Corp, you must also pay Social Security and Medicare taxes at 15.3% regardless of age. Therefore, your marginal tax rate needs to be 22% or higher for this to make sense (see table above). How much sense? 6% difference in taxes multiplied against $15,000 is $900.

Considering Your Children Independent Contractors

Calling your children independent contractors, paying them directly and issuing an eventual 1099-NEC is problematic on two fronts-

First, to truly be a contractor they must generally hold themselves out to the public as someone in that line of work, trade or profession. Here is the verbiage from Colorado, WCG CPAs & Advisors’ home state-

service performed by an individual for another shall be deemed to be employment, irrespective of whether the common-law relationship of master and servant exists, unless and until it is shown to the satisfaction of the division that such individual is free from control and direction in the performance of the service, both under his contract for the performance of service and in fact; and such individual is customarily engaged in an independent trade, occupation, profession, or business related to the service performed.

What Colorado is basically stating is that all services performed are presumptively deemed employment (i.e, as an employee, and not as a contractor) unless you prove otherwise. Many states are similar.

Let’s say you can prove that your children hold themselves out to the public as lawn mowers by mowing other lawns besides the rental properties. Good! However, as independent contractors being paid as a 1099-NEC, they will pay self-employment taxes of 15.3% (which is essentially Social Security and Medicare taxes). 12 years old. 22 years old. It doesn’t matter.

The silver lining of being an independent contractor is the ability to deduct business-related expenses on Schedule C of the 1040 tax return (or business entity tax return such as a partnership or S corporation). As you are painfully aware, a W-2 employee cannot deduct mileage and other expenses against their W-2 income since 2017.

Mom And Dad (your parents)

The concepts above could also be applied to supporting your parents. There could be some scenarios where paying them a salary makes sense as well. Other sources of income and tax brackets all need to be considered, of course.

Summary of Paying Your Children From The Rental

We covered a lot in this section, and as you can see there are a ton of considerations. To repeat ourselves, there are three basic ways to compensate them for their amazing cleaning, painting and social media talents. In descending order of elegance, you can-

• Create a property management company. As mentioned, however, this can create some new problems with state registrations and licensing unless you call it something else, and only provide services such as cleaning and maintenance.
• Process payroll through an S corporation if you already have that deployed. The concerns here are creating a business connection between your rental properties and your S Corp, and the additional payroll taxes for Social Security and Medicare.
• Consider them an independent contractor and issue a 1099-NEC. We just discussed the problems with this scenario.

As you can see, employing your children to help with the rental properties and real estate investments can be a financially smart move but it takes some effort and invites some risk.

By Jason Watson, CPA
Posted Sunday, March 22, 2026

This section is a mini me of our various rental property depreciation sections. Here is the collapsed summary-

A question we entertain on the daily is “I want to save taxes. Should I have the business / rental property buy a car?” Our auto-attendant replies with, “Do you need a car?” If you answer with “Yes” the auto-attendant replies with, “Hold please.” If your “Yes” is not quick or mumbled, or if there is any recognition of hesitation, the auto-attendant is unhappy.

Kidding aside, there are only a few questions you need to ask yourself when considering an automobile purchase in connection with your rental property or small business. Are you the type of person who buys new? How long do you typically keep your cars? Is the car 100% business use? How many miles do you plan to drive? There is a decision tree section that follows on page xx.

Back up for a bit. Remember our previous discussions about tax deductions, and how only a fraction of the money you spend is returned to you? So, back to our auto-attendant, “Do you need a car?” If the answer is “Yes” because your bucket of bolts is getting exceedingly dangerous, then Yes, buy a much-needed car out of a sense of safety. If the answer is “Not really, but I want to save taxes,” then don’t.

Two rules to live by-

• Cash is King (keep it!)

• Depreciation is a tax deferral not a tax avoidance system (typically)

There might be some other external forces at play. For example, if you need a car next year but your income is ridiculously and unusually high in the current tax year, then reducing your income now makes sense. Again, tax modeling and planning is critical.

We use car and automobile interchangeably. Ok, you’ve determined that an automobile purchase should be in your near future, now what? There are five scenarios in descending order of elegance-

• You Own the Automobile, Take a Mileage Deduction (clean and elegant)

• You Own the Automobile, Take Actual Expenses Deduction (a bit more recordkeeping)

• Rental Property Activity Owns the Automobile (mixed bag)

• You Own the Automobile, Get Reimbursed by the Mile (not common in rental properties)

• You Own the Automobile, Lease it Back to Your Business (unnecessarily complicated)

Before we jump into these various situations, we need to revisit rental property travel deductions. We expand on this in an earlier section, but here is a summary of the various issues and considerations-

• Travel to your rental property must be meaningful, ordinary and necessary.

• Travel between work locations is generally deductible. The power of the home office with your rental property activities is critical. A home office is simply another work location, where your commute is now from the bedroom to the basement.

• Travel away from your home (tax home) in pursuit of a trade or business is generally deductible. Your tax home is the location where you earn your primary income.

• Travel costs with research, start-up and acquisition have several rules where they might be deductible, they might not be deductible, or they might be added to the purchase price of the rental property and depreciated accordingly.

• Travel expenses during repairs and improvements also have various rules depending on the classification of repair versus improvements.

As mentioned above, see our rental property travel deductions section for a deeper look into these issues.

You Own the Automobile, Take Standard Mileage Deduction

This is the class favorite for two big reasons- first, the ease of simply recording mileage with a mileage log (paper or phone app) is appealing. Date, beginning odometer, ending odometer and business purpose. Simple!

The other reason is tax arbitrage. According to AAA, the cost to own and operate a 2022 small sedan was 54 cents per mile assuming 15,000 miles driven per year. However, this includes all sorts of fixed costs as well such as insurance, registration and finance. In other words, regardless of the miles driven, you will incur some fixed expenses. Even if you don’t finance, you still have a cost to use your equity (i.e., paying cash).

Back to the tax arbitrage. The data above is for a new automobile, and of the 54 cents above, 24 cents is depreciation. However, automobile depreciation is not linear. If you purchased a 5-year-old nicely used Honda Accord, its annual depreciation is tiny as compared to a new one. Also, depreciation is a cashless expense in a sense. Sure, cash is being spent on the automobile itself, but if viewed as a sunk cost, then depreciation is cashless.

What are we getting at? A lightly used small sedan will operate for a lot less than 60 cents per mile although the IRS allows you to deduct 72.5 cents per mile for the 2026 tax year. Let’s assume that you drive 6,000 miles for the rental property, and your true operating costs are 24 cents per mile. This is a difference of 48.5 cents, and at 6,000 miles this equates to $2,910 as a rental property expense.

Sidebar: You are technically supposed to reduce the cost basis of your automobile by the depreciation portion of the mileage deduction. This in turn could cause a taxable gain should you sell your automobile for more than its original cost basis after being reduced for the mileage depreciation. Most tax professionals don’t know this, and certainly most taxpayers don’t know this either but there you go.

You Own the Automobile, Take Actual Expenses Deduction

There might be times where actual expenses provide for a better tax deduction. However, as we’ve just shown with the mileage deduction calculation above, your automobile would need to operate at a high cost. This is not totally uncommon with large work trucks and SUVs. According to the same AAA data as above, half-ton trucks operate for 86 cents a mile at 15,000 annual miles.

There are two downsides to taking the actual expense deduction. First, you must track all miles driven, both personal and business. This is necessary to support your business use percentage since it will be applied to your actual expenses.

For example, you drive 15,000 miles total and 6,000 were for the rental properties, or about 40%. This 40% is then applied to the costs of insurance, registration, maintenance, fuel, new tires, etc.

The other downside is that once you use actual expenses for a tax year, you must continue to use actual expenses for the remainder of that automobile’s use in the activity (rental property use, small business use, etc.).

Rental Property Activity Owns the Automobile

This one is tough since you would need to demonstrate at least 50% business use in the rental property or series of rental properties to leverage the most tax benefit. You own a single-family home as a long-term rental and would like to take advantage of the electric vehicle credit on that shiny Cybertruck. This idea might not work, and it also might cause an aggressive eye roll from your spouse.

Can you support at least 50% business use? Sure, but why have a $100,000 automobile sitting around most days not being driven?

What if the rental property is a short-term rental? What if your rental property is an 8-unit mini apartment building? What if you purchased four rental properties in one year that needed a lot of minor repairs?

As you can see there are a zillion different facts and circumstances where you could justify having your rental property activity or activities own the automobile. From there, you need to ensure it makes tax sense. As we discussed in the beginning of this chapter, the value of a tax deduction is substantially less than the cash spent. However, with automobiles that degrade in value, at times it makes sense for this value degradation to be a tax deduction as well.

See our buying a car for the rental property section for a deeper dive into the minutia.

You Own the Automobile, Lease It Back to Your Rental

If you owned and operated a landscaping business, you might own the heavy equipment personally, and lease it back to the business. This is very common and is considered a self-rental.

The same thing can be accomplished with your automobile. You would lease a car that you own back to your business. This is not considered the same as the business leasing the car from a dealer. This is creating a self-rental arrangement between you and your business. Why would you want to do that?

The usual reason- it might prove to be a better tax position since you are reducing the income of your LLC which is subjected to self-employment taxes. However, rental properties and real estate investments are not subject to Social Security and traditional Medicare taxes unless they are operated like a hotel.

As such, this automobile strategy is uncommon in a conventional rental property environment. We mention it in case your bartender or produce clerk is compelled to share their tax reduction prowess.

Pile On Those Automobile Expenses

At times you might want to skip tracking your mileage and rental property travel expenses because you are unable to deduct passive activity losses. For example, your W-2 income is too high, and the rental property does not qualify as a short-term rental. Therefore, you tell yourself, “Why bother? My rental losses don’t help me.”

Keep in mind that unallowed losses are not lost forever. Rather, they carried over year after year on Form 8582 Passive Activity Loss Limitations, and can be used when you have rental profits or when you sell the rental property. As such, track that mileage or travel expense, and pile on!

Who Pays for Gas?

With anything that is mixed use between personal and business or rental property, the asset is owned by you the human. Therefore, personal funds should be used to pay for all related costs and payments. The common examples are automobile, cell phone and home office expenditures.

Mileage Log

For the mileage deduction and actual expense deduction, you need a mileage log. This includes date, beginning odometer, ending odometer and business purpose. Most rental property owners use a smartphone app to keep track of the miles. Sure, it is simple to peg the number of round trips or something similar, but there are a lot of other miles driven in connection with the rental property (Lowe’s, landfill, Target, bank, etc.).

Keep in mind that the IRS wants corroborating evidence to support your mileage logs, so keep those Jiffy Lube receipts or other service records showing odometer readings near the beginning and end of the year (so extrapolation can occur). Just whippin’ out a pretty color-coded spreadsheet during an IRS examination is not enough.

Finally, mileage logs must be maintained in real time or what the courts like to call contemporaneous records.

By Jason Watson, CPA
Posted Monday, September 29, 2025

This section is a mini me of our various rental property depreciation sections. Here is the collapsed summary-

Depreciation Overview

Generally, there are two ways to compress time and hurry the tax benefits when you purchase and deploy certain property- bonus depreciation and Section 179 deduction (what some people call instant expensing). To be certain, Section 179 can be viewed as a form of “accelerated depreciation” since a) you list the property on your fixed asset listing of your tax returns, and b) there is depreciation recapture should the business use fall below 50% or you sell property (either the property itself or the associated rental property).

Accelerated Depreciation with Bonus

To reiterate, certain property purchases allow for a portion of the property (asset) to be instantly depreciated, or “bonused.” What do we mean by a portion? 2022 was the last year of 100% bonus depreciation. 2023 was 80% and 2024 is 60%. However, thanks to the One Big Beautiful Bill (OBBB, or OB3 as some like to say), bonus depreciation is back to 100% for 2025 through 2030. 2023 and 2024 tax years are still hosed unfortunately.

Sidebar: Under IRC Section 280F(b)(2), only listed property (passenger automobiles, entertainment / recreation, computers and peripheral equipment, and cell phones/telecommunication equipment) have a similar recapture rule when business use falls below 50% as described above.

Section 179 Deduction

Generally, Section 179 allows businesses to deduct the full purchase price of qualifying equipment and property bought or financed during the tax year. Sounds simple enough, right?

However, rental properties are not automatically considered a trade or business (see definition in our rental property as a business section). Rather, the presumption is that they are passive and on the opposite end of the business spectrum.

When to Bonus? When to use Section 179? Both?

While bonus depreciation usually grabs the real estate headlines, IRC Section 179 is often the more practical tool for small-to-mid-sized investors. Choosing between the two isn’t just about picking the biggest federal deduction; it requires understanding state tax conformity, entity-level income limitations, and recapture rules if you ever decide to move into your rental property. Furthermore, Section 179 might be your primary option for maximizing year-one deductions on properties acquired before the OBBBA January 19, 2025 deadline.

The other issue is that Section 179 has limits. The maximum Section 179 expense deduction is $1,290,000 (for the 2026 tax year). This limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $3,220,000.

Can you use both? Yes. You can dictate to the dollar how much Section 179 you want to use “first” and then piggyback it with bonus depreciation. Technically, Section 179 is deducted first with bonus depreciation being second. The net-net is good tax planning by a qualified real estate-minded tax professional.

See our Section 179 or bonus depreciation section for a ton more information.

Allowed Versus Allowable Depreciation

The question comes up often where a real estate investor does not want to mess with rental property depreciation for whatever reason and decides against deducting it on their tax returns. The most common reasoning is- why depreciate my rental property since I cannot deduct the rental loss on my tax returns?

Generally, if you don’t deduct rental property depreciation, when you sell the property, you will be required to recapture depreciation as if you deducted it. Yuck. However, if you didn’t deduct rental depreciation on prior tax returns, you can easily fix it with a Form 3115 Application for Change in Accounting Method and Section 481(a) adjustment.

This is called the allowed versus allowance rule. Allowed is what you claimed and deducted. Allowable is what you should have claimed and deducted.

Qualified Improvement Property (QIP)

Qualified Improvement Property is defined as any improvement made to the interior of a nonresidential building after the building is placed in service and is eligible for bonus depreciation. Improvements exclude expansion of the building, elevators and escalators (specifically called out, really?!), and changes made to a building’s internal structural framework. Oh, and let’s not forget that residential property also does not qualify.

There is also qualified improvement property that is eligible for Section 179 expensing (as opposed to bonus depreciation) on nonresidential property such as roofs, HVAC (heating, ventilation, air conditioning), and fire protection and alarm systems including security systems.

If your rental property has tenants or guests who stay 30 days or less, then they are considered transient. Subsequently, the rental property is not considered residential. As such, you might be able to immediately expense the new roof or HVAC unit under Section 179.

Sidebar: Don’t get twisted on short-term rental loophole and transient rental. Generally, short-term rentals are rentals where guests or tenants stay 30 days or less. However, for the short-term rental loophole where your rental property losses are no longer limited, the average guest stay must be 7 days or less and you must materially participate in the activity. We discuss this in detail in our short-term rental (STR) loophole section.

Partial Asset Disposition (PAD)

When you replace the air conditioning system, for example, you are replacing a part, albeit tiny, of the entire rental property. As such, and when accounting for depreciation, with a partial asset disposition (PAD) you might have a loss on the old system when you replace it. Specifically, partial asset dispositions allow rental property owners to claim a loss on the disposition of a component (structural or otherwise) of an asset without having originally identified the component as an asset before the disposition.

WCG CPAs & Advisors recommends and uses KBKG for various calculations and tools including PPI. According to their website-

The KBKG Partial Disposition Calculator is designed to make calculations as simple as possible while minimizing unnecessary work. By providing basic data, the calculator provides a PPI adjusted value while considering the condition of the respective component at the time it was acquired (accomplished by considering the component’s normal life, quality, and age).

CAUTION: Using a PPI discounting method to establish tax basis for a retired building component may grossly overstate the taxpayer’s retirement loss deduction.

If your rental property experiences a casualty loss through fire or flood, partial asset dispositions are handy for harvesting tax losses when insurance falls short. Technically, a casualty loss is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.

As stated previously, this section is a reduced version of our various rental property depreciation sections. Here is the list of the topics that we expand upon-

• Accelerated Depreciation with Bonus
• Section 179 Deduction
• Allowed Versus Allowable Depreciation
• Qualified Improvement Property (QIP)
• Partial Asset Disposition (PAD)

By Jason Watson, CPA
Posted Monday, July 7, 2025

Here are some FAQs you might find helpful as a chapter summary.

What makes an expense deductible for rental property purposes?
It must be ordinary (everyone does it), necessary (my rental would die otherwise), reasonable, and directly related to the rental activity.

What’s the difference between a tax deduction and a tax deferral?
A deduction lowers taxable income immediately. A deferral (like depreciation) saves tax now but may result in future tax through recapture.

Is depreciation really a deduction if I don’t spend money?
Yes. It’s a non-cash deduction, allowing you to recover the cost of your investment over time. Since mortgage principle payments are not deductible, depreciation, in part, is designed to help offset the tax burden of using after-tax cash to pay down debt.

Are passive losses lost forever?
No. Unused passive losses carry forward and can offset future rental income or be released upon sale.

What advertising costs are deductible?
Listing fees, staging, signage, platform subscriptions (Airbnb, VRBO), and marketing consultants.

Can I deduct property management fees?
Yes—monthly fees, tenant placement costs, and startup charges are all deductible.

Are software tools deductible?
Yes. Tools like REIHub, Stessa, and QuickBooks are ordinary and necessary.

Can I deduct a home office for managing my rentals?
Yes, if you use a dedicated space regularly and exclusively for rental activities. The “regularly” part can be problematic.

Are commissions deductible?
Yes. Leasing fees and real estate agent commissions associated with finding guests or tenants are transactional deductions. Commissions associated with purchasing a rental property is considered an acquisition cost.

Can I deduct furnishings and supplies?
Yes, if used for the rental. Items under $2,500 may qualify for de minimis expensing.

What about occupancy taxes and permits?
Yes. Licensing, permit fees, and local lodging taxes are all deductible.

Are utilities deductible if tenants reimburse me?
Yes. Report utility income as gross rent and deduct utility costs separately.

How should I allocate general expenses across multiple properties?
Use a consistent method: gross rent, square footage, or equal allocation depending on context.

Can I deduct expenses for a property not yet rented?
Yes, once it’s placed in service, expenses like marketing and repairs, and other operating expenses, are tax deductible. We’ll say it again- get that rental placed in service as we’ve defined elsewhere.

Should my rental property own a car?
Usually no. Use mileage deduction or actual expenses tied to your personal vehicle for cleaner records. However, at some point you might justify (ordinary and necessary) purchasing a work truck or separate vehicle dedicated to your gaggle of rental properties.

Can I write off meals while traveling for my rental?
Sometimes. Only when the travel is related to the rental property and you required substantial rest during the travel (overnight).

Can I deduct travel to buy a rental property?
Generally not—it’s capitalized as an acquisition cost and depreciated.

What is a deductible operating travel expense?
Travel between rental properties, your home office, or suppliers/vendors (like Lowe’s or Home Depot).

What method should I use to deduct vehicle use—mileage or actual expenses?
You can use either the standard mileage rate or actual vehicle expenses, but not both. Most landlords use the standard rate for simplicity.

How do I track mileage for rental-related travel?
Use a contemporaneous log with date, destination, purpose, and miles driven. Apps like MileIQ or REPSLog help automate this.

Is traveling from my home to the rental property deductible?
Yes, if you qualify for a home office deduction. Under IRS rules, travel from your personal residence to a rental property within your tax home is generally considered commuting, which is not deductible. However, if you have a qualified home office that serves as your principal place of business for managing your rental properties, then travel from your home to rental sites is considered travel between work locations is deductible.

What is my tax home?
Your tax home is your primary place of business and for most rental property owners, it will be your primary residence regardless of having a home office. It usually encompasses the general metropolitan area as well such that travel within this space is commuting (unless you have a home office as defined by the IRS).

Can I deduct travel expenses if my rental property is outside my tax home?
Yes, with or without a home office, travel outside your tax home for the rental property or business purposes is deductible.

What if I don’t have a home office—can I deduct local travel to my rental property?
It depends on the distance and purpose of the trip. If you don’t have a qualified home office, then travel from your home to a rental property within your local metro area is generally considered commuting, and not deductible. However, travel outside your tax home (often defined as more than 50 miles or beyond your normal geographic area) can be deductible as business travel, even without a home office.

Can you give me a summary of the FAQ above because my head hurts?
Sure, local trips without a home office = commuting (non-deductible). Long-distance trips (outside your tax home) = business travel (deductible). Keep in mind: you must still have a legitimate business purpose for the travel (e.g., repairs, inspections, meetings), and proper documentation (mileage log, receipts) is essential to support the deduction. Darn recordkeeping!

Is lost rent deductible?
No. Cash-basis taxpayers only report received rent—uncollected rent isn’t deductible. Your deduction if you will is the lower than normal rental income. Doesn’t make you feel any better, we get it.

Can I deduct security deposits I keep?
That would be nice. You recognize the kept security deposit as rental income and deduct the associated repairs as expenses.

Can I expense a water heater replacement in my rental property?
Yes—if the total cost is under $2,500 per unit or invoice, you may use the de minimis safe harbor to expense it. If not, you may qualify under the small taxpayer safe harbor or potentially the routine maintenance safe harbor, depending on your expectations for future replacements.

Is a water heater considered personal property or a building improvement?
Generally, a water heater is part of the plumbing system, which is a building system, not personal property. It typically must be capitalized and depreciated unless a safe harbor applies. See above.

Can I deduct a new roof under Section 179?
Yes, but only if your property qualifies as non-residential real property (e.g., short-term rentals with average guest stays under 30 days or commercial building), and your involvement is regular, continuous with a profit motive. Otherwise, the roof is typically capitalized and depreciated over 27.5 or 39.0 years coincidental with the primary building.

What’s the best tax treatment for replacing an HVAC system?
It likely exceeds the $2,500 de minimis limit. However, it might qualify for small taxpayer safe harbor. Alternatively, it might qualify as qualified improvement property (QIP) under Section 179 if the rental is non-residential and operated as a business.

Is a mini-split air conditioner considered an appliance or HVAC system?
It depends on the installation. Arguably, a stand-alone mini-split could be considered personal property or an “appliance” and thus eligible for Section 179. But the IRS might view it as part of the building system if fastened to the structure requiring capitalization if new (converting an attic, for example). If replacing a mini-split, perhaps small taxpayer safe harbor could be used).

Can I expense a window AC unit or portable appliance?
Yes. These are considered personal property, usually under $2,500, and can typically be expensed immediately under the de minimis safe harbor.

Is a hot tub considered personal property or real property?
Depends. It is 15-year property, but whether it is personal property and eligible for Section 179 depends on the installation. Above ground on a slab, personal property. Cut into a deck or in the ground, real property. Either situation is bonus depreciation eligible; the difference is Section 179 eligibility.

Can I legally pay my children to help with my rental properties?
Yes, but they must perform real, documented work at a reasonable pay rate. The arrangement should resemble a normal business relationship, with timecards, job descriptions, and consistent pay that reflects the work performed.

What are the tax advantages of paying my children from the rental property?
You can pay each child up to $15,000 tax-free (2025 standard deduction) and still claim them as dependents if you provide over half their support. This can reduce your taxable income, offering significant tax savings, especially in higher tax brackets.

What is the best way to pay my children for rental-related work?
The most elegant option is to create a property management company that charges your rentals a standard fee and then pays your children through payroll. Alternatives include using an S corporation (if already in place) or treating them as independent contractors (which has drawbacks).

Are there payroll tax considerations when employing children?
Yes. If your child is under 18 and employed by your sole proprietorship or single-member LLC, you can avoid Social Security and Medicare taxes. However, if they are 18 or older or employed through an S Corp, those payroll taxes must be paid.

Can I pay my child as a contractor and issue a 1099-NEC?
You can, but it’s problematic. Many states presume services performed are employment, not contract work. Plus, your child would be subject to self-employment tax (15.3%), which might offset much of the benefit unless they truly operate a business independently.

How much can I actually save by employing my child to work on my rentals?
That depends on your tax bracket and payroll costs. For example, a parent in the 35% bracket employing a child under 18 and paying $15,000 could net around $4,450 in savings after payroll costs. With older children, savings may drop significantly because of Social Security and Medicare taxes.

Can I still claim my child as a dependent if I pay them?
Yes—as long as you provide more than half of their total support, you can still claim them, even if they earn and save a significant amount. Just make sure their income doesn’t exceed the support you provide in areas like housing, food, and education.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

There are two situations where you need to use some math to determine the expenses and where they end up on a tax return.

Splitting Between Rental and Primary Residence

When you convert your rental property back to a residence, either a primary or second home, or if you convert your primary residence into a rental, there are prorations of expenses. The obvious ones are mortgage interest, real estate or property taxes, and hazard or homeowners’ insurance. Non-rental mortgage interest and taxes might be deductible on Schedule A of your individual tax return (Form 1040) subject to all the hoopla and limitations found there. Non-rental insurance is typically lost.

This is an easy two-step process-

• First, compute the overall rental property percentage. You converted a primary residence to a rental property on August 1. This would be 212 days as a primary residence or 58%.
• Second, apply this percentage to common expenses between the residence and the rental property such as mortgage interests, taxes, insurance, utilities and HOA dues, among others. Keep in mind, and we touch on this below as well, certain expenses might be 100% related to the rental property such as advertising, management fees and supplies. Repairs can be a head-scratcher depending on the repair, timing, and which way you are going (from home to rental, or rental to home).

Splitting Between Rental and Personal

We mentioned this issue here and there throughout this section. There are two common situations where you need to assign a business use percentage to a rental property expense-

• You use a dwelling unit as a home during the tax year if you use it for personal purposes more than the greater of 14 days, or 10% of the total days it is rented to others at a fair rental price. These are vacation home rules.
• You convert your primary residence or second home into a rental property, or take a rental property out of service where it is no longer being held for the production of income.

Advertising, marketing, management fees, licenses, permits and occupancy taxes are usually 100% associated with the rental property.

Supplies can be murky, right? That bottle of dish soap might be used both by guests and you. Perhaps you argue that coffee pods are solely for guests.

Repairs might be equally murky. What if you can demonstrate that a repair was required because of damage from a guest, and not normal wear and tear. Replacing a door handle might be considered normal wear and tear, and as such will be allocated between the rental property use and personal use. However, this same door handle is replaced because your guest broke the key off inside the lock. That might change things a bit, right?

There is no shortage of examples.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

You might have general rental expenses that you want to allocate across all your rental properties. For example, a commercial umbrella policy might cost $1,500 in annual premiums. Do you allocate to each rental property? Usually Yes, and there are a handful of reasons why-

• If you want to assess each rental property’s profitability and return on investment, proper allocation is necessary.

• Lumping a bunch of general expenses to one rental property might skew your tax deductions and increase your audit rate risk unnecessarily.

• Not all rental properties are considered the same; some might be long-term, some might be short-term with an average guest stay of 7 days or less, one might be commercial, and another might be a vacation home. Different allocation methods might create some beneficial tax arbitrage depending on the type of rental activity (assuming the method is reasonable and consistent).

• You might have a triple net lease (NNN) where certain expenses are passed onto the tenants. While these expenses are typically directly and solely related to the singular rental property, you might have some general expenses that need an allocation. For example, you buy paint by the pallet since all your properties are painted with the same lovely yet boring colors including the office building.

Ok, now what? How much? There are five basic ways to allocate rental property expenses, and some might not be appropriate depending on the general expense-

• Gross rent

• Value

• Square footage

• Time spent

• Equally (same weight for each)

Back to our commercial umbrella policy. Do you allocate depending on the value of the rental properties? Or do you allocate based on risk assessment where a short-term rental has a lot more opportunity for injury and related problems (risk)? If the short-term rental is also one that is not limited by passive activity loss limits, then that could influence your allocation calculation provided you have a reasonable and consistent method.

There are several general expenses that you might need to spread across your rental properties and real estate investments. These include a work truck that is dedicated to your rentals, an employee that works directly for you and maintains all your properties, an attorney who is on retainer and handles all your real estate matters, a cell phone, bulk supplies such as paper towels or soap, tax return preparation fees, software and application subscriptions, among other examples.

Home office allocation across all your rental properties poses some issues as well given loss limitations and lost expenses. See our home office deduction section.

Keep it simple of course, but also ensure each of your business units, and in this case your rental properties, are accurately reporting their expenses and subsequent tax deductions. While it might not change your ultimate tax footprint or consequence, it is good business stewardship and accounting. As we’ve mentioned throughout this book, your rental properties and real estate investments should be viewed from a business owner’s perspective.

Another version of the allocation of general rental expenses occurs when you list each unit of a multi-family or commercial real estate property as a separate activity. This might be required if some of the units have different purposes. For example, you have triplex, and one of the units is a short-term rental with an average guest stay is 7 days or less, and the other two units are also short-term but do not qualify for the loophole. You could complicate it further by using one of the short-term rentals personally as well and tripping vacation home rules.

In this example, most tax professionals and even the TurboTax DIYer will want to split this single building into separate rental activities on Schedule E of an individual tax return (Form 1040), and perhaps the same on Form 8825 within a partnership tax return (Form 1065). The simple reason is that it reduces the mental gymnastics of which losses are deductible, which losses are carried over and how.

As such, with a single building, you might still have the need to allocate general rental expenses across separate rental activities just like you would if you had several rentals as separate buildings.

See our splitting rental property activity section for more information.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

The following is a list of common rental property tax deductions. Some of these are short and sweet while others have an entire section to themselves (such as travel). Schedule E on your Form 1040 individual tax return and Form 8825 on your Form 1065 partnership tax return have a similar list. WCG CPAs & Advisors has an Excel template affectionately referred to as the Simplified Rental Operations worksheet, or the “SRO” for short-

wcginc.com/31

The following has a sample of Schedule E where you report rental property income and expenses-

Here we go-

Advertising and Marketing

These expenses include Airbnb or VRBO setup and recurring fees including staging pictures, print media and signage. You might list these as commissions, however, usually commissions are based on a completed transaction such as placing a tenant or scheduling a guest. Then again, we are splitting hairs.

A property manager might have start-up or boot-up fees as well. You might also use AirDNA to collect market data for your advertising and marketing plan. Multiple listing services (MLS), including Apartment Finder, Rent.com and the like are also common advertising expenses for rental properties.

Keep in mind the vacation home rules where certain expenses might be fully deductible even if you trip the vacation home trigger. Advertising and marketing is usually considered one of those expenses that are not prorated or split between rental expenses and personal expenses.

Automobile Expense

Automobile expenses are generally limited to three situations-

• Mileage deduction for eligible miles while managing and operating your rental properties. You own the automobile personally.

• Actual expenses based on eligible miles as a percentage of overall miles. You own the automobile personally.

• Actual expenses associated with the automobile that is 100% dedicated to the rental properties. You might own the automobile personally, or alternatively the business entity, such as an LLC or a real estate holding company, could own the automobile as well.

If you refer to the sample Schedule E form, you’ll see that Line 6 reads auto and travel expense. According to the IRS instructions, this line includes auto, travel and meals. However, it is also common practice to record travel such as airfare and lodging including meals on Line 19.

See our automobile deductions with rentals section and rental property meals section for more information.

Cleaning and Maintenance

This rental expense category seems obvious, but the word maintenance can be confusing. Is changing a light bulb considered maintenance? Likely. Is painting a wall that is scuffed considered maintenance, or is it a repair?

Maintenance is work performed to keep the rental property functioning correctly. Swapping out a light bulb makes sense. Replacing an HVAC filter or re-charging the air conditioning system makes sense as maintenance. Conversely, a repair usually resolves damage. In our scuffed wall example above, this would likely be a repair.

Let’s not forget the root word in maintenance is maintain. Ok, we really beat that up, didn’t we?

Cell Phone

Your cell phone is a commonly overlooked rental tax deduction, but how much do you deduct? A cell phone is what we call a mixed-use expense between business and personal. As such, you use personal funds to pay for the expense, and then assign a business use percentage to calculate the tax deduction.

Neat, how do you calculate business or rental property use? Are you tracking each minute spent? Back in the day, the answer was Yes. However, today any consistent and reasonable method is acceptable.

A single long-term rental property might be 5%. However, that same rental property where you turned over a tenant and several minor repairs were coordinated with contractors, your business use might jump to 15%.

A short-term rental that has one busy season might be 15%. Two busy seasons, such as a ski condo, might be 25%.

You also have to balance other cell phone demands. If you also run a separate business including managing rental properties, the rental portion might be less.

We could go on and on like a Journey song. The big takeaway is to be reasonable. The only time your cell phone could be 100% is if you had a separate and dedicated cell phone only for the rental property. Frankly, this is not a bad idea, so your guests, contractors and other similar people don’t have your personal cell phone number.

Commissions

Later in this section we discuss management fees, so it is important to draw a distinction between commissions and management fees here. Commissions in most walks of life are based on a singular transaction. A commission might be a property manager charging a leasing fee for finding a tenant. They might also charge a monthly fee for managing the property including the tenant relationship. This second example would be a management fee.

Another way to look at this- a commission is an expense paid to facilitate a transaction. A management fee is an ongoing expense to supervise and support a process or relationship.

Depreciation and Amortization

We have several other sections that discuss depreciation including accelerated and bonus depreciation. Here is a mini table of contents-

• Accelerated depreciation and IRC Section 179 expensing.

• Cost segregation and IRC Section 1245 personal property.

• Qualified improvement property (QIP).

• Changing depreciation between 27.5 and 39.0 years.

• Allowed versus allowable depreciation.

Amortization is usually reserved for intangible assets, and for rental properties this is usually loan costs.

Home Office

A home office deduction in connection to managing your rental property or series of real estate activities is tricky but it is also super beneficial for travel expenses. See our home office deduction section for more information. Additionally, see our allocation of general expenses as well.

Homeowners Association Dues

Easy, we’ll move along.

Insurance

Another easy one, but before we move along, at times a real estate investor or rental property owner will have commercial umbrella insurance to provide another layer of coverage to your liability onion. For example, you might have $300,000 in bodily injury coverage, but would like to increase this so you add a $3M umbrella policy. However, this second policy might start at $500,000 for bodily injury, so you will need to increase the limit of the underlying or primary insurance policy to prevent a gap in coverage.

We discuss how to allocate or apportion umbrella premiums across multiple rentals in our allocation of general expenses section.

Internets

Yes, plural. There are two types of internet expenses. First, you have a short-term rental and you customarily provide internet service for your guests and tenants. Second, you use your home internet service in part to manage your rental properties and real estate investments.

The first example is easy, whereas the second example requires a business use calculation similar to cell phone and home office listed previously. WCG CPAs & Advisors uses anywhere from 5% to 80% of your home internet expenses as associated with rental property management or business use, with most owners settling in between 5% and 30% depending the size of their kingdom.

Legal and Professional

Legal and professional fees include what you would expect such as eviction assistance or reviewing a lease. However, many rental property owners neglect to allocate tax return preparation and related expenses. Let’s say your real estate buddies at WCG CPAs & Advisors prepare your tax returns. The following year, we would allocate a portion of the fee to each rental property. For example, if your tax return preparation fee was $900, perhaps $200 of this is associated with the rental activities. Sure, it is a relatively small amount, but at a 29% combined marginal tax rate between federal and state, this might buy you a nice lunch for zero effort. Free food has no calories.

Licenses and Permits

We won’t spend too much time on licenses and permits, but be aware of the insidious application, permit and registration fees that a city or other authority might charge you for the privilege of being a landlord.

Management Fees

As we discussed earlier, management fees are those expenses for the continued and recurring management of the property including tenant relations. These are contrasted with commissions which are more transactional.

Like advertising and marketing, management fees are typically assumed to be 100% related to the rental activity when vacation home rules apply or if you convert a primary residence or second home into a rental.

We don’t want to stuff a bunch of expenses into management fees. The IRS reportedly uses management fees as a proxy of sorts to trigger the inquiry of passive versus material participation. In other words, high management fees suggest a more passive role for the rental property owner. As such, software and related expenses should be reported elsewhere leaving management fees being limited to guest and tenant placement fees or commissions only.

Mortgage Interest

Mortgage interest seems easy enough but when you borrow against your primary residence or another rental property, interest tracing rules will apply. See the mortgage interest tracing section.

Additionally, you might have interest associated with a credit card or other borrowing scenario.

Repairs

Oh boy, we discuss this in a zillion different places throughout our book. Here is a mini table of contents-

• Rental property repairs safe harbors (there are three of them).

• Improvements versus repairs.

• Rental property rehabs and renovations.

Software

Applications and subscriptions such as REIHub, Stessa, QuickBooks Online, Airbnb, VRBO, AirDNA, and the myriad of other support tools are ordinary and necessary expenses for your rental property.

Supplies and Furnishings

Supplies include cleaning supplies, coffee pods and creamers, shampoo and soap, and other similar consumables. Furnishings include dishes, pots and pans, kitchenware, linens, towels, decorations and furniture. Be aware of the $2,500 de minimis safe harbor where a piece of furniture that exceeds this amount must be capitalized as an asset and depreciated over time or Section 179 expensed. What is tricky is the dining room table that costs $4,000 total, but is made up of a table and six chairs where the invoice has each item listed separately.

Taxes

The two most common taxes for rental property owners are property tax, and sales, occupancy or innkeeper tax depending on your geographic location and local nomenclature. Historically, Airbnb, VRBO and the like made it challenging for landlords to be compliant. Today, they do a much better job helping you collect and remit the proper guest-related taxes.

Travel Including Lodging and Meals

Ah, another can of worms. We have two sections for your reading enjoyment. First, rental property travel deductions, and second, rental property meals.

Utilities

Easy, right? At times landlords will charge for utilities on top of the base rent. In these cases, you should still report all monies collected as top line rental revenue, and then deduct utilities as you pay them although some might be reimbursed. This allows for basic reconciliation where all money collected is either rent or a deposit, and money spent is either loan payments or expenses (yes, this is overly simplified, but you get the premise).

Lost Rent

Rental property owners routinely try to deduct lost rent, or the rent they didn’t collect because a tenant skipped out on the last month or broke the lease. This is like a business owner not getting paid on an invoice. Most rental property owners are cash-based taxpayers which means you recognize revenue when you receive cash. As such, if you don’t receive a rent payment then you are not recognizing revenue, and that in itself is the tax benefit.

Bad debts, including accounting for lost rent, only works in an accrual-based accounting world where you recognize income as you invoice the customer or tenant. Later, the invoice does not get paid although you recognized it as revenue originally. A bad debt expense is then used to offset this phantom income, and when combined the result is usually netted to zero which is the same effect as the first example in a cash-based world.

Idle or Vacant Property Expenses

See our idle property versus vacant rental property section on page 338 for several issues during vacancy-

• Expenses Immediately After Closing Before First Tenant or Guest
• Expenses During Renovations
• Expenses Incurred Finding Guests or Tenants

Expenses When Not Ready and Available For Rent

What about mortgage interest and property taxes while you are between tenants? If your rental property is not ready and available for rent, and in line with IRS Revenue Ruling 99-23 and IRC Section 195, these expenses are not considered operating expenses and therefore are not deductible.

You could possibly deduct the mortgage interest as a second home, but further discussion is required. You might be able to deduct the property taxes subject to the current $10,000 combined state and local tax limitations on Schedule A of your Form 1040 tax return.

What’s the answer? The answer is to make that rental property ready and available for rent as soon as possible.

You purchase a rental property on July 1, and it is generally ready to rent. Nothing says you must immediately pay a bunch of money for fancy pictures, staging and VRBO listings. The rental property is available with nothing more than your willingness and a habitable dwelling. Then you can start shooting the money canon.

Nothing says you must align your rent fee with market conditions; for example, you buy a ski condo on September 1. No one is going to rent your condo until at least Thanksgiving, but it is available to rent, and as such you are considered operating.

Nothing says you cannot have the rental property available for rent, and simultaneously be painting various bedrooms and walls waiting for your next tenant or guest.

Know the rules. Assert your facts accordingly. Keep your rental property ready and available for rent.

Kept Security Deposit For Repairs

The IRS in Topic 414, rental income and expenses, spells this out nicely-

Security deposits – Don’t include a security deposit in your income if you may be required to return it to the tenant at the end of the lease. If you keep part or all of the security deposit because the tenant breaks the lease by vacating the property early, include the amount you keep in your income in that year. If you keep part or all of the security deposit because the tenant damaged the property and you must make repairs, include the amount you keep in that year if your practice is to deduct the cost of repairs as expenses. To the extent the security deposit reimburses those expenses, don’t include the amount in income if your practice isn’t to deduct the cost of repairs as expenses. If a security deposit amount is to be used as the tenant’s final month’s rent, it is advance rent that you include as income when you receive it, rather than when you apply it to the last month’s rent.

Takeaways-

• If you deduct the costs of repairs as expenses, then consider a security deposit that is used to cover these costs as rental income.

•  If a part of the security deposit is last month’s rent or any period of rent, then that is considered income at the time you receive the security deposit. If you start a lease October 1, 2025, and collect last month’s rent, you will recognize this as income on your 2025 tax returns although a portion of the security deposit was for September 2026. This aligns with a cash-based accounting system.

Small Equipment Purchases

You purchase a laptop to help manage your rental properties. To say it is 100% business use is likely a stretch, but we can agree that it is more than 0%. Similar to cell phone, home office, internet and related expenses, or what business owners would call mixed-use or Accountable Plan expenses, small equipment purchases receive the same analysis- how much is personal and how much is related to rental property management.

By Jason Watson, CPA
Posted Sunday, May 25, 2025

A home office is simply another work location, where your commute is now from the bedroom to the basement, and your travel between work locations is considered business travel and therefore deductible. The home office deduction in itself is not that thrilling, but when it changes the color of money and converts commuting expenses into deductible business travel, it has some teeth. What are the rules for claiming a home office?

IRC Section 280A reads in part-

So, what are the exceptions?

• Certain business use (typical home office, and discussed more here)

• Certain storage use

• Rental use (tax free… 14-day “Master’s” or “Augusta” rule)

• Providing day care services

IRC Section 280A continues by reading-

Let’s review some of the buzzwords above. Exclusive means the identifiable space or room is used only for business purposes (so let’s not have a bed in your home office).

Regular is squishier since it is a facts and circumstances evaluation. Spending 4 hours a month selling Etsy stuff online or managing your rental property won’t win too many arguments.

Principal place of business was once a hot topic but has been tightened up with this language from IRC Section 280A(c)(1)(C)–

Administrative or management activities include a nice list from IRS Publication 587 Business Use of Your Home such as billing customers, guests, clients, or patients, keeping books and records, ordering supplies, setting up appointments, forwarding orders or writing reports (we list more below).

We have discussed this in other sections, but we’ll do it again here. A trade or business has been defined in Commissioner v. Groetzinger, 480 U.S. 23, and reads in part-

To be engaged in a trade or business, the taxpayer must be involved in the activity with continuity and regularity and that the taxpayer’s primary purpose for engaging in the activity must be for income or profit. A sporadic activity, a hobby, or an amusement does not qualify.

As such, to claim a home office with your rental property activities you must-

• Have an exclusive space that you use regularly,

• To perform administrative or managerial activities, and

• Be involved with your rental property activities with continuity and regularity with a profit-motive.

Is being a Real Estate Professional strongly support a home office claim? Likely.

Commercial property with several tenants? Likely. The same commercial property with a single user (think standalone Starbucks or Auto Zone building)? Unlikely.

Does having a single short-term rental support a home office claim? Less likely than above, but not impossible.

Can you claim a home office with a single long-term rental? Unlikely.

What about three rental properties? Perhaps, and now we are getting more into a facts and circumstances argument which is good and bad. Good, because there isn’t a bright line. Bad, because someone might disagree with you, and you will need to craft an argument.

Multiple Work Locations

While this might not be important for the typical rental property owner, it might be pertinent for the home builder or real estate agent. You can have multiple work locations. The IRS states that if you use a home office as your primary location for substantial administrative activities you are allowed to essentially have two work locations. For example, you own a landscaping business, and you have an office in your shop.

You perform all your administrative activities such as hiring and firing employees, accounting, balancing your checkbook, talking to your attorney, chatting it up with your real estate CPAs at WCG, etc. in your home office, that office counts as a work location in addition to your office in your shop. Here is the play-by-play blurb from IRS Publication 587 Business Use of Your Home-

You can have more than one business location, including your home, for a single trade or business. To qualify to deduct the expenses for the business use of your home under the principal place of business test, your home must be your principal place of business for that trade or business. To determine whether your home is your principal place of business, you must consider:

1. The relative importance of the activities performed at each place where you conduct business, and

2. The amount of time spent at each place where you conduct business.

Your home office will qualify as your principal place of business if you meet the following requirements.

1. You use it exclusively and regularly for administrative or management activities of your trade or business.

2. You have no other fixed location where you conduct substantial administrative or management activities of your trade or business.

Home Office Safe Harbor

There is a safe harbor provision for home office deductions where you can deduct $5 per square foot up to $1,500. For rental property owners and real estate investors, there are some real advantages for using the safe harbor method such as being able to use all mortgage interest on Schedule A instead of an allocation. Another benefit is the reduced recordkeeping requirements (safe harbors commonly have an element of reduced taxpayer burden of proof).

Sidebar: The simplified home office deduction (a.k.a., the safe harbor provision just described) cannot add to your rental property losses. This is a big deal. Whether you can deduct your losses in the current year doesn’t matter- you still want to pile on to your losses either to be used right away, or later with a carryover. As such, the traditional home office deduction (versus simplified) is preferred.

But there are also some limitations that need to be considered. WCG CPAs & Advisors typically optimize for both methods in these situations.

What about the real estate broker, or fix and flipper, where you are using an S corporation? According to IRS Revenue Procedure 2013-13 which reads in part-

02 Reimbursement or other expense allowance arrangement. The safe harbor method provided by this revenue procedure does not apply to an employee with a home office if the employee receives advances, allowances, or reimbursements for expenses related to the qualified business use of the employee’s home under a reimbursement or other expense allowance arrangement (as defined in § 1.62-2) with his or her employer.

An expense allowance arrangement is synonymous with an Accountable Plan which is how an S Corp shareholder is being reimbursed for a home office since they are also considered an employee.

Home Office Depreciation

Similar to rental properties (among other things), depreciation on a home office is required by the IRS. Here is a Q&A from their website under Sale or Trade of Business, Depreciation, Rentals > Depreciation & Recapture #3-

Question- I have a home office. Can I deduct expenses like mortgage, utilities, etc., but not deduct depreciation so that when I sell this house the basis won’t be affected?

Answer- No. All allowed or allowable depreciation must be considered at the time of sale. You can generally figure depreciation on the business use portion of your home up to the gross income limitation, over a 39-year recovery period and using the mid-month convention. As long as you determine actual expenses and the correct amount of allowed or allowable depreciation, the depreciation reduces the basis of your home accordingly, whether or not you actually claim it on your tax return.

Note that last phrase, “whether or not you actually claim it on your tax return.” That is the kicker. Truth be known, when a client sells their primary residence most tax professionals do not ask if it was ever used as a home office. Right, wrong or indifferent, it is often overlooked.

Additionally, home office depreciation is tough to track within a tax return. Sure, if you are a disregarded LLC or sole proprietor and reporting your business activities on Schedule C, you will use Form 8829 to generate the home office deduction and that form helps track home office depreciation. Easy. But as we discuss below, at times you are crunching these numbers separately from a tax form.

If you use the simplified method for the home office deduction, you do not have a depreciation recapture problem since you do not have to depreciate your home office. Back to easy again.

Home Office Deduction Mechanics

Ok, you have a home office for your rental property. Neat. How is it ultimately deducted on your tax returns? If you sold widgets as a sole proprietor or a single-member LLC as disregarded entity, you would report the home office details on Form 8829 Expenses for Business Use of Your Home. Simple.

If you operated an S corporation, you would be reimbursed by the business through an Accountable Plan. The tax deduction would occur on the S Corp tax return (Form 1120S). Simple and easy.

For rental properties, the calculus is similar to an Accountable Plan. You figure out the business use percentage typically using square footage, and then apply that percentage against various expenses such as mortgage interest, property taxes, utilities, insurance, maintenance, cleaning, HOA dues, etc.

That is the easy part. The challenging part is the deduction itself. Generally, a home office deduction cannot create a loss, nor can it increase a loss. However, only certain allocated expenses such as mortgage interest and real estate taxes are allowed to increase a rental property loss. This loss in turn is either limited by passive activity loss limitations or it is deducted (for example, a real estate professional or short-term rental situation).

Home office depreciation would be tracked separately as a carryover and deducted should the rental activity become profitable.

Other allocated expenses such as utilities, insurance, maintenance, cleaning, HOA dues, etc. which are personal in nature are lost. However, should the rental property be profitable in the future, these allocated expenses for that particular tax year would be tax deductible (but you cannot go back in time and claim lost deductions from prior years).

Keep in mind the allocation of general expenses across multiple rental properties that we discussed in a previous section. Using that logic, here is a conundrum- let’s say you have two rental properties where one grosses $100,000 in rental income and the other grosses $50,000.

Do you allocate your home office expenses 2/3 and 1/3 respectively? Seems simple, but that might not provide the best tax deduction based on some of those lost home office expenses given the ultimate rental activity profitability. What if the $100,000 rental property is a commercial office building with a bunch of headaches and problems? Could you argue an 85% and 15% allocation for home office expenses? Perhaps.

Back to the mechanics-

• For a typical rental property activity reported on your individual tax return (Form 1040), you would use Form 8829 Expenses for Business Use of Your Home which is detailed as Other Expenses on Schedule E. Alternatively, you could compute the home office deduction separately, or off-book if you will, and list the expense directly in Other Expenses.

• For the same situation above, but with multiple rentals, you would need to calculate the home office expense including limitations, allocate among the various rentals according to reasonable and consistent method, and list in Other Expenses.

• For a rental property reported on a partnership tax return (Form 1065), you could either calculate the home office expense including limitations and list on Form 8825 as Other Expenses, or preferably you would deduct the home office expense as unreimbursed partnership expenses (UPE) on your individual tax return using Form 8829. Another benefit is that deducting home office expenses using UPE is that the rental activities are netted together at the entity level, and as such, you don’t have to allocate among the underlying rental properties subject to certain limitations.

We chopped a lot of wood as they say! WCG CPAs & Advisors can help navigate the home office deduction for your rental properties and real estate investments.

Recall how we started this section by saying- A home office is simply another work location, where your commute is now from the bedroom to the basement, and your travel between work locations is considered business travel and therefore deductible. The home office deduction in itself is not that thrilling, but when it changes the color of money and converts commuting expenses into deductible rental property travel, it has some teeth.

By Jason Watson, CPA
Posted Saturday, September 28, 2024

One of our primary focuses at WCG CPAs & Advisors is ensuring you are paying the least amount of taxes allowed by law through tax reduction strategies. Some of our other primary focuses are helping you build wealth and leverage the most of your financial worlds for you and your family. However, these focuses or objectives are not isolated; they are very much related to each other and intertwined.

Before we run through several tax reduction and tax avoidance ideas, let’s talk about some basic concepts-

There is not a secret tax deduction club that only a few people know about. If there were, it would be like fight club, right? But trust us when we say no one is intentionally not talking about a tax deduction club.

Most people are interested in saving cash when they say they want to reduce or avoid taxes, but saving cash and reducing taxes are not necessarily the same.

Two households, making the exact same income, might have wildly different tax liabilities based on the myriad of variables such as children, mortgage interest, charitable donations, available tax credits, and, Yes, the proficiency of the tax professionals involved. So, just because your neighbor or produce clerk pays x does not mean you will too.

As household incomes travel through the ranges, a lot of things happen. The first $100,000 in income for most households is well-sheltered with itemized deductions and low tax brackets. The next $100,000 in income sees certain tax credits go away, higher tax brackets and fewer available tax deductions such as IRAs and other things (what we call income phase-outs).

In other words, if you go from $100,000 to $200,000 in household income, you will pay way more than double in taxes (you could easily see 2.5 to 3.0 times more). Yuck! The next $100,000 and beyond is completely naked, and is generally purely taxable (unless some tax reduction tactics are deployed). Super yuck!

Tax deductions and tax deferrals are not the same. Tax deferrals are tax bombs later in life; little IOU’s to the IRS and they will eventually call in the chit. But if you use the immediate tax savings to build wealth, then a tax deferral is worth it. Deferring taxes to pay for a cruise vacation might not always be the best approach (then again, live a little!).

You want to match the highest tax deduction to the high income. Let’s say it’s December and you are considering buying a piece of equipment. If next year’s income is going to be significantly higher, wouldn’t it make sense to wait until January to complete the purchase? Probably.

Alternatively, you received a huge bonus and your W-2 income skyrocketed this year. It might be a good year to buy some short-term rentals, crank up the depreciation with a cost segregation report, and then chill the following year with a property manager.

Tax deductions commonly need separation with cash. For example, you can save $2,500 (for example) in taxes right now if you write a check for $10,000 to a charity. That might not make sense if you are more interested in cash than taxes, right? Tax deferrals commonly need separation with cash as well, but at least you get it back. IRA’s and 401k plans (among others) come to mind.

Ok, here we go on those tax reduction and tax avoidance headlines. Some of this might not make sense purely based on the headline. We expand on each of these tax reduction strategies on our dedicated webpage-

• Sell Stock Losers to Offset Gains
• Borrow Against Your Unrealized Stock Gains
• Budget Review, Business Connection
• State Deferrals, Arbitrage
• 401k, SEP IRAs, and IRAs
• Health Savings Accounts (HSA)
• Advanced Tax Planning for IRA’s, Roth IRAs and Roth Conversions
• Donor Advised Fund, Qualified Charitable Distribution
• Optimized Shareholder Salary (S Corps)
• Pass-Through Entity Tax (PTET) Deduction
• Profit Sharing, Defined Benefits Pensions (Cash Balance)
• Accountable Plan Reimbursements
• Prepay Expenses
• Depreciation Optimization
• Switching to Accrual Accounting
• Adding Spouse to Payroll
• Adding Children to S Corp Payroll
• Adding Children to Payroll Family Management LLC
• Consider Yourself a Passive Business Owner
• Short-Term Rental (STR) Loophole
• Cost Segregation on Real Estate
• Real Estate Professional
• 1031 Exchanges (Like-Kind) on Real Estate Transactions
• Tax Free Rental of Your Home
• Medical C Corp
• Permanent Life Insurance Plans
• Conservation Easement
• Captive Insurance
• Family Limited Partnerships (FLP) and LLCs
• Discounted Roth Conversions
• GRATs, GRITs, and Private Annuities

If you want to know about these bulleted items, please visit our tax reduction strategies webpage.

By Jason Watson, CPA
Posted Saturday, September 28, 2024

Let’s briefly discuss record keeping, and then jump into a famous New York entertainer named Cohan who ultimately provided a nifty rule that can be used during an IRS audit. To be able to demonstrate a business or rental property deduction you need to show the date, the amount and the person or business you paid. A bank or credit card statement, or canceled check, satisfies this. The second element is the business purpose must be documented either through a logbook, planner or accounting software. Proof of payment plus business purpose equals tax deduction.

Do you need receipts? Yes and no. For travel, gifts and meals, if the amount is under $75 then you only need to document the event and business purpose in a logbook or planner. However, if you spend $10 at Costco for some paper, then you need proof of payment plus business purpose documentation. Seems a bit onerous and even contradictory, but it is true.

Enter Cohan vs. Commissioner, 39 F. 2d 540 (2d Cir. 1930). Yes, 1930 and we still use it today. George Cohan gave us “Yankee Doodle Dandy” and “Give My Regards to Broadway”, and he also gave us a tax deduction rule. His rule is simple- you can approximate your expenses and ultimately your business or rental property tax deduction. What?! No, it is not that simple.

You must have corroborating evidence that demonstrates your expense. For example, as a public accounting firm, WCG CPAs & Advisors can demonstrate that we prepare so many tax returns which are so many pages in length, and therefore we can approximate our paper costs. Treasury Regulations 1.274-5T(c)(3) also gives latitude to the IRS to allow substantiation of a business expense by other means. Here is the blurb-

The good news is that we’ve been paperless for a while, so we don’t have to worry about estimating our paper costs. One less thing to worry about like Forrest Gump and money.

We have successfully used the Cohan rule in IRS examinations. We have also implemented it during tax preparation when records are incomplete or missing (i.e., one hot mess). Having said that, using estimates and approximations looks bad. Keep good records, please. Do not rely on the Cohan rule or some treasury regulation to save your butt.

The Cohan rule or any type of estimation cannot be used for travel, business gifts and meals. All the good stuff needs strict record keeping habits. IRC Section 274(d) also states that listed property must be substantiated with proper documentation. Listed property includes automobiles, and equipment generally used in entertainment such as cameras and stereo equipment. Seems a bit outdated, but there you go. So, if you are a photographer who drives a car for business while entertaining guests, you will be a master at recordkeeping.

A logbook or planner is very influential during an audit. When a client can show contemporaneous records in a planner that coincides with travel, meals and home office use, the audit lasts about 90 minutes as opposed to four hours with a deficiency notice at the end. Contemporaneous comes from Latin, and means existing or happening during the same period. In other words, as things happen in your world, write them down in a logbook or planner.

By Jason Watson, CPA
Posted Saturday, September 28, 2024

Here is a quick list of the rental property tax deductions that the IRS cannot stand. That isn’t phrased correctly. The IRS actually likes these tax deductions since most business owners and rental property owners either incorrectly deduct them or cannot substantiate an otherwise qualified tax deduction for lack of proper record keeping.

The IRS plays pot odds on the following rental tax deductions since the recovery of taxes is probable and therefore profitable for the government. In poker, if it costs you $10 to bet and there is $100 in the pot, then you can be wrong 90% of the time and still break even. This is the essence of the pot odds: You’re paying a fraction to win a larger sum, and the IRS is no different.

Here we go-

• Meals (shocker)

• Car and Truck Expenses, Mileage Logs (another shocker)

• Travel (abused regularly, say it isn’t so)

• Home Office (probably not as much anymore)

There are others, but these are the biggies. The benefit for rental property owners is that only auto expense and travel are listed as a separate expense line on Schedule E of your Form 1040 tax returns (they are combined on line 6). As such, the IRS can directly track these expenses as portion of rental income and apply their massive database of statistics to your tax return. The other expenses such as meals and home office get tucked into other expenses. While this is less glaring, the IRS likely have or will have tools to read your clever list of disguised other expenses looking for certain buzzwords like meals, office, facilities, occupancy, etc.

This should not have a chilling effect on you deducting these expenses. You should not be afraid of an audit. You should not be afraid of losing an audit. You should only be afraid of having an unreasonable or indefensible position. Sure, easy for us to say.

At the same time, if you have legitimate expenses and you can back them up with proof, then happily deduct them. Like Muhammad Ali once said, “It’s not bragging if you can back it up.” Well, the same can be said of small business tax deductions that are at higher risk of audit. If you can back it up then deduct it!

By Jason Watson, CPA
Posted Saturday, September 28, 2024

There aren’t 185 rental property tax deductions that you cannot take. It’s just a dramatic headline. However, we want to start with the crazy things small business and rental property owners try to do since it is such a good springboard for discussion. Some of these expenses require a deeper discussion in a separate section, and we provide references to other pages.

100% Cell Phone

Most landlords, property managers and real estate investors operate on a cell phone. However, most people also use their cell phone as a personal phone. The minute you get the “Hey honey… we need milk and eggs” text message to your cell phone, it drops from 100% business use to something else.

If you attempt to deduct 100% of your cell phone as a tax deduction, the IRS will claim 0% and then force you to demonstrate why it should be something else. Conversely, if you approach this from a position of being reasonable it is extremely challenging for the IRS to argue otherwise. What is reasonable?

We usually start with a single phone line cost of about $150 per month in 2024 dollars. While it might only take $10 to add another line, you would still need to spend $150 for yourself. From there it becomes a preponderance of the facts and circumstances. Some people say there are 40 hours in a work week and there are 168 available hours (24 x 7).

However, this calculus assumes your personal use “density” is the same as your business use “density.” For most rental property owners, this is not true. You probably talk more often with tenants, guests, property managers and business associates, than you do with friends.

Moreover, this would assume your cell phone is being used 168 hours out of the week which is simply not true. As such, the calculation becomes business use divided by total use. Business minutes divided by total minutes used.

Huh? Are we complicating the uncomplicated? Perhaps. So, what can you do?

Anywhere from 5% to 80% is a good jumping off point. That’s quite the range, right? If you work a W-2 job and have one long-term rental, then 5% might be reasonable. If you take this same property but it is now a short-term rental, then 15% might be reasonable. What about a real estate professional? The key is to keep a good time log which is necessary for so many other things such as real estate professional status, short-term rental loophole and overall material participation.

Since this is a mixed-use expense between personal and business, the cell phone charges should be paid by you personally and then deducted as a rental property expense.

We discuss in a duplicative way in our common rental property deductions section on page xx.

Client Gifts Over $25

Yuck, more IRS publications stuff on the way. In IRS Publication 463 Travel, Gift and Car Expenses, here is the blurb on tenant or guest gifts-

You can deduct no more than $25 for business gifts you give directly or indirectly to each person during your tax year. A gift to a business that is intended for the eventual personal use or benefit of a particular person or a limited class of people will be considered an indirect gift to that particular person or to the individuals within that class of people who receive the gift.

If you give a gift to a member of a customer’s family, the gift is generally considered to be an indirect gift to the customer. This rule does not apply if you have a bona fide, independent business connection with that family member and the gift is not intended for the customer’s eventual use.

If you and your spouse both give gifts, both of you are treated as one taxpayer. It does not matter whether you have separate businesses, are separately employed, or whether each of you has an independent connection with the recipient. If a partnership gives gifts, the partnership and the partners are treated as one taxpayer.

$25 is the maximum per year per person. The second paragraph explains you cannot give $100 to a family of four (as an example), unless you have a separate bona fide relationship with each family member.

What does this mean for the rental property owner or short-term rental owner? That pretty bouquet of snacks and wine and whatnot might only be up to $25. Keep in mind that you might need to spend $100 because of the quality of tenants or guests, or the length of stay, or the premium rent that is being charged. Good business practices are not always tax deductible. Building wealth is your primary objective.

Some people might claim that the pretty bouquet of snacks and wine for that short-term rental guest is advertising and marketing, not necessarily a gift. However, this is not entirely accurate since there isn’t a transaction or an exchange of consideration. But wait! How is a basket of snacks and wine different than a basket of coffee pods? Perhaps it isn’t. Perhaps, instead of calling it a tenant gift, you call it supplies; no different than coffee, tea, creamer and sugar.

It’s a matter of perspective, right?

Keep this in mind as well- note that the IRS refers to individuals in their little pontification above. Gifts to another business are limitless. So, if your client or tenant is a business and you want to express your gratitude, theoretically there is no limit provided an individual is not the designated recipient.

Promotional items that are under $4 in unit cost and have your business name or logo on them are not considered gifts and do not contribute to the $25 maximum.

Commuting Expenses

It is unfortunate, but expenses associated with your commute to your rental properties are not deductible. Tolls and parking are the common ones rental property owners attempt to deduct. There is a subtle difference to be aware of- driving from one work location to another work location is not commuting. Commuting is generally driving from your home to your rental property. Having said this, travel expenses and rental properties is a hot topic that we discussed earlier in our rental property travel deductions section.

You can solve a lot of problems surrounding commuting expenses by qualifying for a home office. Then your commute is from the bedroom to the home office. If you shower, then the commute is from the bathroom to the home office.

All kidding aside, or least most of it, the tax benefit of the home office deduction is not too low, not too high. In our experience, about $250 or so of cash in your pocket benefit comes from the additional deductions associated with home office expenses. But! Where the big benefit comes from is the deduction of travel expenses; without a home office, your mileage or automobile expenses to your first client or local rental property is not tax deductible. However, with a home office, this drive is now considered travel between work locations. Huge difference!

We did a deep dive into the home office deduction earlier.

Home Office Improvements

You cannot spend $30,000, finish your basement, plop your desk in the middle of it and deduct the $30,000 for two reasons. First, the entire space must be regularly and exclusively used as a home office. This means the theater room must be a conference room, and the wet bar must be the office kitchen. Might be tough in the world of rental property tax deductions.

Second, even if the entire basement is designated business use, the $30,000 represents an improvement. Therefore, it must be capitalized as an asset and subsequently depreciated over 39.0 years. From there, only the business use portion of mortgage interest, property taxes, insurance, HOA dues and utilities are deductible.

Don’t worry, the 96” projection TV with the non-glare screen was still worth it.

Country Club Dues

Nope. The IRS does not care how many times or how much you entertain your tenants and business associates at your country club. Membership dues are not allowed. However, the specific out-of-pockets expenses associated with qualifying meals incurred at your country club are deductible as rental property expenses. There are some other devils in the details, but this is the general gist. Also, recall that since the Tax Cuts and Jobs Act of 2017, entertainment is no longer deductible.

Don’t confuse this with other types of dues such as Chamber of Commerce or other professional organizations such as BNI. Those dues are 100% deductible although there is some scuttle butt about BNI since a portion of the dues are likely for meals.

See our rental property meals section.

Professional Attire

The tax code is very clear on this. Anything that you can convert to everyday use is considered personal, and therefore not tax deductible. Many business owners want to deduct dry cleaning expenses or Men’s Warehouse purchases, but they usually cannot. We know you are rocking it in the double-breasted vest without a coat look, but the IRS doesn’t have fashion sense and therefore doesn’t care. However, there are some exceptions (of course there are).

WCG CPAs & Advisors prepares several tax returns for pilots, flight attendants, military personnel, nurses and firefighters. These uniforms are not suitable for everyday use and / or are protective in nature (such as steel-toed boots), and therefore are business tax deductions. We also have a handful of models and actors as clients, and their clothing is considered theatrical costumes not suitable for everyday use (this is a bit tricky).

How does this affect rental property owners? It doesn’t since most owners are not wearing suits to their tenant showings nor are they wearing protective clothing not suitable for everyday use. Certainly a high-powered real estate mogul meeting with lenders and other investors might need to look professional, but it is not tax deductible.

By Jason Watson, CPA
Posted Saturday, September 21, 2024

There are many conference organizers offering real estate investment and landlord-related classes, seminars and online education. Some good. Some bad. At times the scene from Good Will Hunting comes to mind where Will states “you wasted $150,000 on an education you coulda got for $1.50 in late fees at the public library.” In other words, these real estate conferences might be a tad oversold to the person looking for some simple knowledge. Your limiting factor for building wealth with real estate is likely money and not smarts. We digress.

There are three situations for education expenses.

Education as a Start-Up Cost

You want to buy a rental property, but you are unsure about some of the basics. You attend a conference for $3,000. Later, you purchase your first rental property. Yay! This $3,000 might be considered a start-up cost and deducted accordingly (see our start-up costs section for various rules and limitations).

Education as Improvement or Required

As such, under the first provision, you would need to demonstrate that the education maintained or improved your current skills as a rental property owner. You can get a little nutty with this as well. There are tax court cases on both sides of the aisle about deducting the cost of an MBA. Taxpayers have successfully argued that the cost of their MBA improved their current skills as a business owner. Some taxpayers have lost miserably yet arguably with the same set of facts. Yuck.

Here is some gee whiz stuff to think about- In Singleton-Clarke v. Commissioner, Tax Court Summary Opinion 2009-182, the court ruled in the taxpayer’s favor. Lori was an established nurse, and she went back to school to obtain an MBA in Health Care Management. She was already in charge of quality control from a management perspective, and the MBA did not lead to an additional and discernable skill. Additionally, the court stated that the MBA improved her current work skill as a quality control coordinator. Subtle difference.

However, in Colliver v. Commissioner, Tax Court Summary Opinion 2017-93, Mary Colliver held a Bachelor’s degree in speech pathology and was offered a position with a hospital doing similar work. The hospital position required Mary to obtain her Master’s degree in speech pathology, but the hospital allowed her to complete her studies while performing the tasks of the position. Specifically, the Master’s degree allowed her to be a medical speech pathologist.

Mary subsequently deducted about $8,500 in qualified education expenses, and upon examination the IRS disallowed the deduction. The Tax Court also agreed with the IRS and their summary concluded that the tasks and activities before and after the additional education were different enough to qualify as a new trade or business. In other words, Mary could not work in hospitals without the Master’s degree, and her education allowed her to do so. The Tax Court found this convincing enough to deny the qualified education expense deduction.

Education That Cannot Be Deducted

If you only take real estate related classes and attend seminars, but never actually pull the trigger on purchasing a rental property, then these expenses are not tax deductible. Why? They are not start-up costs nor are they improving your current skill as a landlord (since you aren’t one).

Another example- let’s say you do not own a rental property or have any real estate investments. You feel that obtaining a real estate license would be a good thing to have. This education unfortunately leads to a new trade or profession, and therefore is not deductible.

However, if you own a rental property and purchase education materials to obtain your real estate license, you could easily argue that this improves your current work skills as a landlord. Subtle differences indeed, and a lot of this is influenced by timing.

Lifetime Learning Credit

Don’t forget that other education-related credits exist. While you might not qualify for the American Opportunity Tax Credit (AOTC) you might be able to leverage the Lifetime Learning Credit. There are several resources out there to help with this tax credit.

By Jason Watson, CPA
Posted Saturday, September 7, 2024

In deciding whether to own the automobile personally or through your small business or rental property, here is a set of examples to help you make a decision. It is not a hard and fast set of rules but will provide some guidance.

First, let’s establish the bookends. On one end is the $100,000 luxury auto that you barely drive, and you recycle automobiles every 2-3 years. This is clearly business owned.

On the other end is the $30,000 modest automobile that you drive a tone of miles, and you keep automobiles for at least 5 years. This is clearly individually owned and deducted using the standard mileage rate.

Armed with that information, here we go-

Example 1

You like big fancy cars that cost $100,000 and you only drive 5,000 miles for the business or rental property. Degradation of value is a way of life simply based on time so this automobile will go down in value, and as such you might as well get a tax deduction for it. Ergo, have the business or rental property activity own it. In other words, if you have already budgeted for the degradation of automobile value you might as well get a tax deduction for it, right?

Example 2

You are frugal and therefore you like to buy used Subaru’s costing around $20,000 and you drive the wheels off the thing because you are a real estate agent. Degradation in value is not as severe as example 1, so in this example you should own the automobile personally and use the standard mileage deduction.

Example 3

You like big heavy trucks that cost $100,000 and you drive 12,000 miles for the business or within your gaggle of rental properties. You would like to save some taxes this year as well (shocking). This is a great example of using Section 179 plus bonus depreciation to deduct a big chunk of the truck.

Example 4

Same as example 3, but you expect your income to dramatically increase next year versus this year. In this case, have some patience and purchase the truck next year to match the excellent tax deduction against the higher income. We know, patience stinks. Our job is to build your wealth and save taxes over your lifetime… not just today.

Example 5

You buy a lightly used SUV that weighs over 6,000 pounds for $50,000 and you drive it 6,000 miles per year. Yuck. This is right in the middle of “no man’s land” where the decision is not obvious. Yes, you can deduct a large portion of the $50,000 since the Section 179 expense and bonus depreciation deductions are not based on a new automobile, just new to you.

But recall that depreciation is a tax deferral… if you sell your business automobile for $40,000 a few years later, you will have depreciation recapture on the $40,000 taxed at ordinary income tax rates. To make matters worse, IRC Section 1031 Like-Kind Exchanges no longer apply to personal property since Tax Cuts and Jobs Act of 2017 so you can’t trade it in to kick this depreciation recapture can down the road. In other words, you need to buy another automobile to avoid being taxed on the recent automobile you just sold or traded in. Talk about chasing your tail.

It might behoove you then to own this automobile personally and get a mileage reimbursement from the business. Then again, if you have an unusually high income this year perhaps deducting it in full today makes sense. Again, “no man’s land” since the decision now has a ton of variables and what-ifs.

Example 6

Same as example 5 but you keep the automobile for 10 years and drive 15,000 miles. This changes the narrative. Since you will be owning it for so long with so many miles, the standard mileage deduction is the way to go. In other words, own it personally and deduct mileage for the business miles you drive.

By Jason Watson, CPA
Posted Saturday, September 7, 2024

This section is a mini version of our repairs versus improvements and rental property rehab sections on pages xx and yy. Here is a quick summary-

According to IRS Revenue Ruling 2000-4,

Section 263(a) and § 1.263(a)-1(a) provide that no deduction is allowed for any amount paid out for permanent improvements or betterments made to increase the value of any property or estate. Section 1.263(a)-2(a) provides that capital expenditures include the cost of acquisition, construction, or erection of buildings, machinery and equipment, furniture and fixtures, and similar property having a useful life substantially beyond the taxable year.

Cool. The things you buy that have a useful life substantially greater than one year are considered a capital expenditure (capex) and must be capitalized in most situations. What the heck is capitalized? Is this a grammar thing?

Simply put- you can either expense or capitalize a purchase. Expensing the purchase is an immediate deduction and therefore reduction in taxable income. Capitalizing the purchase requires listing the asset on your fixed asset listing and expensing over time through depreciation.

Step 1 Unit of Property

The first step is determining what you are repairing or improving? The unit of property (UOP) is generally the entire building including its structural components. However, under the final tangibles regulations, the improvement versus repair analysis applies to the building structure and each of the key building systems separately. There are a total of 9 separate systems if you also count the building structure itself.

Step 2 Safe Harbors

The next step is to run through the three big safe harbors for rental property owners-

• De Minimis Safe Harbor Election

• Safe Harbor Election for Small Taxpayers (sounds a bit condescending)

• Safe Harbor for Routine Maintenance

We discussed these in fine detail in our improvements versus repairs section. De minimis is the class favorite since it is quite simple and covers most purchases or situations. However, small taxpayers and routine maintenance have some teeth, but are commonly overlooked by even the most experienced tax professionals.

Step 3 Betterment, Restoration and Adaptation

If the expenditure falls under the betterment, restoration and adaptation tests, then it is considered a capital improvement, and therefore must be capitalized and depreciated (versus immediately deducted).

The final tangible property regulations define these terms in amazing detail, but here is a small summary with the real estate investor in mind-

• Betterment. You fix a material defect in the rental property or UOP such as a cracked foundation. An addition or enlargement, such as finishing the basement, is also a betterment. A betterment is also amounts paid that are reasonably expected to materially increase productivity, efficiency, strength, quality, or output of the unit of property (UPO) where applicable.

• Restoration. You replace a major component such as replacing a roof. You restore a UOP that has deteriorated to a state of disrepair and is no longer functional for its intended purpose, including rebuilding after a casualty loss.

• Adaptation. According to the final tangible property regulations, “An amount is paid to adapt a unit of property to a new or different use if the adaptation is not consistent with your ordinary use of the unit of property at the time you originally placed it in service.” Is converting a garage into a casita or another bedroom considered an adaptation or betterment? Hmmm…

You can think of BRA or BAR when trying to remember these. No one thinks of ARB or RAB, however.

Qualified Improvement Property

Keep in mind the mini loophole that is afforded to rental properties deemed to be nonresidential based on transient tenants or guests. There are some expanded Section 179 expensing opportunities that we review as well in our qualified improvement property (QIP) section.

Rental Property Renovations (Rehab)

The first consideration with renovating your rental property is to keep excruciating details on what was purchased. A refrigerator. A cabinet. A light fixture. Parse those out best you can. Why? As you learned with cost segregation, if we can clearly identify personal property, we can accelerate depreciation without the need of a cost segregation report.

We mentioned the Hospital Corporation of America v. Commissioner, 109 Tax Court 21 (1997) court case in the Cost Segregation section. This is the landmark case that allowed the property owner to detail their renovations line by line, and assign certain items to be 5-, 7- or 15-year property (and therefore eligible for accelerated depreciation with bonus depreciation or Section 179 expensing).

As mentioned previously, this section is a truncated version of our repairs versus improvements and rental property rehab sections.

By Jason Watson, CPA
Posted Saturday, September 7, 2024

There are three safe harbors relevant to rental property owners and real estate investors-

• De Minimis Safe Harbor Election

• Safe Harbor Election for Small Taxpayers (sounds a bit condescending)

• Safe Harbor for Routine Maintenance

This section is a mini me of our rental property repairs safe harbor section. Here is a quick summary-

De Minimis Safe Harbor Election

We’ll start with the easiest one. As outlined in IRS Notice 2015-82, the IRS increased the de minimis safe harbor threshold from $500 to $2,500 per invoice or item for taxpayers in 2015. What does this mean? Anything you purchase including repairs and maintenance that are $2,500 or less per line item on an invoice may be expensed and therefore deducted immediately (versus capitalizing as a fixed asset and depreciating).

Safe Harbor Election for Small Taxpayers

For the little people in the real estate investment world, we have a practical safe harbor for expenditures that would otherwise be deemed improvements requiring them to be listed as a fixed asset and depreciated. Yuck.

Two criteria-

• The building’s unadjusted cost basis is $1 million or less. This excludes land, land improvements, and personal property identified through a cost segregation study.

• You have less than $10 million in gross rental income across all activities.

If you meet these, then if the total amount paid during the taxable year for repairs, maintenance, improvements, or similar activities performed on such building property are under 2% of the unadjusted cost basis and under $10,000, they may be expensed immediately as repairs and maintenance.

Safe Harbor for Routine Maintenance

This one is a bit trickier, but certainly a nice and mostly underutilized safe harbor for rental property owners. According to the tangible property final regulations, you are not required to capitalize as an improvement, and therefore may deduct, amounts that-

• Keep the property in its ordinarily efficient operating condition, and

• You reasonably expect, at the time the rental property is placed in service, to perform the improvement more than once during the 10-year period beginning when placed in service for building structures and building systems, or more than once during the life of the unit of property for property other than buildings.

There is no clear answer as to what routine maintenance is, but the regulations provide a zillion examples and explanations regarding the requirement under Treasury Regulations Section 1.263(a)-3(k)(7). There are a total of 31 examples if you cannot get enough. The IRS shapes some thresholds, such as the 30% threshold that you see in other materials.

As mentioned earlier, this is a high-level summary. See our rental property repairs safe harbor section for thrilling details.

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

The question comes up often- what costs can I deduct in the acquisition of a rental property. There are several, but the rub is that most expenditures associated with purchasing a rental property are considered costs (versus expenses) and are depreciated or amortized accordingly. As such, you get a deduction for acquisition expenditures, but it takes time.

This section is a mini me of our rental property acquisition costs section. Here is a quick list-

• Travel Expenditures

• Meals During Acquisition

• Closing Costs

• Loan Costs

Here are some more acquisition and closing costs that are commonly overlooked-

• Application fees, and similar expenses.

• Property appraisals and inspections including architectural, engineering, environmental, and geological services.

• Legal and accounting fees including tax advice to review offers, purchase or sales agreements.

• Costs to obtain regulatory approval or secure permits (think short-term rental permits).

• Cost of services provided by a qualified intermediary in a like-kind exchange.

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Generally, interest expense can fall into any of the following categories-

• Investment interest is interest on debt incurred for the purchase of property-held investments, such as stocks and mutual funds, for which the yearly deduction is limited to net investment income. If the investment generates tax-exempt income, the interest is not deductible.

• Residence interest is interest on a home mortgage and is generally deductible as an itemized deduction on Schedule A subject to loan limitations. Qualified home is the IRS terminology, and it includes your main home and second home if necessary.

• Passive activity interest is interest on debt incurred for business or income-producing activities in which you don’t materially participate. This is usually deductible only if income from passive activities exceeds expenses from those activities. Your rental property might fall under this category depending on your participation.

• Trade or business interest is interest on debt incurred for activities in which you do materially participate and can generally be deducted in full. Your rental property might also fall under this category.

• Personal interest, such as personal credit card debit or personal automobiles, is not deductible.

Can you borrow against the equity in your primary residence to purchase a rental property? Absolutely, and it is a common strategy. Can you sidestep loan limitations and deduct the mortgage interest? Yes. It is called interest tracing, and the concept is quite simple. The use of the loan proceeds determines its deduction eligibility regardless of the actual real estate property or other asset securing the loan.

Treasury Regulations 1.163-8T(c) reads in part-

The last sentence is the important one and it reads in part, “debt proceeds and related interest expense are allocated solely by reference to the use of such proceeds.” As you might be aware, the Tax Cuts and Jobs Act of 2017 added limitations to how much home mortgage interest may be deducted. Specifically, for loans after December 15, 2017, the limit is $750,000. This means if you have $50,000 in mortgage interest on a $1,000,000 loan, only the first 75% or $37,500 would be eligible for deduction on Schedule A of your Form 1040 tax return.

How does this play into the interest tracing rules? Treasury Regulations 1.163-8T(m) reads-

What does this gibberish mean? Loan interest is chopped up (fancy accounting term would be allocated) depending on the ultimate use of the loan proceeds without regard to limitations. However, once allocated to various categories (as we listed above), then various interest limitations come into play which are mostly detailed in IRC Section 163 such as the $750,000 limit above.

Now what? Here are some examples. Let’s say you own a primary residence with $500,000 in mortgage loan debt. You borrow another $600,000 for home improvements and to buy a rental property. Of the $600,000, $200,000 is used for home improvement with the remaining $400,000 being used for the rental property purchase. Freshen up that kitchen and master bath plus build some wealth. Nice!

The interest on the $200,000 is fully deductible on Schedule A on your individual tax return alongside the first loan interest (since both balances combined are $750,000 or less). The interest on the $400,000 portion is fully deductible on Schedule E of the new rental property.

We’ll reverse it a bit. Let’s say you borrow $1,000,000 against your rental property to buy a primary residence and to also buy another rental property. Why not, right? $800,000 was used to buy the primary residence and $200,000 was used to acquire the second rental.

You would deduct 75% of the interest ($750,000 divided by $1,000,000) on Schedule A. 20% or $200,000 would be deductible on Schedule E for your new rental property, and $50,000 ($800,000 less $750,000) or 5% would be excess interest associated with the primary residence and therefore not deductible.

Here are some pitfalls-

• There are ordering rules should you mix borrowed funds with un-borrowed funds. As such, keep monies separated to assist in the tracing part of the interest tracing provisions.

• The qualified home limitation of $750,000 referenced above encompasses your main and second home. Depending on your objectives and tax footprint, if your second home slips into being a rental property you might be limited on your mortgage interest deduction. See our vacation home rules section.

Keep in mind that the cost of your equity is usually more expensive than the cost of borrowing. Not always, but usually. We can get into the tax-effected rate of return on your equity versus the property appreciation-effected cost of borrowing, internal rates of return, and all the hoopla, but generally using other people’s money to fund your real estate investment empire is preferred. There are several books and internet content dedicated to the real estate leverage topic.

Please see our capitalizing construction mortgage interest section which discusses the capitalization of mortgage interest during construction or renovations.

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Let’s talk about deducting your rental property travel expenses ahead of others. Sure, accelerated depreciation or repairs versus improvements are class favorites, but let’s check off the travel rental tax deduction issue first. As stated previously, all rental property expenses must be ordinary and necessary, and you must be operating your rental property as a business and not just an investment.

We need to provide a mini agenda to this section since there are several moving parts-

• Travel expenditures associated with research (start-up), acquiring, maintaining and improving a rental property are all handled differently. Five discrete scenarios since the start-up costs versus acquisition costs versus operating expenses varies depending on timing and having an existing rental property in the same geographic area.

• Defining your tax home and how a home office tilts the scales in your favor.

• Meals and lodging are inextricably connected to the eligibility of the rental property travel expense and deduction.

Travel to Your Rental Property Must be Meaningful

The IRS has smart people. Don’t laugh. Really, they do. If you think they don’t know that real estate investors and rental property owners like to travel and mix a little fun with business, then you might need to recalibrate your thinking. You own a ski condo as a short-term rental, and interestingly you only do repairs when there is a nice storm coming with fresh snow. Coincidental?

The primary purpose of the travel must be for business purposes. We will expand on what that means with examples in a bit. In IRS Publication 527 Residential Rental Property, the IRS states-

Travel expenses.
You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property. You must properly allocate your expenses between rental and nonrental activities. You can’t deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property. The cost of improvements is recovered by taking depreciation. For information on travel expenses, see chapter 1 of Pub. 463

Let’s back up a bit. It is a longstanding legal position within the Tax Court and the IRS that regular and continuous travel between your personal home and your work location is considered commuting and therefore non-deductible. Treasury Regulations 1.274-14 reads in part-

However, IRC Section 162(a)(1) also reads in part-

How do you reconcile this gibberish? There are two important fundamentals-

• Travel between work locations is generally deductible. The power of the home office with your rental property activities is critical.

• Travel away from your home (tax home) in pursuit of a trade or business is generally deductible.

We will discuss deducting your travel meals in a later section, but here is a sneak peek- to deduct meals in connection with travel to your rental property, you must be away from your tax home and require substantial rest (overnight travel). In other words, just because you can deduct your travel costs such as airfare or mileage, does not automatically mean your meals are deductible.

Travel Expenses Must Be Ordinary and Necessary

Your travel expenses must be ordinary and necessary, and not lavish or extravagant. Can you fly first class? Yes. Can you bring your spouse? Yes, provided they have a business interest in the rental property.

What is ordinary and necessary? In Strickland v. Commissioner, Tax Court Memo 1982-195, the Tax Court found that traveling 500 miles to two rental properties 80 times over a two-year period was not ordinary and necessary since the taxpayer could not demonstrate the business need.

Defining Your Tax Home

Your tax home is the location where you earn your primary income. Here is the word for word description from IRS Topic Number 511 Business Travel Expenses–

Travel expenses are the ordinary and necessary expenses of traveling away from home for your business, profession, or job. You can’t deduct expenses that are lavish or extravagant, or that are for personal purposes.
You’re traveling away from home if your duties require you to be away from the general area of your tax home for a period substantially longer than an ordinary day’s work, and you need to get sleep or rest to meet the demands of your work while away.

Generally, your tax home is the entire city or general area where your main place of business or work is located, regardless of where you maintain your family home. For example, you live with your family in Chicago but work in Milwaukee where you stay in a hotel and eat in restaurants. You return to Chicago every weekend. You may not deduct any of your travel, meals or lodging in Milwaukee because that’s your tax home. Your travel on weekends to your family home in Chicago isn’t for your work, so these expenses are also not deductible. If you regularly work in more than one place, your tax home is the general area where your main place of business or work is located.

Ok. Neat. How big is that geographical location? Is the rental property down the street outside my tax home? Unlikely. How about the one in a neighboring town? Perhaps.

Here is the IRS excerpt again-

Generally, your tax home is the entire city or general area where your main place of business or work is located.

This is certainly ambiguous, right? To make matters worse, and in the context of a home office, there is a derived (some would say contrived) 50-mile radius rule. It is derived from various sources-

• IRC Section 162(h) defines the local area for state legislatures as 50 miles.

• The federal government defines metro area for IRS employees as 50 miles (Internal Revenue Manual 6.550.1.1.7).

• Part 301-11 Per Diem Expenses, U.S. Dept of Interior says no per diem if your temporary duty (TDY) assignment is within 50 miles of duty station or residence. Many other government agencies including states have similar 50-mile rules.

Administering Your Rental Property from Your Home Office

A home office is simply another work location, where your commute is now from the bedroom to the basement. Travel between work locations is considered business travel and therefore deductible. The home office deduction in itself is not that thrilling, but when it changes the color of money and converts non-deductible commuting expenses into deductible rental property travel expenses, it has some teeth.

Home office considerations-

• Is being a Real Estate Professional strongly support a home office claim and therefore travel deduction? Likely.

• Does having a single short-term rental support a home office claim? Less likely than above, but not impossible. Regular and continuous are the legal thresholds as you’ve seen throughout this material.

• Can you claim a home office with a single long-term rental? Unlikely.

What about three rentals? Perhaps… and now we are getting more into a facts and circumstances argument which is good and bad. Good, because there isn’t a bright line. Bad, because someone might disagree with you, and you will need to craft and possibly defend an argument.

At the risk of repeating ourselves, there are two important considerations with rental property travel deductions-

• Travel between work locations is generally deductible. The power of the home office with your rental property activities is critical.

• Travel away from your home (tax home) in pursuit of advancing a trade or business is generally deductible.

For a deep dive or a double click or whatever the latest slang is on how to qualify for a home office with your rental property, see our home office deduction section. Riveting!

Travel to Home Depot or Bank

Your travel to the rental property might or might not be deductible depending on your facts and circumstances as compared to the above thresholds. So, while your drive to the rental property might be considered commuting expenses, your travel from the rental property to Home Depot, Lowe’s, Bed Bath & Beyond, Target, your local bank, your other rental, and any other location that has a business purpose or supports your rental property is generally deductible as operating expenses.

Here is another way to look at this-your rental property is a work location of sorts, and travel to another work location is no longer considered commuting. Could you always visit the hardware store before going to your rental property with the hope of reducing your commuting miles and increasing your business miles? Perhaps.

What do we mean here? The miles from your home (assuming no home office) to the hardware store is commuting. But the drive from the hardware store (assuming the stop had a business purpose for the rental activity) to the rental property is business travel and deductible as rental operating expenses.

Travel Expenses for Start-Up and Acquisition

Travel expenses associated with start-up and acquisition have four important distinctions-

• Start-up travel costs, before a specific rental property is identified, are generally immediately deductible under IRC Section 195. There are limitations. See our start-up costs and acquisition costs sections for more information.

• Acquisition travel costs in a new geographical location. These are generally added to the purchase price of the rental property, and depreciated accordingly. Yuck.

• Travel expenses for additional rental properties in the same geographical location are generally immediately deductible as operating expenses. Yay.

• Travel costs, after you already have a rental property but in a different geographical location, are considered a new business venture and therefore would be considered start-up costs if you have not identified the target rental property. Once identified, the travel costs change to acquisition costs.

So, travel expenditures could be start-up costs, acquisition costs or operating expenses depending on timing, geography and whether you already own a rental property.

Sidebar: Did you also notice the word change between expenses and costs? Costs and expenses are similar concepts, and they’re sometimes used interchangeably. However, a cost typically refers to the price paid to acquire an asset such as a rental property, while an expense is an ongoing expense or associated with operations. This also aligns with the term cost basis when speaking about assets.

We are repeating ourselves a bit here from an earlier section, but let’s run through the same examples anyway. First example- you travel to Miami four different times looking at various rental properties each time, and you eventually identify and close on a nice condo. Prior to identifying the target business or in this case, the rental property, these expenses might be considered start-up expenses and therefore deductible.

IRC Section 195(c)(1) reads in part-

Next example- you’ve identified a nice rental property, and you travel to Miami four different times to a) do an initial walk-through, b) be present for inspections, c) sign-off on a seller repair and contingency and d) final walk-through and closing. The costs associated with these four trips to Miami would be considered acquisition costs (not start-up expenses) and added to the purchased rental property’s cost basis and depreciated accordingly.

Next example- you travel to Miami to look for and purchase another rental property. This is considered a business expansion, and travel expenses are considered operating expenses. This is an important distinction since these expenses are a) not considered start-up expenses which have limitations and b) not added to the purchase price as acquisition costs with the slow tax benefit of depreciation. Rather, they are generally immediately deductible.

Final example- you’ve had your fill of Miami and decided to pursue a rental property in Key West. This is likely to be considered a new business venture and therefore start-up expenses might be leveraged but you also have the downsides of adding acquisition costs to the purchase price and subsequent depreciation. In other words, the travel costs associated with Key West would not be operating expenses like the example above.

What if you never purchase a rental property or make a real estate investment during the tax year? IRS Publication 535 Business Expenses reads in part-

If your attempt to go into business is unsuccessful. If you are an individual and your attempt to go into business is not successful, the expenses you had in trying to establish yourself in business fall into two categories.

1. The costs you had before making a decision to acquire or begin a specific business. These costs are personal and non-deductible. They include any costs incurred during a general search for, or preliminary investigation of, a business or investment possibility.

2. The costs you had in your attempt to acquire or begin a specific business. These costs are capital expenses and you can deduct them as a capital loss.

You have two scenarios here. Let’s look at some examples- you spend $4,000 on a real estate investment course, but you never identify the target business. Meanwhile December 31 comes and goes, and you fall out of favor with real estate. This $4,000 would fall under the first scenario, and therefore would not be deductible.

You identified a rental property, and you spent $4,000 on travel and legal fees. However, the deal falls through and you do not purchase another property. This would fall under the second scenario, and become a capital loss subject to those limitations.

What if you spent $4,000 on travel and legal fees in November, identified your target business or rental property in December, filed your tax returns in February with a nice $4,000 tax deduction because WCG CPAs & Advisors is wicked fast, but the deal falls through in April? Oh boy, a discussion certainly needs to be had. What if another rental property in the same area is identified and purchased?

For fun, let’s go back and spend $4,000 on a real estate investment course. However, you already own and operate a rental property. This could easily be considered an education expense that is tax deductible since it improves your current work skills. If you were launching another rental property purchase or some other real estate business, this same $4,000 could be start-up costs. It’s all a matter of perspective.

How about this one- you already own a nice short-term rental property in Miami but you also are snooping around in Vail. Why not, right? You spend $4,000 on travel and legal fees to check out the area but have not identified the target property to purchase. Time goes by, and you back out of the Vail market. This $4,000 is lost as a tax deduction since you never started your business (purchased a rental property), nor can you consider it an operating expense for your current short-term rental for lack of business connection.

Our apologies for the slight digression.

Travel Costs with Research

What if you travel to Miami, Hilton Head and Key West, and then finally find and close on a real estate investment in Miami. Do the Hilton Head and Key West travel expenses get added to the Miami rental property? Short answer, No because they were different geographical locations.

Travel Expenses During Improvements

What if the purpose of the travel was to improve the rental property? Let’s go back to IRS Publication 527 Residential Rental Property which states-

Travel expenses.
You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property. You must properly allocate your expenses between rental and nonrental activities. You can’t deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property. The cost of improvements is recovered by taking depreciation. For information on travel expenses, see chapter 1 of Pub. 463.

This little sentence below is a bit problematic, no?

You can’t deduct the cost of traveling away from home if the primary purpose of the trip is to improve the property.

But the opening sentence below might be an escape hatch, right?

You can deduct the ordinary and necessary expenses of traveling away from home if the primary purpose of the trip is to collect rental income or to manage, conserve, or maintain your rental property.

As such, if the primary purpose is to improve the rental property, then your travel expenses must be capitalized by adding them to the improvement costs, and depreciated accordingly. However, if the primary purpose is to conserve or maintain the rental property, then travel expenses might be immediately deducted.

Let’s say you travel to your rental property to do a tenant walk-through at the end of their lease, and you also wanted to paint a few walls, then the primary purpose is to manage, conserve and maintain. When you arrive, however, you discover that the bathroom needs to be completely remodeled. You could argue that the bathroom improvement was a secondary or tertiary purpose of the trip.

Let’s add to this example- let’s say your hotel stay was supposed to be 3 nights to turnover the rental property plus paint the walls, but now your hotel stay is 7 nights to also complete the bathroom renovation. Conservatively, you could allocate 3 of the nights to operating expenses as travel, and the other 4 nights to the bathroom improvement. Aggressively, you could argue that the primary purpose of the trip has not changed, and as such all 7 nights are operating expenses.

Travel Activities

What activities are travel activities and therefore deductible? Here is a quick list in descending order of elegance-

• traveling to the rental property to handle tenants, maintenance and repairs (but not improvements since they are handled differently),

• traveling to Home Depot, Bed Bath & Beyond, Target and related stores to obtain supplies and materials for the rental property,

• the garbage dump where you haul refuse from your rental property,

• the bank where you do banking for your real estate activity,

• learning new skills to help in your rental activity, by attending landlord-related classes, seminars, conventions, or trade shows, and

• traveling to see people who can help you operate your rental activity, such as attorneys, accountants, or real estate brokers.

The Travel Deduction Itself

We will discuss mileage rates and actual expenses when using your personal automobile for travel in a later section. Keep in mind that lodging and travel-related expenses such as mileage to the airport, airport parking, car rental and hotels are usually eligible travel expenses. We will also discuss meals and per diem in a later section.

Rental Property Travel Deduction Summary

We covered a lot with travel deductions and rental properties. Here is a summary-

• Your rental property must be a business and not just an investment. In other words, it must rise to IRC Section 162 as they say. See our real estate and rental properties as a business section.

• Travel expenses must be ordinary and necessary, and not lavish or extravagant.

• Travel must either be outside your tax home or between work locations to be deductible as operating expenses. Your tax home is the entire city or general area where your main place of business or work is located. A home office is simply another work location, and travel expenses between work locations are deductible. Lowe’s could be a work location should you visit for rental property purposes.

• Travel for research might or might not be deductible as a start-up cost depending on whether a new business venture is started. See our start-up costs section.

• Travel for acquisition of a rental property is either added to the purchase price as acquisition costs and depreciated (yuck), or considered an expansion of a current business and deducted as an operating expense (yay). The distinction between these two situations rests on whether an owned and operated rental property exists in the same geographical area.

As a summary to the summary, travel expenditures could be start-up costs, acquisition costs or operating expenses depending on timing, geography and whether you already own a rental property. Here is a table that might be helpful as well-

There is a row missing, right? It is the row that represents-

• travel outside your tax home or

• between your home office and the rental property, or

• between the rental property and a place of business (think bank or Home Depot), and

• does not represent purchasing a new property or improving an existing rental property.

Those travel expenses are deducted as normal rental property operating expenses. We covered a lot. WCG CPAs & Advisors can help navigate the rental property travel expense and deduction.

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

You cannot deduct your meals as business meals unless your rental property or real estate activity is considered a business (we discussed this legal threshold in our Section 199A and business entity sections), and you fall under one of two situations-

• You are meeting a client or tenant, prospect or other business associate (or a small group such as 12), and discussing business matters which can include rental property issues such a reviewing the lease, or

• You are away from your tax home where you require substantial rest (such as an overnight trip), and that trip has a business purpose specific to the operation of your rental property.

As such, if you cruise through the Starbuck’s drive-through and grab your triple grande vanilla breve on the way to doing a repair on a rental property, no good. However, if you are traveling away from your tax home for business purposes including that same rental property repair, and that travel requires substantial rest, then order the venti. Live a little.

How about draining that same breve while meeting your real estate attorney to discuss an eviction? This works too.

Sidebar: The reason business meals are deductible is the presumption that the meeting was the primary objective, and by happenstance occurred while eating a meal. The business purpose is the meeting, and the meal is incidental to the meeting.

Your meal tax deduction is limited to 50% under both circumstances (the 100% that we enjoyed for all meals was only for the 2021 and 2022 tax years, so we are back to the same old same old).

The theory on this is straightforward- you must eat regardless of owning a rental property or not. In other words, your meal is not contributing directly to the operations or success of your rental property activity. The IRS is clever- they don’t mind giving you a tax deduction today on something that eventually will result in taxable income through growth and profits in the future. Think of it this way- if you had a regular W-2 job, you wouldn’t be able to deduct your meals. Why would that change with your shiny new rental property?

Meals Compared and Contrasted with Travel Deduction

In a previous section we discussed the rental property travel deduction. The two fundamentals in that discussion were travel away from your tax home and home office, with a ton of little details in between such as existing rental properties and geography.

Deducting your meals is similar but different all the way. On one hand, travel away from your tax home requiring substantial rest such as overnighting in the rental property for repairs, or a hotel allows you to deduct meals as business meals. On the other hand, you can be meeting your real estate broker or mortgage lender at a deli down the street from your home (with or without a home office), and that meal is also a business meal.

Meals During Acquisition

In playing off our travel deduction examples in another section, let’s say you’ve identified a nice rental property in Miami. You travel there four different times to a) do an initial walk-through, b) be present for inspections, c) sign-off on a seller repair and contingency and d) final walk-through and closing. You must eat right?

Assuming that your trips to Miami required overnight rest, or that you met with a business associate (real estate broker or prospective tenant), and happened to eat a meal during the meeting, the meals associated with these four trips to Miami would be considered acquisition costs (not start-up expenses) and added to the purchased rental property’s cost basis and depreciated accordingly.

This aligns with the general premise that a real estate investor or rental property owner might incur costs that facilitate a transaction, and they include such things as commissions, advertising fees, appraisal fees, meals, travel, and professional fees.

However, if you already owned a rental property in the Miami area, then these same meals would be deductible as operating expenses. Either way, they would be limited to 50% to remain consistent with the treatment of meals. Keep in mind the subtle difference between costs and expenses as we outlined in our rental property travel deductions section.

Deduction Rental Property Per Diem

Sole proprietors including single-member LLC owners, and partners in a multi-member LLC are allowed to deduct the federal per diem rate for meals. Lodging can only be deducted using the actual cost of lodging. This means that as a rental property owner operating the activity as a business can use per diem for meals allowance when away from their tax home on business travel.

Where are S corporations for those real estate brokers, property managers, and fix and flippers? You are not going to like this. Employees of corporations are eligible for per diem allowances, reimbursements and deductions unless this same employee owns more than 10% of the corporation.

This means that most S corporation shareholders are hosed, and can only deduct (or get reimbursed) for actual meal costs. IRS Revenue Procedure 2011-47 has this limitation and IRS Publication 463 Travel, Gift and Car Expenses states in part “A per diem allowance satisfies the adequate accounting requirements for the amount of your expenses only if…you are not related to your employer.”

You are related to your employer if-

• Your employer is your brother or sister, half-brother or half-sister, spouse, ancestor, or lineal descendant,

• Your employer is a corporation in which you own, directly or indirectly, more than 10% in value of the outstanding stock, or

• Certain relationships (such as grantor, fiduciary, or beneficiary) exist between you, a trust, and your employer.

Meals Deduction Summary

Assuming your rental property activity is a business and not an investment, here is a summary again on deducting meals as rental property tax deductions-

• You are meeting a client or tenant, prospect or other business associate and discussing business matters, and that meet happens to occur over a meal, or

• You are away from your tax home where you require substantial rest, and that trip has a business purpose specific to the operation of your rental property.

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

There are some over-arching themes and concepts for all small business and rental property tax deductions. The expense must be-

• Ordinary and necessary (IRS Publication 334 Tax Guide for Small Business), and

• Paid or recognized in the current tax year, and

• Directly related to your business, and

• Reasonable, and not lavish or extravagant (IRC Section 162 and IRS Publication 463 Travel, Gift and Car Expenses).

Ordinary and Necessary

Let’s break these down. An ordinary expense is one that is common and accepted in your field of business, trade, or profession. A necessary expense is one that is helpful and appropriate, although not necessarily required, for your business. In Samp v. Commissioner, Tax Court Memo 1981-706, an insurance agent had a handgun since he traveled to an area with a recent unsolved murder. The Tax Court responded with “A handgun simply does not qualify as an ordinary and necessary business expense for an insurance agent, even a bold and brave Wyatt Earp type with a fast draw who is willing to risk injury or death in the service of his clients.”

You must appreciate a Wyatt Earp reference from a Tax Court judge. Ouch. Clean up on aisle Allstate.

Paid in the Current Year

The expense must be paid or recognized in the current year. Expenses that were paid but not deducted in previous years cannot be “caught up” by deducting them today without amending your prior tax returns (which are easy to do, and should be done if there is money to be had). There is some wiggle room by paying expenses in advance. Under Treasury Regulations 1.263(a)-4(f) there is a rule called the 12-month rule. This allows you to deduct in full an amount where the benefit received from paying the expense spans two tax years.

Here is the exact wording-

(f) 12-month rule-

(1) In general. Except as otherwise provided in this paragraph (f), a taxpayer is not required to capitalize under this section amounts paid to create (or to facilitate the creation of) any right or benefit for the taxpayer that does not extend beyond the earlier of-

(i) 12 months after the first date on which the taxpayer realizes the right or benefit; or

(ii) The end of the taxable year following the taxable year in which the payment is made.

An example you see often is a one-year rental lease that starts July 1 and ends June 30 the following year. If you pre-paid the entire lease amount, you can deduct the entire amount since the benefit (the use of the rental space) is 12 months. However, let’s say the lease term started February 1 of the following year, but you prepaid the entire amount December 31 of the current year. Since the benefit extends past the end of the following tax year, none of it is deductible in the current year and only a portion is deducted the following year.

Just because you can deduct an expense in one lump sum, doesn’t mean that you should. Remember the conversation about depreciation, tax planning and increased marginal tax rates in the future? In other words, if your taxable income is going to be higher next year, then keep some of the tax deductions in your pocket to whack against the higher income.

Related and Not Lavish

The expense must be related to your rental property and its operations- that seems obvious, but it can trip people up especially with things like education and travel. Finally, the expense, specifically in the context of travel, lodging and meals, must not be lavish or extravagant. IRS Publications 463 Travel, Gift and Car Expenses states-

Lavish or extravagant.
You can’t deduct expenses for meals that are lavish or extravagant. An expense isn’t considered lavish or extravagant if it is reasonable based on the facts and circumstances. Meal expenses won’t be disallowed merely because they are more than a fixed dollar amount or because the meals take place at deluxe restaurants, hotels, or resorts.

This comes directly from IRC Section 162 which reads in part-

(a) In general

There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including-

(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

(2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Here is another concept that many rental property owners miss. Every December, we field hundreds of phone calls and emails from clients asking if they should buy something to save on taxes. Or do that big cost segregation study. Or buy that short-term rental property. Our response is a simple flowchart-

• If you are buying equipment like an automobile, do you need it for improved business operations or personal desire? If No, then stop. Don’t buy anything. If Yes, or if you considering a cost seg or rental property purchase, then continue to the next question.

• Is the current year’s income unusually high, or do you expect to earn more next year?

Without sound snarky, why would you buy something on December 31 if your tax rate will only increase the following year? Wait 24 hours, buy the cool thing you need and get a better yet delayed tax deduction. If you don’t need it, why would you spend money unnecessarily only to get a portion of that back in tax savings? Another way of saying this is- keep some tax deductions in your pocket for next year. You don’t want to be in a position where you ran out of perfectly good deductions in a year of increased taxable income.

Conversely, if your current taxable income is unusually high and you expect it to go down next year then perhaps you should accelerate your timelines for major purchases. What do we mean here? Timing your cost segregation study with your taxable income is good business. If you have an unusually high-income year, and you can find a way to not be limited by passive activity loss limits through real estate professional status (REPS) or the short-term rental loophole, then smash that cost seg purchase. WCG can help with the tax modeling and planning.

At times you might want to skip tracking your rental property expenses because you are unable to deduct passive activity losses. For example, your W-2 income is too high and the rental property does not qualify as a short-term rental. Therefore, you tell yourself, “why bother?” Keep in mind that unallowed losses are not lost forever. Rather, they carried over year after year, and can be used when you have rental profits or when you sell the rental property. As such, pile on those expenses!

Finally, all too often we hear people at cocktail parties say something silly like “Don’t worry, it’s a write-off.” Remember that money is still leaving your person, and the money you are getting back in the form of a tax deduction is substantially less. Just because it is a “write-off” or a business tax deduction doesn’t mean that you are using Monopoly money. Yes, it is easy to spend someone else’s money but calling it a write-off doesn’t change who owns the money.

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Section 199A deduction also known as the Qualified Business Income Deduction (QBID) arises from the Tax Cuts & Jobs Act of 2017. This is a significant tax break for small business owners and rental property owners but there are rules and limits of course.

Sidebar: It is a misnomer of sorts since it uses the term “pass-through” which is usually thought of in the context of S corporations and partnerships. To be certain, the Section 199A deduction is available from S Corps, partnerships, Schedule C, Schedule E and Schedule F activities.

Section 199, without the A, is the section covering the Domestic Production Activities Deduction. Section 199A is seemingly modeled after this (or at least a portion was ripped off by legislators) since the mathematics and reporting is similar between Section 199A and Section 199.

Section 199A Qualified Business Income deduction is a deduction from gross income on Line 13 on Page 1 of your individual tax return (Form 1040) for the 2023 tax year. Please recall that it is a deduction on your tax return since there are personal limitations. Therefore, two owners of the same business or rental property might have different results.

Calculating the Qualified Business Income Deduction

The basic deduction is 20% of net qualified business or rental income (profit) which is huge. If you make $200,000, the deduction is $40,000 times your marginal tax rate of 24% which equals $9,600 in your pocket. Here is the exact code-

(2) DETERMINATION OF DEDUCTIBLE AMOUNT FOR EACH TRADE OR BUSINESS. The amount determined under this paragraph with respect to any qualified trade or business is the lesser of-

(A) 20 percent of the taxpayer’s qualified business income with respect to the qualified trade or business, or

(B) the greater of-

(i) 50 percent of the W-2 wages with respect to the qualified trade or business, or

(ii) the sum of 25 percent of the W-2 wages with respect to the qualified trade or business, plus 2.5 percent of the unadjusted basis immediately after acquisition of all qualified property.

Sounds easy enough, right? We don’t want to spend too much time on the calculus nuances, but rather move along to how rental properties play into all this.

Section 199A for Rental Properties

Rental properties are not automatically considered a trade or business (see definition below). Rather, the presumption is that they are passive and on the opposite end of the business spectrum. We discuss this in other sections of our book.

A business must have a profit motive; whether you actually earn a profit is irrelevant; it is your motivation and subsequent actions that dictate this determination. This is a critical distinction since most rental properties have a loss, especially in the early years with current market rent combined with depreciation and / or with relatively high mortgage interest, or both.

In addition to your profit motive, your participation in the business must be regular and continuous. Do not confuse this with material participation which has a series of bright line tests for short-term rental loophole or real estate professional status when viewed in the context of rental properties and real estate investments.

Armed with this knowledge, does your rental property qualify as a business and therefore for the Section 199A deduction?

Owning a rental property should generally qualify- profit motive, and regular and continuous participation. Easy! However, it is not a slam dunk. By using Alvary v. United States, 302 F.2d 790 (2d Cir. 1962) and Gilford v. Commissioner, 201 F.2d 735 (2d Cir. 1953), the IRS and others have come up with a mini facts and circumstances checklist-

• the type of rented property (commercial versus residential property)

• the number of rental properties (volume)

• taxpayer reliance on the activity for lifestyle or income

• time and effort spent on daily operations

• the types and significance of any ancillary services provided within the activity (think short-term rental, hunting lodge, tours, etc.)

• the terms of the lease (for example, a short-term versus long-term lease), and

• conformity to Section 199A’s preamble

What is the Section 199A preamble? Here is a snippet from page 16 the final regulations which eerily looks familiar to the list above-

In determining whether a rental real estate activity is a section 162 trade or business, relevant factors might include, but are not limited to (i) the type of rented property (commercial real property versus residential property), (ii) the number of properties rented, (iii) the owner’s or the owner’s agents day-to-day involvement, (iv) the types and significance of any ancillary services provided under the lease, and (v) the terms of the lease (for example, a net lease versus a traditional lease and a short-term lease versus a long-term lease).

That doesn’t really stand out as helpful or definitive either. The good news is that both the courts and the IRS have consistently found in favor of rental property owners and have allowed broad support for the profit motive including the regular and continuous requirements. Yay!

What is also a bit noteworthy is that the Section 199A proposed regulations summary released way back in August 2018 for rental activities had an example of a landowner who leased unimproved land to an airport for parking lots. People got hung up on the use of land this way, and leaped to the argument that all land rental activities rise to the level of a trade or business. The final regulations for Section 199A removed the land examples and stated that land rental activities might or might not be a trade or business depending on the facts and circumstances. Like Peyton Manning in his SNL United Way skit, “I’m not saying I’ve killed a snitch; I’m not saying I haven’t.”

The IRS and the Treasury Department recognized this conundrum, so they released IRS Notice 2019-7. In that Notice they defined a safe harbor for using the Section 199A deduction for rental properties-

Solely for the purposes of section 199A, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the taxable year with respect to the rental real estate enterprise:

Separate books and records are maintained to reflect income and expenses for each rental real estate enterprise;

For taxable years beginning prior to January 1, 2023, 250 or more hours of rental services are performed (as described in this revenue procedure) per year with respect to the rental enterprise; and

The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents, regarding the following: (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services. Such records are to be made available for inspection at the request of the IRS. The contemporaneous records requirement will not apply to taxable years beginning prior to January 1, 2019.

There are some other devils in the details such as not being able to combine commercial and residential rentals into a single enterprise, and there are lease type rules as well.

In our opinion, this safe harbor is anything but a safe harbor. A safe harbor is meant to cut down on the onerous nature of recordkeeping or provide bright lines to bolster the tax position. This is in favor of having a facts and circumstances based argument for your tax position. Read this Section 199A safe harbor again- separate books, a bunch of hours, and a log. Sounds like business as usual to demonstrate your regular and continuous involvement. The only silver lining we see is if you meet the safe harbor, then you are determined to have a profit motive.

Triple Net “NNN” Leases and Section 199A

We won’t spend too much time on this since there is no clean answer to this issue. Triple net leases or what most call NNN leases offload some of the expense to the tenants. This is very common in commercial real estate properties like office buildings and build-to-suit single user tenancy. Specifically, certain operating expenses, maintenance and property taxes are paid by the tenants on a pro-rata basis.

In turn, some argue then that this type of rental activity is not a business since expenses are being passed directly to the tenants. To make matters a bit worse, the rental property owner or property manager has very little incentive to reduce expenses since the tenants pay them directly. This is inconsistent with the profit motive of a business where you want to maximize revenue and minimize expenses.

Some resources suggest that NNN leases still rise to the level of IRC Section 162 and qualify for the Section 199A qualified business income deduction. How? Going back to the safe harbor, the profit motive is assumed should you meet the requirement in IRS Notice 2019-7. This is tricky to say the least.

Specified Service Trade or Business Inflection Point

This is a slight digression, but interesting, nonetheless. The IRS was concerned that a specified service trade or business (SSTB) could shift income that would normally not qualify for a Section 199A deduction into self-rental income that may qualify. This was part of the “crack and pack” strategy of splitting up an entity into SSTB and non-SSTB operations, thus being able to qualify for a Section 199A deduction on the non-SSTB operation (provided you hit those income limits that required the secondary SSTB test with the sliding scale of phaseout).

The proposed regulations 1.199A-5(c)(2) (and later finalized in the regulations) added provisions preventing this. So, if an accountant owns the firm and the office building in separate entities, the self-rental income becomes “tainted” and is considered SSTB income. This is because both entities have greater than 50% common control. No, you cannot have your spouse own the building and you own the SSTB business; attribution rules get in the way and state that you both own everything. Again, common control. Here is a blurb right from the regulations-

Example. Law Firm is a partnership that provides legal services to clients, owns its own office building and employs its own administrative staff. Law Firm divides into three partnerships. Partnership 1 performs legal services to clients. Partnership 2 owns the office building and rents the entire building to Partnership 1. Partnership 3 employs the administrative staff and through a contract with Partnership 1 provides administrative services to Partnership 1 in exchange for fees. All three of the partnerships are owned by the same people (the original owners of Law Firm). Because there is 50% or more common ownership of each of the three partnerships, Partnership 2 provides substantially all of its property to Partnership 1, and Partnership 3 provides substantially all of its services to Partnership 1, Partnerships 1, 2, and 3 will be treated as one SSTB under paragraph (a)(6) of this section.

This is unfortunate in our opinion. This same law firm leases office space from an unrelated party; the law firm might not qualify for the Section 199A deduction because of SSTB income limitations, sure, but the landlord might. Provided the rent charged in a self-rental situation is market rent, why can’t the law firm also be a landlord and enjoy a partial Section 199A deduction?

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Before we get into which tax deductions and tax moves you can take, there are some basic concepts to help formulate your thinking.

Marginal Tax Rate

Quick lesson on rental property tax deductions. When you write a check and it has a tax savings element (repair, office expense, 401k, IRA, charity, etc.) it is not a dollar-for-dollar savings. For example, if you are in the 22% marginal tax bracket, you must write a check for $4,000 just to save $880 in taxes. Keep this in mind as you read this information on tax deductions. Also keep in mind that cash is king, and that perhaps paying a few more taxes today with the added flexibility of cash in the bank can be comforting.

Tax Deductions versus Tax Deferrals

Tax deductions generally reduce taxes today, and you are done. Tax deferrals, on the other hand, are little IOUs to the IRS. They are tax savings today but you might owe the money back. A 401k deferral is a great example- you lower your taxable income today, but when you pull the money out during retirement, it will be taxable income.

Rental property depreciation is similar since when you sell the property you will have depreciation recapture. This permits the IRS to take back (i.e., “recapture”) some of the tax benefits you received over the years through depreciation deductions. As such, depreciation is like a 401k deferral and might be a little tax bomb later on. Sure, you can do a series of 1031 like-kind exchanges and pull cash out with refinancing, but you get the idea.

Cash Savings or Tax Savings

You can save $50,000 today! Yes, today! You just need to write a $150,000 check to your church. Huh? That might not sound like the best idea to a lot of people since so much cash is leaving their checkbook. Another way to look at this is this- most people say, “I want to save taxes” but really what they are saying is “I want to save cash.” Who doesn’t?

In other words, most people are in the cash-saving business not the tax-saving business. If we can do both, great. However, most tax-saving moves take cash, and cash is what you want to keep. Having said that, the biggest weapon to a rental property owner is depreciation, especially accelerated depreciation. Unlike most other tax savings strategies, depreciation can be viewed as a cashless tax deduction although cash is used to purchase the rental property. Why? You get it back when you sell the property.

Said differently- if you travel to your rental property, the cash you spend is lost forever although it might provide some tax benefit. Therefore, you want to ensure the travel expense is necessary for operational considerations. Conversely, when you depreciate a rental property, you are not writing a check or swiping your credit card directly. This makes the deduction cashless in a sense.

Please keep cash savings versus tax savings in mind as we get into the rental property deductions below.

Building Wealth

At the end of your life, you’ll measure your financial success on the wealth you built not the tax you saved. We agree that a part of wealth building includes tax savings or deferrals. For example, you purchase a cost segregation study that creates a big tax deduction yielding a nice chunk of accelerated cash flow. This in turn is redeployed to buy another rental property. Tax deferral (because of depreciation recapture) used to build wealth. Beauty!

However, be careful not to sacrifice wealth for the thrill of a tax deduction (or deferral). Here is an example- let’s say you stuff all your available cash into a tax-advantaged retirement account such as a 401k. A few years go by, and a great rental property comes on the market, but your cash is all tied up in a 401k. So, you sacrificed potential building of wealth by not having an intermediate investment strategy that is not tax-advantaged for the sake of tax deferrals.

Let’s really drive this point home- to reduce taxes by spending cash just to have tax savings bragging rights at the party tonight is silly. To reduce taxes by spending cash to turn around and use the savings to build wealth is ideal. The 401k deferral isn’t all bad if the tax deferral is used to build wealth elsewhere.

Moving on…

The Trick

Here’s the trick. The Holy Grail if you will. You need to find a way to deduct money you are already spending. Read that again. For example, if you have a travel budget then you are already comfortable with a certain amount of money leaving your person. Let’s find a way to deduct it through your business or rental property activity.

Automobile depreciation? Same thing. You are already comfortable with automobiles losing thousands of dollars in value especially in the early years, so let’s find a way to make this degradation in value a tax windfall.

Remember that the greatest trick the devil ever pulled was convincing the world he didn’t exist. The second greatest trick was finding a way to deduct the expense. You gotta love The Usual Suspects. Classic!

By Jason Watson, CPA
Posted Tuesday, August 27, 2024

Ahh… the good stuff. Yes, you work hard. Yes, you want to be able to get a little extra from your rental property and real estate investment business. Yes, you want this to be tax-advantaged. We get it. This chapter will discuss the 185 tax deductions you cannot take (not really), explain how to position yourself on allowable rental property tax deductions, and then get into hot topics such as automobiles, travel, home offices, repairs, Cohan rule and other fun things.

This chapter’s underpinnings come from our book titled Taxpayer’s Comprehensive Guide to LLCs and S Corps aimed at small business owners. However, we sprinkle in real estate specific things here and there. Additionally, please keep in mind that we encourage rental property owners to view their activities as a business and not just an investment. We will discuss the technical difference between investment activities and business activities in a bit.

If you are real estate broker or agent, property manager or fix and flipper, and have earned income outside of rental properties and real estate investments, this chapter will feel truncated. Please visit our companion book above for nauseating details on general small business tax deductions and tax efficiency strategies.

The rental property tax deductions chapter is long, but it might be the most sought after.