Tax Rules for Rental Income

Real estate can be a great investment. But it's important to know the tax rules for rental income.

You plan to purchase a second home down south to stay out of the snow and cold, or maybe one in the mountains to take advantage of these elements.

Or maybe you plan on never living there at all.   

Regardless, if you’ve bought property that you plan to rent for any length of time, the good news is that tax law is extremely friendly to investors in real estate – a reason why it’s become such a good investment. 

The law allows rental property owners to lower their income tax burdens in several ways and, in some cases (even with solid cash flow), show little or no income, or even a loss for tax purposes. 

For starters, the IRS defines any property rented to tenants for a minimum of 15 days as a rental property. This can be a single-family home, a condominium, apartment, mobile home, or similar dwelling. 

Rental income typically consists of normal rent payments, advanced rent, parts of security deposits the owner keeps, any outside expenses paid by the tenant that they are not obligated to pay (e.g. an electric bill they deduct from their monthly rent), and services received from the tenant in lieu of monetary payments (like mowing the lawn in exchange for a rent reduction). 

Common expense deductions that you can subtract from your income include cleaning, repair and maintenance costs, management and leasing fees, insurance costs, landscaping costs, rental or sales taxes, property taxes, HOA fees, and professional fees (such as services paid to an accountant or attorney).

Subtracting your expenses from the income gives you your net income, which the federal government taxes as ordinary income on your tax return. So, if you collect $20,000 in rent and have expenses of $10,000, your taxable income is $10,000. 

Only, it doesn’t end there.  You can then write off property depreciation expenses. The IRS allows you to depreciate your rental property over 27.5 years. So, if you paid $250,000 for the rental property and the land itself is worth $50,000 (land is not counted as depreciation), you can depreciate $200,000 divided by 27.5, or $7,272.73 annually. Subtract this number from your $10,000 taxable income and you end up paying taxes on $2,727.27. At the 22 percent tax rate, that’s about $600.

Rules for When You Use Your Rental Property for Personal Use

What if you use a portion of the rental property for your own use? This is where it becomes tricky.

Let’s look at the various situations from easiest to most complicated:

  • If you rent the home out for 14 days or fewer during the year, you are not required to report rental income on your tax return. That is because the IRS considers the home to be a personal residence and the rental income to be incidental.
  • If your personal use is limited to 14 days or 10% of the time the home is rented, then the property is considered business rental property. Expenses can be deducted against rental income, and if those expenses exceed your rental income, you may be able to deduct up to $25,000 of expenses over and above the rental income (subject to income phaseouts).
  • If you rent the home for more than 14 days and your personal use is more than the greater of 14 days or 10% of the number of days rented, then the home is considered a personal residence. You will need to report the rental income on your tax return but can deduct rental expenses up to the amount of rental income. Losses in excess of rental income cannot be deducted.

Rental income is reported on your tax return using Form 1040, Schedule E, where you include your property’s (or properties’) revenue, expenses, and depreciation.

Understanding the deductibility of rental properties, even those used for both personal and business purposes, can save you income taxes while allowing you to also enjoy the use of the property.

If you need further clarification about how these rules impact your situation, contact your EKS Associates advisor.

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