Understanding rental property taxes is essential if you want to operate a profitable rental property portfolio.
Updated August 2023
One of the major benefits of being a landlord is that taxes for rental property income can be offset by deductible expenses. This allow investors that understand the tax code to minimize their taxable income and maximize their rental property profits.
To take full advantage of these tax benefits though it is absolutely imperative that landlords keep careful records of all their income and expenses as well as carefully filing their supporting documentation throughout the year.
In this article we take a closer look at rental property taxes, and how you can use software like Landlord Studio to stay organized for tax time so you can maximize your end of year deductions and overall ROI.
In order to operate a profitable rental property portfolio you need to have a comprehensive understanding of the ins and out of rental property taxes.
This means understanding what qualifies as rental property income, getting to grips with passive vs active income, understanding how rental property taxes are calculated and reported, and of course learning what strategies you can employ to minimize your end-of-year tax bill.
Yes, rental income is taxable. However, this doesn't mean that every cent you receive from your tenant will be subject to rental property taxes. You have the opportunity to lower your rental income by deducting the costs associated with operating your rental property business including mortgage interest, operation costs, marketing costs, and maintenance expenses.
You will need to report your rental property income and expenses on Schedule E, titled "Supplemental Income and Loss” which will be filed along with your Form 1040 at the end of the tax year.
Read on to learn more about the Schedule E form.
You're required to declare all earnings on the tax return for the year you physically receive them, even if they might be attributed to your tenant for a different year.
For instance, if you collect rent for the month of January 2023 early in December 2022, you would record that rent as income on your 2022 tax return. And vice a versa, if a rent payment was due in December 2022 but your tenant was late with the payment and paid in January 2023 this income would be reported on your 2023 tax return.
Likewise, if you receive a payment covering the first and last month's rent, it's subject to taxation as rental income in the year it's actually received.
When you receive goods or services from your tenant as an exchange for rent, you're obligated to report the value of those goods or services as rental income on your tax return for the year in which you obtain them.
Additionally, you must also account for income that you have constructively received. This means that the funds are at your disposal even if you haven't physically acquired them. For instance, if your tenants place their checks for January 2023 in your mailbox towards the end of December 2022, you can't evade reporting the rent as income for 2022 by merely leaving the checks in your mailbox until after the tax year ends.
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As you calculate your rental earnings, it's essential to consider more than just the monthly rental payment. Here's an in-depth exploration of various factors that are recognized as rental income for tax considerations:
According to the IRS, if you actively participated in the management of your rental property, you may be able to deduct up to $25,000 against your income each year.
However, let’s say your property brings in $20,000 but you spend $50,000 on it that year. You’d record a loss of $30,000 which is more than the allowed limit of $25,000.
In this scenario, you deduct the $25,000 from your current tax year and then carry over and “recapture” the remaining $5,000 in the following year. If you continue to have losses of more than $25,000 then you can continue to carry over the losses beyond that amount year after year.
For more detailed information read the IRS Publication 925: Passive Activity and At-Risk Rules
Read more about Passive Activity and Passive Activity Loss Limitations
A Homeowners Association (HOA) is a local governing body that sets specific rules and guidelines for the maintenance and presentation of a property in a condominium, gated community, apartment, or another type of planned development. By purchasing the property you agree to abide by these rules and guidelines and to pay regular HOA fees. These fees are often used to pay for maintenance, landscaping, and general upkeep of the community and common areas.
If your property is used for rental purposes the IRS considers HOA fees a regular business expense, and as such the HOA fees are tax-deductible.
Essentially, determining whether your HOA fees are tax-deductible depends on whether or not you live in that property.
There are some exceptions to these rules, however. If the HOA fee is for an assessment for an improvement this HOA fee is not deductible and you’ll need to recoup your share of the costs of the improvement via depreciation.
Learn more about how to categorize and track rental property HOA fees here.
There are several tax benefits when investing in rentals. This includes things like 1031 exchanges that allow you to indefinitely defer capital gains tax, depreciation, which allows you to deduct the cost of the property against your income over 27.5 years, and a range of tax deductible expenses. We outliune the main tax deductible expenses below.
Interest is often a big deductible expense. For example:
These interest payments can quickly add up which makes the ability to offset these payments back against your taxes very valuable.
Depreciation is one of the major tax benefits of rental property. According to the IRS, the property has a useful life. As such, over the time you own the asset the cost of the property – though not the land can be depreciated and the depreciation makes up a large rental property tax deduction. the useful lifetime of a property according to the IRS is 27.5 years. This means you can claim the full value of the purchase price of the property back over this period.
You should also be aware that the IRS will claim a portion of the depreciated value back upon the sale of the property in a process called depreciation recapture.
Additionally, any capital improvements (this is work on the property that adds to or increases the property’s value and is generally a permanent fixture), or costs, such as replacing appliances, cannot be deducted as rental property expenses but must be added to the cost basis of the property and depreciated.
Repairs and maintenance often come unexpectedly and can quickly add up affecting the cash flow and overall profitability of your rentals. Thankfully, the cost of maintenance and repairs qualify as rental property tax deductions and can be fully reclaimed at the end of the tax year.
It should be noted that repairs and maintenance costs do not include expenses or costs for improving the property.
Repairs are defined as any effort to maintain the current condition of the property and provided they are “reasonable, necessary, and ordinary” they can be fully deducted in the year which they occurred.
Examples of repairs include:
Maintenance costs are a little different. These are necessary expenses related to maintaining the property’s current condition – not fixing things that are broken.
A few examples of claimable maintenance expenses:
You can deduct the expense of any property owned by the landlord used in the property.
For example, any furnishings supplied by the landlord, appliances, or gardening equipment.
The cost of personal property used in a rental activity can usually be deducted in one year using the de minimis safe harbor deduction (for property costing up to $2,000) or 100% bonus depreciation which will remain in effect for 2018 through 2022.
Formally known as the Section 199a Qualified Business Income Deduction, and also called the QBI deduction, the pass-through tax deduction is designed to encourage Americans to start small businesses and engage in other entrepreneurial ventures.
In a nutshell, it treats income that comes from certain non-employer sources in a favorable manner.
This was part of the Tax Cuts and Jobs Act, which went into effect in the 2018 tax year. Like most of the provisions in this tax reform bill that affect individuals, it’s scheduled to end after the 2025 tax year.
Specifically, the pass-through tax deduction lets U.S. taxpayers deduct as much as 20% of their business income that comes from “pass-through” entities such as:
This deduction is scheduled to expire after 2025.
Landlords are entitled to a rental property tax deduction for most of the driving undertaken in order to manage and maintain their rentals. For example, you can deduct travel expenses when you drive to your rental building for a routine inspection or to deal with a tenant complaint, or when going to the store to purchase parts for necessary repairs.
However, it’s important to note that you can’t deduct the cost of travel you do to improve your rental property. Instead, these expenses must be added to the property’s tax basis and depreciated over the 27.5 years you are allowed to depreciate the property.
If you drive between your rentals for business purposes you can:
Note: To qualify for the standard mileage rate, you must use it in the first year you use a car for your rental activity.
If you travel overnight for your rental activity, you can deduct your airfare, hotel bills, meals, and other expenses.
IRS auditors closely scrutinize travel expenses, especially for overnight travel. This is why you must keep concise and detailed records of all travel undergone and the purpose of that travel using a system like Landlord Studio.
To stay within the law (and avoid unwanted attention from the IRS), you need to properly document your long-distance travel expenses.
The wages of anyone hired to assist you in the managing and running of your rental property are counted as a business expense and are also an allowable rental property tax deduction.
This is for independent contractors, full-time employees, or just part-time.
Many costs associated with the management of your rental are normally deductible. For example, if you hire a property management company – or if you use a landlord software like Landlord Studio.
Both of these are tax-deductible expenses for active-passive landlords. Other expenses in line with this that are often allowable include listing fees or expenses.
You can deduct the premiums you pay for almost any insurance for your rental activity. This includes fire, theft, and flood insurance for rental property, as well as landlord liability insurance. And if you have employees, you can deduct the cost of their health and workers’ compensation insurance.
The final item on this list is fees you pay to accountants, attorneys, advisors, or other professionals that help you in the running and management of your real estate business.
You can deduct these fees as operating expenses as long as the fees are paid for work related to your rental activity. Visit the IRS Website for more information.
In order to correctly claim your rental property tax deductions, you will likely need to report your income and expenses using the IRS f. This is the form that you need to use to report income and loss for rental real estate, royalties, partnerships, and a couple more classifications.
Report your income and expenses using this form split up by property and itemized as shown in the below screenshot.
Landlord Studio has these categories already preloaded for you and easily allows you to generate property-specific Schedule E reports.
Save weeks of time and hundreds of dollars each year with Landlord Studio. Find out more about rental property accounting with Landlord Studio →
Running a rental can be expensive. There are many miscellaneous costs and expenses which can quickly add up and become unmanageable. At times it can seem like making a property cash-flow positive might never happen.
This is why it’s so important to take advantage of the tax benefits of rental property. In order to do so, you need to make sure that you keep immaculate records of all your rental property tax deductions and income along with any of the required evidence.
This can be easily managed with a property management and rental accounting system like Landlord Studio – meaning you will never miss a deductible expense again and can maximize your tax deductions.
Laws on what is an acceptable expense varies from state to state so if you are uncertain how to classify an expense or whether it needs to be deducted or treated as a capital expense and depreciated you should discuss this with your CPA and/or check local state laws to ensure you remain compliant.
Thanks for reading and we hope you found this blog interesting! However, do note that the purposes of this article are for general information. We are not licensed financial or legal professionals and as such nothing in this article should be understood to be financial or legal advice. If you require financial or legal assistance please seek the help of a competent professional.