Key Takeaways

• Understand and Track All Taxable Income and Deductions - Landlords must accurately report all forms of rental income and maintain detailed financial records to ensure compliance. Knowing which expenses qualify as deductible can significantly reduce taxable income.
• Leverage Depreciation and Pass-Through Deductions - Depreciation allows landlords to recover the cost of their rental property over time, while eligible landlords can also benefit from up to a 20% Qualified Business Income (QBI) deduction under the Tax Cuts and Jobs Act.
• Prioritize Documentation and Professional Guidance - Keeping organized, verifiable records is essential for accurate tax filings and protection during audits. Due to the complexity of real estate taxation, consulting tax professionals or property management experts can help landlords avoid costly errors and optimize tax benefits.

Tax season is both an obligation and an opportunity for landlords. Tax season offers a unique set of financial complexities. Knowing how to navigate these challenges and maintain compliance is essential to prevent tax liabilities and ensure long-term profitability.

In this article, we at Propertycare Property Management will provide crucial tax season tips for landlords, outline best practices, and offer strategies to promote compliance while enhancing financial efficiency.

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Know Your Tax Responsibilities as a Landlord

It’s essential to understand what the Internal Revenue Service (IRS) considers as taxable income and legitimate deductions before strategizing on tax savings.

All payments listed below are considered rental income and must be reported in the year they are received:

• Regular rent payments.
• Advance rent payment.
• Nonrefundable deposits.
• Tenant-paid expenses that are the landlord’s responsibilities.
• Fees for lease cancellation.

It’s the landlord’s responsibility to maintain accurate and clear records of every transaction involving the property, rental income, and expenses. The required documents here include lease agreements, invoices, bank statements, and maintenance records.

To ensure that tax filings are accurate and to provide the needed evidence during audits, proper record-keeping is mandatory. Landlords should also maintain a separate bank account for their rental property to prevent mixing business and personal expenses. Doing so will simplify financial management and recordkeeping during tax season.

Know the Deductible Expenses

Owning a rental property offers numerous benefits. You can reduce your taxable income, but careful documentation and justification are required. According to the IRS, landlords can deduct ordinary and necessary expenses they incur when managing and maintaining rental properties. Examples of some common deductions include:

• Property Taxes - Landlords can deduct local real estate taxes as part of the business expense.
• Professional Services - These include consulting, accounting, and legal fees relating to the rental property.
• Mortgage Interest - Interest that is paid on the loan used in purchasing or updating the property.
• Property Management Fees - Payments made to property management companies.
• Repairs and Maintenance - All costs associated with maintaining the property in good working condition.
• Utilities - Water, gas, or electricity bills paid by the landlord.
• Insurance Premium - This includes premiums for landlord, liability, and property insurance.

It’s should be noted that there’s a clear difference between repairs and improvements. Landlords should review the IRS guidelines under Publication 527 to differentiate between depreciable improvements and deductible repairs.

Repairs are activities done to maintain the property in its current condition for example, repainting walls or fixing a leaking pipe. They are deductible expenses for the year incurred. Improvements are actions that enhance the property’s values and extend its lifespan like kitchen remodeling or adding a deck. These expenses are capitalized and depreciated over several years.

Make Use of Depreciation

Property investors consider depreciation as one of the most significant tax benefits. Through annual deductions, landlords can recover the cost of their income-producing property. For residential rental properties, landlords are allowed to depreciate the value of the building, excluding the land, for over 27.5 years. Every year, the landlord can deduct a portion of the property’s value for wear and tear. Other aspects that landlords can depreciate include:

• Appliances and furnishings. This can qualify for accelerated depreciation under the Modified Accelerated Cost Recovery Systems, MACRS.
• Bonus depreciation and section 179 deductions for some equipment and property improvement.

It’s essential to note that although depreciation reduces the annual taxable rental income, it also affects the calculation of capital gains when selling the property. Landlords are mandated by the IRS to “recapture” depreciation.

That means the cumulative depreciation deductions will be taxed when selling the property. Consult a tax professional to ensure that depreciations are calculated accurately and to effectively strategize for future recapture.

Take Advantage of Pass-Through Deductions

According to the Tax Cuts and Jobs Act (TCJA), some landlords who operate through pass-through entities, such as partnerships or LLCS, or as individuals can qualify for the Qualified Business Income (QBI) deduction. Here, eligible landlords can deduct up to 20% of their qualified business income from the taxable rental income. To benefit from this, rental activities must be a business or trade under IRS standards. Below are some factors that determine qualification:

• The intent to earn a profit.
• Regular and continuous rental activity.
• Active involvement in oversight or management.

Landlords who want to be eligible need to formalize the rental operation through an LLC, document active participation, and maintain detailed records of the hours they spend managing the property.

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Ensure Proper Documentation and Recordkeeping

Apart from being a best practice, documentation and record keeping offer legal protection. Landlords are required to keep records to substantiate their rental income and expenses. Below are some essential documents that the IRS requires:

• Lease agreements and tenant correspondences.
• Tax returns.
• Depreciation schedules.
• Mortgage documentation.
• Bank statements and canceled checks.
• Insurance documentation.
• Invoices and receipts for expenses.

As best practice, store these records for at least three to seven years. This will depend on the type of deduction or expense. For ease, you can use digital accounting tools to automatically categorize expenses and income all year round.

Bottom Line

Tax season is more than a requirement for compliance. It’s an essential aspect of financial growth and successful property management. It is advisable to leverage professional assistance because of the complexity involved in rental property taxation. Even landlords with experience can still make mistakes when preparing taxes.

Avoid common errors such as failing to report all rental income, missing deadlines for filing, overstating deductions, or ignoring depreciation recapture when selling the property. Ensure that you work with a property management company to help with your tax and financial records. Contact our professional team at Propertycare Property Management today!

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