Being a landlord is not for everyone. But it can provide an income stream that is not subject to self-employment tax (social security and medicare). It can create a tax "negative" while still generating a cash "positive".
- If you receive rent for January 2017 in December 2016, you report the rent as income on your 2016 tax return.
- If you receive a deposit for first and last month's rent, it's taxed as rental income in the year it's received even if the “last month” occurs years later!
- If your tenant paints the unit in lieu of rent, you must report the value of the goods or services as income on your return in the year the tenant provides the service.
- A security deposit is not included as income when received if the plan is to refund it to the tenant when the lease ends.
Some deductible expenses include:
- Cleaning and maintenance
- Commissions paid to realtors
- Condo fees
- Insurance premiums
- Mortgage interest
- Property taxes
- Management fees
- Pest control
- Trash removal fees
- Yard maintenance, snow removal
You can even deduct the cost of travel to your rental property, if the purpose of the trip is to check on or perform work on the property. If you travel by car, you must keep a mileage log as proof.
It is imperative to keep good records. In order to deduct an expense, you must be able to document it with logs, and receipts. So hold on to all receipts, cancelled checks, credit card and bank statements.
Okay, this is where things get confusing. According to the IRS, there is a big difference between and an improvement and a repair. The cost of improvements generally get depreciated over time using IRS depreciation tables rather than deducted in the year the expense was generated. However, repairs can be written off in the year the repair is made.
Improvements “materially add to the value of the property” or substantially “prolong the life of the property”.
- A totally new roof
- Modernizing a kitchen or bathroom.
- Installing insulation or new windows.
Repairs are basically seen as keeping the property in good working condition.
- Repairing appliances (vs. buying a new one)
- Fixing leaks (vs. a plumbing “do-over”)
- Replacing a broken window (vs. replacing a number of windows for upgrading purposes)
- Patching part of a roof (vs. replacing the whole roof)
Calculating depreciation can get pretty confusing. But to give you an idea of how it works consider that depreciation is a deduction you take over an IRS specified number of years. The IRS determines the “life” of the property and different kinds of property have varying “useful life years”.
To figure out the depreciation on your rental property:
- Determine your cost or tax basis for the property (in some cases this sounds easier than it is).
- Calculate depreciation for each property type based on methods, when the property is put into use and the number of years the IRS deems as “useful life” for each asset.
Examples of property class lives and recovery periods per the IRS:
- The building itself minus the value of the ground it sits on for residential rental real estate = 27 1/2 years.
- Nonresidential rental real estate = 39 years
- A fence or shrubs = 15 years.
- Furniture, carpets and appliances = 5 years
- Office furniture = 7 years
- Additions, improvements, renovations for residential rental real estate = 27 1/2 years.
In general your cost basis in the property is the amount that you paid for the property (acquisition cost plus any expenses). But if you are converting your primary home to a rental, your tax basis in the property is the lower of (1) your acquisition cost or; (2) the fair market value at the time you convert the property from personal to rental use.
Yeah, I warned you it can get cumbersome.And of course there are a lot of special rules for figuring out your basis if you inherited the property or took ownership in a like-kind exchange.
For more information check out IRS Publication 551: Basis of Assets and IRS Topic 414: Rental Income and Expenses.