Although the economy is showing signs of life, the housing market continues to lag behind the recovery. A new generation of landlords is emerging as investors snap up foreclosure properties at bargain prices hoping for a return on investment. In very different scenarios, homeowners unable to pay their mortgages are renting their homes as an alternative to foreclosure.
While becoming a landlord may indeed offer solutions, there are tax implications that individuals may not be aware of, say tax experts at the Virginia Society of Certified Public Accountants (VSCPA). And these days, the IRS is taking a closer look to make sure landlords are reporting all of the income they should. Whether you own one rental property or 20, make sure you know and follow the tax rules.
What is Rent?
If you rent out part of your personal residence for fewer than 15 days, you need not include the rent you receive in your income. CPAs refer to this as the “Olympics Rule” — a nod to very short rentals for major events in a community. But, if you do rent space in your personal residence (including a vacation home) for more than 15 days, you must declare the income.
IRS Publication 527: Residential Rental Property contains information about different types of rental activity, what must be reported to the IRS, and the types of deductions permitted.
You must include in your income all amounts that you receive as rent. But what is considered rental income? Rental income is any amount you receive for the use or occupation of a property. And, of course, there are some special considerations such as first and last month’s rent, advance rent and non-refundable deposits. All of these are included in the current year income.
Take Advantage of Deductions
When you rent your home, property taxes become a deduction. In addition, any loss you incur while renting your home can also be deducted from your overall income. This can be an important issue if you are renting your home for less than your mortgage payment — a common scenario in today’s economy.
Save every receipt related to the rental of the home. Many advertising or marketing materials, agent fees and repair costs can be deducted from the rental revenue to lower the overall income from the rental. You can also write off all other operating expenses such as utilities, insurance, homeowner association fees, repairs, maintenance and yard care.
Additionally, the mortgage on the property should also be considered when deducting expenses. If you pay mortgage points, you must amortize them over the term of the loan (unlike points on a mortgage to purchase a principal residence, which can be deducted immediately).
If you’ve never been great at record keeping, now is the time to make a change. Keep all lease/rental agreements and tenant applications. If you are audited, the IRS will want to examine these documents as part of the verification that this is indeed a rental property. Keep all cancelled checks and credit card receipts for all rental expenses deducted on your tax return.
You generally must include in your gross income all amounts you receive as rent.
Traditionally, homeowners are not able to count depreciation as an expense, however, once it becomes a rental, homeowners can deduct depreciation. Be careful when considering this deduction, however. If a homeowner moves back into the home to use it as his/her primary residence this tax deduction might have to be repaid.
Note that you cannot simply deduct your mortgage or principal payments as an expense.
You can depreciate your property if:
- You own the property;
- You use the property in your business or income-producing activity (such as rental property);
- The property has a determinable useful life; and
- The property is expected to last more than one year.
A CPA Can Help
While it may seem like an unnecessary step to consult a real estate tax expert, many homeowners who filed their own taxes before will find that becoming a landlord complicates matters.
A real estate tax expert can help advise you when a rental situation is less than straightforward. For example, if you decide to rent only a portion of your home, one room or one floor, the tax issues will be different than if you rent the entire house to someone. With increased scrutiny of landlords, make sure you are following IRS regulations.
If you would like assistance with your rental properties, contact the VSCPA or visit the VSCPA website at vscpa.com
The Virginia Society of Certified Public Accountants (VSCPA) is the leading professional association dedicated to enhancing the success of CPAs. Founded in 1909, the VSCPA has 13,000 members who work in public accounting, industry, government and education. The money management columns are a joint effort of the VSCPA and the American Institute of CPAs, as part of the profession’s nationwide 360 Degrees of Financial Literacy program. For general information, please visit the Press Room on the VSCPA website at vscpa.com, email [email protected] or call (804) 612-9424.