3 Tax Questions You Must Ask Before Buying Rental Property

posted on 06-07-2019

What easier way to bring in income than with rental property, right?

Check in on the tenants periodically, stay on top of the repairs and watch the money roll in. But in one way, it can turn into a nightmare if you aren't careful: getting the tax man on your back.

It's easy to lose sight of the intricacies of taxes as a landlord -- both good and bad... because there are deductions to be made along with the income you claim. But with a little organization, keeping up with your tax records as a landlord doesn't have to be a daunting task.

So before you become a landlord, you need to know this about taxes:

1. What Exactly Is Considered Rental Income, And How Do I Report It?

Your rental income is taxed at your regular income rate; use Schedule E (Part I) to report income and expenses related to your property. Each Schedule E has space for three rental properties -- use as many schedules as necessary to cover all of your rental properties.

As a landlord, you need to determine which accounting method you will use:

Cash basis:  Income is reported when you receive it, and expenses are deducted in the year you pay them.

Accrual: Income is reported when you earn it, not when you actually receive it, and deductions are taken in the year you incur them, even if you don’t pay the bill until the following year.

Many landlords use the cash method of accounting since it is often less hassle to keep track of income and expenses as they are received or paid.

In addition to the regular rent payments you receive, the IRS considers the following items rental income:

  • First and last month’s rent. You pay taxes when you receive this, even if the last month’s rent will be applied to the tenant’s account another year. Same goes for advance rent payments.
  • Non-refundable deposits made to help with cleaning or other expenses.
  • Barter. If you knock off some of the rent for your tenant because he agrees to maintain the yard, you need to report the value of the services as income.
  • Expenses paid by the tenant. If your tenant fronts money for a repair and then deducts it from his or her rent, you need to include the cost as part of your income. You can later deduct the cost of the repair.
  • Lease cancellation: Any payment you receive as part of a lease cancellation is considered income.

If you accept a security deposit and plan to return it when the term ends, you don’t have to count that amount as rental income.

If you lease out your residence or your vacation home, but the total days you rent the property for amount to less than 15, you don’t have to count the money as rental income. Also, if you have part interest in a rental property, you are required to report your portion of the property’s income to the IRS.

2. What Tax Deductions Can I Take?

Once you have properly accounted for your rental income, you can claim tax deductions against it. The IRS allows you to deduct the following expenses related to your rental properties:

  • Advertising vacancies
  • Cleaning
  • Maintenance
  • Travel to actively take care of the property
  • Commissions paid to those who pay vacancies
  • Fees paid to your property management company
  • Insurance
  • Legal fees
  • Mortgage interest paid
  • Repair costs
  • Supplies for proper upkeep
  • Utilities
  • Taxes you pay on the properties

It’s also possible for you to deduct any depreciation experienced by your rental properties.

3. What Records Should I Keep?

Anytime you report income and expenses to the IRS, you should have the records to support your case in the event of a tax audit.

Not only should you keep your receipts, but you should also keep a good record of repairs and maintenance activities performed for each of your properties. Make sure you separate your receipts into different categories. Minor repairs and maintenance are considered a different category than major items. Items like remodeling work, roof replacement, major home upgrades, and insulation installation are all considered capital improvements, and they should be reported separately from the minor repairs.

The Investing Answer: A knowledgeable tax professional can help set up a good record-keeping system, and help you understand how to value your rental income and how to properly take your deductions.

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