Buying real estate for investment reasons can be a lucrative business. However, it is vital to make certain your accounting is in order and taxes are paid accordingly. Understanding the income and expense requirements the IRS dictates will protect you from paying unnecessary taxes or making a costly mistake on your tax return. A tax return with real estate rental income is more complicated so consulting with a professional CPA is always a wise decision.
What Is Considered Real Estate Income?
The IRS website defines the following as rental income:
- Gross income paid as rent
- Advance rents must be claimed in the year received
- Amounts received in cancellation of a lease
- Security deposits are not considered income if returned to the tenant at the end of the lease; however if you keep any portion of the security deposit due to damages or as the last month's rent, a security deposit becomes income.
- Trade payments such as the tenant replacing flooring in exchange for rent should be included as income
- When a tenant pays expenses for the property that are not his/her responsibility and deducts the expense from the rent, this is designated as rental income
Deductible Expenses
While the income from your rental is taxable, there are also many expenses that can be used to lower your tax liability. There are some obvious expenses but not everything is 'cut and dried'. Again, the IRS has specific instructions:
- Ordinary and necessary expenses - This includes property management fees, lawn, pest and cleaning services, utilities, insurance, taxes, HOA or condo fees, legal and accounting services, advertising costs, and mortgage interest
- While you can claim costs for maintenance and repairs of the property, you cannot claim improvement costs for remodeling, renovations or upgrades
- Depreciation on the property as well as the replacement of items such as an oven, dishwasher, air conditioning system, etc. can be claimed over a period of time dictated by the IRS. Remodeling, renovation or upgrading the property can be depreciated as well.
Depreciation write-offs are one of the best ways to lower your taxable rental income. The amount of depreciation is based on the useful life of the asset and divided into equal amounts over that useful life.
Qualified Business Income Deduction
Once all rental income expenses are deducted, a real estate rental owner can also claim a qualified business income deduction or QBI. This deduction allows taxpayers to lower as much as 20% of pass-through income. There are thresholds of income but even those who exceed these thresholds may qualify for all or a portion of the 20% deduction.
The tax laws surrounding rental income are complicated. Many property owners do not have all of the knowledge or the time to stay up to date on the changes. In these cases, it may be wise to hire a professional real estate CPA to assist and advise on the best course of action. At Chandler & Knowles CPAs, we are specialists in rental income tax law. Call us today to get a handle on proper reporting of your rental income taxes: (817) 369-3874.
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