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Tax Facts For Rental Property

Author: Alex Delaney

So you’ve taken the plunge into developing a passive income stream. Pat yourself on the back. Not only are you creating future monthly income, but you also own an appreciating asset. In addition, you have just given yourself some great tax benefits.

There are, of course, two major issues when dealing with taxes: income and expenses.

Income:

Income from passive income can drastically change your filing strategy. You may need to consider changing your withholding or paying a quarterly amount to the IRS. Talk to your accountant about what the new income stream means for your tax liability and the best way to handle it.  

You must claim all the amounts you receive as rent. If you are using a cash basis accounting system,(most commonly used), all income should be reported in the year in which it was received, even if it is for future rent. If you are using an accrual method of accounting, you should report the income when it is earned, not necessarily when it is received.

If the security deposit you received was considered last month’s rent, that is income and should be reported when it is paid. However, if the deposit will be returned at the end of the tenancy, or held for damages, it is not considered rent until it is assessed against damages. Keep in mind, damages will give you a deduction. Make sure you abide by State holding requirements for the deposit.  

Other items considered income: lease violations, work for rent and early termination fees should all be reported in the year they were received, regardless of which accounting method you are using. If your tenant offers to provide professional work in lieu of rent, (such as providing a plumbing repair), you must still include the rental amount as income for the period in which the work covers the rent.

If you are in a lease to own agreement, the income and expenses still operate as if a standard rental. 

Expenses:

Now, to offset that increase in income, you must prepare to prove deductions. Standard deductions for landlords include property taxes, mortgage interest (up to the current level of $750,000), depreciation, operating costs and repairs. Make sure to keep receipts and clear records.  If you are audited, and cannot provide proof of expenses, you may be subject to additional fines.

Some appropriate expenses include insurance and utilities. If you manage your own property or incur the following costs yourself, you can deduct for advertising costs, maintenance, and any supplies or repairs necessary to keep the property in good condition. If you use a management company, such as Compass Property Management, you will receive an end of year record of income and expenses which you should submit to your accountant. This record will include what you pay Compass to manage the property.

You should also be aware of travel guidelines as travel miles can add up when running errands for a rental property that you manage yourself.  You can deduct the standard mileage rate, currently at 58 cents per mile for 2019, or actual expenses via gas receipts. You can also deduct any business-related tolls and parking costs. But you must be aware of the difference between necessary repairs versus improvements. Improvements, or costs to restore, better, or adapt for a new or different use, are not deductible. Those costs can be offset through depreciation but will have to be spread out over several years.

You can recover some or all of your improvements by using Form 4562 to report depreciation beginning in the year your rental property is first placed in service, and beginning in any year you make an improvement or add furnishings. Only a percentage of these expenses are deductible in the year they are incurred.

The most important two tax steps you can take as a landlord are 1) to keep careful records of all expenses and income, and 2) find the services of a good accountant that has rental property experience.  

Important Federal Tax links:

Residential Rental Property

Travel, Entertainment, Gift, and Car Expenses

Business Expenses (including business use of your home)