Key Takeaways
- Report all sources of rental income accurately: This includes not only regular rent payments but also advance rent, non-refundable security deposits, tenant-paid expenses, and lease cancellation fees.
- Take advantage of allowable tax deductions: Landlords can significantly reduce their taxable income by claiming deductions for depreciation, mortgage interest, property taxes, repairs, improvements, and operating expenses.
- Keep thorough and organized records: Maintaining proper documentation—such as receipts, loan documents, and lease agreements—ensures a smoother tax filing process and helps substantiate deductions in case of an audit.
- Seek professional guidance when needed: Working with experienced property managers or tax professionals, like InterWest Properties, can simplify the process and help maximize your financial returns while staying compliant with IRS regulations.
Every tax season, landlords have a federal obligation to report all their rental income. You must ensure that you report all rental income earned from your investment property accurately to avoid potential penalties.
That said, taxes can be intimidating, regardless of whether you are a first-time landlord or seasoned landlord. This is because tax filing requires meticulous record-keeping, knowledge of applicable tax laws, and proper classification of deductions and expenses, among other things.
It’s no wonder that most rental property owners run to property management professionals for help. In this guide by InterWest Properties, you’ll learn what exactly to do when filing taxes for your rental property.
What Is Rental Income per the Internal Revenue Service?
The Internal Revenue Service (IRS) defines rental income as any income a landlord receives from a resident in exchange for occupying a rental property. But rental income goes beyond just the recurring rent payments.
The following are the common types of payments that the IRS considers to be rental income:
- Rent Payments: Whether weekly, monthly, quarterly, or any other regular payment you receive, you must report it.
- Advance Rent Payments: Is there any amount you collect before the period it covers, such as the first and last month's rent? If you do, you must report it as rental income for the year you receive it.
- Any Security Deposit Meant to Be the Final Rent Payment: The IRS considers this an advance rent payment and must be reported as income when the landlord receives it.
- Non-Refundable Security Deposit: Any portion of the security deposit you withhold after the resident leaves counts as rental income. For instance, any deductions you may have made to cater for damage exceeding normal wear and tear.
- Lease Cancellation Fees: Do you require residents to pay a fee before cancelling their lease? If you do, such fees count towards rental income in the year you received them.
- Tenant-Paid Expenses: Has the resident paid for any of your expenses? These can include expenses such as repair bills or utility bills that fall under your responsibility. In such a case, you must consider the payments as rental income.
- Any Property or Service You Have Received From the Resident in Exchange for Rent: For instance, if the resident paints their apartment in exchange for a one-month rent break. In such a case, you must determine the fair market value of such a service and deduct the amount as a rental expense.
What Deductions Do Landlords Qualify For?
You don’t have to pay more taxes on your rental income than you have to. As a landlord, you can claim a variety of tax deductions every tax season. Done right, they can potentially save you thousands of dollars every year.
Some of the common tax deductions available for landlords include the following:
Depreciation
Depreciation is a non-cash expense and makes up a significant portion of the overall tax deductions. Under this deduction, the IRS allows landlords to deduct the cost of the building and structural improvements over 27.5 years.
Interest Payments
One of the biggest deductible expenses for landlords is interest. When it comes to the mortgage, for instance, you can deduct the interest portion of the loan that you used to acquire or improve the property.
Aside from mortgage interest, you can also deduct credit card interest, which you used to purchase goods or services.
Property Taxes
You can also deduct real estate taxes that are imposed by your state or local jurisdiction on your investment property.
Repairs and Improvements
To ensure accurate tax filing, it’s important to distinguish the differences between repairs and improvements and what kinds qualify for tax deduction.
The IRS defines tax-deductible repairs as expenses that help keep a rental property in good condition. Examples of common deductible repairs include the following:
- Unclogging drains.
- Fixing a leaky faucet.
- Repairing a broken-down stove.
- Replacing a faulty light switch.
- Patching a section of the roof.
You can deduct these costs in the year you pay them. As for deductible improvements, these are the ones that meet either of the three requirements: adding value to the property, extending the property’s useful life, or adapting it to a new use.
Examples of tax-deductible improvements include the following:
- Replacing the entire roof structure.
- Replacing the carpeting or installing a whole new flooring system throughout the unit.
- Painting the entire exterior of the rental building as part of a major renovation plan.
You must capitalize and recover them through depreciation over many years.
Operating Expenses
Operating expenses are the day-to-day costs of running a rental property. They include the following: insurance, utilities, advertising costs, and property management fees.
What Records Do Landlords Have to Keep During the Tax Season?
As a landlord, it’s important to keep accurate records to take maximum advantage of tax deductions. With tidy rental documents, it can be easy to find receipts, track deductible expenses, and prepare your tax returns.
The following are some of the records you may want to keep organized for the next tax season:
- Rental agreements.
- Insurance policies.
- Loan documents.
- Legal documents, such as fines and inspection reports.
- Business entity documents.
- Property titles and deeds.
- Documents related to income or expenses, such as advertising and listing costs, receipts for repairs, and legal or professional fees.
Bottom Line
Tax season calls for detailed planning. You must ensure that you have the proper records and know how to take maximum advantage of tax deductions.
Lowering your tax bill can help you save thousands of dollars in taxes every year, lowering your operational costs and maximizing your ROI.
InterWest Properties can help you file taxes on your rental income accurately and seamlessly. Additionally, you can count on us for reliable and professional property management services in the Portland, Oregon Metro, and Vancouver, WA areas. Get in touch to learn more!