I thought I follow-up this week with rental income tax tips for those of you that are landlords or considering becoming landlords. For tax purposes you need to be sure you document all your money coming in and going out of the rental property. That means giving receipts and keeping copies of the rent payments you collect. Keep in mind that generally you must report rental income on your tax return in the year you actually receive it. If you collect some advanced rent, such as someone paying two or three months’ rent upfront, you would again report this for taxes in the year you receive the payment, regardless of when that rent would’ve been due.
Now security deposits are handled a bit differently. Like income when you receive a security deposit, you need to record it and provide a receipt. But if you plan to return the deposit to the tenant at the end of the lease, it is not income. So you do not report it on your tax return. If in the end you keep part or all of the security deposit because your tenant doesn’t live up to the terms of the lease, then you would report the amount you kept as income that year. If your tenant gives you property or services instead of money as rent, you need to include the fair market value of the property or services as rental income. Also, if the tenant pays any of your expenses than those payments are also rental income. In this case you record what the tenant paid as income, and then claim the expense on your taxes as well.
Generally, the expense of renting your property out like maintenance, repairs, insurance, property taxes, interest if you have a mortgage on the property, advertising for new tenants can be deducted from your rental income which lowers the amount of income you have to pay income taxes on.
One area that can be confusing especially to new landlords, is how to treat improvements to the property for tax purposes, as opposed to maintenance and repair. One way to look at whether something is a repair or not is ask yourself if what needs to be done makes the property livable, but doesn’t increase the value of the property. Good examples are repairing holes in the wall from nails, unclogging a drain, or fixing the leak in a roof.
One way to know if something is an improvement rather than a repair is whether or not it improves the value of the property. If it does or it way extends the life of the property, then it is considered a long-term asset and deducted over years instead of all at once. Improvements can be things like replacing a roof, renovating the interior, or replacing a heat pump instead of fixing it. So for example having a repairman come out to fix a broken washing machine is repair. Buying a new washing machine is an improvement.
The key difference for tax purposes as the entire cost of a repair can be deducted as an expense in the year you do it. The cost of improvements cannot be deducted as an expense all at once. You have to claim part of the expense each year over the life of the improvement. This is called depreciation. Different improvements are depreciated over different lengths of time which are set by the IRS. And there are extra forms to fill out with your taxes for each improvement.
In addition to improvements, the price you paid for the rental property (not including the value of the land it sits on) is also depreciated. In this case for 27 ½ years. So each year you will claim depreciation for the rental property itself, as well as each of the improvements you make, each on its own timeline. This can be a bit complicated and this would be a good time to discuss it with the CPA. Or if you still want to do your own taxes, dive into IRS publication 527, Residential Rental Property.
If you have any questions or comments, please drop me a line at katie@moneypilotadvisor.com
