If you’re a landlord with rental property, you need to declare rental income on your taxes. However, you also have the benefit of deducting expenses you incur for maintenance of your rental property and other associated expenses.
Learn more about taxes on rental income and find out what tax relief is available for rental properties.
Your gross income should include all the money you receive as rent, which covers any payments received for the use or occupation of your properties. Along with these amounts, you also have other amounts that may be considered rental income that you must report.
Advance rent is an amount you receive before its specified time period, such as a payment on a future month’s rent. Advance rent should be included in your rental income in the year you receive it, regardless of what year the advance rent covers. For example, the first and last month’s rent with a five-year lease will all be included on the first year’s taxable income.
Security deposits used as a final payment of rent are also considered advanced rent, which should be included when you receive payment. If you intend to return the security deposit at the end of the lease, you don’t need to report it, but if you keep some or all of it because your tenant broke the lease, the security deposit needs to be included as income for that year.
Payment for canceling a lease should also be reported. This reporting occurs if your tenant pays you to cancel the lease, which is considered rent. The payment should be included in the year you receive it.
Expenses paid by the tenant include any expenses that the tenant is responsible for, such as water or sewage bills. These expenses should be included in your rental income if they are deductible under normal circumstances.
Any bartered property or services provided as rent need to be reported as well. These items are included as fair market value of property or services. For example, services such as painting or repair work from a tenant in that field could be traded for the equivalent month or months of rent, which would be reported as rental income for you.
A lease with an option to buy is a rental agreement that gives your tenant the rights to buy your rental property. These payments are still considered rental income, however.
The rental income you declare on your income taxes can be done in one of two ways.
Many landlords use the cash basis method for declaring income from rental property. You count money as you receive it as income for the relevant tax year. You may also count the security deposit that your tenant provides, whether it’s the final rent payment or whether it’s applied to repairs for damage to the property. If you take the security deposit with the intention of returning it when the tenant leaves — provided the tenant hasn’t damaged the property — it isn’t counted as income.
An in-kind payment can be counted as income as well, according to the month it covers. If you agreed to accept goods or services in exchange for rent, for example, the IRS still considers it a rental income. As a result, you need to report it as income when you file your taxes.
As a landlord, you need to report other types of income. This income can include money derived from tenants paying their way out of a lease or tenants paying for building expenses or repairs. These payments also count as rental income, regardless of what accounting process you use.
Although you need to account for and declare many types of rental income, you can also take advantage of certain deductions to reduce your tax liability. Mortgage interest, property taxes, repairs, depreciation, and operating expenses are all examples of deductions for a rental property.
What doesn’t fall under ordinary and necessary expenses is anything you do to improve, remodel, or renovate your property. Regular, necessary maintenance is fine, but work done to make your rental property more upscale or desirable does not. Expenses that follow from this approach are classified as discretionary spending.
You can also deduct the depreciation of your rental property and its features, which gives you the opportunity to balance out your expenses. You use IRS Form 4562 for this purpose.
Consider what happens if you have to evict a tenant:
Now that the 2018 tax rules have taken effect, landlords should be clear on the provisions in the new legislation and how they affect income taxes. Fortunately, landlords are at an advantage and may have one of the following deductions:
When you file your income tax, you’ll use IRS Form 1040 with Schedule E: Supplemental Income and Loss. You’ll include your total income, depreciation, and expenses for each rental property, which may include taxes, insurance, repairs and maintenance, travel and auto, advertising, and anything else related to your rental property. You’ll use Form 4562 to file your depreciation expenses.
You can report up to three properties on Schedule E, but any additional properties will need to be recorded on another Schedule E form. The totals will be combined, however, on all your Schedule E forms.
Since filing for rental property income and deductions can be complicated, you want to keep detailed records of your rental properties and all related expenses and payments. Keep rent checks or money orders, financial statements, recorded expenses, and anything else related to your rental property needs in the same place. If you can’t provide these records, you may not be eligible for a deduction you deserve, or you could end up with more taxes and tax penalties.
If you typically receive a big refund each year, you can also adjust the amount you withhold from your paycheck to give yourself smaller sums of money throughout the year instead of one lump sum. Making sure to file your taxes correctly is the best way to avoid expensive tax debt or the possibility of a time-consuming audit.
Maximizing your potential tax deductions requires good recordkeeping. Thorough and organized records will help you prepare your financial statement, keep track of deductible expenses, identify receipts, and prepare your tax returns, as well as having verifiable proof of expenses to support the deductions.
These records should include all information related to managing your rental property, including the associated expenses and rental income. This information should be easy to document in case you happen to undergo an audit. If an audit occurs and you can’t find proof to support the deductions on your tax returns, you may be subject to taxes and penalties.
In addition, you may need to substantiate some of your expenses in order to deduct them. Typically, these items will include canceled checks, receipts, bills, invoices, and other documentation to support your expenses. You should also keep thorough records of any travel related to your rental properties.
Owning a rental property is a great way to earn extra income and provide yourself with multiple lines of revenue. However, owning rental property involves many responsibilities and liabilities. As a landlord, you need to be sure that you are well aware of the types of income you need to report when you file your tax returns. Be sure you’re prepared to stay on top of your rental properties and records to save yourself the hassle in the future.
If you’ve made mistakes with your rental income on your taxes in the past, Solvable can help you. Rather than facing back taxes, we can help you get a tax settlement and prevent possible wage garnishment or frozen assets. Contact us today to find out how we can help with tax debt relief and help you get a fresh start on your financial future.