Rental Income, Expenses, and Tax Returns

As an investor in rental property, the rental income you’ll collect is generally taxable, whether the income is cash or the fair market value of property.

Although the income is taxable, you can deduct many of the expenses incurred.

For more information on deducting and reporting the expenses, visit the IRS website.

Generally, cash or the fair market value of property you receive for the use of real estate or personal property is taxable to you as rental income. You can generally deduct expenses of renting property from your rental income. Income and expenses related to real estate rentals are usually reported on Form 1040, Schedule E (PDF). If you provide substantial services that are primarily for your tenant’s convenience, you report your income and expenses on Form 1040, Schedule C (PDF). Income and expenses related to personal property rentals are reported on Form 1040, Schedule C (PDF) or Form 1040, Schedule C-EZ (PDF) if you are in the business of renting personal property and directly on Form 1040 (PDF) if you are not.

Property Management Company & Accountant

Many landlords use a property management company to manage their portfolio of investment rental properties, and they use an accountant to advise on tax issues and take care of tax filings.

Whether or not you use the services of a property manager and accountant, it’s helpful to have a basic working knowledge of income and expenses as they relate to your rental property.

Graystone Investment Group coordinates and helps each investor select a property management company that is a good fit for each property investment portfolio.

Overview of Investment Property Income and Expense

Landlords commonly collect their rental income on a cash basis, which means they count the rental income as income when it is actually or constructively received, and deduct the expenses as they are paid. Here are some specific types of income:

• Advance rent –Generally you count any advance rent paid as income in the year you receive it, regardless of the period covered by the rent or the accounting method you are using.
• Expenses paid by a tenant – If a tenant pays any of the landlord’s rental expenses, those payments are rental income. If the expenses are deductible expenses, you are generally allowed to deduct the expenses.
• Amounts paid to cancel a lease – If a tenant cancels a lease, the money collected for termination of the lease is considered income, and must be reported in the year you receive it.
• Security deposits – Do not count a security deposit as income, if you might return it to the tenant at the end of the lease.
  • However, if you keep any of the security deposit because the tenant breached the lease by vacating the property early, count that as income in the year the lease is breached.
  • If you keep any part of the security deposit to repair property the tenant damaged, count that amount as an expense if it’s your policy to deduct the cost of repairs as expenses.
  • If the security deposit is used as the tenant’s final month’s rent, count that amount as income when you receive it, rather than when you apply it to the last month’s rent.

There are several categories of expenses you may deduct from your total rental income, which include:

• Uncollected rents – If you are a cash basis taxpayer, you cannot deduct uncollected rents as an expense because you have not included those rents in income.
• Operating expenses.
• Repairs – Repair costs, such as materials, are usually deductible, as long as they keep the property in good working condition and do not add value to the property.
  • For a discussion of the difference between repairs and improvements, and information on the depreciation of most rental property, refer to Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
• Depreciation –You begin to depreciate your rental property when you place it in service. You can recover some or all of your original acquisition cost and improvements by using Form 4562 (PDF) (to report depreciation) beginning in the year your rental property is first placed in service, and beginning in any year you make improvements or add furnishings.
  • For additional information on depreciation, refer to Publication 946, How To Depreciate Property.

This overview of rental property income and expenses was compiled from the IRS website: Topic 414 – Rental Income and Expenses. Please see this IRS document for updates, changes, and more information.