Deductions For Your Start-Up Expenses This Tax Season

Starting a rental property business can be difficult and costly. Before you even open your doors, you may have already spent thousands of dollars readying your business for its opening. It may feel never-ending and downright stressful, but luckily for you and for many other business owners, the IRS understands this. If you’re fresh on the scene and haven’t yet heard about start up expenses rental property businesses can deduct, then read further to learn how you can save thousands of dollars each year.

What Is the Start-up Expense Deduction?

The start-up expense deduction is a tax break used to relieve new business owners of some of their tax liability in the early days of business ownership . The IRS encourages the growth of new businesses by providing this avenue for owners to get some of the money spent on their business’s earliest expenses back.

Many expenses incurred before the opening of your rental business (when it is “placed in service” or ready to rent) can be reported as tax deductions, which will put some money back in your pocket. Advertising expenses incurred before your first business day, for instance, can qualify as start-up expenses, since they were incurred in preparation for your business’s opening. Below, we’ll dive into the specifics of what qualifies and how to take advantage of this tax break.

How to Qualify for the Start-up Expense Deduction

New rental business owners can deduct up to $5,000 of start-up expenses in their first year of operation under this special tax rule. Anything left over can then be amortized evenly over the following 15 years (if their total start-up expenses do not exceed $50,000). To qualify for the $5,000 deduction, start-up expenses must meet the following general criteria for operating expenses:

1. Be a cost the business could deduct if they were already an operating business when the costs were incurred. This means they must be:

• • Ordinary and necessary: They must be a common expense in the industry (necessary doesn’t mean essential here, just that it is appropriate and nearly essential).
  • Current: They must improve your business for less than a year, meaning you will have to incur this expense again next year (otherwise it is a capital expense).
  • Directly related to rental activity: They must not be for personal use (with the exception of certain special circumstances, such as the home office deduction).
  • Reasonable in amount: They must be economically reasonable and sound (if there is a much cheaper and simpler way to get the same result, the IRS may flag an expense)

2. Be incurred before the first day of operation.

• • You must have tangible proof (receipts, invoices, ledgers, etc.) that these expenses were incurred before your first day of operation.
  • You must also be legally considered a business by the IRS, which can be tricky in the world of rental property and passive income. Be sure to research local laws to ensure that you’ve taken the correct steps (registering for an Employer Identification Number if you have employees, etc.).

Here are a few examples of what may and may not qualify as deductible expenses for rental property under the start-up break:

What Can Qualify:

• Office supplies
• Advertising
• License and permit fees
• Employee training
• Website-building costs

What Cannot Qualify:

• Improvements
• Real property
• Travel expenses
• Interest and taxes

Claiming the Start-up Deduction

Before claiming anything, the rental start up expenses IRS rules dictate that you must have evidence of these costs and their relevance. It’s vital that you safely store receipts, records, and ledgers to prove that you incurred these costs before your business was operational. Additionally, you’ll likely only be able to write these expenses in the year in which they were incurred. For tax purposes, it’s recommended that you have a concrete date recorded as your first official day of operation, typically the day that your property is “placed in service” or ready to rent, rather than “opening” the day you get your first tenants.

With this in mind, you’ll claim the $5,000 deduction on your Schedule E under “Other”, listing the expenses and the election. For any expenses that exceed the $5,000 limit, you’ll fill out Part VI of Form 4562 to amortize them over a 15-year period. As seen on the 2024 version, you’ll fill out the descriptions, amortization dates, and more. However, if your start-up expenses exceed $50,000, then the maximum deduction amount is reduced dollar-for-dollar by the amount exceeding $50,000 (meaning totals of $55,000 and up will likely not qualify for deduction).

How Much Can I Save With the Start-up Deduction?

Given the vast amount of start up expenses rental property businesses can incur, it’s safe to say that you can save a lot of money with this deduction. As mentioned, you can elect to deduct up to $5,000 in the first year of your business’s operation. Then any excess (which does not exceed $50,000) can be amortized over the following 15 years.

If you were to spend $30,000 in start-up expenses, you’d be able to deduct the first $5,000 (given that all of these expenses meet the previously discussed criteria). The remaining $25,000 would be depreciated over the span of 15 years, meaning you would deduct an additional $1,667 each year for fifteen years (using the straight-line method).

Your actual tax savings will depend on your tax bracket, but you can see how these numbers quickly add up. The compiled savings over the course of those fifteen years will give you more wiggle room to grow your business to your liking.

Conclusion

When building your business from the ground up, ensure that you take advantage of as many deductible expenses for rental property as you can, including the start up expenses rental property businesses qualify for. By filling out a few extra lines on your tax forms and keeping close record of your expenses, you can save thousands of dollars each year.