April 12 , 2024
As a rental real property owner, it is important to keep accurate accounting records and to understand what income should be reported on the tax return and what tax deductions are available.
Record Keeping and Accounting Methods
Good records help landlords monitor the progress of their rental property, prepare their financial statements, identify the source of receipts, track deductible expenses, prepare their tax returns, and support items reported on tax returns. Landlords must be able to substantiate certain elements of expenses to deduct them. Generally, the landlord must have documentation such as receipts, canceled checks, or invoices to support his or her expenses. It is also necessary to keep track of any travel expenses incurred for repairs to the rental property.
If a landlord is a cash basis taxpayer, they will report rental income on their return for the year they receive it, regardless of when it was earned. As a cash basis taxpayer, a landlord generally deducts their rental expenses in the year they pay them. If a landlord uses an accrual method, they generally report income when they earn it, rather than when they receive it and they deduct their expenses when they incur them, rather than when they pay them. Most individuals use the cash method of accounting.
Rental Income
Landlords must include in their gross income all amounts received as rent. Rental income is any payment received for the use or occupation of property. Landlords must report rental income for all of their properties. In addition to amounts they receive as normal rent payments, there are other amounts that may be rental income that includes:
Amounts paid to terminate a lease
Advance rent
Expenses paid by a tenant
Security deposits
If the rental property is used for multiple purposes and is rented for less than 15 days during the tax year, the rent received is not required to be included as income; Expenses related to the rental activity are also not deductible. If the rental is for more than 14 days during the tax year, deductible expenses must be calculated based on the number of days the property is used for each purpose.
Rental Expenses
Landlords can deduct the ordinary and necessary expenses of managing, preserving, and maintaining their rental property. Ordinary expenses are those that are common and generally accepted in the business, such as advertising, auto and maintenance, commissions, depreciation, insurance, interest, legal and other professional fees, local transportation expenses, management fees, mortgage and interest paid to bank, points, rental payments, repairs, taxes, and utilities.
The cost of repairs, including the cost of labor and materials, is deductible, but landlords can’t deduct the value of their own labor. If any improvements added to the property increase the value of the property or extend its useful life, the cost of these improvements is not deductible and must be depreciated over time.
Rental property owners can use depreciation to deduct the costs of purchasing and improving a rental property. Generally, a residential property has a useful life of 27.5 years (30 years if owned overseas), and the depreciation period for a commercial property is 39 years (40 years if owned overseas). Certain parts of the building can be depreciated separately over 5 years, 7 years, or 15 years. Some examples of properties that can be depreciated over 5 years include office machinery such as typewriters, calculators, and copiers, appliances, carpets, and furniture, etc. used in a residential rental real estate activity. On the other hand, office furniture and fixtures such as desks, files and safes can be depreciated over 7 years. In addition, certain improvements made directly to land or added to it such as shrubbery, fences, roads, sidewalks and bridges can be depreciated over 15 years.
