Rental income is taxable, but you may be able to take a lot more deductions than you realize, which can save you big come tax day.
The deadline to file taxes for U.S. residents is less than two months away. If you own an investment or rental property or have clients who do, it can get a bit more complicated than just putting a W2 into an online tax prep software.
For many property investors, the big tax bill comes if you actually flip a property. If you hold onto an asset for more than a year, you have to pay capital gains taxes on that asset, that is generally, at most, 15 percent of the net profit you made from that asset. If you sell it in less than a year, you pay capital gains at whatever income tax rate under which you fall.
Do landlords have to pay taxes on rental income?
Rental income, including income from short-term rentals, must be reported on your annual tax return, but the general expenses associated with that property can be deducted from your rental income, according to the Internal Revenue Service (IRS).
“You generally must include in your gross income all amounts you receive as rent,” a fact sheet from the IRS reads. “Rental income is any payment you receive for the use or occupation of property. You must report rental income for all your properties.”
You’re also required to include any advanced rent payments — including a security deposit if it’s not returned to the tenant — you receive on your tax return. If a tenant, for example, signs a 10-year lease but gives the first and last month upfront, in the first year of that lease, the owner must pay taxes on both of those payments.
It doesn’t matter where the property is located if you are a U.S. citizen. It could be a rental property in the Caribbean, New York City, Aspen or Paris, but as long as it’s rental income, it needs to be filed.
Landlords report rental income and expenses on Form 1040, Schedule E, Part I, according to the IRS.
What can landlords deduct?
Landlords can deduct a number of expenses from their rental property income filing, which include mortgage interest, property tax, various operating expenses and any depreciation or repairs.
“You can deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property,” the IRS fact sheet reads. “Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance.”
You cannot, however, deduct all repairs made in the interest of upgrading the property, unless they are deemed necessary work.
Rental properties, according to Intuit, the financial services firm that owns the popular TurboTax filing service, often offer much larger deductions and tax benefits than most investments.
“Many of these are overlooked by landlords at tax time,” a tax deduction guide from Intuit reads. “This can make a difference in making a profit or losing money on your real estate venture.”
Commonly Overlooked Deduction
One commonly overlooked deduction is the wages and salaries for employees like residential managers and staff grounds and maintenance workers. The services of independent contractors — again, in the necessary upkeep of a domicile — like carpenters, roofers, electricians, plumbers, landscapers and gardeners, can also be deducted.
Meal expenses for those employees, too, are a commonly overlooked deduction, David Ayoub, a CPA based in Syracuse, New York, said, according to Intuit.
“You can only deduct 50 percent of meal expenses incurred while doing business with potential clients or business associates,” Ayoub said. “However, if you throw a Christmas party or a summer picnic for your staff, it’s generally 100 percent deductible.”
Ayoub also brought up the semi-uncommon landlord: One that is renting their property out not by choice, but a necessity.
“You see people moving out of town or state to go to a better job. If they can’t sell their house, they rent it,” Ayoub said. “If you rent your home for three years out of five, and then sell it, the capital gain is taxable.
“However, if you sell it within two years, you don’t have to claim capital gain,” Ayoub added. “You’re also entitled to the same deductions as any other landlords. As with any rental property, make sure you have landlord insurance on your home. It’s deductible as an expense, too.”