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A review of the taxes on your rental income

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Owning a rental property comes with many benefits. Passive income, a diversified portfolio, and tax breaks are the main advantages that you can expect. But having rental property comes with its own responsibilities, such as paying taxes. 

Be prepared for tax season by following our comprehensive guide below.

What counts as rental income?

Rental income is defined as the amount of money you received from the use of your property. Aside from the normal rent payments, rental income also includes unreturned security deposits, advanced rent payments, and lease cancellation fees. 

A single-family home, condominium, apartment, or vacation home can be considered a rental property. According to the Internal Revenue Service (IRS), the property must be rented out for at least 15 days.

Calculating your rental income taxes

When you own a rental property, knowing your way around rental income tax is a huge plus. Aside from being aware of how much you’ll be paying monthly and annually, it also allows you to properly evaluate your property and rental business as a whole.

The first step to calculating your rental income tax is to know your tax rate. Is your rental business a passive or non-passive one? Most rental properties are considered passive rental businesses. Non-passive businesses, on the other hand, are concerned with the development or construction of properties. Being an active participant in handling your rental business is also a factor in the computation of your tax rate.

Next, determine your rental income and rental expenses. After subtracting the rental expenses from your income, you’ll have your taxable income. You’ll also have to compute your rental property’s depreciation to know your tax rate.

Rental property tax deductions

As mentioned earlier, property owners like you are entitled to certain tax breaks, as long as these expenses fall within the purchase, management, or operation of your rental property business. Keep in mind that not all expenses can be used as a tax deduction. 

These are the common expenses that you can deduct from your tax return:

  • Depreciation
  • As your rental property experiences wear and tear over the course of its useful life, its value goes down. However, you can claim this expense as depreciation as soon as your property can be rented out. According to the IRS, rental properties have a depreciation rate of 3.636% for 27.5 years. 

  • Mortgage interest
  • It’s not uncommon for a real estate investor to take out a loan to finance the purchase of a rental property. Since interest will be charged to the loan, this can be used as a business expense instead. Only the interest can be deducted.

    Aside from the mortgage interest, you can also deduct the interest from other loans and credit cards used for the improvement or operation of your rental property.

  • Property taxes
  • Property tax is an amount based on the property’s value and location. The amount also depends on the local and state government. While homeowners can deduct up to $10,000 on property taxes, there is no limit if this is counted as a business expense. 

  • Repairs and improvements
  • Another rental property expense that you can use as a deduction is from property repairs and improvements. However, these repairs must not add value to your property. As long as the said repairs are done to keep the property in good condition, they can be included in the deduction. 

  • Other expenses that can be deducted
    • Cleaning and maintenance expenses
    • HOA fees
    • Utilities
    • Landscaping fees
    • Insurance fees
    • Legal and professional fees
    • Advertisements

Commonly asked questions on rental income

Where do I file my rental income and expenses?

Property owners must report their rental activity using Schedule E (Form 1040). In this form, you need to declare your total rental income, expenses, and depreciation. 

When do I need to file my report?

The income you earn from your rental property must be reported on your return for the year it was received. For example, if the rent payment was received before the year ended, it must be included on the tax return of that same year.

Are security deposits included in my taxable income?

Since security deposits are given back to tenants once their lease is over, the amount is not included when computing your taxable income. The security deposit will only be counted in your taxable income if it doesn’t need to be returned to the tenant.

Learn more about running your own rental property by talking to us at Berkshire Hathaway HomeServices Caliber Realty. Reach out to our Berkshire Hathaway property management experts at  979.694.8844 or send us an email here.

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