Although rental properties can provide an extra revenue stream, they also come with additional tax responsibilities. If you’re thinking of becoming a landlord, here’s what you need to know about rental property taxes.
What Is Considered Rental Income?
Understanding what the IRS considers to be rental income is important because failing to report all of it can lead to tax headaches. Some people are surprised to learn that rental income not only includes the payments you receive for use of the property you own but also:
- Advance rental payments – such as the first and last month’s rent
- Late payment fees
- Expenses paid by tenants – this often includes utilities, parking, and garbage pickup fees
You must also report rental income for payments you receive due to lease cancelation and security deposit forfeiture. If you receive property or services in exchange for rent, you are required to report the fair market value of these items or services in your rental income, as well.
Payments and fees received are counted as income in the year they are paid. For example, if you receive a deposit for the first and last month’s rent (this is considered an advanced rental payment) when a tenant moves in on February 10, 2023, you should report these amounts as income on your 2023 tax return.
Are Deposits Considered Income Too?
Although the first and last month’s rent deposit is considered income immediately, security deposits are not counted as income in the year they are received. This is because a tenant may be refunded their deposit upon termination of their lease. If you keep a portion of the security deposit after the tenant vacates, the amount retained would then be considered rental income for the year the client terminated their lease.
In most cases, however, you’ll be able to offset the income from the safety deposit by deducting the expenses incurred for repairing the damage left by the tenant.
Common Rental Property Tax Deductions
Speaking of deductions, many expenses can be deducted from your rental income when preparing your taxes, including:
- Advertising. This may include digital and traditional advertising (radio, TV, and print), as well as yard signs to attract potential renters.
- Travel expenses. Costs to travel to your rental property to maintain it or collect rent are deductible (if you have an office or home office). Use either the standard mileage rate or actual expenses to determine your total cost. You can also deduct hotel and meal expenses if you stay overnight.
- Cleaning and maintenance. This typically includes yard services (not a major landscaping project), cleaning services, painting a room, and other routine tasks that keep your property in good condition.
- Insurance. Premiums paid for fire, flood, hurricane, theft, and other liability insurance.
- Legal and other professional fees. If you hire other people to help manage your rental property, such as real estate agents, accountants, or an attorney, their fees are deductible.
- Mortgage interest. If you have a home loan on your rental property, you can deduct the mortgage interest.
- Repairs. Fixing a leaky sink or toilet, patching a hole in the roof, and other efforts that keep your property in rentable condition.
- Property taxes. Any local property taxes levied are deductible in the tax year they are paid.
- Utilities. This generally includes water, sewer, gas, and electric, as well as cable and internet fees.
- Office space. Whether you rent a commercial space or have a dedicated home office, you can deduct the expenses associated with maintaining your office space.
If you plan to take any of these deductions, good recordkeeping is a must. Always save invoices and receipts, just in case you are audited.
Improvements vs. Repairs
It’s important to note that upgrades and improvements aren’t treated as deductible repair expenses. Instead, these types of expenses fall under capitalization and depreciation rules (check out IRS Publication 946, How to Depreciate Property, to learn more). Examples of “repairs” that the IRS considers to be an upgrade or an improvement include:
- Room additions
- New roof
- HVAC systems
- Flooring
- Insulation
- Water heaters
- Landscaping and sprinkler systems
Generally, any repair that materially adds value to the rental property or substantially extends its life should be treated as an improvement. Misclassifying an improvement as a repair may raise red flags and can lead to a potential tax audit. When in doubt, always consult a tax professional.
Rental Properties & Personal Use
If you use your rental property as a residence or vacation home, there are limitations on the rental expenses you can deduct. If you want to deduct 100% of the eligible expenses, you can’t use the property for personal use for more than 14 days or 10% of the total days you rent it out to others during the year, whichever is greater.
Additionally, if you rent your property for fewer than 15 days annually, do not report any of the rental income, and don’t deduct any expenses as rental expenses.
In cases where you use the property for both rental and personal use (greater than 14 days), you’ll need to divide your total expenses based on the number of days used for each purpose. The math can get a bit tricky, so we strongly encourage working with a tax professional if your property falls under mixed use.
How Do I Report Rental Income on My Taxes?
If you rent a room, vacation home, or other rental property, you should report your rental income and expenses on Form 1040 or 1040-SR, Schedule E, Part I. You will need to list your total income, expenses, and depreciation for each rental property on the appropriate line (Schedule E).
For those with four or more rental properties, multiple Schedule E forms are required. Complete lines 1 and 2 for each property. For the “totals” column, however, only complete this on one Schedule E and it should include the totals for all Schedule E forms submitted.
Depending on your specific situation, you may also need to complete Form 4562, Depreciation and Amortization (Including Information on Listed Property), Schedule C, Profit and Loss From Business, and/or Form 4684, Casualties and Thefts.
Need Help?
Preparing your rental property taxes is not always straightforward. If you’re unfamiliar with the rules, or calculating depreciation stresses you out, it’s a good idea to work with a tax professional. At Tax Defense Network, we offer affordable tax preparation services for individuals and small business owners. Call 855-476-6920 for a free consultation and quote today!