Rental property taxes are indeed more complex than ordinary income taxes. But the taxes from owning rental properties aren’t as complicated as you might think. Plus, the benefits of owning rental properties are many. Explore this guide on everything you need to know about rental income tax.
What’s considered rental income?
Rental income refers to any payment you received as a property owner from your investment in rental property. This income is taxable and includes the following:
- Monthly rent payments.
- Security deposits.
- Leasing fees at the time of signing.
This income usually comes from renters who pay their monthly rent and includes payments made when they move in, such as advance rent. You pay taxes on rental income, even if your lease lasts for more than one year.
Security deposits can also be considered for rental income taxes, whether you consider them as rent payments or not. Verify the payment agreement you reach with your renter. These funds are reported as income when a renter pays rent. Scheduling payments for this year versus next year can impact how much money you’re claiming on rental income.
Learning how rental income tax works will help you draft rental agreements that can help you save money on taxes and other business expenses.
How does the tax on rental income work?
Rental income is subject to tax as ordinary income. For example, if you are in the 15% marginal tax bracket and have $10,000 in rental income available to report, you will pay $1,500 in taxes, per the rental property tax rate.
Rental property owners have plenty of options when filing taxes for rental property. The key is finding ways to calculate your rental income or to deduct any additional fees from your total. To reduce your rental income, you can subtract some expenses. For example, an investment that helps you get your property in conditions to rent could be a qualifying deduction from your taxes.
How do you calculate rental income taxes?
To calculate your rental income correctly when paying tax on a rental property, you need to classify it accurately. According to the IRS, the cash flow you receive from renting a property is taxable.
With that point about rental property taxation in mind, you can consider the following payment types you receive from renters as part of your rental income:
- Security deposits.
- Any services you receive from your renters in exchange for renting a property from you.
- Regular rent payments.
- Advanced rent payments.
- Other renter expenses that you previously included in the agreement.
Rental income is not ordinary income. It’s qualified business income (QBI). This type of income allows for up to 20% deductions. Because you’re dealing with investment income, you can deduct certain expenses and depreciation from your rental property to help lower your income taxes.
What type of deductions can you take?
In the first year as a property investor, you likely won’t be able to take advantage of as many tax deductions. However, once you start working with an accountant and learn more about real estate, you’ll find the different types of deductions you can take from your taxable income:
- Property depreciation: Your property will lose value with time, and you can factor in property depreciation in your rental income. Property depreciation will be the lost value due to ordinary wear and tear.
- Interest: Mortgage or loan interests get paid during the year. You can also deduct the interest on your business credit cards.
- Repairs: Not to be confused with improvements (changes made to the property to add value), repairs made to your rental property are projects that keep your rental home or apartment in livable conditions. You may also deduct repair expenses.
- Employee or independent contractor costs: Any contractors or employees you hire to perform work on the rental property are taxable. You can deduct wages from your taxable income. You can also consider the work contractors perform to make minor repairs as expenses.
- Insurance: Deductions can also consist of any premiums related to your rental property. Depending on the location of your rental property, insurance will include liability insurances, flood, theft, and hurricane insurances often required by banks to hold a mortgage.
- Travel activity related to your rental: If you need to travel for any activity related to your real estate investments, these expenses could qualify as deductions.
- Legal or other extra services: You may deduct any fees paid for additional services, such as attorneys, managers, or accountants.
- Office expenses: Any office-related expenses such as office rent, printers, papers, and office supplies can be deductible items.
How do I report rental income and expenses?
As a real estate investor, you can report your income from rental real estate using the Schedule E: Supplemental Income and Loss Form 1040 or 1040-SR. Also, use Form 4562 to report your property’s depreciation expense.
Schedule E lets you report taxes for up to three properties. If you currently own more than three rentals, you will need to file an additional Schedule E form. While you use multiple Schedule E forms, you will report your totals only in one form.
Keeping a record of all expense receipts, financial statements, and rent checks will help you accurately report all your income and deductions to the IRS.
What tax records should you keep?
Digital and paper records of checks, business expenses, and any other costs related to maintaining your rental property are important documents to keep.
Whether you are renting property for the first time or have multiple rentals that you’ve established over the years, working with a tax professional for reporting tax on a rental property is always recommended. Working with a tax professional with real estate experience can help you understand the income tax rate on rental income and navigate the intricacies of rental income tax.
Disclaimer: This article doesn’t constitute legal advice, and landlords should not substitute this information for professional legal or tax advice.
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