Taxes are a yearly responsibility that can be just as complex no matter how many times you do it. Rental properties often add another layer of complexity, making this routine task even more challenging. Follow this step-by-step guide on how to file taxes as a landlord to stay compliant and maximize your tax benefits:
- Choose your accounting method
- Gather rental income
- Figure out rental expenses and deductions
- Calculate depreciation
- Accounts for any rental losses
- Calculate total rental income and expenses
- Fill out tax forms
Step 1: Choose Your Accounting Method
Before you start gathering records and filling out forms, you need to decide when you’ll report your rental income on your tax return. The two ways to report income are either cash basis or accrual. Most people use cash basis, but here is a breakdown of both methods so you can pick the right one for you.
Cash basis
With the cash basis method, you report rental income in the tax year you receive it, regardless of when it was earned. This includes expenses; they’re deducted in the year you pay them as well. Most landlords prefer this method as it tracks cash flow more accurately.
Accrual method
The accrual method is all about reporting income and expense when you earn or accrue them, rather than when you actually pay. Some prefer this method as it matches income and expenses to the proper year, instead of when the money was actually received or spent.
Step 2: Gather Rental Income
Rental income consists of more than just rent. In order to properly report your rental income on your taxes, then you need to know what counts as income on a rental property:
- Rent
- Advance rent
- Lease cancellation payments
- Expenses paid by tenant
- Security deposits
- Other fees
- Payments for services (parking or utilities) that are paid to you, the landlord
Step 3: Figure Out Rental Expenses and Deductions
Deductions are one of the major tax benefits of being a landlord. However, to properly claim all the allowable deductions, you need to know what counts.
Expenses
A variety of rental property expenses can be deducted from your taxes. They are generally deducted in the year you pay them. Here is a list of some common expenses that you can deduct:
- Depreciation: helps you recover the cost of an income-making property over the life of the property.
- Insurance: if you pay insurance for more than one year in advance, you can only deduct the part of the premium payment that applies to that year.
- Interest expense: deduct the mortgage interest you pay on the rental.
- Legal and professional service fees: can deduct legal and other professional expenses as a rental expense. Like tax return preparation fees.
- Local transportation and travel expense: can deduct necessary transportation expenses if you do it while getting rent or maintaining your rental.
- Pre-rental expense: can deduct necessary expenses for property upkeep from even before the rental is rented.
- Vacancy: you can deduct expenses for maintaining a vacant property, but not the loss of rental income.
- Repairs/maintenance: necessary maintenance and repairs can be deducted.
Points
Points are another common deduction. This term describes the fees a borrower (you, the landlord) pays to get a loan or mortgage. Since these are paid in advance, you usually can’t deduct the full amount in the same year. Instead, deduct points little by little over the life of a loan.
Repairs and improvements
Most of the time, any expense for repairing, maintaining, and improving the property can be deducted. Improvements may need to be capitalized instead, which is when the cost is not deducted all at once, but added to the property’s basis and recovered over time through depreciation.
Step 4: Calculate Depreciation
Depreciation can be complicated, but it is essential to taxes as it is a major deduction. It is recovering your cost for an income-making property over the life of the property. You can start depreciating a rental as soon as it is ready for use, regardless of whether you have a renter or not.
Depreciation is affected by the basis of your property, the recovery period, and the depreciation method. For residential rental property, landlords generally use the Modified Accelerated Cost Recovery System (MACRS), the straight line method, and a 27.5-year recovery period under the General Depreciation System (GDS). However, in order to depreciate your property it must meet the following requirements:
- You own the property
- You use the property in your business or income-making activity (like as a rental)
- The property has a determinable useful life (it must be something that wears out/decays/get used/loses value from natural causes)
- The property is expected to last more than one year
How to calculate depreciation
There are two main ways to calculate depreciation: manual calculations or using the MACRS GDS percentage tables. In the year a rental property is placed in service, depreciation is calculated by multiplying the property’s adjusted basis by the straight line rate and then applying the proper convention.
In later years, landlords start with the property’s basis, subtract any depreciation already claimed or allowed in prior years, determine the straight line rate for that year, and multiply the adjusted basis by that rate to find the deduction.
Landlords can also calculate depreciation using MACRS percentage tables by applying the percentage for the applicable year to the property’s unadjusted basis. The correct percentage comes from the row for the month the property was placed in service, and that same row continues to apply in future years because the table already accounts for the mid-month convention.
Once you choose a depreciation method, you generally must keep using it unless the property’s basis changes for a reason other than depreciation, or you add a separate improvement that must be depreciated on its own.
Step 5: Account for Any Rental Losses
Losses occur when deductible rental expenses are more than rental income. There are two main rules that limit the amount of loss that you can report on your taxes: at-risk rules and passive activity limits.
At-risk rules
At-risk rules come into play if you put money into a rental real estate activity where you are not fully at risk. That means that you won’t lose all the money yourself if the activity fails. These could apply to you if:
- You have a loss from a business activity or from an activity meant to earn income, and
- You invested money in that activity that you are not fully responsible for losing.
If the activity is covered by at-risk rules, you can only deduct losses up to the amount you had at risk in the activity. The risk you have in the activity can include:
- Cash you put into the activity
- The adjusted basis of other property you contributed
- Some borrowed amounts used in the activity
Passive activity limits
For tax purposes, rental real estate is generally treated as a passive activity, even if you actively manage the property. Because of that, rental losses usually can’t offset wages, business income, or other nonpassive income.
However, some landlords may qualify for a special allowance of up to $25,000 in rental loss deductions if they actively participate in the rental activity. Active participation generally means making management decisions such as approving tenants, authorizing repairs, or setting rental terms. If you do not qualify for that exception, rental losses are typically deductible only against income from other passive activities.
Step 6: Calculate Total Rental Income and Expenses
In order to fill out the proper forms, you need to know what numbers to put in by calculating the taxes on your rental.. You’ll need to calculate the total income for the tax year as well as any expenses and deductions. Doing these calculations ahead of time makes filling out the tax forms quick and easy.
First, determine your taxable rental income by totaling all rental-related income you received over the year. Then, subtract any deductions, including depreciation and allowable expenses. Store all calculations and results in your records. On the tax forms, you may have to do a couple of additional calculations depending on your situation, but it will clearly state what is required.
Step 7: Fill Out Tax Forms
Landlords report rental income and expenses on Schedule E (Form 1040) that is submitted alongside the usual federal income tax return forms, like Form 1040. Schedule E is divided into five parts. Part one is the main part of filing your taxes, where you state all rental income, expenses, and deductions. Parts two through five on page two are for reporting income or loss from partnerships, S corporations, estates, trust, and real estate mortgage investment conduits.
Schedule E has enough room for three properties. If you have more than that, you can complete and attach as many forms as needed. Only lines 23a through 26 need to be filled on one form that compiles all properties reported on the multiple schedule E forms.
Form 4562
In certain cases, like the first year you place a rental in service, you likely will submit Form 4562, Depreciation and Amortization. After that year, you will just report depreciation on Schedule E, without submitting another Form 4562 unless required. Still keep a record of depreciation and any calculations.
Form 6198, At-Risk Limitations
If you have any losses and are subject to at-risk rules, you will need to file Form 6198.
Form 8582, Passive Activity Loss Limitations
Use Form 8582 to calculate and report how much passive activity loss you can deduct on your tax return. You do not need to file the form if you meet the following criteria:
- The only passive income activities you had were rental properties that you helped manage.
- Your total loss from those rentals was no more than $25,000, or $12,500 if you are married filing separately and lived apart from your spouse for the entire year.
- If you are married filing separately, you must have lived apart from your spouse all year.
- You do not have any unused passive losses from earlier years.
- You do not have any unused passive activity tax credits from this year or earlier years.
Schedule C (Form 1040), Profit or Loss from Business
Only fill out Schedule C when you provide significant services for tenant convenience, like regular cleaning or changing linens.
Apartments.com Makes Tax Season a Breeze
Make tax season an easy responsibility with Apartments.com. You can track rental income and expenses in one place, helping you stay organized when it’s time to fill out Schedule E (Form 1040). Expense tracking is built for landlords, so you can log costs, keep your records up to date, and get a clearer picture of your property’s finances year-round. Apartments.com also offers online rent collection, which can help keep payment records organized in the same account for simpler tax prep.
The above information is in no way intended to be a substitute for qualified legal advice. Please conduct your own research and comply with all your state and local laws. If you need tax advice, please contact a tax professional or real estate lawyer in your area.
FAQs
Can I deduct points on rental property?
Yes, you can deduct points on rental property, but usually not all at once. Points on a rental property loan are generally treated as prepaid interest, so they must usually be deducted over the life of the loan rather than in the year you paid them.
The first thing to determine is whether the points are considered de minimis original issue discount (OID). If they are, you can choose among several deduction methods, including straight-line over the loan term, constant-yield over the loan term, in proportion to stated interest payments, or all at maturity. In general, points are de minimis if they are less than 0.25 percent of the loan’s principal amount, multiplied by the number of full years in the loan term. If the OID is not de minimis, you must use the constant-yield method.
What do you need to file taxes as a landlord?
To file taxes as a landlord you will need these forms:
- The appropriate federal income tax return form: Form 1040, 1040-SR, 1040-NR, or 1041
- Schedule E
- If applicable: Form 4562, Form 6198, Form 8582, and Schedule C
