Taxes can be tricky for real estate professionals. You might have a lot of expenses maintaining your properties, but how do you report those on your tax return?
The IRS has specific restrictions on rental real estate income and how to report it, but they also offer deductions for many eligible business expenses. If you want to maximize your take-home income after taxes, you need to know how to navigate those rules and claim every deduction you can.
If you’re worried about saving money and avoiding any risk of an audit, find an accountant to help you. Regulations change all the time, and only a tax professional with the latest information will be able to give you the best answers for your unique circumstances.
What is Considered Rental Income?
Landlords and other real estate professionals sometimes see money changing hands, but it can be hard to tell for sure what counts as actual income. This is the first challenge to face when tax time comes around.
When your rental income is taxed, it doesn’t just include the money you received directly in the form of rent checks. It consists of any payment you receive for the use of your rental property.
Your rental income in the year will include:
- Direct payments for rent
- Security deposits that are kept and not returned
- Advance rent payments
- Expenses tenants deduct from their rent
- Any non-monetary good or service a tenant uses for paying rent
Cash or Accrual Accounting
How you calculate your taxable income for a given year may also depend on your personal method of accounting. If you use the cash method, you will record income and expenses according to the moment that money changes hands. However, if you use the accrual method, you can report income and expenses according to when those payments are earned or scheduled.
If you made significant repairs at the end of December 2020, but you don’t send the contractor’s payment until January 2021, your accounting method will tell you which year to claim that expense. With the accrual method, you would include the expense in 2020, but using a cash basis, you would wait to claim it in 2021.
Most individuals and many small businesses use the cash-based method of accounting. However, the most important thing is to stay consistent.
What Rental Property Tax Deductions Can You Claim?
Once you’ve figured out what will count as your income and expenses for the year, you can start to consider what rental property tax deductions you might be eligible for.
Remember that to claim these deductions, you must qualify as an active real estate professional and not merely an investor with rental holdings.
Rental property owners who want the full value of these deductions must spend at least half of their work hours on rental business and more than 750 hours each year.
Maintenance and Repairs
Rental property owners can claim tax deductions for any expenses paid for regular repair and maintenance. As long as it’s clearly necessary maintenance, you can deduct the cost of any of those repairs from your taxable income.
It’s a landlord’s responsibility to maintain their property and keep everything in good order, so you shouldn’t hesitate to claim those costs on your tax return. But while repair costs are deductible, improvements to your facility are not.
You must keep careful records of these expenses. The IRS may heavily scrutinize unusually large repair expenses or seemingly unnecessary costs.
You may not be able to deduct the cost of improvements you make to your properties; you can still recollect some of the cost of those investments over time by reporting depreciation.
With depreciation, you can report the decreasing value of your investments over time and claim those losses on your tax return.
Another significant tax benefit available to individuals and rental property owners is the mortgage interest deduction. You can deduct the money you spend paying off the interest on your mortgage from your income. This does not apply to money used to pay back the principal of the mortgage itself.
The mortgage interest deduction applies both to your home mortgage and to any mortgages you hold on rental properties, although they should be listed in different places on your tax return.
As a rental property owner, paying property taxes on those properties counts as part of your everyday business costs. Paying that rental property tax is a business expense, and therefore it can be deducted from your total taxable rental income.
Travel and Transport
While driving to and from your workplace doesn’t count, all other transportation and travel costs may be eligible tax deductions for business purposes.
Deductible expenses include travel costs for visiting properties and making repairs. You can also deduct transport and lodging expenses for overnight travel away from home when you have an apparent business reason to be traveling.
You must keep comprehensive records of these costs to claim them correctly on your tax return. Business use of your personal vehicle can be claimed and deducted according to a standard mileage rate set by the IRS.
Professional or Legal Fees
All of your necessary professional and legal expenses are deductible as well. This includes membership fees in a professional association and subscriptions to any professional renter publications.
Deductible legal fees include notary costs and attorney consultations. If you hire an attorney for a business-related purpose, then those fees also count as business expenses.
If you pay for utilities on a property yourself, instead of passing them on to a renter, those payments also qualify as deductible business expenses. You can deduct utility costs for rental properties and your office.
Pretty much any of the everyday costs of doing business may also be eligible tax deductions you can claim on your federal income tax return. Here are just a few of the business costs that may fall into this category:
- Employee costs: wages and employment taxes
- Insurance premiums
- Office supplies
- Technology expenses: internet and business software
- Office space rent and utilities
What Tax Form Do You Use to Claim Deductions?
Most rental property owners will report their rental income and expenses on their personal tax returns using IRS form 1040. You will specifically use 1040 Schedule E, Supplemental Income, and Loss to report the income you’ve received from rental real estate and to claim deductions for the business expenses you’ve made.
Follow the instructions on the form for reporting the relevant revenues and costs related to your rental holdings.
If you have more than three rental properties, you will need to fill out multiple copies of Schedule E so that you can include information for each site.
Work With a Tax Professional
Before you submit your tax return, consult with a tax professional to ensure you’re claiming all of the deductions you’ve earned. You can also gather your tax records and hire an accountant to file the return in your place, leaving you with more time to focus on managing and maintaining your properties.