Are down payments on rentals tax deductible?

Question

I know the mortgage interest and any expenses associated with the rental property are tax deductible but, is the down payment of a rental property tax deductible?

If I put $40,000 down on a rental property, can I deduct that as a business expense on my income tax?

Omi C. · Answer

I asked my CPA this same question once and this is how he explained it to me:

You can't claim the downpayment as an expense because you really haven't spent it. You've just converted the downpayment into equity in your property. It still belongs to you, just in a different form. This is also why the principal pay down portion of your isn't deductible - its just getting converted into more equity. Finally, this is also why the interest portion of your payment *is* deductible. The interest was a cost of borrowing money, and is therefore an actual expense. Hope that helps.

And of course, do talk to a CPA about this.

Jane A. · Answer

@Kyle Scholnick

you may found yourself even more upset when you will discover that your expenses on changing windows, new kitchen and bathroom remodeling in rental are not fully deductible in the same year :))) the are depreciating forever  :((( at least I found myself very upset about this :)))

Anna Buffkin · Answer

Disclaimer: consult your tax accountant.  I am not giving you actionable tax advice.

That said, you don't get to deduct your down payment just like you don't get to deduct your principal portion of your mortgage; however, you do get to take a deduction for depreciation expense for the useful life of the asset.  Land does not depreciate for the purposes of tax deduction.  A SFH has a useful life (for tax purposes) of 27.5 years.  In very basic turns, it can be a little more complicated,  you get to write off 1/27.5 per year of the capital outlay to purchase less land value in depreciation expense.   Commercial property, I believe has a different useful life as does certain capital improvements.

I am the accountant for a manufacturer. I have an accounting degree, but am not a CPA.  I also own 3 properties.  I have an understanding of taxes, but do not consider myself an expert.

James Miller · Answer

My question is why would you want to put that much money down on a rental?

Brandon Hall · Answer

@Kyle Scholnick

It's a great question and thought provoking. Why can't you deduct your cost of an asset acquisition?

It really comes down to useful life, that is, the length of time the asset is expected to produce a benefit. If an asset has a useful life of greater than one year, the IRS takes the stance that you have to recognize the cost recovery of your acquisition over the useful life of the asset. And that makes sense, otherwise we'd revert to the 80s/90s when people were recklessly buying real estate simply for tax write-offs with no intention of earning a profit.

Tools typically have useful lives of less than one year, therefore you deduct their costs in the current year.

What about flippers? Why can't they deduct the cost of their down payment? Flippers have to treat their houses like inventory. GAAP/IRS rules stipulate that the cost of inventory can only be recognized upon sale, as cost of goods sold. The IRS does this to protect themselves because again, if you said you were "flipping" a house and held it for ten years, you'd have pulled one over on the IRS.

But really this whole discussion is moot because the IRS is the lawmaker and they say you can't fully deduct your purchase price of your cost to acquire real estate. Rules are rules.

Marco G. · Answer

Not directly.  The property must be depreciated, just like your computer, car, etc.  If you bought a car with a down payment for business purposes, you depreciate the car.  Here you depreciate the house (not land).

Linda Weygant · Answer

I think the best way to explain this is that it IS deductible, but not all at once.  In accounting, there is a theory called The Matching Principle.  That is, the income generated by an asset is matched up with the appropriate expenses.  Because real estate generates income for many, many years (some would say indefinitely), you must match the expense of owning that property with the income it generates.  I'm not sure why the IRS determined that 27.5 years is appropriate, but that's the rule and it's what we're stuck with.  So essentially, depreciating is the act of using up a bit of the income generation ability of a property a little at a time to "match" it with its income.It's a bit like paying for a multi-year insurance policy.  You expense a portion of it each year, because that "matches" the expense with the actual time period of coverage.

Joe Kling · Answer

@kyle scholnick

You're using the term expense very loosely. Expenses are generally used in the course of operating your business. Capital expenditures are made to improve your business. Expenses and capital expenditures differ in value and life expectancy. Purchasing a new property would be considered a capital expenditure not an expense. Because of that, the purchase would be capitalized (the entire amount attributable to structure and improvements on the land but not the land itself) and depreciated over the expected life of the structures.

As everyone else had pointed out, I encourage you to speak to your own attorney so that he or she can advise you on your specific situation.

Joe

Kyle Scholnick · Answer

I see the responses here, and of course that makes sense that the down payment is converted to equity in the house. However it is still a business expense, is it not?

If I buy a hammer and a bunch of tools and install a sink, that hammer and the tools ians the sink is still mine but it is still tax-deductible because I'm spending it as a business expense for my business, so why isn't buying a house that I'm using as a legitimate business tax deductible?

Are down payments on rentals tax deductible?

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