The challenge for real estate investors is understanding what counts as operating expenses and what's not included.
If you’re going to run a profitable rental business, it’s essential that you know what counts as an operating expense and is immediately deductible in that tax year, what needs to be tracked and recorded as a capital expense, and what cannot be deducted at all.
By tracking this data with quality property management and accounting software, such as Landlord Studio, you can gain complete oversight of your portfolio’s financial performance. This allows you to identify potential weaknesses (for example, are you spending too much for some services or are any of your properties not cash flow positive?) and enact data-driven changes to improve your portfolio performance.
The challenge for real estate investors then is understanding what counts as an operating expense and what’s not included.
Whilst “debt service” (your debt repayments, such as mortgage payments) are a major component of cash flow, they are not included in your financials as operating expenses.
These expenses are not deductible at the end of the year. It’s valuable to track these numbers on Landlord Studio for cash flow purposes, but when running your end-of-year reports or analyzing operating expenses, you will want to exclude mortgage principals from your reports using our filters.
Identifying which expenses are operating expenses and which are not can be tricky. If you’re uncertain if something should be included as an operating expense you should talk to your accountant or licensed financial advisor.
Below we list some of the key examples of rental property operating expenses:
Expenses to exclude when calculating operating expenses:
Depreciation is one of the major perks of owning and operating a rental property. The IRS allows you to depreciate residential rental properties over a period of 27.5 years and commercial properties over 39 years. To calculate your annual depreciation amount, take the value of the property, subtract the value of the land and divide that number by 27.5 years (for residential property).
This is a major end-of-year deduction that could be essential for keeping your rental property business profitable. However, it is not included in your operating expenses. This is money you haven’t actually spent. Rather, it’s a calculation for tax purposes. Consult with an accountant to nail down the finer details.
Positive cash flow on a monthly basis paired with long-term appreciation is why many investors choose rentals as an investment vehicle. You can supplement your monthly income while building equity. However, it’s not just a case of buying a rental property. You need to treat your rentals as a business. This means understanding the financials inside and out.
One key aspect of this is understanding your operating expenses and their impact on your overall cash flow. You can easily track this data using software such as Landlord Studio and use it to make long-term financial projections, improve profitability, and minimize your end-of-year tax bill.