Rental income can be a lucrative industry for landlords. It is a fast-paced industry with many moving parts, such as interviewing potential tenants, managing current tenants, and maintaining property quality. Income tax and deduction for rental properties may not be the first thing on a landlord’s mind, but there are tax benefits that may be useful.
If you’re a landlord that is earning income from rental income, you should know about rental income tax and potential tax deductions.
What Is Rental Income?
Rental income is a broad term that includes four sections:
- Amounts paid to cancel a lease
- Advance rent
- Expenses paid by a tenant
- Security deposits
First, money that comes from a lease cancellation is considered rental income. You need to report this for the tax year in which you received it. Advance rent paid in the tax year in which you receive it is rental income. Expenses paid by tenants are also rental income; however, this form of rental income may be deductible.
Security deposits have several components that are rental income. First, security deposits that will be returned to your tenant after their lease does not count as rental income. Second, if your tenant broke the lease early or moved out of the property early, you must include the amount of income that you kept as income for the tax year.
Third, if you kept part or all of the tenant’s security deposit because of damaged property to make repairs, you will include the amount you kept as rental income if you deduct the cost of repairs as expenses. Finally, the security deposit applied to your tenant’s last month of their lease is advance rent. Upon receiving the money, it is rental income.
How Much Tax Do You Pay on Rental Income?
The tax that you pay on rental income is the same as ordinary income. This means that your tax bracket as a landlord or would be the same as an individual earning the same amount of income.
How Is Rental Income Tax Calculated?
To calculate your rental income tax, add up all the rent that you’ve received. Include any expenses from your property. You should also include the fair market value of any merchandise or services that you received. If you are planning to return security deposits at the end of the lease, don’t include that amount in your gross income total.
Next, add the amounts of property-related costs such as advertising, depreciation, insurance, maintenance, and taxes. Finally, subtract the expenses from your gross income. This amount is your taxable income.
There are three possible results: For a total greater than zero, this is the amount of your taxable rental income. For a total that is less than zero, this is the amount that you can deduct from other income sources, such as lost business revenue. A total of zero doesn’t affect your income.
Is Rental Income Considered Earned Income?
Rental income is not earned income because of the source of the money. Instead, rental income is considered passive income with few exceptions.
What Else Should I Know?
There are expenses that you’ll be able to deduct from your rental income.
- Operating Expenses
- Repair Costs
It is possible to have several deductions to avoid paying higher taxes. Expenses such as ordinary expenses and necessary expenses can reduce your tax liability, or the amount you owe in taxes.
Ordinary expenses include everyday payments that you make to maintain your property. Necessary expenses purchases such as advertising, insurance, maintenance expenses, and utility costs.
Costs of maintenance, materials, repairs, and supplies are eligible for deductibles. You can also deduct expenses paid by a tenant if they are deductible rental expenses. However, you can’t deduct the cost of improvements to your rental property.
Work with a Professional
Rental income and potential deductions can help landlords save a lot of money in tax liability. Work with an accounting professional to make sure that you take advantage of as many tax deductions as possible. Don’t hesitate to seek advice from the experts to maximize your rental property income.
Author: Josh Meller is Sr. Manager of Accounting Services in the Pacific zone at 1-800Accountant. Before shifting into tax & accounting, he worked at Chase Bank as Personal Relationship Manager. Josh holds a degree in accounting and he is a licensed Enrolled Agent. Outside of work, Josh spends time playing with his kids, watching television & the NJ Devils and playing vintage video games. He’s a typical dad that likes to laugh and spend way too many hours on the couch.