The most common questions that come from our investors are whether receiving rent is considered as income for tax purposes and expenses associated with investment rentals are deductible. The answer is “yes” to both questions. Any rental income, be it from a short term rental or long term lease, must be reported on your annual tax return.
What are cash basis and accrual basis accounting?
IRS has published several guidelines on tax reporting, record keeping and deductions for rental income. The guidelines are very clear about tax payment methods and rental income reporting. There are two bases of tax accounting: Cash basis and accrual basis.
Most individual investors generally use the cash method of accounting. A cash-basis taxpayer reports rental income in the same year the income is received, and deduct expenses in the year the expenses are paid. An accrual basis taxpayer, the income is reported when earned rather than when it was received; and the expenses are deducted when incurred rather than when paid.
What is Considered Rental Income?
Generally one must report under gross income any amount received as rent on all properties. Received amounts that may be considered as reportable rental income are:
- Normal rent payments
- Advance rent payments i.e. rent received before the period it covers
- Unreturned portions of security deposits
- Lease cancelation payments
- Expenses paid by the tenant
- Services in lieu of rent at fair market value of the service
- Payments under lease to own or buy
What is considered tax-deductible?
An investor can deduct the expenses for managing, conserving and maintaining the investment property. Depending on circumstances, general deductibles may be when an income is received from the rental unit:
- Mortgage interest
- Property Taxes
- Advertising
- Utilities
- Insurance
- Costs of certain materials, supplies, and repairs for property upkeep and maintenance
- Depreciation
- Expenses paid by the tenant
Services in lieu of rent at fair market value of the service
You may not deduct the cost of improvements separately as it may be recovered through depreciation using Form 4562.
You can recover some or all of your improvements by using Form 4562 to report depreciation beginning in the year your rental property is first placed in service, and beginning in any year you make an improvement or add furnishings. Only a percentage of these expenses are deductible in the year they are incurred.
What are IRS resources?
There is ample information available from the IRS in the sources listed below.
Sources:
Note that Investimate MyND management does not provide investment advisory, tax, legal or financial services, and recommends that you consult a licensed tax, legal, accounting or investment professional to perform an independent analysis.
