You can deduct expenses incurred when you rent a property or earn rental income. These expenses include property tax, mortgage interest, depreciation, repairs, and operating expenses. A tax incentive for homeowners is the mortgage interest deduction, which can sometimes be applied to rental properties.
Mortgage Interest Deduction
You can reduce your taxable income through the mortgage interest deduction. This deduction is available for loans used to purchase, build or improve a property, as long as they are tied to a primary or secondary residence of at least $750,000. Borrowers who borrowed a mortgage loan before December 16, 2017, can deduct interest up to $1,000,000
Investment properties are not eligible for the mortgage interest deduction. However, by filling in Schedule E, you can deduct mortgage interest as a business expense to reduce your taxable income.
Here’s how to deduct mortgage interest from the rental property: Let’s assume you bought a rental property worth $500,000 using a $350,000 mortgage loan. Let’s say that interest is $15,000. You can deduct $15,000 for mortgage interest if your rental property generates $50,000 in rental income per year. This reduces your taxable rental income down to $35,000.
To show how much interest you have paid, your lender should send Form 1098 annually.
You can’t deduct the expenses you have paid to get the mortgage on your rental home. These expenses can be added to the basis of the property and depreciated along with the property. These expenses include:
- Legal fees
- Commissions on mortgages
- Title insurance
- Recording fees
- Installation charges
- Transfer taxes
- You agree to pay the amount that the seller owes, but not back taxes, mortgage fees, or charges for improvements or repairs.
Common deductible interest payments
Mortgages don’t qualify for interest deductions. These are the most popular deductible interest payments that rental property owners receive:
- To acquire the rental property, mortgage interest payments
- To improve rental properties, mortgage interest payments are used
- Credit cards that are used to rent goods or services will charge interest
- Personal loans to rent items are subject to interest
Mortgage interest deduction limitations
“Section 163(j), limitation” on deductions for business interest expenses was established in 2018. This limit applies to taxpayers’ business interest deductions in the following amounts:
- 30% of the adjusted taxable income that the taxpayer has for that year
- The taxpayer’s business income for the year
- The floor plan financing interest rate for the year
Businesses with an average gross receipt of $26million (indexed for inflation) over the past three years can deduct interest payments up to 30% of adjusted taxable income. If you earn more than this amount, your tax return can allow you to elect to deduct 100% of your interest expense.