Investing in property can be a smart financial decision, but it also comes with some hurdles that are tough to navigate. Even with the IRS offering generous rules regarding rental income, the process can be overwhelming.
Because of this, you need to educate yourself before getting into real estate. Understand what rental income actually means, how taxes on it work, and how you can get the most money out of your tax write-offs. A financial advisor can help you dig even deeper, but this information should help you get started.
What Counts as Rental Income
Rental income includes any payment received in exchange for using a property such as:
- Kept security deposits
- Normal rent
- Advance rent
- Extra monthly rent fees
- Lease cancellation fees
- Expenses paid by tenants in lieu of rent
Normally, a security deposit doesn’t count as income since it usually ends up returning to the tenant. But if part or all of the deposit is kept due to lease violations, that portion is included as rental income.
Advance rent also must be included for the year received, not the year it will go towards. For example, if a tenant pays for the first and last month, it counts immediately as income rather than being split between the years where the first and last month fall.
There may also be times when tenants pay for expenses on their own. These must also be taken into consideration when it comes to rental income, especially since they may be deductible.
How Rental Income Taxes Work
For tax purposes, rental income counts as ordinary income.
You report rental income as Supplemental Income on Form 1040. There are also special rules for properties which you use as your home but rent for less than 15 days during a year. Rents received in cases like this aren’t considered rental income and expenses can’t be written off as rental expenses.
Landlords must keep meticulous records and spreadsheets or software will definitely come in handy! Most importantly, you’ll want to track:
- Purchasing price of the property
- Accumulated and annual depreciation
- Rental income
- Security deposits
- Property management fees
- Advertising costs
- Maintenance and repair costs
- Utility costs
- Mortgage interest expenses
If, after tallying up income and expenses, the total net income is negative, you can’t deduct that loss from the rest of your annual income. As passive income, any losses simply offset passive profits, and the IRS has few exceptions. You can, however, carry forward losses to deduct in a subsequent year.
Making the Most of Rental Tax Write-Offs
There are various expenses which can count as write-offs:
- Operating expenses
A property is considered depreciable if it’s owned in full, used in an income-producing activity, has a useful life which will decay or lose value, and is expected to last for more than one year. Depreciating the property means you distribute the deduction across the entire useful life of the rental property rather than get one deductible up front. Only improvements on the property (like buildings) depreciate, not the land.
Much like operating a business out of your home, rental properties come with everyday expenses that can be written off, such as insurance, maintenance, utilities, or even advertising.
Repairs count as regular expenses and thus can be itemized for a deduction, compared to property improvements which cannot be deducted. Instead, you can deduct the depreciation on these improvements, helping recover expenses over time as the value of the improvement declines.
Things to Keep In Mind
A financial advisor can help you make the most of your rental income. With their help, you can plan in advance so that you save money when it comes time for tax season. Contact us to connect with an experienced financial advisor.