Rental Properties and Taxes: What You Need to Know

Tax time is approaching quickly. Here’s a brief introduction to what property investors need to know about types of taxes on rental real property.

What Tax Form Do I Use to Report Rental Income?

Rental income is reported on your tax return using Form 1040, Schedule E. You’ll list your rental income, expenses, and depreciation. Be prepared to supply the IRS with full documentation of everything you list on Schedule E and keep those records for at least three years after filing.

How is Rental Income Taxed?

In most cases, rental income is taxed as ordinary income. Generally, you’ll be taxed according to your income tax bracket rate.

How Is Rental Income Determined?

The IRS defines rental income as “any payment you receive for the use or occupation of the property.” Obviously, this includes rent that you receive from tenants. It could also include:

      • Advanced payments of rent. If a tenant paid their first and last months of rent when they moved in, that would count as rental income in the year you received the payments.
      • Any part of the security deposit you keep. If your tenant gives you a $1,000 security deposit, and you plan to refund the entire $1,000, it’s not considered rental income. However, if you keep $500 for damages at the end of the lease, it counts as rental income.
      • Services by the tenant in exchange for rent. For example, if a tenant agrees to paint the house in exchange for $500 off rent, it counts as rental income.

What Deductions Can I Take from Rental Income?

Your expenses for owning and renting the property will offset the amount of your rental income. These expenses may include, but are not limited to:

      • Property taxes
      • Mortgage interest
      • Insurance
      • Marketing of the property (ads, signs, flyers, etc.)
      • HOA/condo dues
      • Maintenance and cleaning
      • Services (utilities, pest control, etc.)
      • Property management fees
      • Other legal and professional fees

Other Deductions:

      • Depreciation.One of the best tax advantages real estate investors can take advantage of is depreciation. Residential real property is deductible over a 27.5-year period. So, if you buy a rental property, you can divide the cost of acquiring the property (minus the value of the land) by 27.5 to determine your annual depreciation deduction. For example, if you buy a rental property for $350,000 and the land is worth $50,000, you can deduct $10,909 per year as a depreciation expense. That’s in addition to other deductions listed above. Of course, there is some fine print associated with this deduction, so be sure to ask your accountant how much you can claim.
      • The Qualified Business Income Deduction. There’s another tax break, called a Qualified Business Income (QBI) deduction. It allows taxpayers to deduct as much as 20% of their pass-through business income. This includes income from an LLC, S-Corporation, and an investment property. This deduction is new and complex, so consult a tax professional for the details.

What Taxes Will I Pay When I Sell an Investment Property?

There are two types of taxes when selling an investment property:

      • Capital Gains. Any profit you receive from the sale of an investment property is taxed as long-term capital gains.
      • Depreciation Recapture Tax. Whether you claimed the depreciation deduction or not, you’ll be hit with a tax on the allowable depreciation.

You can avoid paying capital gains and the depreciation recapture tax by doing a 1031 exchange. Generally, you won’t have to pay taxes on the sale if you use the proceeds to purchase a similar property. Do you research and check with an accountant about the details.

How Can I Make Tax Time Easier?

One of the benefits of having TMG Property Management Services NW manage your rental property is that at the end of the year, you’ll be given a report of all income and expenses for your property, making tax time much easier. Having the best property management company on your side makes all the difference in the world. Give us a call for a quote and a free rental analysis.

View the IRS’ Tips on Rental Real Estate Income, Deductions, and Recordkeeping.

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