• Getting Started with Rental Property Accounting

Overview of Rental Income

December 18, 2024 10 min read

Understanding And Tracking Rental Income

Property management offers considerable earning potential for landlords, yet it also entails a host of responsibilities. From screening potential tenants to maintaining properties, landlords operate in a dynamic, fast-paced environment.

To achieve success, landlords need more than just strong tenant relations or well-maintained properties, but also some financial savvy. Properly understanding and tracking rental income and taxes is essential for maximizing profitability. Knowing what qualifies as rental income, when to report it, and which deductions you’re eligible for can make a substantial difference in your returns.

In this article, we’ll cover the fundamentals of rental income, reporting requirements, and key tax considerations to keep in mind about rental income as you prepare for tax season.

What is Rental Income?

According to the Internal Revenue Service (IRS), rental income is any payment you receive for the use or occupation of property. This can include not just standard monthly rent payments, but other types of payments associated with rental agreements like late fees.

Rental income is generally classified as unearned income—also known as passive income—by tax authorities, including the IRS. Earned income like wages or salaries is reported differently and typically received from an employer. Unearned income, on the other hand, typically includes sources like interest, dividends, and rental income from real estate.

Recognizing and tracking your rental income is essential for accurate reporting. There are two main accounting methods landlords use when tracking rental income. If you’re a cash basis taxpayer, common for individual taxpayers, rental income is reported in the year it is received or constructively receive it.

Constructive receipt, on the other hand, occurs when payment is available to you (e.g., like credited to your bank account), regardless of when it was earned. For more information on this, the IRS’s Publication 538offers further details on constructive receipt.

What Qualifies as Rental Income?

Rental income encompasses any payment received from tenants for using your property, which can be in cash, or the fair market value of goods or services in lieu of rent.

Here are a few categories that qualify as rental income:

• Regular Rent Payments: Tenants paying rent monthly is the primary form of rental income.
• Amounts Paid to Cancel a Lease: If a tenant pays a fee to terminate a lease, this is considered rental income.
• Advance Rent: Any rent paid in advance by a tenant counts as rental income.
• Expenses paid by a Tenant: If a tenant pays any costs that are not their responsibility and deducts that from their rent, that amount must be reported as income (e.g., If the furnace in your rental property stops working while you’re out of town and your tenant takes care of the necessary repairs, they may and deduct the cost from their rent payment. You should include the repair bill paid by the tenant and any amount received as rental income and deduct it as a rental expense).
• Security Deposits: Generally, security deposits are not considered income if returned at the end of the lease, but retained portions for damages do count.
• Tenant-Paid Expenses: If a tenant covers an expense that you, as the landlord, are responsible for (such as utility fees), this amount is treated as income.
• Property or Services in Place of Rent: If a tenant performs work or provides goods in exchange for reduced rent (for example, a tenant who is a painter offering to paint your property), the fair market value of these services provided is counted as rental income.

You can lower your taxable income by deducting expenses related to your rental property business, including mortgage interest, marketing costs, maintenance, and repairs. Specific tax rules apply to vacation homes and short-term rentals, so it’s crucial to familiarize yourself with IRS guidelines for these rental guidelines.

What is Net Rental Income?

Net rental income is the amount of rental income left after you subtract expenses associated with your rental property. Calculating your taxable rental income begins with summing up all the rent received, plus any additional forms outlined above. From this total rental income received, you can deduct allowable expenses, such as maintenance costs, property taxes, and mortgage interest, to get your net rental income.

After accounting for these expenses, the remaining amount is your taxable income from rental activities.

What is Tax Deductible from Rental Income?

Maximizing tax deductions helps reduce tax liability and enhance the profitability of both commercial and residential rental property investments. It’s crucial to adhere to legal guidelines to avoid complications with your return. Here are some common tax-deductible expenses:

• Mortgage Interest: This is typically deductible if a mortgage is held on the rental property.
• Property tax: Local and state property taxes are usually deductible.
• Maintenance and Repairs: Routine maintenance and necessary repairs can be deducted.
• Depreciation: Spread out the cost of property over its useful life.
• Travel Expenses: If traveling for rental business purposes, certain expenses may be deductible.
• Legal and Professional Services: Fees for attorneys, accountants, and property managers can often be deducted.
• Utilities: If the landlord pays for utilities, these costs can be deducted.
• Insurance Premiums: Landlord insurance premiums are typically deductible.
• Homeowners Association Fees: These fees can also be deducted if applicable.

Managing detailed records is essential for claiming these deductions. Consult with a qualified tax advisor or CPA to navigate the complexities of tax rules and utilize the IRS’s Publication 527 as a helpful resource.

Tax Rules for Rental Income

The IRS treats rental income as regular income, meaning it’s subject to federal income tax at your usual rate. Keep in mind, however, that you may also be liable for state income tax, depending on your state’s rules.

Consulting with a financial advisor or tax expert is advisable when navigating these waters.

Calculating Your Taxable Rental Income

To calculate your taxable rental income, add together all the rental income you’ve received in a year. Do not include security deposits you intend to return. Then subtract your deductible property-related costs, such as advertising, maintenance, and taxes, from your gross income. Your resulting amount is your taxable rental income.

IRS Forms Required for Reporting Rental Income

Accurately reporting rental income is an essential part of tax compliance, providing a clear picture of your rental business and ensuring you meet all IRS requirements.

Rental property owners typically report their income using Form 1040and Schedule E (Supplement Income and Loss). Schedule E is the primary form used to report rental income, as well as associated expenses, depreciation, and other deductions.

If you own multiple rental properties, you may need to file multiple Schedule E forms, one for each property. This form is essential for detailing the income, expenses, and depreciation for each rental property.

Common Property Types for Schedule E Reporting

The IRS requires landlords to categorize their rental properties in specific ways. Below are some common property types and key considerations for each:

• Single-Family Residence: The most common type of rental property, typically reported as rental income on Schedule E.

• Multiple-Family Residence: If you rent out a building with multiple units, you’ll report rental income from each unit individually on Schedule E.

• Vacation or Short-Term Rental: If you rent your property for short-term stays (like on Airbnb or VRBO), the income is reported on Schedule E, but you may need to consider additional rules for such rentals, especially if personal use is involved.

• Commercial Property: Rental income from commercial properties, such as office buildings or retail spaces, is also reported on Schedule E.

• Land: If you rent or lease land (for example, agricultural or recreational use), discuss with your accountant how to properly report it, as there may be unique depreciation rules and other tax considerations.

• Royalties: If you receive income from royalties (for example, from oil, gas, or mineral rights), you will report this on Schedule E, line 4. A tax advisor can help guide you on how to complete this section correctly.

• Self-Rental: If the property is used in a trade or business, special rules apply. It’s important to check with both the IRS and your tax advisor for proper reporting.

• Other: If your rental property doesn’t fall into any of the above categories, you’ll need to include a statement describing the property type. Keep in mind that if you file your return electronically, attachments are not permitted, so the statement must be included in paper filings.

Fair Rental Days vs. Personal Use Days

Understanding the distinction between fair rental days and personal use days is crucial for accurately reporting your rental income and maximizing your tax benefits. Renting a property for more than 15 days per year must be reported, even if the property is also used for personal purposes.

• Fair Rental Days: These are the days when your property is rented out to tenants, generating income. These days are critical for calculating allowable deductions and depreciation on Schedule E.
• Personal Use Days:These are days when you or your family members use the property for personal purposes, not rental. The IRS places restrictions on deductions when personal use days exceed a certain threshold.

Imagine you own a lakeside property that is rented out as a vacation home. The property is occupied for 250 days in total over the year. Of these 250 days, 200 days are rental days, and 50 days are for personal use. However, 10 of those 50 personal-use days were spent on maintenance and repairs.

So, which of these days are fair rental, and which are personal use?

• Fair Rental Days: 200 days, the period during which tenants occupied the property.
• Personal Use days: 40 days, the number of days you used the property for personal reasons, excluding the 10 days spent on repairs.

This distinction is key for tax reporting, as the IRS only allows deductions related to rental activity for fair rental days. By properly identifying and separating these days, you’ll ensure that you comply with IRS rules while maximizing your eligible deductions.

By understanding and following the IRS guidelines for reporting rental income, you can better manage your rental properties and optimize your tax benefits. Keeping accurate records of rental and personal use days, as well as categorizing your properties correctly on Schedule E, helps you avoid costly mistakes and ensures compliance with federal tax laws. Always consult with a qualified tax professional to navigate the complexities of rental property tax reporting.

The Importance of Tracking Rental Income

Accurately tracking rental income and expenses is essential for a smooth tax season and maximizing deductions.

Proper record-keeping throughout the year ensures you’re well-prepared when it’s time to file your taxes. Be diligent about retaining receipts, lease agreements, and records of payments and expenses, as these documents support your deductions and may be necessary for potential audits.

Conclusion

Understanding rental income and the related tax requirements is essential to running a profitable rental business. Accurate records, clear categorization of income and expenses, and compliance with IRS guidelines enable landlords to avoid costly errors, maximize deductions, and enhance profitability.

Working with a tax professional is often advisable, as they can ensure you meet IRS regulations and maximize deductions when renting property.

By staying informed and managing finances effectively, landlords can optimize the benefits of property ownership, foster financial security, and focus on growing their rental income.