Interest Expenses

There is no upper dollar limit on the amount of mortgage interest you can deduct on rental property, as there is with home mortgage interest.

Furthermore, you can deduct almost any type of interest you pay when you borrow money to further your rental activity, such as interest on a revolving charge account or even credit card late fees.

Tip You purchase new kitchen appliances for a home that you rent out to others, and charge the amounts on your department store credit card. You can deduct the interest charges until you pay off the appliances.

The loan need not be secured by the property, but you must be liable for repayment, and the proceeds of the loan must be used for the rental activities. If you don't use the money immediately to pay for a particular expense (such as to buy or improve the property) you must keep records showing where the loan money went.

Save Time Ideally, you should keep a separate bank account for each major type of activity you have. Don't commingle funds from your small business with funds from your rental activities. Having separate checking accounts, and separate deposit and check records, will also help you to limit the scope of an IRS audit if one of your activities (but not the others) draws the focused attention of the IRS.

Unlike other types of investment interest, interest on loans pertaining to rental real estate activities in which you actively participate is not limited by the amount of income you receive from the activity.

However, you can't deduct prepaid interest, and there is no exception for points paid to obtain a mortgage on a rental property as there is with home mortgage loans. Consequently, points you pay to obtain a mortgage for commercial or residential property must be spread over the life of the loan, and deducted in equal amounts over the entire period.

Fees and charges you pay to obtain a mortgage on rental real estate, such as application fees, appraisals, abstract fees, recording fees, cannot be deducted as interest but can be amortized (deducted evenly) over the life of the mortgage.

Financial Calculators Use this Loan & Credit Line Tax Savings Calculator to determine your tax savings on loans or credit lines with tax deductible interest payments.

Warning Beginning in 2013, a new 3.8 percent net investment income tax may be imposed on individuals whose modified adjusted gross income exceeds $250,000 for joint filers, $125,000 for married taxpayers filing separately, and $200,000 for others. Trusts and estates with income over a certain amount are also subject to the NII tax. Form 8960, Net Investment Income Tax Individuals, Estates, and Trusts is attached to the tax return. For 2013, the IRS has provided taxpayers the ability to rely on more than one set of net investment income tax rules. The best choice varies by taxpayers and depends on the taxpayer's unique situation. Consult your advisor to determine which approach would be best for you.