Owning rental property is a good way to increase your net worth. When you purchase properties and lease to tenants, you often collect rent that will cover the cost of the mortgage and home repairs while also allowing you to own the property with little to no out-of-pocket expense. Liberty Tax® can sort out the confusion and assist you in properly reporting rental income and expenses on your tax return.
Reporting Rental Income and Expenses
Rental income and expenses are generally reported on Schedule E, Supplemental Income and Loss. Rental income must be reported in the same year in which it is received. If you do not rent your property to make a profit, you can only deduct your rental expenses up to the amount of rental income. If you rent part of your property, that must be separated from property used for personal purposes. The IRS website has more information on reporting rental income and expenses, as well as special tax rules that apply to condominium owners and rent paid for cooperatives.
Rental income can include the following payments:
- rent paid and advance rent payments (such as first and last month's rent)
- security deposits not returned to the tenant
- payment for canceling a lease
- rental expenses paid by tenant in lieu of rent
- property or services you receive in lieu of rent, at fair market value
Rental expenses may include the following and are deductible in the year in which they were paid:
- advertising for renters
- cleaning and maintenance
- commissions or management fees
- insurance premiums
- local transportation expenses to oversee the property
- depreciation of rental property
- legal expenses concerning rental property
- mortgage interest
- travel expenses
- real estate taxes
- tax return preparation for rental forms
Rental expenses can be deducted from the time the property is made available for rent. The expenses incurred and paid in connection with managing and maintaining the property while it is vacant are deductible. However, you cannot deduct the loss of rental income during the period in which the property is vacant.
Deducting Improvements and Repairs
You can deduct the cost of repairs that you make to your rental property. However, you may not deduct the cost of improvements. This cost is recovered through depreciation.
A repair keeps your property in good operating condition and does not materially add value to the property. Examples of repairs would include painting, fixing leaks and cracks, and replacing broken doors or windows or other parts of the rental property.
An improvement adds to the value of your property, prolongs its useful life, or adapts it to new uses. An improvement would include adding a room, deck, fence or new roof.
Depreciation of Rental Property
You can recover the cost in income-producing property through depreciating the property. Depreciating the property means you deduct some of the cost on your tax return each year. Depreciation is based on the expected life of the item. For example, residential rental buildings have a 27.5 year life while business and office building rentals have a 31.5 or 39 year life. Most improvements that are building components, such as a furnace or a new roof, will have the same life as the building, with depreciation starting when the individual improvement is placed in service. The cost of the land is never depreciated and must be subtracted from the building’s basis, or the amount that was originally invested in the property.
Furniture and appliances used in rentals have a 5-year life starting when they were placed in service. Items such as furniture and appliances are NOT eligible to be written off all in one year.
The rental house or building MUST be depreciated yearly. When the property is sold, the IRS will treat this amount as having been deducted and will reduce the basis.
Updated for 2015 Tax Year