Renting out a residential property can be a solid investment, but there are many tax rules that must be followed in order to claim income and expenses properly. Tracking and organizing your rental receipts is the first step in managing the tax side of your rental property, but there are a number of other important—and often-overlooked—tax tips for landlords.
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Claim your home office
You may not consider your rental income to be a regular business with an office, but it is. You have to record your income and expenses somewhere, and that is likely to be a desk or room in your home. If you use a room or other dedicated space in your home exclusively for your rental activities, you can claim a portion of your house expenses as a deduction against your rental revenues.
Your business portion can be based on either the office's square footage divided by the square footage of the entire house or by how many rooms it encompasses versus the total number of rooms in the house. Calculate it both ways and use the percentage that gives you the largest deduction.
Beginning with 2013 tax returns (filed in 2014), the IRS began a simplified option for claiming the deduction. This new method uses a prescribed rate multiplied the allowable square footage used in the home. For 2019 the prescribed rate is $5 per square foot with a maximum of 300 square feet. The space must still be dedicated to the business activity as described above.
Repairs versus improvements
Maintaining a rental property includes fixing the building up over time. Some of these costs are repairs, and some are improvements. The basic definition of a repair is anything that puts the property back into the same condition it was in originally.
For example, if you paint the walls, fix a broken window, or change the locks on the doors, you are simply restoring it the way it was in the beginning. An improvement, on the other hand, increases the value or the longevity of the property over what it had been originally. For example, if you build a room in the basement, put a new roof on the structure, install a solar electric array for the first time, or put in a new outdoor pool, the value of the property increases or it will last longer.
The reason it is important to differentiate between the two types of costs is that repairs and maintenance costs can be expensed in the year incurred, whereas improvements must be capitalized and the expense taken over a period of years through depreciation.
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Track your mileage
If you have to use your personal vehicle for rental activities—such as buying supplies, picking up rent checks, or showing the property to potential renters—the proportion of the vehicle usage related to business purposes is deductible against rental revenue.
You can choose one of two methods to calculate your allowable deduction. The first requires that you track the percentage of your mileage you are using for business versus the total mileage of the vehicle. Apply this percentage to your total vehicle expenses for the year including gas, insurance, repairs and maintenance, and loan interest or lease cost. A more simplified method allows you to apply a per-mile rate to your total business miles for the year. These rates change once or twice a year and can be found on the IRS website (irs.gov).
Watch out for recapture
The tax code allows you to expense the cost of purchasing your rental property building and improvements (but not the land) over a number of years, through depreciation. This can provide you with a hefty annual expense to lower your taxable rental income each year. However, if you sell the property for more than the depreciated value, you may have to add some or all of the depreciation you have taken over the years back into your taxable income. This is called "recaptured depreciation," or "recapture" for short. It can be a nasty and expensive surprise in the year you sell the house.
Plan ahead for recapture if your property is in an area with increasing property values.
Legal and professional fees
You can deduct the cost of hiring a lawyer or an accountant to provide services related to your rental property. For example, if you have a lawyer draft your rental contracts, or engage an accountant to file your personal taxes that include your rental income, the rental-related portion of the expense is considered business-related, and you can deduct it against rental revenues.