Over the years, Axela Management has helped property investors overcome a lot of headaches through our property management work. Out of all of the stresses that landlords face, one that only comes annually tends to be a common point of tension for those doing rental business. It’s three dreaded words: rental income tax.
You don’t have to allow anxiety to creep in as rental income tax season approaches, however. With the right knowledge and help from a seasoned tax professional on your side, you can understand the implications of taxes on your rental business and improve your financials with the right deductions.
Today we’ll cover the ins and outs of rental income tax to help you stress less about what not to do and succeed in what you should be doing.
Rental Income Tax Basics
So what exactly qualifies as rental income? It might include more than you might assume. The IRS defines rental income as “any payment you receive for the use or occupation of property.” This includes residential, multi-family, commercial, student housing, and any other property type that you rent out. If you receive money from a person occupying your property, then it must be reported as income.
This includes many tenant payments that could be easy to overlook as income. Security deposits kept in full or partially for any reason are considered a part of your rental income. Also included in your tax reports should be any payment a tenant makes to cancel a lease early.
Deductible Expenses
Deductions are the biggest benefit to tax time and are often worth the trouble of the season. But it’s important to be especially careful during this portion to make sure you’re not claiming the wrong deductions or missing out on deductions you could be claiming.
Some of the most common rental income tax deductions for property investors include:
- Mortgage interest from any payments made towards the property.
- Property taxes paid towards your rental property, depending on your state’s regulations.
- Costs of repairs and maintenance.
- Property management fees paid to your property manager (if you don’t have one, here’s why you should hire a property management team)
- Property value depreciation.
Keeping Detailed Records
The biggest favor you or your property manager can do for your rental daily is to keep comprehensive records of all financial transactions. Doing so will ensure that come tax season, you can easily find every document you need for filing purposes.
A few of the most important records you can keep include:
- Rental income records (including security deposits, prorated payments, and early cancellation payments)
- Expense receipts for maintenance and any other services
- Property improvement costs
- Rental agreements and leases
Common Rental Income Tax Mistakes
So many regular people, business owners, and investors worry about their taxes for the time it takes, how complicated they perceive it to be, and the stress making a mistake can cause. But often, rental property owners make the same mistakes during tax season. And those mistakes are totally avoidable!
The two biggest mistakes come from what we’ve discussed already. You have to report all forms of rental income, big and small, to avoid paying fines and elongating the process for yourself. You also have to maximize the deductions you can claim on your rental. But both of these mistakes tend to stem from not keeping detailed records and not going to a tax professional for help.
Another common mishap comes from the property owner misunderstanding the rules of depreciation. Luckily, the IRS lays out clearly for us as well.
Understanding Depreciation
Rental property depreciation is defined as the loss of value on a rental property over time due to use, market conditions, and degradation. The IRS views running an investment property much like running a business. Just like a business, value is perceived to be lost over time due to usage. In this case, that comes from tenants living in the property and the property needing maintenance.
Even if your property value goes up, the business of your rental is still seen as depreciating over time. Which means you can deduct it from your taxes. However, the way you calculate this can get complicated. Different systems can be used for calculating this with different percentages, and each of them does so yearly for the duration of the “useful life” of the rental property.
Depreciation is an exceptionally easy way to miscalculate your taxes because of the differing ways it can be tallied. Make sure you’re consulting a tax professional for this part of your tax forms.
Strategies for Minimizing Tax Liability
Deducting rental expenses as well as depreciation are where you start on getting money back on your rental income tax. Be sure you are establishing your rental properties under an LLC in order to deduct your expenses. This is an important step to securing your tax deductions legally.
If you have a portfolio of property investments or plan on expanding, you can sell your rental property and use the money from the sale to purchase another rental under what’s known as a 1031 exchange. This will allow you to complete the sale while deferring on paying capital gains tax.
It’s also wise to set up a self-directed IRA account for your rental income. This will allow you to defer paying taxes on your income until the money is withdrawn at retirement, potentially at a lower tax rate. It also allows your rental income money to grow tax-free in the IRA account.
Less Stress, More Success with Rental Income Tax
Rental income tax can feel like a heavy burden. But with all the ways you can capitalize throughout the year through deductions, depreciation, and proper recordkeeping, it is possible to make tax season a success for your rental property investment.
If you’re feeling overwhelmed, we always suggest consulting a tax expert to fully organize the way you run your investment. A seasoned property manager can always help you get your documents in order and make tax time a breeze as well. A property manager like our team at Axela Management is what you should be looking for if you want to improve.
Axela Management specializes in large investments that can be a lot to manage. Multi-family properties, commercial rental property, and student housing are all challenges that we welcome daily. We carry a track record of success in these venues and know how to improve our investors' financial gains no matter what is required.
Schedule a free consultation with us to learn more about what Axela Management can do for you.
