If you own rental real estate, you should be aware of your federal tax responsibilities. All rental income must be reported on your tax return, and in general the associated expenses can be deducted from your rental income.
If you are a cash basis taxpayer, you report rental income on your return for the year you receive it, regardless of when it was earned. As a cash basis taxpayer you generally deduct your rental expenses in the year you pay them. If you use an accrual method, you generally report income when you earn it, rather than when you receive it and you deduct your expenses when you incur them, rather than when you pay them. Most individuals use the cash method of accounting.
Below are some tips about tax reporting, recordkeeping requirements and information about deductions for rental property to help you avoid mistakes.
You generally must include in your gross income all amounts you receive as rent. Rental income is any payment you receive for the use or occupation of property. You must report rental income for all your properties.
In addition to amounts you receive as normal rent payments, there are other amounts that may be rental income and must be reported on your tax return.
Advance rent is any amount you receive before the period that it covers. Include advance rent in your rental income in the year you receive it regardless of the period covered or the method of accounting you use. For example, you sign a 10-year lease to rent your property. In the first year, you receive $5,000 for the first year's rent and $5,000 as rent for the last year of the lease. You must include $10,000 in your income in the first year.
Security deposits used as a final payment of rent are considered advance rent. Include it in your income when you receive it. Do not include a security deposit in your income when you receive it if you plan to return it to your tenant at the end of the lease. But if you keep part or all of the security deposit during any year because your tenant does not live up to the terms of the lease, include the amount you keep in your income in that year.
If you receive rental income from the rental of a dwelling unit, there are certain rental expenses you may deduct on your tax return. These expenses may include mortgage interest, property tax, operating expenses, depreciation, and repairs.
You can deduct the ordinary and necessary expenses for managing, conserving and maintaining your rental property. Ordinary expenses are those that are common and generally accepted in the business. Necessary expenses are those that are deemed appropriate, such as interest, taxes, advertising, maintenance, utilities and insurance.
You can deduct the costs of certain materials, supplies, repairs, and maintenance that you make to your rental property to keep your property in good operating condition.
Good records will help you monitor the progress of your rental property, prepare your financial statements, identify the source of receipts, keep track of deductible expenses, prepare your tax returns and support items reported on tax returns.
Maintain good records relating to your rental activities, including the rental income and the rental expenses. You must be able to document this information if your return is selected for audit. If you are audited and cannot provide evidence to support items reported on your tax returns, you may be subject to additional taxes and penalties.
You must be able to substantiate certain elements of expenses to deduct them. You generally must have documentary evidence, such as receipts, canceled checks or bills, to support your expenses.