Owning rental property in California comes with significant tax advantages that can offset the high costs of Bay Area real estate. Understanding which expenses are deductible—and how to properly document them—can save you thousands of dollars annually. This guide covers both federal and California-specific considerations for rental property owners.
Most day-to-day costs of operating your rental property are fully deductible in the year you pay them. These "ordinary and necessary" business expenses reduce your rental income dollar-for-dollar.
If you hire a property manager, their fees are fully deductible. This includes monthly management fees (typically 8-10% of rent or a flat fee), leasing fees, lease renewal fees, and any other charges from your management company. For Bay Area landlords paying $200-400/month in management fees, this deduction alone can provide $2,400-4,800 in annual deductions.
Repairs that keep your property in good working condition are immediately deductible. This includes plumbing repairs, HVAC servicing, appliance repairs, painting, roof repairs, electrical work, pest control, and landscaping maintenance. The key distinction: repairs maintain the property's current condition, while improvements add value or extend useful life (improvements must be depreciated instead).
Examples of deductible repairs: Fixing a leaky faucet, replacing a broken window, patching drywall, repairing appliances, clearing clogged drains, replacing worn carpet in one room, repainting in the same color scheme.
Examples of improvements (must depreciate): Adding a new bathroom, replacing all flooring throughout the property, installing a new roof, adding central air conditioning where none existed, major kitchen remodels.
All insurance premiums related to your rental property are deductible: landlord insurance policies, liability insurance, fire insurance, flood insurance (common in some Bay Area zones), earthquake insurance, and umbrella policies that cover your rental. California's high insurance costs—often $1,500-3,000+ annually for comprehensive coverage—make this a valuable deduction.
Property taxes paid on rental property are fully deductible against rental income. This is separate from the $10,000 SALT (State and Local Tax) limitation that applies to personal residences—rental property taxes are a business expense with no cap. For Bay Area properties with assessments often exceeding $10,000-20,000 annually, this is one of your largest deductions.
If you pay any utilities for your rental property, they're deductible: water, sewer, garbage, electricity, gas, and internet/cable if provided. This includes utilities paid during vacancy periods while marketing the property.
For condos and townhomes, monthly HOA fees are deductible. In the Bay Area where HOA fees often range from $300-800/month, this provides $3,600-9,600 in annual deductions. Special assessments are also deductible, though large capital improvement assessments may need to be depreciated.
Depreciation is often the most valuable deduction for California landlords. It allows you to deduct the cost of your rental property (excluding land) over time, even though you haven't actually spent that money. For expensive Bay Area properties, depreciation can provide $10,000-30,000+ in annual deductions.
Residential rental property is depreciated over 27.5 years using the straight-line method. You divide your depreciable basis (purchase price minus land value, plus closing costs and improvements) by 27.5 to get your annual depreciation deduction.
This $29,090 deduction reduces your taxable rental income without requiring any out-of-pocket expense.
The IRS requires a reasonable allocation between land and building. Common methods include using the property tax assessment ratio (check your tax bill for land vs. improvement values), obtaining an appraisal, or using comparable sales data. In the Bay Area, land often represents 30-50% of total property value, though this varies by location.
For properties worth $500,000+, a cost segregation study can accelerate depreciation by identifying components that can be depreciated over 5, 7, or 15 years instead of 27.5 years. Items like appliances, carpeting, landscaping, parking lots, and certain fixtures qualify for faster depreciation. The study typically costs $3,000-10,000 but can generate tens of thousands in first-year deductions.
Under current tax law, certain property components identified through cost segregation qualify for bonus depreciation, allowing 60% immediate expensing in 2024 (phasing down 20% each year). This significantly accelerates deductions in early ownership years. Consult with a tax professional to determine if bonus depreciation benefits your situation.
All interest paid on mortgages for rental property is deductible—there's no cap like the $750,000 limit for personal residences. For Bay Area landlords with large mortgages, this can be a substantial deduction, especially in early loan years when payments are interest-heavy.
What's deductible: Interest on the original purchase mortgage, home equity loans used for the rental property, refinanced mortgages, and construction loans. Points paid on purchase or refinance loans are also deductible (spread over the loan term for refinances).
Important note: Only the interest portion of your mortgage payment is deductible. The principal portion builds equity but isn't a deductible expense. Your lender provides Form 1098 showing annual interest paid.
Many landlords miss legitimate deductions simply because they don't know they exist. These smaller deductions add up over time.
Travel to and from your rental property for management activities is deductible. You can deduct actual vehicle expenses (gas, maintenance, insurance proportional to rental use) or use the standard mileage rate (67 cents per mile in 2024). Keep a mileage log documenting date, destination, purpose, and miles driven.
Deductible trips include: Showing the property to prospective tenants, collecting rent in person, meeting with contractors, conducting inspections, picking up supplies, and traveling to your property manager's office.
Out-of-town travel: If you own rental property far from your home, airfare, hotels, and meals during property visits can be deductible if the primary purpose is property management (not personal vacation).
If you use part of your home exclusively and regularly for rental property management, you may qualify for a home office deduction. This includes a percentage of your home's mortgage interest/rent, utilities, insurance, and depreciation based on the square footage used. The simplified method allows $5 per square foot up to 300 square feet ($1,500 maximum).
California has some unique tax rules that affect rental property owners differently than federal law.
California generally follows federal tax treatment for rental property deductions, including depreciation, operating expenses, and mortgage interest. However, there are some differences in timing and treatment that can affect your state tax liability.
California does not conform to federal bonus depreciation rules. While you can take accelerated bonus depreciation on your federal return, California requires the standard depreciation schedule. This creates a timing difference that requires tracking separate federal and state depreciation schedules.
The federal Qualified Business Income (QBI) deduction allows landlords to deduct up to 20% of qualified rental income. However, California does not conform to this deduction—you won't get this benefit on your state return. This is a significant difference for California landlords.
If you own rental property through an LLC or other business entity, California imposes an $800 minimum franchise tax annually, regardless of income. This applies even if your rental operates at a loss. Some landlords choose to hold property personally rather than in an LLC to avoid this fee (though LLC protection has other benefits worth considering).
Rental real estate is generally considered a "passive activity" for tax purposes. This means rental losses can typically only offset other passive income, not wages or active business income. However, there are important exceptions:
If you actively participate in managing your rental (make management decisions, approve tenants, set rent), you can deduct up to $25,000 in rental losses against other income. This allowance phases out between $100,000 and $150,000 of modified adjusted gross income (MAGI). At $150,000+ MAGI, this allowance is completely eliminated.
If you qualify as a "real estate professional," rental losses can offset any income without limitation. To qualify, you must spend more than 750 hours annually in real estate activities AND more than half your working time in real estate. This is difficult to achieve for W-2 employees but can provide significant benefits for full-time landlords or real estate agents.
If passive activity rules prevent you from deducting rental losses this year, those losses aren't lost forever. They carry forward indefinitely and can be used in future years when you have passive income or when you sell the property.
Good record-keeping is essential for maximizing deductions and surviving IRS scrutiny. The IRS can audit returns up to three years back (six years for significant understatements), so maintain records accordingly.