Are operating expenses tax-deductible? & Other Tax questions

7 Replies

Hello, I got some caffeine in my system so let me know if you do not follow.  


1a) I know that Interest on the mortgage is deductible 
1b) I know that property depreciation is tax-deductible

Total Tax Deductions = (Interest) + (Property Depreciation) + (?Operating Expenses?)

2) Are operating expenses tax-deductible?
-I define operating expenses as mandatory expenses that I need to run the rental. Ie property taxes, insurance, HOA fees and repairs.

-Side note 1: For improvements (not repairs) I know that the cost needs to be amortized over its life term. It's probably best if I ask my CPA about this because it varies per improvement. It seems like the detail to attention is not worth the benefit in this situation.

-Side Note 1b: With only 1 rental can I go to a normal CPA? When would I need to switch over to a Real Estate Accountant? I'll have all of this info in an excel spread sheet, what should I bring to make their job easier? 

-Side note 2: If my bathroom tub is leaking and it causes water damage and I replace the whole thing does that count as an improvement or a repair? 
-I replaced the 10+ year old carpet with vinyl, is that a repair or improvement? 

Is the following formula the correct way to calculate depreciation?
[Gross Income] - (Total Tax Deductibles: Op Expense - Interest - Prop Depreciation) = Taxable Income
IE
[8000] - (4000) - (2000) - (1000) = $1000 Taxable Income
Assuming I have a tax bracket of 28%; $1000 * 28% = 280
I have to pay $280 of taxes on my $8000 rental income.

Extra Question: 
How do you determine the market cap rate? 

Do you have any favorite formulas or ratios that you look at before investing?
IE: ROI, Cap Rate, IRR

I'd also like to know the answer to this question

@Daria B. thanks for tagging me!

@Minh Lai you are asking a lot of great questions. You also ask whether you should get a real estate CPA or a regular one, though I think you answered that yourself simply by the number of questions you are asking :)

Call up a real estate savvy CPA and get them on your team sooner rather than later. You don't want a regular CPA answering these questions as real estate knowledge is very niche and complex.

Medium logo blackBrandon Hall CPA, The Real Estate CPA | http://www.therealestatecpa.com | Podcast Guest on Show #196

basically all your expenses related to the property are tax deductible.  I suggest you go to irs.gov and print out the form 1040 schedule E, and categorize your expenses according to the form instead of a general catch all "operating expense". 

Basic IRS rule on repair or improvement, an improvement is anything that increases the useful life of the structure for example new roof.  There are what are called safe harbor rules when it comes to improvements,  small improvements can usually be expensed as repairs and maintenance, instead of having to depreciate them over the life of the building.  Find a good tax professional in your area that owns rental property themselves, I promise they will save you more in tax saving than their fee. Do it now so they can teach you how to keep track of expenses and deductions you might be missing.  Good luck!

@Brandon Hall - Lol you're right. I'll find myself a real estate CPA. 

@Cameron Skinner - Thanks. 
IRS.gov -> 1040 schedule E -> Categorize my 'operating expenses'
Find a good tax professional now and learn from them.

Roger that good sir. 

The caffeine might only be 50% tax deductible.....
Originally posted by @Minh Lai :


Is the following formula the correct way to calculate depreciation?
[Gross Income] - (Total Tax Deductibles: Op Expense - Interest - Prop Depreciation) = Taxable Income
IE
[8000] - (4000) - (2000) - (1000) = $1000 Taxable Income
Assuming I have a tax bracket of 28%; $1000 * 28% = 280
I have to pay $280 of taxes on my $8000 rental income.

Extra Question: 
How do you determine the market cap rate? 

The formula may be how you calculate your net cash flow, but this is nowhere close to how to calculate depreciation.  Suggest you let your CPA handle this for you and explain everything you don't understand.

As a general rule, Cap Rate is useless information for a 1 - 4 unit residential property. Value of the property is determined by appraisal, not by cap rate.  If you still want to compute the CapRate, the formula is CapRate = (Net Operating Income) / (Purchase price) * 100%.