The many benefits of owning rental properties are well known. Unlike other investments, real estate has various avenues for profitability such as: monthly cash flow, property appreciation, equity growth from mortgage paydown, and the ability to use depreciation to reduce tax expenses. ALL GOOD THINGS!
Of course, it’s important to properly report income, expenses and depreciation properly to the IRS come tax time. Here’s some guidance on what needs to be reported for income and what qualifies for expenses the reduce your tax burden.
Rental Income that Must be Reported
Rent Collected – Most rental owners report on a “cash basis”, which means income is reported when received. For example, if John’s tenant owes his rent on January 1st, 2021 but he pays on December 29th, then John must include rent income on his 2020 taxes.
Lease Buyouts – Susan’s tenant had signed a year lease, but got a job transfer six months later. The tenant bought out his lease agreement and paid a fee to Susan. Susan must now include the amount she received in her income.
Rent Bartered – For example, Abby owns a quadplex, and each unit is $1800/month. However, the tenant in Apt. A gets a 5% rent deduction in return for taking care of the grounds and landscaping. That’s $90 x 12 months for a total of $1080. Abby has to include the $1080 as income.
Additional Charges – If the tenant is charged for additional items such as pool or landscape service, then this too is considered income and must be reported.
Kept Security Deposits – For example, Bob collected a $1500 refundable damage deposit from his tenant. When the tenant vacated the apartment, the carpet was stained and torn, the side of the refrigerator had a sizeable dent, and there were issues with trash, etc., throughout the home. Cleanup, repairs, and replacement costs came to $1075, so Bob only refunded $425. The amount held for damages then must be reported as income. This income will be offset by the repair expenses though – noted below.
Bottom line – money collected, the value of services, and deposits that are kept for damages are all income. Fortunately, tax laws also allow for deductions. For example, that $1080 rent value that Abby received in groundskeeping services, and that $1075 that Bob kept covering damages can be deducted in the expense column to reduce taxes owed. The key is maximizing your deductions.
8 Primary Deductions for Rental Property Owners
Interest – Often one of your most sizeable deductions, it includes the interest you pay on:
-
- Your mortgage
- Short-term loans for repairs or improvements
- Credit card interest if the purchases charged were for rental repairs or improvements
Depreciation – Some costs/expenses cannot be deducted in its entirety the year they were purchased but can be depreciated over a set number of years. This includes:
-
- The initial cost of the rental property.
- Costs of major improvements, such as a new roof or windows.
- Cost of replacing appliances. (Note: If your rental investments/activities qualify as a business for tax purposes, then under Section 179, you can skip depreciation and deduct the entire amount in the year purchased. This includes personal property items bought for use in the rental – such as appliances. Section 179 also covers office equipment –such as computers, printers, and maintenance equipment –such as tools, mowers, etc.)
Repairs – From replacing a broken window or lock to patching/painting walls to repairing/cleaning carpets, multiple items come up in need of repair. Your expenses (document with invoices, receipts, notes) can be deducted in the year you paid the bill. It’s essential to understand the difference between a repair and an improvement – particularly if you don’t qualify as a business for tax purposes. We will cover the difference and the benefits of each in our next blog.
Labor and Professional Fees –Whether you have employees or use independent contractors, many property owners choose to hire or contract various responsibilities from groundskeeping to office assistance to partial or full property management. If you do, their wages/charges are fully deductible. This includes professional fees. For example, fees paid for property management professionals, as well as accountants, attorneys, consulting, etc.
Home Office – If you work from an office in your home, providing you follow the IRS guidelines, you can deduct the cost of maintaining it. These deductions can include heating and cooling, furniture, office equipment, and supplies. If you designate a section of your garage or shed as a workshop for repairs, this can also be a deduction.
Insurance –Insurance premiums that are connected to your rental property can also be deducted. This can include:
-
- Insurance on the property itself (fire, flood, and other natural disasters, as well as theft).
- Landlord liability insurance.
- If you have employees – workmen’s compensation, health insurance.
Travel – When travel is connected to your rental property, expenses are deductible.
-
- Local – From a quick trip to the store for minor repairs, such as a new kitchen faucet, to a drive to your rental to handle a complaint, conduct an inspection, or complete a repair, etc., your mileage is deductible. You can document miles, gas, oil, car repairs, or take a standard mileage deduction.
- Long-distance – If your property is several hours or several states away, requiring an overnight stay or even a flight, you can deduct your travel expenses. This includes tickets, meals, lodging, and so on, but be sure to follow IRS guidelines and requirements.
Casualty and Theft –You’ve already deducted the cost of insurance on your property, but what if you have a claim? Your insurance will pay according to your policy, but inevitably there will be additional expenses. Some of these will be deductible.
Summary: When you complete your taxes, it is critical not only to include all your rental property income but also to get every deduction you can. Consult with your tax accountant to ensure you don’t miss something vital in either column. We hope this helps you. Meanwhile, if you need any assistance with your rental properties, the team at Rentals America stands ready.
About Rentals America
Rentals America provides full-service property management for residential rental properties. Our team is completely dedicated to property management and we’re here to help landlords navigate the rental market.
