Deduction of Startup Expenses

Certain expenses incurred while preparing a rental property (in advance of ultimately renting) are tax deductible. So let’s have a look at a few.

Note: Startup expenses discussed within this segment of the Rental Property Tax Guide, are dissimilar to the expenses which are deductible (under section 195 of the Internal Revenue Code.) Under the section 195, certain startup expenses (in an active trade or business) are deductible up front up to $5,000 with a balance amortizable over fifteen years. However, in this section 195 of the Internal Revenue Code, rental activity is not included because rental activity is considered a passive activity not an active trade or business. See the article titled Tax Deductible Rental Losses, included in this Guide, for a more focused study of passive activity rules.

Note: It isn’t just once you have literally rented real estate that rental activity “begins”, but when you have made the property available for rent.

The Expenses of Obtaining a Mortgage

Recording fees, mortgage fees, and abstract fees (amongst others) are capitalized and thus become part of your basis in the rental. Rather than expensing these fees all at once, you need to depreciate those expenses.

Points

“Points” are charges paid by a borrower to take out a loan or a mortgage. This points or charges may also be called origination fees, or premium charges, or maximum loan charges. Points are essentially prepaid interest. Thus, they are deductible as interest, but you cannot deduct the full amount at once. Rather, you must amortize the points over the life of the loan. Figuring out how many points to amortize per year is no simple chore. Visit a tax professional.

Improvements versus Repairs

You need to capitalize and depreciate all improvements you make to the property in advance of putting it on the market. Improvements prolong the use of the property or materially increase the property’s market value. Repair expenses, on the other hand, you may freely deduct. A repair aims to keep your property in good working condition, not to increase the market value or prolong use.

Tax CPA +John Huddleston has written numerous articles on accounting and other tax related subjects of interest to small business owners. He is a graduate of Washington State University and the University of Washington.