Many Americans who live abroad choose to keep their US properties for rental purposes. It can be an excellent source of income and allows you to maintain a US home if you decide to move back some day. But it is important to keep a close record of your income and expenses because you are obligated to report any income (or loss) on your US expat tax return. We'll take a closer look at the additional form you will need to complete and what expenses you may (or may not!) be able to deduct.
All income and expenses for rental properties are reported on Schedule E, Supplemental Income and Loss. If you hired a management company to take care of your rental property operations, you'll be pleasantly surprised to receive a neat, tidy statement of all your income and associated expenses at the end of the tax year. Unfortunately, management companies can be quite expensive and many expats choose to manage their properties on their own. In this case, it is up to you to keep accurate, detailed records of everything relating to the property. You may want to consider utilizing rental property management software, such as Quicken Rental Property Manager, which will help to keep you organized. But tracking can also be done through a simple Excel spreadsheet.
You can list up to 3 rental properties on Schedule E. You will enter your rental income and all expenses, including your calculated depreciation expense, which is an often overlooked deduction. From the day you start renting your home, you begin depreciating the property over a 27 ½ year period. The amount you depreciate (or 'basis') is determined by the lesser of the fair market value of the property or the adjusted basis (which is typically calculated as your purchase price, adjusted for any improvements you made).
There are several deductible expenses that can help lower your US tax liability on the rental property.
When setting up your rental for business, there are often associated start-up costs. Fortunately, the IRS allows you to deduct up to $5000 of such costs in your first year of renting. If your start-up expenses exceed $5000, the remaining costs can be capitalized and deducted over the next 15 years. Expenses that relate to start-up costs are:
Maintenance costs prior to renting
Minor repairs (to get the property ready to rent, not improvements that increase the value of the property)
Licenses, permits and registrations
Professional fees (such as legal fees) that you incurred in establishing a business entity
Any repairs you make to restore the property to its original state can be deducted on your expat tax return. Repairs are different than improvements, which are those 'repairs' that increase the value of the property and prolong its life. So, if you fixed a leaky roof on your property, this is a deductible repair--you have simply restored the roof to its original state. However, if you needed to replace the entire roof, this is considered a capital improvement (as it is extending the life of the property) and this must be capitalized and depreciated over 27 ½ years--it is not deductible against rental income.
If you have chosen to hire a company to manage your property, you are able to deduct any fees paid on your expat tax return.
You may deduct the interest paid on a mortgage used to purchase or improve a rental property. This is certainly one of the best tax benefits of purchasing a property in the US. Note that if your property is held jointly, the interest can only be deducted by the investor who is legally responsible for the payment.
If you use a home office exclusively to manage the day-to-day operations of your rental property, you can deduct a portion of your home's expenses, based on the square footage of the office and your home. Home office expenses you can deduct are:
Your rent or mortgage interest
If you returned to the US from overseas in order to purchase your rental property, some of the expenses you incurred are deductible. The following expenses would be capitalized with the property price and depreciated over 27 ½ years:
The travel expenses that can be deducted outright are those directly related to the management of the property. If you travel to the US and spend 4 days working on the property and 3 days visiting with family, you can only deduct costs incurred on those 4 days (i.e. 57% of your total travel costs).
There are a handful of expenses you may think are deductible...but they are not. Any time spent personally working on the property is considered 'personal labor' and this is not deductible. Charitable contributions, country club dues and federal income taxes are also off-limits. The expenses discussed in this article are surely not a comprehensive list of all the types of expenses you incur as a property owner. If you have any questions about your expenses, you are encouraged to speak with a tax professional who can help identify all the possible deductions that may reduce your taxable income, as well as ensure you aren't taking ones that the IRS disallows.