Tax season is a stressful time for anyone, but especially for landlords. If you are a landlord and are interested in seeing how much money you pay to the IRS each year, read on. Here are the 9 most common tax questions for rental properties.
The 9 Most Common Tax Questions for Rental Properties
Before we dive in, please remember that we are not accountants (nor do we play one on TV). While we do cite our sources, make sure you verify this information with your accountant before taking it as gospel.
With legalities out of the way, let's begin.
Is rental income taxable?
The short answer is yes.
The IRS website states "You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of a property. You must report rental income for all your properties."
In plain English, this means that you need to include all the money you make from rent (before deductions) in your taxes.
What to declare as rental income?
It's difficult to determine what qualifies as rental income. As previously stated, rental income is any amount of money you receive in exchange for the use or occupation of a property.
Some property owners receive rental income from the power company for the spot of land their power line pole is in. Others get rental income from allowing people to live on their property in trailers or homes. Still others charge businesses rent to store their items on their property or use their office space.
All those ways of getting an income should be declared as rental income.
Beyond that, if you receive money from your tenant to cancel a lease or repair a piece of the property, it's considered rental income. Any money you receive from your tenant that you don't plan on returning to them at a later date must be declared as rental income.
There are many ways to rent things out-- but the gist of it is if it's property and you are receiving money from someone else to use or occupy it, it's considered rental income.
When do I owe taxes on rental Income?
You owe taxes on any rental income that you receive in that fiscal year.
You also pay taxes on the entire amount of advance payment you receive in that year. If you get advance payments on your commercial space, and they give you two year's worth of rent upfront, you'll pay taxes on that amount in the year it is received.
If you own the property in your name and receive the rental income in your name, your taxes are due the same time your income taxes are due. That's in April of the following year, for those curious when annual taxes are due, although you can get an extension.
If your business (such as an LLC or corporation) owns your rentals, that's a different story. You'll still owe taxes once a year to the IRS, but you may also owe quarterly taxes on the income to your state. To find out more information about your state tax requirements, go here.
Are security deposits taxable?
A security deposit that is used as the last month's rent is considered rental income and needs to be included on that year's tax statement.
If you plan on giving back the deposit to the tenants at the end of their rental term, you do not need to include it in your gross rental income. If you do keep part or all of the security deposit as payment for the tenant not holding up their end of the deal, then you need to include that amount in your taxes in the year you withhold it.
What can I deduct from rental income?
When declaring your rental income on your taxes, you can't deduct anything before claiming it on your taxes. For example, Joe makes $1600 per month from his rental but pays $1200 per month in mortgage. Joe cannot write down $400 as his gross income because his actual income was $1600.
You can deduct the mortgage interest from your rental income as outlined by your tax form, however.
What Deductions Can I Take as an Owner of Rental Property?
While all of your rental income is considered taxable, you may not have to pay any taxes on it. How is this possible, you ask? Because of deductions. You can deduct quite a bit from your taxes when you own a rental.
Here are some of the things you can deduct:
For each year you own the property (up until it's fully depreciated) you can deduct the depreciation value on your taxes. When you are claiming depreciation you are saying that there is wear and tear on the property because your tenants are living there, so your investment itself is depreciating in value.
Depreciate your property properly, though. It's a good idea to work with your accountant to make sure everything is above board and depreciated in the right way.
If you have commercial multi-family properties, you can also do something called cost segregation. Cost segregation allows you to depreciate certain parts of your property separately-- such as the roof and other pieces of the property. This can add a 6-7% increased depreciation value.
You can deduct any travel expenses that you incur while taking care of or checking in on your property. This could include travel expenses to go look at an out-of-state property, trips to your accountant or bank-- any traveling you do for your rental property is deductible.
On that note, you can also deduct the wear and tear of your vehicle if you use it for your rental business. You can only write off a portion of the wear and tear, but don't leave that out of your deductions if you use your car for your rental.
Many meetings happen over lunch. If you are the owner of a rental property and like to discuss your rental business over a bowl of spaghetti, you can deduct that meal from your taxes.
Any form of education you invest in to help your real estate investments is a write-off. This includes courses, services, and coaches.
The fee you pay your property manager is also a write-off. It's pretty typical to pay about 10% of your monthly rental income to a property management team and you can write that off as a deduction.
Repairs and Improvements
You can write-off any repairs you make to the property in the year you make them. Improvements are a different story, though. You'll have to depreciate the improvements over the life of the property if you want to write those off.
How Do I Calculate Depreciation?
There are several ways to calculate depreciation.
The first way is called "the straight-line method." The straight line method is where you take the salvage value (the amount you'd be able to sell the item for when it's exceeded it's "useful life") and subtract it from the original value.
For example, if you bought a new washer for $1000 and found out the useful life of the washer is 8 years, at which point you could sell it for $200, you would subtract $200 from $1000 and divide it over 8 years.
To depreciate the house, the IRS requires you to depreciate it over 27.5 years. To do this, you use a method called the modified accelerated cost recovery system. This system allows you to depreciate the entire value of your home over 27.5 years.
How Do I Report Rental Income and Expenses?
If you own real estate rental properties you report an income on tax Form 1040, Schedule E, Part I. If you have more than three rental properties, you'll fill out lines 1 and 2 in as many Schedule E's as you need to, but you'll include the total of all the properties on only one of the forms.
What Records Should I Keep?
Keep records of everything that you are planning to deduct.
That includes airline tickets, meal, lodging, and gas receipts, and proof of rental income. Any repairs that you make during that fiscal year, you'll want to keep records of those as well. It's better to save too many records than too little.
If you have a question on whether or not you should keep a particular record, ask your accountant. They'll be able to tell you if it's a document they'll need come tax season.