3 Safe Harbors to Help You Deduct More Rental Expenses

December 20, 2024 7 min read

Rental Expense Deduction Safe Harbors

Contrary to their name, safe harbors have nothing to do with boats and everything to do with your rental property business. Or at least, they should! If complicated tax regulations have been an obstacle keeping you from maximizing your deductions, then safe harbors may be the solution.

If you’re looking for a way to simplify your tax preparation while growing your business, understanding tax safe harbors for your rental business is a good place to start.

What is a Safe Harbor?

Before we get started, it’s important to understand what safe harbors are and why they exist.

Safe harbors are regulations that simplify taxes for business owners and landlords to make the tax filing process easier. They essentially help you to sidestep some of the more complicated parts of filing, allowing business owners to reduce their yearly taxable income while following federal and state government law. Under safe harbor tangible property regulations (regulations referring to the acquisition or improvement of physical property), taxpayers reduce the risk of errors, misinterpretations, and potential penalties from the IRS.

Safe harbors are completely voluntary, but if you choose to utilize any, you must do an annual election, as the status will not transfer. With safe harbors, you’ll classify certain expenses a little differently, but once you get the hang of it, they will simplify your tax season.

How Do I Make a Safe Harbor Election?

To claim a safe harbor election, you’ll attach a statement to your federal tax return upon filing that generally contains your name, address, Taxpayer Identification Number, and a statement of the election (some elections may require more information). Making a safe harbor election for financial accounting purposes should not affect your method of accounting, as you will only file these expenses as “other” or miscellaneous on your Schedule E, using something like “De minimis safe harbor election” as the description.

You’ll need to keep close documentation of your rental property expenses (which you should be doing anyway!) to qualify for safe harbor elections. It’s also vital to note that you must include a statement of election every single year for certain safe harbors. For more information, ask a certified tax professional or visit the IRS website, which details when and how you can make an election.

Three Kinds for Landlords

Though there are a few different kinds of safe harbor elections, there are three simple ones for landlords and rental property owners. Below, we’ll dive into what each one is and how you can qualify for them.

1. Small Taxpayers Safe Harbor

The safe harbor for small taxpayers (SHST) allows small landlords and taxpayers to deduct all annual maintenance expenses, including but not limited to repairs and improvements. Instead of tediously classifying each maintenance cost as either a deductible repair or depreciable capital expense, you can simply file all maintenance expenses as operating expenses on your Schedule E. As operating expenses, they can be deducted from your taxable income in the same year rather than depreciated in smaller parts over time (as capital expenses are normally treated) in smaller parts over time (as it would with capital expenses).

In order to qualify for the small taxpayer election, landlords must meet all the following size, expense, and income requirements:

Your building must be valued at less than $1 million
Your total income cannot exceed $10 million in the span of the past three tax years
Your repairs, maintenance, or improvements expense total must be less than $10,000 or 2% of the unadjusted basis (original cost of the building)

So, if you bought new appliances for your building and they totaled to less than $10,000 (and you met the other two monetary requirements as well), then you would be able to take advantage of the SHST. Doing so will help you avoid complicated rules and math associated with capital expenses, which the appliances would otherwise classify as. To do this, however, you must claim the SHST each year by including a safe harbor election for small taxpayers each fiscal year.

2. Routine Maintenance Safe Harbor

The routine maintenance safe harbor election (also known as the election to capitalize repair and maintenance costs), similarly to the SHST, allows business owners to file routine maintenance expenses as operating expenses rather than capital expenses. There are different stipulations and qualifications to meet for this safe harbor, as there are no income or property value caps, which means any landlord can make this election.

Business expenses may qualify if:

You expect the maintenance expense to recur multiple times during ten years of the building’s service
The expense doesn’t increase the value of the building, meaning it only repairs the issue rather than improving its functionality

There are a few more nuances. For instance, you cannot use this election directly after the purchase of a building, as these expenses would not qualify as maintenance needs incurred by the current taxpayer. In order for repairs and maintenance to qualify, they must be attributed to you, not the previous owner.

Additionally, the ‘no betterments or restorations’ rule prevents landlords from using this election for any improvements or renovations to the building. With improvement rules, expenses must only repair the eligible building property back to functionality and must not better its functionality or increase the property’s value. Performing an annual HVAC inspection could qualify under this safe harbor, but replacing it entirely would not.

Another important aspect to remember is that any costs deducted within the routine maintenance safe harbor will also count towards your $10,000 total for the safe harbor election for small taxpayers (if applicable).

To make the routine maintenance safe harbor election, you must also track these expenses accordingly throughout the year (as operating expenses rather than capital expenses), so it’s important to plan ahead if you want to use this safe harbor.

3. De Minimis Safe Harbor

Meaning “pertaining to minimal things” in Latin, the de minimis safe harbor allows you to deduct expenses that are smaller in cost (less than $2,500 per item) rather than classifying them as capital expenses and depreciating them over time. It relieves the stress of determining how small expenses should be classified. The de minimis safe harbor election for your taxes is applicable regardless of whether or not the expense is technically a repair or improvement, so long as it stays under the $2,500 per item cap.

It’s important to note that the aggregate rule prevents the abuse of de minimis safe harbor. It essentially means that you cannot break large expenses up into smaller ones in order for them to be filed with de minimis. If you as a landlord were to improve your HVAC system and it amounted to $5,000, you could not break down the individual costs of the improvement (wiring, motor, etc.) in order to stay under the limit.

However, if you were to add different improvements to the same property, you would be able to break these expenses down. Improving kitchen appliances, painting walls, replacing carpets, and repairing AC within the same unit are all different invoices, and therefore, different expenses. Meaning if each of these expenses were under $2,500, you could file them all under de minimis separately.

You also cannot utilize the de minimis safe harbor election for inventory or land, so it’s important to research IRS regulations or to ask a tax professional to determine whether your expenses qualify or not.

Conclusion

By taking advantage of the safe harbor applicable financial statement options outlined above, your tax filing process should be less stress-inducing, time-consuming, and confusing. Though they may seem confusing at first, safe harbors are a fantastic way to decrease your taxable income while increasing your profits at the same time.