If you own property that is used as a rental, there are many different rules that affect the taxes owed. This includes how the income is reported, and what expenses can be used to offset the income generated by the rental. You will want to use every allowable expense to help to minimize taxes, but it is equally important not to take deductions that are not allowed. You can't deduct the full amount of the mortgage from your taxes, but deducting a portion of the expense is allowed.
Status of Dwelling
If a rental property is used exclusively as a rental, the owner reports all income and deductions related to that property. If, however, the property is used at least part of the year as a second home for the property owner, different rules apply. If the home is used less than 15 days of the year as a rental, the rent is not reported and rental expenses are not deducted. If it is rented, but is also uses as a home part of the year, certain expenses are deductible, including mortgage interest. But all income from the property must also be declared. This is also the case if the unit is used as a full-time rental.
The amount of the mortgage payment that is applied toward principal cannot be deducted. This money is considered to be used specifically for building the owner’s equity in the property, and is therefore not an expense. The portion of the mortgage payment that is applied toward the interest on the loan is deductible as an interest expense, and can be used to offset rental income. The property owner receives a form 1098 from the lender at the end of the year. This form will provide these amounts.
Although the principal amount of mortgage payments cannot be used as a deduction, depreciation can help offset some of that amount. Since the property is being used to produce income, it is considered to lose some value each year through wear and tear, reducing the overall worth of the property. Only the buildings that are actually used as rentals may be depreciated in this case. The value of the land does not depreciate. There are different methods for determining depreciation. Normally the same depreciation method is used for the life of the structure.
There are other expenses on a rental property that are allowable as tax deductions. Such expenses include property taxes, mortgage insurance premiums, improvements to the dwelling, repairs, advertising and rental agency fees. There are other allowable expenses that are deductible, but many depend on the specific situation, especially if the property has a net loss for the year. All of these combined typically provide a significant amount of offset to the rental income, making the tax liability much less than it would be otherwise.
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