• Landlord Taxes

What Counts As A Rental Operating Expense?

December 20, 2024 6 min read

Rental Operating Expense

If you’re a rental property manager, there’s no doubt that having your work and investments officially classified as a ‘business’ is the best scenario for tax season. The process of being considered a business by the IRS—which we cover in more detail in another article—grants you the opportunity to deduct a number of rental operating expenses from your taxable income each year.

However, it’s essential that when tracking your rental property expenses, you can distinguish what counts as an operating expense and what doesn’t. This article will walk you through a number of different expenses and clarify what category they fall into so that you can avoid confusion and move into tax season with clarity and confidence.

What Is an Operating Expense?

Simply put, an operating expense is any expense for landlords and real estate investors involving the everyday, regular upkeep of the rental business. A key point to remember is that operating expenses have to do with the operation of a rental property rather than its acquisition. For instance, you cannot claim your down payment for a rental property as an operating expense, nor your ongoing mortgage payments thereafter, though you’ll continue to make both principal and interest payments.

Operating expenses are reported on Schedule E, the IRS form used to report income or loss from rental real estate.

So, what’s included in operating expenses for a rental property? Operating expenses can range widely, but include many smaller costs related to keeping your business running, such as repairs, maintenance, advertising, utilities, and more. These costs are deductible from your taxes each year, but only during the year that they are incurred.

How to Determine Your Operating Expenses

The definition of operating expenses for rental property is relatively straightforward, which has the potential to leave you wondering about the sheer amount of everyday expenses you incur over the course of the year and whether you should include them in your deduction. Fortunately, there is a list of four criteria provided by the IRS to further specify whether a particular expense will qualify for a full deduction. Let’s take a look at them below:

Ordinary and Necessary

First, your deducted expense must be reasonably ordinary and necessary. This basically means that it must be a common expense that is in some way vital to the operation of your rental business. This can apply to one-time maintenance expenses or to recurring payments. While your mortgage itself does not qualify, mortgage interest is often deductible.

Current

An operating expense must also be considered current, meaning that its benefits for your business are immediately relevant, lasting less than the span of a year. For instance, hiring a cleaner for one of your rentals will benefit your business immediately, but it is likely that it will need to be cleaned again before the year is over, making the benefits of the initial cleaning obsolete to some degree. For that reason, a fee to hire a cleaning person meets the ‘current’ criteria for operating expenses.

The ‘current’ criteria makes operating expenses different from capital expenses, which have longer-lasting benefits. For instance, buying any sort of cleaning or maintenance equipment like a carpet cleaner or an air conditioning unit are not current expenses because their benefits are likely to last longer than a year.

Directly Related to Rental Activity

Next, any operating expense must be directly related to your rental business. You cannot deduct anything that is purchased solely for your personal use or for the benefit of another business, but you can claim a partial deduction for an expense used for both personal and business uses.

For instance, if you pay rent on an office space that acts as a central business hub for your rental business, this qualifies as being directly related and can likely be deducted. However, if you regularly use that space for activity unrelated to your business, then you must subtract the proportional cost for time that the space is being used for non-business purposes.

Let’s say you use the office fifteen hours a week for your rental business and fifteen hours a week for an unrelated catering business. In this case, you can only deduct half of the rent from your taxable rental income.

Reasonable in Amount

Finally, any operational expense you deduct from your income must be reasonable in amount. This essentially means that the listed price that you paid for the expense must be generally in line with expectations of market value, and any exorbitant amount may not be refunded in its entirety. The IRS is likely to flag any amount that is not in line with the average operating expenses for rental property.

Common Deductible Operating Expenses

Below is a list of the most common operating expenses for rental businesses. Each of these expenses will typically align with the above criteria.

• Repairs
• Preventative maintenance
• Advertising and marketing costs
• Auto and travel expenses
• Tenant screening fees
• Leasing fees & commissions paid to rental brokers
• Insurance
• Legal and professional fees (e.g., accounting)
• Property taxes
• Property management fees or (software premium)
• HOA fees
• Office expenses
• Mortgage interest
• Some other interest expenses
• Utilities you pay (e.g., water, sewer, trash)
• Regular landscaping/snow removal services

Non-Deductible Operating Expenses

There are certain operating expenses that, even if they meet these criteria, will still not qualify for any deduction:

• Entertainment expenses, such as optional business outings or vacation trips
• Fines imposed by the government for violating the law
• Illegal activity such as bribes or parties for government employees
• Lobbying expenses
• Athletic, social, or country club membership fees or dues
• Federal income taxes paid on your rental income
• Capital expenses, like finishing a basement or building an addition to a property
• Certain interest payments

Conclusion

As the owner of a rental business, it’s important that you are vigilant and responsible about making sure that your taxes are done correctly. By taking a look at your expenses and maximizing your deductions, you’ll be able to identify trends and increase both your gross operating income and net operating income. Hopefully this article will help you navigate how to uphold that responsibility while taking advantage of the benefits of valid operating expense deductions.