Except when you receive a gift, you can’t escape owning income tax on just about any money you receive. Expect the Internal Revenue Service to consider anything you’re paid as income. This includes receiving rent for use of real estate or personal property. Fortunately, any expenses you incur to conduct the rental activity are deducted from the rent you receive in order to determine the taxable income.
Accounting for Rent
You need to maintain records of the rent income and expenses for each rental property. Rental income includes cash and the fair market value of tangible items you receive in exchange for use of your property. Your records must account for the entire amount of rent before any deduction.
If someone manages rental property for you and deducts a fee, you need to account for the rent collected by the manager as income and the fees as an expense. Don’t include security deposits as rental income when they are refundable. Only count any amount of security deposit you retain after a lease expires. Rents are counted as income when they are actually received, not when due but unpaid.
Separate income and expenses are reported for each real estate rental property on Schedule E of a tax return. Any ordinary and necessary expense required to generate the rental income is a tax-deductible expense. The common categories of expense for real estate rental property are mortgage interest, property taxes, insurance, utilities, homeowners’ association dues, maintenance and repairs.
When a property management company collects rent for you, it normally pays for some types of expenses before remitting to you the remaining balance. You must keep a record of the total amount of rent received and the separate totals for each expense category deducted by the property manager.
Some expenses are billed directly to you even if you us a property manager. Typical examples are payment of insurance and property taxes. Expenses are tax-deductible in the year actually paid. Count the expense when you pay it, even if it is insurance for a future year or property taxes for a prior year.
Income you receive for renting personal property is normally reported directly on page 1 of your personal income tax return. For example, you have rental income if your neighbor pays you $500 to rent your truck for a weekend to haul mulch. You may have some expenses that can be deducted from the rental income.
Your original cost for rental property is a tax deduction starting in the year the property becomes available for rent. The type of rental property determines what percentage of the cost is deductible each year.
Although repairs are a tax-deductible expense, any cost that adds to the value of your property must be capitalized and depreciated. This means that the expenditure is deducted over a number of years. The type of improvement and the date it is added to the rental property determines the percentage of your cost that’s deductible each year.
Renting Your Personal Residence
Rent received for renting part of your primary residence or vacation home is also taxable income. Special rules apply to tax deductions for property you occupy for significant parts of the year. If that is the source of your rental income, you should consult a tax adviser about your particular circumstances.