Understanding the tax implications of rental income is essential to being successful as a landlord. Whether you own a single rental unit or a portfolio of properties, you must know how to properly report your rental income and expenses to the IRS to maximize your tax savings and ensure you remain in compliance with the law.
The consequences of getting this wrong should not be taken lightly. In fact, failing to report rental income accurately can make you vulnerable to costly penalties and fines, interest, a lien on your property, or even criminal liability.
Likewise, while some ordinary and necessary expenses associated with managing and maintaining your rental property may be deductible, claiming these valuable write-offs means knowing what they are!
In this post, we’ll cover the basics of rental income and expenses and the deductions that landlords or property owners need to know at tax time.
Rental income is any payment you receive for the use or occupancy of property, be it residential, commercial, or industrial. In addition to standard rent payments, other types of income that the IRS also considers rental income include:
Interestingly, a security deposit does not count as rental income if you plan to give it back to the tenant at the end of the lease. If you end up keeping a portion of the deposit because the tenant did not live up to the terms of the lease, then that amount does count as rental income. The same is true if you apply the deposit as a final payment of rent, in which case the IRS considers it advance rent and requires you to income it as income for the year in which you received it.
Critically, rental income is subject to taxation — generally as ordinary income or a type of income taxed at ordinary rates. That means you must report all your rental income and expenses on your tax return for the year you actively or constructively received the payment.
Nevertheless, you can lighten your tax burden by deducting certain common expenses, such as mortgage interest, insurance, and utilities. We’ll dive deeper into potential deductions later in this post.
The most common way the IRS learns about your rental income is simple: You report it! Correctly reporting your income and expenses is a vital part of your tax responsibilities as a landlord, and it’s a good idea to prioritize accuracy in your tax filings.
If you fail to do so, there are other ways the IRS can discover income you don’t report, including audits, real estate paperwork, and public records.
To avoid potentially costly or devastating problems down the line, you must report all rental income and keep detailed records of any rental activities.
The good news is by making an accurate report, you can take advantage of any deductions for which you are eligible, including those related to expenses.
As mentioned above, if you receive rental income, you can deduct certain expenses on your tax return that are considered “ordinary and necessary.” This refers to expenses that are common and generally accepted as part of the business of being a landlord or property owner and necessary to conduct that business.
Examples of what the IRS considers expenses “ordinary and necessary” may include mortgage or other interest, property tax or other taxes, operating expenses, advertising, utilities, insurance, and depreciation.
You can also deduct the costs of certain materials, supplies, repairs, and maintenance that you make to keep your rental property in good operating condition. Furthermore, you can deduct the expenses paid by the tenant if they are deductible rental expenses. Lastly, when you include the fair market value (FMV) of the property or services in your rental income, you can deduct that same amount as a rental expense.
One important note: You may not deduct the cost of improvements. However, you can recover the cost of some of your improvements through depreciation by using Form 4562.
Suppose you’re accustomed to simply taking the standard deduction rather than itemizing your tax return. In that case, you may wonder if you can claim deductions for specific rental property expenses while refraining from itemizing the rest of your return.
The tax code can sometimes be a minefield for taxpayers who want to keep things simple…but in this case, there’s good news — many rental property tax deductions for landlords are, in fact, “above-the-line,” deducted directly from your gross income. That means that you can deduct those expenses in many cases while still taking the standard deduction!
Generally speaking, here are some of the categories of expense deductions that you may be able to claim above the line:
As mentioned above, remember that you cannot deduct improvements or travel costs related to progress. Other costs you cannot deduct include lost rent during vacancies, unpaid rent, commuting expenses, and points or origination fees you paid for your mortgage.
This recent blog post discussed good record-keeping for taxpayers, and many of the same principles apply. However, record-keeping is essential for landlords, so it’s a good idea to go even further in tracking your income and expenses and maintaining supporting documents like receipts, credit cards, and bank statements.
Spreadsheets, created in programs such as Microsoft Excel, Apple Numbers, or Google Sheets, are an effective way to keep track of everything. You should also consider utilizing personal finance software like Microsoft Money or Quicken and accounting software like Quickbooks.
Some examples of types of records you should keep include:
Rental property expenses can be categorized in several different ways. One way is to categorize them by type, such as repairs and maintenance, property taxes, tenant screening, etc. You may also categorize them by time period, such as one-time expenses (like licenses and permits) and recurring expenses (like utilities or regular maintenance). A third option is to categorize them by purpose, such as tenant-related expenses or landlord-related expenses.
Finally, rental property expenses can be categorized by their tax status (deductible and non-deductible expenses, for example).
If you use a spreadsheet program to track your income and expenses from multiple rental properties simultaneously, you may create separate spreadsheets for each property. Alternatively, you could create a single master spreadsheet document but track each property in a separate tab.
No matter how you decide to track and categorize your income and expenses, the most vital takeaway is that your ability to maximize your deductions (and thereby minimize your tax burden) depends on one thing: Organization!
Of course, if you want to be sure you are taking full advantage of all the deductions and credits available, there is no substitute for the expert advice of a tax professional.
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Above & Beyond
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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
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