Deducting Expenses You Incur Before Your Real Estate Business Begins
Special tax deductions are available to landlords when they start a residential rental business.
Landlords often need to spend money to get their rental business started. Costs you incur before you are actually in business are called start-up expenses. Special tax rules govern the deduction of these costs. If you are a landlord who is already actively engaged in the residential rental business, you may not need to read this article. But if you aren’t yet in business or are considering expanding your residential rental business into new geographic areas, this piece explains what type of expenditures are start-up expenses and how you can deduct these costs.
What Are Rental Business Start-Up Expenses?
Start-up expenses are the costs you incur to get your rental business up and running. Any expense that would be deductible as an operating expense by an ongoing business is a start-up expense when it’s incurred before a business begins. Common start-up expenses for landlords include:
- minor or incidental repairs to get a rental property ready to rent
- outside office expenses paid for before a rental business begins, such as office rent, telephone service, utilities, office supplies, and office equipment rental
- home office expenses
- the cost of investigating what it will take to create a successful residential rental business, including research on potential real estate markets
- attending real estate seminars or conferences or other educational programs or classes
- insurance premiums (but not title insurance)
- maintenance costs for a rental property paid for before the property is offered for rent—for example, landscaping and utilities (but not the cost of connecting utilities)
- costs for recruiting and training employees before the business opens—for example, hiring and training an apartment manager
- fees paid to a market research firm to analyze the demographics, traffic patterns, and general economic conditions of a neighborhood
- business licenses, permits, and other fees, and
- fees paid to lawyers, accountants, consultants, and others for professional services; however, legal and other fees paid to purchase a rental property are not start-up expenses.
Unlike operating expenses, start-up expenses cannot automatically be deducted in a single year. This is because the money you spend to start a rental (or any other) business is a capital expense—a cost that will benefit you for more than one year. Normally, you can’t deduct these types of capital expenses until you sell or otherwise dispose of the business. However, a special tax rule allows you to deduct up to $5,000 in start-up expenses the first year you are in business, and then deduct the remainder, if any, in equal amounts over the next 15 years.
How to Deduct Start-Up Expenses
There is a limit on the amount of start-up expenses you are allowed to deduct the first year you are in business. For the past several years, the limit has been $5,000. You’ll have to deduct any expenses in excess of the first-year limit in equal amounts over the first 180 months (15 years) you’re in business. This process is called amortization. The 180 months is the minimum amortization period; you can choose a longer period if you wish (almost no one does).
However, you won’t be entitled to the full $5,000 first-year deduction if you have more than $50,000 in start-up expenses. Your first-year deduction is reduced by the amount by which such start-up expenditures exceed the $50,000 limit. For example, if you have $53,000 in start-up expenses, you may only deduct $2,000 the first year, instead of $5,000. If you have $60,000 or more in start-up expenses, you get no current deduction. The whole amount must be deducted over 180 months.
Avoiding the Start-Up Rule’s Bite
The start-up tax rule will adversely affect you only if you spend more than the $5,000 first-year limit before your rental business begins. Amounts over the limit will have to be deducted over 15 years. So, if possible, you want to stay under the limit. To do this, you will need to keep careful track of how much you spend. If you go near or over the limit, cut back on your spending until your rental business begins.
As a landlord, there are many expenses you can put off paying until after you are in business. For example, you can hold off on expensive repairs you don’t absolutely have to do before you list the property for rent. Repairs you pay for after the property is available for rent will be currently deductible operating expenses, not start-up expenses.
If you must spend more than the first-year limit on start-up expenses, go ahead and do it. But at least try to keep your total start-up expenses below $50,000. This is because your first-year deduction limit will be reduced by any amount you spend over these amounts on start-up expenses.
For more advice on deducting start-up expenses, including how to determine your business start date, and what happens if your business doesn't last 15 years (180 months), see Every Landlord's Tax Deduction Guide, by Stephen Fishman (Nolo).