For many individuals, investing in rental properties is a step toward financial security. The rental income usually covers the cost of the mortgage and expenses. It does, however, impact your taxes.
Individuals generally use the “cash basis” method of reporting income from rental properties. That means income is taxable when received. Commercial businesses may use the “accrual basis,” which means income is taxable when due rather than when received.
What Counts As Rental Income?
Income on rental properties is more than the rent you receive each month. Other income includes:
Amounts that tenants pay to break a lease – report these as current income.
Expenses paid by tenant – tenants may pay for goods or services, such as utilities, that the lease agreement doesn’t require them to pay. Add those amounts as rental income, even if tenants deduct them from the rent.
In-kind – if you accept goods or services in lieu of rent, you report the value as income.
Security deposits – you may have to report deposits as income, depending on whether you retain or refund them.
Rental income is taxed as ordinary income rather than as capital gains.
What Expenses Are Deductible?
When you invest in rental properties, you are allowed to deduct what the IRS calls “ordinary and necessary” expenses. These include:
Repairs and maintenance
Be sure to substantiate your deductions with complete records.
Expenditures to improve, renovate, or remodel your rental properties are not deductible. You may be able to depreciate them.
How Do I Report Rental Income And Expenses?
You calculate depreciation using IRS Form 4562. Different items have different rates of depreciation, ranging from five years to more than 20 years.
Income and expenses from rental properties are reported on Schedule E, which is attached to your tax return. There is a line for deducting depreciation, which you carry forward from Form 4562.
You may wish to consult a professional financial advisor or tax preparer for help in investing in rental properties and correctly reporting the income from your investment.